XBiotech Inc. - Quarter Report: 2018 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2018

or

Commission File Number 001-37437

XBIOTECH INC.

(Exact name of registrant as specified in charter)

5217 Winnebago Ln, Austin, TX 78744

(Address of principal executive offices)(Zip Code)

Telephone Number (512) 386-2900

(Registrant’s telephone number, including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    

Yes ☒      No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of October 31, 2018, there were 35,819,772 shares of the Registrant's common stock issued and outstanding.

XBIOTECH INC.

THREE MONTHS ENDED SEPTERMBER 30, 2018

INDEX

SIGNATURES

CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements, which reflect our current views with respect to, among other things, our operations and financial performance. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q are forward-looking statements. You can identify forward-looking statements by terminology such as “may,” “will,” “should,” “would,” “could,” “expects,” “plans,” “contemplate,” “anticipates,” “believes,” “estimates,” “predicts,” “projects,” “intend” or “continue” or the negative of such terms or other comparable terminology, although not all forward-looking statements contain these identifying words. Forward-looking statements are subject to inherent risks and uncertainties in predicting future results and conditions that could cause the actual results to differ materially from those projected in these forward-looking statements. These forward-looking statements include, but are not limited to statements about:

All forward looking statements in this Quarterly Report on Form 10-Q involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. Factors that may cause actual results to differ materially from current expectations include, among other things, those under the heading “Risk Factors” included in our annual report for the year ended December 31, 2017 filed with the SEC on March 16, 2018, and elsewhere in this Quarterly Report on Form 10-Q. These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this Quarterly Report on Form 10-Q.  Given these uncertainties, you should not place undue reliance on these forward-looking statements. Except as required by law, we assume no obligation to update or revise these forward-looking statements for any reason, even if new information becomes available in the future.

This Quarterly Report on Form 10-Q also contains estimates, projections and other information concerning our industry, our business, and the markets for certain medical conditions, including data regarding the estimated size of those markets, and the incidence and prevalence of certain medical conditions. Information that is based on estimates, forecasts, projections, market research or similar methodologies is inherently subject to uncertainties and actual events or circumstances may differ materially from events and circumstances reflected in this information. Unless otherwise expressly stated, we obtained this industry, business, market and other data from reports, research surveys, studies and similar data prepared by market research firms and other third parties, industry, medical and general publications, government data and similar sources.

XBiotech Inc.

Consolidated Balance Sheets

(in thousands, except share data)

See accompanying notes.

XBiotech Inc.

Consolidated Statements of Operations

(in thousands, except share and per share data)

See accompanying notes.

XBiotech Inc.

Consolidated Statements of Comprehensive Loss

(in thousands)

See accompanying notes.

XBiotech Inc.

Consolidated Statements of Cash Flows

(in thousands)

See accompanying notes.

XBiotech Inc.

Notes to Consolidated Financial Statements (Unaudited)

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

Overview

XBiotech Inc. (“XBiotech” or “the Company”) is a pre-market biopharmaceutical company engaged in discovering and developing True Human™ monoclonal antibodies for treating a variety of diseases. True Human™ monoclonal antibodies are those which occur naturally in human beings—as opposed to being derived from animal immunization or otherwise engineered. We believe that naturally occurring monoclonal antibodies have the potential to be safer and more effective than their non-naturally occurring counterparts. XBiotech is focused on developing its True Human™ pipeline and manufacturing system.

We have never been profitable and, as of September 30, 2018, we had an accumulated deficit of $231.6 million. We had net losses of $5.1 million and $15.0 million for the three months and nine months ended September 30, 2018, respectively, compared to $6.2 million and $25.9 million for the three months and nine months ended September 30, 2017, 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, 2018, we had 48 employees.

Recent Events:

Clinical Programs

Atopic Dermatitis

In April 2018, XBiotech announced the launch of a Phase 2, open label clinical trial to evaluate the Company’s True Human™ monoclonal antibody, bermekimab, in patients with moderate to severe Atopic Dermatitis (AD). This ongoing study is evaluating the safety and efficacy of bermekimab in AD patients after relatively short durations of weekly treatment compared to the currently approved antibody therapy (4 and 8 weeks compared to 16 weeks, respectively). The study utilizes the Company’s new pre-filled syringes to deliver bermekimab therapy via subcutaneous injection. During Q3, we announced successful completion and positive interim findings for the first cohort of this study, which involved nine patients who received a low dose (200mg/weekly) and four weekly treatments with bermekimab. The Company reported that the 200mg subcutaneous injections were well-tolerated and that bermekimab treatment was associated with statistically significant improvement in several endpoints assessing efficacy. Enrollment was completed during Q3, totaling 37 patients, with 28 patients in the second, higher-dose cohort. Completion of the study and results analysis is expected around year end 2018 or early 2019.

