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XOMA > SEC Filings for XOMA > Form 10-K on 12-Mar-2014All Recent SEC Filings

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Form 10-K for XOMA CORP


12-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

XOMA discovers and develops innovative antibody-based therapeutics that have unique allosteric modulating properties. Our lead drug candidate, gevokizumab, is a proprietary potent, fully humanized allosteric-modulating monoclonal antibody that binds to the inflammatory cytokine interleukin-1 beta ("IL-1 beta"). We believe that by targeting IL-1 beta, gevokizumab has the potential to address the underlying inflammatory causes of a wide range of diseases that have been identified as having unmet medical needs.

Together with our development partner, Servier ("Servier"), a leading independent French pharmaceutical company, we initiated three Phase 3 clinical trials evaluating gevokizumab for the treatment of non-infectious intermediate, posterior or pan-uveitis ("NIU") and Behçet's uveitis, a severe subset of NIU. XOMA is responsible for all of the clinical study sites in the United States, and Servier is responsible for all of the clinical study sites outside of the United States. These studies are known as the EYEGUARD™ program, which includes EYEGUARD-A (patients with active NIU), EYEGUARD-B (patients with Behçet's uveitis), and EYEGUARD-C (patients currently controlled with systemic treatment).

In addition to the NIU clinical trials, we also are conducting a trial of gevokizumab in pyoderma gangrenosum ("PG"), a rare ulcerative skin disease. Based upon what we believe are compelling data from our pilot study in patients with PG, we requested an End of Phase 2 meeting with the U.S. Food and Drug Administration ("FDA") to solicit feedback on our proposed Phase 3 clinical development program. We have been granted a Type B meeting, which we expect to occur in March 2014 and to receive feedback from the FDA early in the second quarter of 2014.

We also have an active gevokizumab Proof-of-Concept ("POC") development program to identify indications for pivotal development. We conducted POC trials in moderate-to-severe inflammatory acne and in erosive osteoarthritis of the hand ("EOA"), and we have several other ongoing POC studies. In early 2013, we reported top-line results from our moderate-to-severe inflammatory acne study. Based upon market analysis, we have decided not to pursue a pivotal program in moderate-to-severe inflammatory acne; however, we will consider conducting pilot studies in rare acne indications classified under the umbrella diagnosis of neutrophilic dermatoses. In October 2013, we reported promising results from the Day 84 pain, stiffness and function endpoints in our gevokizumab POC study in patients with EOA and elevated C-reactive protein ("CRP"), known as Study 160. At the same time, we announced we completed patient enrollment in a supplemental study for patients with EOA and non-elevated CRP, known as Study 162. On March 4, 2014, we reported that despite early positive results in Study 160, the top-line data at Day 168 in that study, as well as data at Day 84 in Study 162, were not positive. These results led to our decision not to pursue Phase 3 testing in the broad EOA population. We will continue to review the data to determine if there is a subgroup of the EOA population that could benefit from gevokizumab therapy.

Gevokizumab has been generally well tolerated across all of our clinical studies. In both the acne and EOA studies, there were no drug-related serious adverse events reported. The most common adverse events were headache, pain, arthralgia, urinary tract infections, upper respiratory tract infections and pneumonia, and they were comparable between gevokizumab and placebo.

We also have ongoing clinical studies assessing gevokizumab's potential to treat several other rare diseases. Two studies are being conducted in collaboration with the U.S. National Institutes of Health ("NIH"). In March 2013, we announced that a gevokizumab study in patients with non-infectious anterior scleritis had opened for enrollment at the National Eye Institute ("NEI"). In August 2013, we announced a gevokizumab clinical study in patients with inflammatory autoimmune inner ear disease ("AIED") run by the North Shore-Long Island Jewish Health System in collaboration with the National Institute on Deafness and Other Communication Disorders ("NIDCD").

Separately, Servier instituted its own active development program for gevokizumab beyond the NIU and Behçet's uveitis Phase 3 program. In 2012, Servier initiated a gevokizumab Phase 2 study in patients with acute coronary syndrome, a cardiovascular disease. In 2013, Servier also began testing gevokizumab in a variety of POC studies, including polymyositis/dermatomyositis, Schnitzler syndrome, and giant cell arteritis. Servier has indicated these are the first studies in an extensive multi-indication exploratory program it expects to conduct.

Our proprietary preclinical pipeline includes classes of allosteric modulating antibodies that activate, sensitize or deactivate the insulin receptor in vivo, which we have named XMet. This portfolio of antibodies represents potential new therapeutic approaches to the treatment of diabetes and several rare diseases that have insulin involvement.


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We have developed these and other antibodies using some or all of our ADAPT™ antibody discovery and development platform, our ModulX™ technologies for generating allosterically modulating antibodies, and our OptimX™ technologies for optimizing biophysical properties of antibodies, including affinity, immunogenicity, stability and manufacturability.