Hidradenitis Suppurativa

During Q3, XBiotech announced enrollment of the first patient in its Phase 2, open label clinical study to evaluate bermekimab in patients with moderate to severe Hidradenitis Suppurativa (HS). U.S. recruitment in this study was completed in Q3 with enrollment rates exceeding expectations. The very robust enrollment is viewed by the Company as evidencing the strong desire for new treatment options in HS and the potential marketability for HS bermekimab therapy should it successfully advance through marketing approval. Importantly, the clinical study is evaluating bermekimab in patients that have failed anti-TNF therapy and in patients that have had no prior anti-TNF treatment history (the only approved biological drug to treat HS is the anti-TNF drug, Humira, which is projected to reach $21 billion in annual sales by 2020). HS patients are being treated with 13 weekly subcutaneous injections of bermekimab. It was previously demonstrated in the Company’s double blind, placebo-controlled study of patients with HS that bermekimab, when administered as an intravenous therapy, was effective for treating HS patients who failed or were ineligible for anti-TNF therapy. The Company projects completion of the current study and a results read-out during the first quarter of 2019.

Pancreatic Cancer

XBiotech is evaluating bermekimab in combination with chemotherapy for the treatment of patients with pancreatic cancer. A clinical study headed by Dr. Andrew Hendifar, MD is being conducted at Cedars-Sinai Medical Center, Los Angeles, CA to examine the safety of bermekimab in combination with Onivyde (nanoliposomal irinotecan) and 5-fluorouracil (5FU)/folinic acid (leucovorin) for pancreatic cancer patients with wasting syndrome. Enrollment is expected to be completed around year end 2018. Bermekimab is believed to block tumor-related inflammation that is involved in neovascularization and tissue matrix remodeling, which is a crucial process for the growth and spread of tumors. As well, bermekimab may block tumor related inflammation that causes central nervous system (CNS) mediated metabolic dysregulation that can lead to wasting. The molecular target of bermekimab, IL-1⍺, may also be involved in tumor metastasis. In a Phase III randomized study in advanced cancer patients, patients that achieved the primary endpoint (as defined in Hickish et al., Lancet Oncology 2017) had lower incidence of disease progression. In another Phase III cancer study, bermekimab treatment was associated with a significant increase in lean body mass. Patients with pancreatic cancer often suffer from aggressive disease progression and wasting. The disease is known for its rapid mortality and high degree of morbidity. Bermekimab may also improve the anti-tumor activity of the cytotoxic chemotherapy and help patients endure longer exposure to these agents by reducing the inflammatory response caused by the treatment. Although the mechanism of cachexia in pancreatic cancer is not fully understood, bermekimab could help reduce this debilitating symptom by enabling patients to maintain and/or gain lean body mass during cancer treatment.

Research & Development

Overview

During Q3, XBiotech continued to consolidate operations at its Winnebago campus facility. All personnel and operations with the exception of in vivo research activities were successfully transferred and are now operating at the Winnebago campus. During Q3, the Company completed design and received city permits for constructing an annex building to house a new animal research facility at its Winnebago campus. This new facility will mark the final stage of the Company’s move to consolidate operations and transfer its R&D group from the East Riverside Drive location to the Winnebago campus. XBiotech’s new annex facility will include a state-of-the-art “biobubble” for working with infectious diseases, will house a Class II containment work space for pathogenic virus culture and propagation, and will include a lab for screening human blood donations and conducting the first stage of discovery work for identifying new antibody therapies. R&D activities in the new facility are planned to commence during Q1 2019.

C. difficile

XBiotech continues to make progress with its key pre-clinical R&D programs. In vivo testing of the C. difficile prophylaxis is ongoing. The Company’s scientists have established what we believe is a more challenging model for the disease. The strain of C. difficile now being used in pre-clinical development work produces a more aggressive and lethal form of disease. We believe that the new model will better establish the potential for our True Human™ antibody to prevent or treat human infections with C. difficile.

Influenza

The Company continues to progress with developing its True Human™ antibodies for the treatment and prevention of influenza. XBiotech has focused on developing antibodies that target hemagglutinin and neuraminidase, two key surface moieties of the influenza virus. These key antibodies have been genetically introduced in cell lines to enable manufacturing production. A highly specific selection process has been ongoing during Q3 to identify True Human™ antibodies that target precise regions of the hemagglutinin. This process, which is expected to allow the antibody therapy to be effective in a broader range of virus strains, is proceeding as planned and is expected to continue through 2018.

Anti-Tumor Antibody 12D7G

XBiotech’s manufacturing development group has progressed with advancing the 12-D7G antibody cell line production system. During the quarter, the gene for 12D7G was synthesized and inserted into a cell line, which was used to produce the first set of stable clones for potential manufacturing. The candidate production cells are undergoing further selection and a high-producing cell line suitable for clinical or commercial production is expected by year end. The True Human™ antibody 12D7G binds to a tumor-related protein, NYESO-1, for which it has the potential to stimulate the body to produce a highly specific immune response against tumors. 12D7G is a candidate immunotherapy that could be used to enhance the specificity and potential efficacy of checkpoint inhibitor therapies.

Manufacturing

Highlights

XBiotech continues to optimize its upstream and downstream manufacturing processes. Process development work is ongoing to increase bioreactor volume and running time for its cell culture systems, to enhance yields and reduce costs. Ongoing optimization of our manufacturing technology reflects our continued effort to establish the lowest possible cost of goods. We believe that lowering the cost of goods for monoclonal antibodies opens up new and larger potential areas of unmet medical need. We believe that considerable opportunities exist for safe and effective medicines derived from human antibody immunity; and that some of these opportunities will require competitive pricing that will be enabled by reduced cost of goods.

This year, the Company invested in plant and equipment infrastructure and product formulation development to enable the launch of syringes that are pre-filled with bermekimab for use in subcutaneous injection. A new filling machine capable of loading syringes with bermekimab was installed at the Winnebago manufacturing center. The filling line operation was also transferred from the East Riverside Drive facility to the new filling suite at XBiotech’s Winnebago campus. The first release of bermekimab-filled syringes (pre-filled and ready for use in the clinic) occurred during Q3. These syringes are already being used successfully in two ongoing clinical trials. The Company is increasing the output capacity for the syringes with a target capability to fill 1,200 syringes per day, with an annual production capacity of about 300,000 units by 2019. We believe this will be adequate output to support a market launch should an approval be granted.

During the third quarter, XBiotech began to reestablish and optimize manufacturing production of its monoclonal antibody, 514G3, for the treatment or prevention of Staphylococcus aureus (S. aureus) infections including MRSA. The Company expects to improve yields and processing efficiencies, and to reduce overall cost of production for 514G3 to support its initiatives to potentially use 514G3 as a prophylaxis.

Strategic Direction

Highlights

XBiotech is in clinical development with bermekimab for therapeutic indications including oncology, cardiovascular medicine, and dermatology. The Company’s anti-infective antibody, 514G3, is in clinical development to treat S. aureus infections. Other anti-infectious disease antibodies are in pre-clinical development and are not expected to enter clinical studies before 2020.

The use of monoclonal antibodies as prophylaxis (i.e. to prevent disease) has not generally been considered a large or highly profitable business. The cost to produce antibodies is generally too large for them to be ideal for use in disease prevention, especially when the incidence of most diseases is not frequent enough among the general population to justify relatively high unit costs. To date, therefore, most marketed monoclonal antibodies have been for therapeutic use only (to treat patients already afflicted by disease). We believe there are two crucial components for the ideal medical and commercial success of monoclonal antibodies for use in prophylaxis: a high incidence of the target disease in the population; and strong evidence of significant clinical benefit as a result of therapy. We believe that the aforementioned situation potentially exists for XBiotech’s product candidates being administered prophylactically to patients with end-stage renal disease (ESRD) who are undergoing maintenance hemodialysis. In patients undergoing hemodialysis, there is a high relative incidence of cardiovascular and infectious disease-related morbidity and mortality compared to the general population. With bermekimab and 514G3, the Company has product candidates that could potentially reduce the incidence of cardiovascular and infectious disease mortality and morbidity, respectively, in this population.