Our biodefense initiatives include XOMA 3AB, a biodefense anti-botulism product candidate comprised of a combination of three antibodies. XOMA 3AB is directed against botulinum toxin serotype A and has been developed through funding from the National Institute of Allergy and Infectious Diseases ("NIAID"), a part of the NIH. A Phase 1 trial was completed on XOMA 3AB, with no product-related serious adverse events. In January 2012, we announced that we will complete our NIAID biodefense contracts currently in place but will not actively pursue future contracts. Should the government choose to acquire XOMA 3AB or other biodefense products in the future, we expect to be able to produce these antibodies through an outside manufacturer.

We also have developed antibody product candidates with premier pharmaceutical companies including Novartis AG ("Novartis") and Takeda Pharmaceutical Company Limited ("Takeda"). Two antibodies developed with Novartis, LFA102 and HCD122 (lucatumumab), are in clinical development by Novartis.

Significant Developments in 2013

Gevokizumab

· In January 2013, we announced preliminary top-line data from an interim analysis of our Phase 2 proof-of-concept study to evaluate the safety and efficacy of gevokizumab for the treatment of moderate-to-severe inflammatory acne. Preliminary data from the 125-patient trial demonstrated clear activity according to the Investigator's Global Assessment ("IGA") parameter. Gevokizumab was well-tolerated in this trial, with no significant differences in adverse events between gevokizumab and placebo and no serious drug-related adverse events were reported. Based upon market analysis, we have decided not to pursue a pivotal program in moderate-to-severe inflammatory acne; however, we will consider conducting pilot studies in rare acne indications classified under the umbrella diagnosis of neutrophilic dermatoses.

· In April 2013, the NEI opened a non-infectious, active, anterior scleritis trial for patient enrollment. The open-label single-arm Phase 1/2 study is designed to assess the safety and potential efficacy of gevokizumab in patients experiencing non-infectious, active, anterior scleritis, which is the inflammation of the sclera.

· In May 2013, we announced we had initiated a second clinical study in inflammatory osteoarthritis of the hand based upon our findings that patients who met all of the eligibility criteria for our original study were not able to participate due to the requirement C-reactive protein (CRP) levels must be greater than or equal to 2.5 mg/L. This second study has the same design and eligibility requirements with the exception that participants with a CRP level of less than 2.5 mg/L may enroll. The study is capturing the same pain and functional endpoints as the primary study, yet the design does not include radiographic/MRI images of the affected joints.

· In June 2013, we opened enrollment in an open-label pilot study to determine gevokizumab's potential to treat acute inflammatory PG. In October 2013, we announced compelling data from our pilot study in patients with PG, and we have requested a meeting with the FDA to solicit feedback regarding PG as a potential indication for gevokizumab in Phase 3 trials.

· In June 2013, Servier launched its own independent proof-of-concept clinical program to evaluate the safety and efficacy of gevokizumab in indications different from ours. The first such studies are in polymyositis/dermatomyositis, Schnitzler syndrome, and giant cell arteritis.

· In July 2013, we announced the completion of patient enrollment in our Phase 2 proof-of-concept study in EOA.

· In August 2013, we announced that a gevokizumab clinical study in patients with AIED will be conducted by the North Shore-Long Island Jewish Health System in collaboration with the National Institute on Deafness and Other Communication Disorders.

· In October 2013, we announced three-month results from our gevokizumab Phase 2 clinical study in patients with EOA who also have CRP levels greater than or equal to 2.5 mg/L. The three-month results demonstrated that gevokizumab has a clinical effect on the target patient population. On March 4, 2014, we reported that despite early positive results in the first Study, the top-line data at Day 168 in that study, as well as data at Day 84 in the second study, were not positive. These results led to our decision not to pursue Phase 3 testing in the broad EOA population. We will continue to review the data to determine if there is a subgroup of the EOA population that could benefit from gevokizumab therapy.


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Perindopril Franchise

· In July 2013, we transferred U.S. development and commercialization rights to the perindopril franchise to Symplmed Pharmaceuticals, LLC ("Symplmed"). Under the terms of the arrangement, we received a minority equity position in Symplmed and up to double-digit royalties on sales of the first fixed-dose combination containing perindopril arginine and amlodipine besylate, if it is approved by the FDA. We recorded the minority equity position in the other assets line of our consolidated balance sheets. Symplmed, under a sublicense agreement, assumes U.S. marketing responsibilities for ACEON (perindopril erbumine), and we continue to manage and be reimbursed for sales and distribution within our established commercial infrastructure until the ACEON New Drug Application ("NDA") is transferred to Symplmed. The ACEON NDA was to be transferred on March 1, 2014, but Symplmed has requested an extension. Terms of an extension agreement, if any, are being negotiated. We will continue to record gross ACEON sales in the contracts and other revenue line of our consolidated statements of comprehensive loss until the ACEON NDA is transferred. Following the ACEON NDA transfer, Symplmed will pay us single-digit royalties on sales of ACEON.