Cardiovascular Risk in ESRD

Major adverse cardiovascular events (MACE) account for a 20% annual mortality rate in ESRD patients undergoing hemodialysis; only 35% of patients on maintenance hemodialysis will survive five years¹. MACE is by far the leading cause of death and morbidity in this population. Clinical data, a body of scientific research, and recent discoveries (from Dr. Peter Libby’s group: Folco et al. Arterioscler Thromb Vasc Biol. 2018;38:1901-1912) suggest a potential role for bermekimab in reducing MACE in ESRD patients.  More than 500,000 patients are currently undergoing maintenance hemodialysis in the United States for the treatment of ESRD. Reducing cardiovascular risk in patients with ESRD is thus a major unmet medical need—for which there are no approved therapies. The successful application of bermekimab as a prophylaxis in patients receiving maintenance hemodialysis would thus represent a very important breakthrough for management of this disease.

_________________________

¹ USRDS 2013 Annual Data Report: Atlas of End-Stage Renal Disease in the United States, National Institutes of Health, National Institute of Diabetes and Digestive and Kidney Diseases, Bethesda, MD, 2014.

Beyond the importance of possibly reducing cardiovascular risk in patients suffering with ESRD, bermekimab represents a potentially unequalled opportunity for profit growth in a hemodialysis industry where there is little opportunity for growth beyond the core hemodialysis service provided. The success of bermekimab in the hemodialysis unit would also mean significant recovery of lost revenues that result from patient attrition due to cardiovascular events. Since 2011, Medicare reimbursement for new drugs in the hemodialysis business has been constrained by the implementation of the bundled payment system. Medicare’s bundled payment system has created major difficulties in establishing new profit centers around drugs needed by hemodialysis patients—and it has stymied the development of new and necessary treatments for patients with ESRD. However, we believe new reimbursement strategies are possible. Medicare currently considers payment for qualifying drugs exclusively within the context of the End-Stage Renal Disease (ESRD) Prospective Payment System (PPS). In this system, only nominal additional revenue can be generated with supporting medications or agents during maintenance hemodialysis. These funding constraints are driven by the fact that drugs/substances currently reimbursed under the ESRD-PPS scheme largely provide only a supportive role to hemodialysis treatments. That is, there is little or no evidence that any currently approved treatments available under the ESRD-PPS system can reduce mortality events and/or reduce morbidity of patients with ESRD. 

We believe that bermekimab used as a prophylaxis has the potential to reduce major cardiovascular events in ESRD patients undergoing hemodialysis. Clinical development around this “hard” clinical endpoint will largely distinguish bermekimab prophylaxis from treatments currently approved under the ESRD-PPS system and will justify consideration for substantial reimbursement. We plan to pursue discussion with important industry players regarding this opportunity.

S. aureus infections in ESRD

The incidence of S. aureus infection in patients undergoing hemodialysis is about one hundred times that of the general population, and the bacteria accounts for about 10% of all-cause mortality in the hemodialysis population. Each year an estimated 37,000 hemodialysis patients will develop S. aureus infections. Of the 500,000 patients currently receiving hemodialysis in the United States, it is expected that about 40,000 will die from S. aureus infections over their hemodialysis careers².

Based on an annual prophylaxis cost of $18k per patient, there is an estimated $9 billion market potential for 514G3 in the U.S. alone for preventing S. aureus in patients with ESRD³. We believe that with potential 514G3 clinical findings for reduced mortality and morbidity due to S. aureus, reimbursement outside of the bundled payment system could be achieved (Please see discussion above regarding bundled reimbursement). We plan to pursue discussion with important industry players regarding this opportunity.

Dermatology

XBiotech has two ongoing clinical studies in dermatology, to assess bermekimab therapy in patients with Atopic dermatitis (AD) and hidradenitis suppurativa (HS). The Company believes that there continues to be considerable unmet medical need for effective treatment of both AD and HS. Moreover, recent FDA approvals of other biological agents to treat AD and HS have provided clinical study endpoints that we believe reduce uncertainty for our clinical study designs; therefore, these endpoints are included in XBiotech’s current studies. Based on outcomes of the ongoing studies, XBiotech expects to initially focus on only one indication (AD or HS) to conduct pivotal registration stud(ies). The market for dupilumab (the recently approved AD biological drug) has been estimated to be as much as $5 billion⁴, and Humira (the recently approved biological drug for HS) is expected to generate $21 billion in sales by 2020⁵. Marketing approvals in either AD or HS indications for bermekimab would represent a very significant entry into the market.

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² Vandecasteele et al. Staphylococcus aureus Infections in Hemodialysis: What a Nephrologist Should Know. Clin. J. Am. Soc. Nephrology. August 2009, 4 (8) 1388-1400

³ Based on the estimated 500,000 hemodialysis patients in the United States receiving treatment.

⁴ https://www.mdmag.com/medical-news/promising-atopic-dermatitis-and-asthma-drug-fast-tracked-by-fda

⁵ https://www.reuters.com/article/us-abbvie-results/abbvie-says-humira-sales-will-balloon-to-21-billion-in-2020-shares-rise-idUSKBN1CW1JK

Oncology

XBiotech continues to analyze data generated from its Phase III studies in oncology, particularly with respect to stratifying the groups to better understand which patients are likely to benefit most from bermekimab therapy. In Q3, these analyses have provided important information suggesting that patient selection based on biomarkers could significantly enhance response rates (response as defined in Hickish et al., Lancet Oncology 2017) to bermekimab therapy by nearly 50%. Analysis and manuscript preparation of these findings is being performed by our scientific board members, including leading oncologist Dr. Razelle Kurzrock, and others. The findings will be submitted for peer review and described in their entirety upon successful publication. The Company believes that these findings may provide a rationale for seeking registration or conducting further clinical work based on a biomarker-defined subgroup. The Company plans to seek FDA guidance based on these findings.

Other Developments

Scientific Board

During the quarter, XBiotech announced the addition of two leading physicians and researchers to its Scientific Advisory Board (SAB): Dr. Alice Gottlieb and Dr. Peter Libby. Both of these extraordinary scientists are world-recognized leaders in their fields.

Dr. Alice Gottlieb, M.D., Ph.D. is internationally recognized for her expertise and trail-blazing work in the development of biological therapies to treat skin diseases. She has played leading roles in the clinical development of therapies including etanercept, infliximab, ustekinumab and secukinumab. Dr. Gottlieb is working to help guide development of bermekimab for the treatment of skin diseases. She currently serves as Study Chair for XBiotech’s ongoing Phase 2 study in hidradenitis suppurativa.

Dr. Peter Libby, M.D. is the Mallinckrodt Professor of Medicine at Harvard Medical School and clinical cardiologist at Brigham and Women’s Hospital. Dr. Libby is collaborating with XBiotech on basic research into the mechanism of inflammation and the use of bermekimab to treat cardiovascular disease. Pioneering research by Dr. Libby and his team was recently published in the journal of the American Heart Association, Arteriosclerosis, Thrombosis, and Vascular Biology. The breakthrough findings of this research showed that bermekimab could potentially be used to prevent heart attacks and strokes.

Intellectual Property

XBiotech continues to aggressively expand its already extensive patent portfolio. During the quarter the Company was awarded 4 new patents and 7 patent allowances.  A Canadian patent and Russian patent both cover bermekimab. Two European patents were awarded, one covering the use of IL-1α-specific antibodies for the treatment of dermatological pathologies and the other the use of IL-1α-specific antibodies for the treatment of cancer-associated cachexia.  Patent applications allowed in Q3 include one each in Australia, Canada, Israel, Mexico, the Philippines, Russia, and South Korea.  The allowed Australian application relates to using IL-1α-specific antibodies to treat arthritis.  The allowed Canadian application relates to using IL-1α-specific antibodies to reduce a subset of blood cells that contribute to inflammatory diseases.  The allowed Israeli and Mexican applications each cover key aspects of the Company’s innovative True Human^TM antibody discovery platform.  The allowed Russian application relates to using IL-1α-specific antibodies to treat vascular diseases and complications thereof, and the allowed Philippines application relates to the Company’s antibody for treating S.aureus infections, 514G3.

Risks

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 clinical trials, is expected to depend on the amount and timing of cash receipts from future collaboration or product sales and/or financing transactions. The Company believes that its cash and cash equivalents of $20.8 million at September 30, 2018 will enable the Company to achieve some key inflection points, including advanced clinical studies in certain indication(s), as well as on-going R&D efforts for the Company’s pre-clinical pipeline. Based on our research and development plans and our timing expectations related to the progress of our programs, we expect that our cash and cash equivalents as of September 30, 2018 will enable us to fund our operating expenses and capital expenditure requirements through 2019. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect.

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, bermekimab, 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, 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 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, 2018, we have recorded total research and development expenses, including share-based compensation, of $180.8 million. Our total research and development expenses for the three months and nine months ended September 30, 2018 were $3.9 million and $10.9 million, respectively, compared to $4.9 million and $20.5 million for the three months and nine months ended September 30, 2017, respectively. Share-based compensation accounted for $0.2 million and $0.5 million for the three months and nine months ended September 30, 2018, respectively, compared to $0.2 million and $0.2 million for the three months and nine months ended September 30, 2017, respectively.

Research and development expenses, as a percentage of total operating expenses for the three months and nine months ended September 30, 2018 were 77% and 73%, respectively, compared to 75% and 77% for the three months and nine months ended September 30, 2017, respectively. The percentages, excluding stock-based compensation, for the three months and nine months ended September 30, 2018 were 79% and 76%, respectively, compared to 77% and 83% for the three months and nine months ended September 30, 2017, respectively.

There was a slight increase in our clinical development costs this quarter as the Company continues to progress with its two on-going phase 2 dermatology studies.

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

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 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, stock–based compensation, and professional fees for legal services. Our total general and administration expenses for the three months and nine months ended September 30, 2018 were $1.2 million and $4.0 million, respectively, compared to $1.7 million and $6.0 million for the three months and nine months ended September 30, 2017, respectively. Share-based compensation accounted for $0.2 million and $0.7 million for the three months and nine months ended September 30, 2018, respectively, compared to $0.2 million and $1.8 million for the three months and nine months ended September 30, 2017, respectively.

General and administrative expenses, as a percentage of total operating expenses for the three months and nine months ended September 30, 2018 were 23% and 27%, respectively, compared to 25% and 23% for the three months and nine months ended September 30, 2017, respectively. The percentages, excluding stock-based compensation, for the three months and nine months ended September 30, 2018 were 21% and 24%, respectively, compared to 23% and 17% for the three months and nine months ended September 30, 2017, respectively.

Critical Accounting Policies

The preparation of financial statements in conformity with generally accepted accounting principles requires us to make judgments, estimates and assumptions in the preparation of our consolidated financial statements and accompanying notes. Actual results could differ from those estimates. We believe there have been no significant changes in our critical accounting policies as discussed in our Annual Report on Form 10-K for the year ended December 31, 2017.

Results of Operations

Revenue

We did not record any revenue during the three months or nine months ended September 30, 2018 and 2017.

Expenses

Research and Development

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

We do not currently track our internal research and development costs or our personnel and related costs on an individual drug candidate basis. We use our research and development resources, including employees and our drug discovery technology, across multiple drug development programs. As a result, we cannot state precisely the costs incurred for each of our research and development programs or our clinical and preclinical drug candidates.

Research and development expenses decreased by 20% to $3.9 million for the three months ended September 30, 2018 compared to $4.9 million for the three months ended September 30, 2017. Research and development expenses decreased by 47% to $10.9 million for the nine months ended September 30, 2018 compared to $20.5 million for the nine months ended September 30, 2017.

The three month decrease in research and development expenses was mainly due to a $1.3 million decrease in clinical trials and sponsored research expenses, due to the completion of a global trial in 2017 and a new study being initiated in 2018 Q2. In addition, there was a decrease in salary and related expenses due to the reduction of our research and development workforce from 49 to 44. The increase in other research and development expenses was mainly caused by the amortization of the new manufacturing equipment.

Compared to the nine months ended September 30, 2017, the research and development expense decrease in the nine months ended September 30, 2018 was primarily caused by the decrease in clinical trials and sponsored research expense, due to the completion of a global trial in 2017 and a new study being initiated in 2018. Labor costs also decreased due to the reduced size of the research and development workforce. In addition, the decrease in laboratory and manufacturing supplies expense occurred due to a reduction in clinical trial drug manufacturing. Other research and development expenses increased, due to the amortization of the new manufacturing equipment.

General and Administrative

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

General and administrative expenses decreased by 29% to $1.2 million for the three months ended September 30, 2018 compared to $1.7 million for the three months ended September 30, 2017. General and administrative expenses decreased by 34% to $4.0 million for the nine months ended September 30, 2018 compared to $6.0 million for the nine months ended September 30, 2017.

The three months decrease was primarily related to a $0.2 million decrease in professional fees, due to the reduction of legal expense. Salaries and related expenses decreased $0.2 million, due to the general and administrative workforce decrease from 7 to 4. The decrease in other expense is mainly caused by the decrease in corporate insurance.

Compared to the nine months ended September 30, 2017, the general and administrative expense decrease in the nine months ended September 30, 2018 was primarily caused by the decrease of stock-based compensation due to a $0.7 million repurchase of stock options from a certain individual in the second quarter of 2017 and the forfeitures of terminated employees’ stock options in 2018. Professional fees decreased $0.6 million due to the reduction of corporate legal and public relations activities. The decrease in labor cost was primarily related to the decrease in workforce from 7 to 4.

Other income (loss)

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

The interest income for the three months and nine months ended September 30, 2018 is mainly from the interest generated from the Company’s Canadian bank account. Foreign exchange gain and loss was mainly due to the fluctuation between US dollar and Euro in the three months and nine months ended September 30, 2018 compared to the three months and nine months ended September 30, 2017.

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, 2018, we have funded our operations principally through public offerings and the private placement of equity securities, which have provided aggregate cash proceeds of approximately $257.4  million. The following table summarizes our sources and uses of cash (in thousands):

During the nine months ended September 30, 2018 and 2017, our operating activities used net cash of $11.4 million and $26.8 million, respectively. The use of net cash in each of these periods primarily resulted from our net losses. The decrease in net loss from operations for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 was mainly due to the decrease in clinical trials and sponsored research expenses and salaries and related expenses.

During the nine months ended September 30, 2018 and 2017, our investing activities used net cash of $114 thousand and $1.2 million, respectively. The use of cash was for the purchase of new research and development equipment.

During the nine months ended September 30, 2018 and 2017, our financing activities provided net cash proceeds of $0.2 million and $33.3 million, respectively. During the nine months ended September 30, 2018, employees exercised stock options to purchase a total of 80,500 shares of our common stock for approximately $0.2 million in net proceeds. During the nine months ended September 30, 2017, we entered into subscription agreements with accredited investors, and sold 2.4 million common shares at $13 per share for approximately $31.6 million in net proceeds. Also, we sold 87 thousand shares under a Common Stock Sales Agreement with H.C. Wainwright & Co. LLC for net proceeds of approximately $1.0 million. Employees exercised stock options to purchase a total of 289 thousand shares of common stock for a total of approximately $0.8 million in net proceeds.

We expect to continue to incur substantial operating losses in the future. We will not receive any product revenue until a drug candidate has been approved by the EMA or similar regulatory agencies in other countries and successfully commercialized. As of September 30, 2018, our principal sources of liquidity were our cash and cash equivalents, which totaled approximately $20.8 million.

Contractual Obligations and Commitments

On January 12, 2008, we entered a lease agreement to lease our office space in Austin, Texas. On September 15, 2010, we entered into a second lease agreement to lease additional space in Austin, Texas. On March 20, 2013, we extended the lease for an additional 21 months on the same terms and rental rates as the current lease. On February 28, 2015, we extended the lease for another 4 years. The future minimum lease payments are as follows as of September 30, 2018 (in thousands):

Rent expense for the three months and nine months ended September 30, 2018 were $197 thousand and $590 thousand, respectively, compared to $186 thousand and $558 thousand for the three months and nine months ended September 30, 2017, respectively.

Off-Balance Sheet Arrangements

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

The Company is not currently exposed to material market risk arising from financial instruments, changes in interest rates or commodity prices, or fluctuations in foreign currencies. The Company has no need to hedge against any of the foregoing risks and therefore currently engages in no hedging activities.

Management's Evaluation of our Disclosure Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was carried out by the Company’s management, with the participation of the Chief Executive Officer and Principal Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. 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 second quarter of the year ended December 31, 2018 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

On October 23, 2018, the honorable Judge Dustin M. Howell of the 459^th Travis County District Court has issued a letter ruling granting the Company’s Motion to Dismiss the securities class action complaint brought against XBiotech (Case D-1-GN-17-003063). The District Court has directed the parties to prepare a formal order memorializing the ruling. Two federal cases were previously filed in the U.S. District Court for the Western District of Texas, but both of those cases have also been dismissed. Therefore, there no longer remains any litigation involving the Company.

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, 2017. 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, 2017, 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.

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.

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