Management Addition

· On March 18, 2013, the Company announced Tom Klein has joined the Company as Vice President, Chief Commercial Officer, a newly created position reporting to John Varian, Chief Executive Officer.

Financing

· In August 2013, we completed an underwritten public offering of 8,736,187 shares of our common stock for gross proceeds of $31.6 million, before deducting underwriting discounts and commissions and estimated offering expenses totaling approximately $2.2 million.

· In December 2013, we completed an underwritten public offering of 10,925,000 shares of our common stock for gross proceeds of $57.4 million, before deducting underwriting discounts and commissions and estimated offering expenses totaling approximately $3.8 million.

Other

· In December 2013, we received a milestone payment of $7.0 million from Novartis under the 2008 Amended and Restated Research, Development and Commercialization Agreement between Novartis and XOMA (US) LLC, in connection with the clinical advancement of an undisclosed product in an undisclosed indication. Pursuant to our obligations under the Agreement, in January 2014, we made a payment, equal to 25 percent of the milestone received, or $1.75 million, toward our outstanding debt obligation to Novartis.

Critical Accounting Estimates

The accompanying discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements and the related disclosures, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts in our consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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

We believe the following policies to be the most critical to an understanding of our financial condition and results of operations because they require us to make estimates, assumptions and judgments about matters that are inherently uncertain.


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Revenue Recognition

License and Collaborative Fees

Revenue from non-refundable license, technology access or other payments under license and collaborative agreements where we have a continuing obligation to perform is recognized as revenue over the expected period of the continuing performance obligation. We estimate the performance period at the inception of the arrangement and re-evaluate it each reporting period. This re-evaluation may shorten or lengthen the period over which the remaining revenue is recognized. Changes to these estimates are recorded on a prospective basis.

Milestone payments under collaborative and other arrangements are recognized as revenue upon completion of the milestone event, once confirmation is received from the third party and collectability is reasonably assured. This represents the culmination of the earnings process because we have no future performance obligations related to the payment. Milestone payments that require a continuing performance obligation on our part are recognized over the expected period of the continuing performance obligation. Amounts received in advance are recorded as deferred revenue until the related milestone is completed.

Contract Revenue

Contract revenue for research and development involves our providing research and development and manufacturing services to collaborative partners, biodefense contractors or others. Revenue for certain contracts is accounted for by a proportional performance, or output-based, method where performance is based on estimated progress toward elements defined in the contract. The amount of contract revenue and related costs recognized in each accounting period are based on estimates of the proportional performance during the period. Adjustments to estimates based on actual performance are recognized on a prospective basis and do not result in reversal of revenue should the estimate to complete be extended.

In addition, revenue related to certain research and development contracts is billed based on actual hours incurred by XOMA related to the contract, multiplied by full-time equivalent ("FTE") rates plus a mark-up. The FTE rates are developed based on our best estimates of labor, materials and overhead costs. For certain contracts, such as our government contracts, the FTE rates are agreed upon at the beginning of the contract and are subject to review or audit by the contracting party at any time. Under our contracts with NIAID, a part of the NIH, we bill using NIH provisional rates and thus are subject to future audits at the discretion of NIAID's contracting office. These audits can result in adjustments to previously reported revenue.

In 2011, the NIH conducted an audit of our actual data under two contracts for the period from January 1, 2007, through December 31, 2009, and developed final billing rates for this period. As a result, we retroactively applied these NIH rates to the invoices from this period which resulted in an increase in revenue of $3.1 million from the NIH, excluding $0.9 million billed to the NIH in 2010 resulting from our performance of a comparison of 2009 calculated costs incurred and costs billed to the government under provisional rates. Final rates were settled for one contract resulting in the recognition of revenue of $2.0 million in 2012. The remaining contract will be settled through negotiations with the NIH. This revenue has been deferred and will be recognized upon completion of negotiations with and approval by the NIH.

Upfront fees are recognized ratably over the expected benefit period under the arrangement. Given the uncertainties of research and development collaborations, significant judgment is required to determine the duration of the arrangement.

Stock-based Compensation

The valuation of stock-based compensation awards is determined at the date of grant using the Black-Scholes option pricing model (the "Black-Scholes Model"). This model requires inputs such as the expected term of the option, expected volatility, and risk-free interest rate. Further, the forfeiture rate also impacts the amount of aggregate compensation. These inputs are subjective and generally require significant analysis and judgment to develop. To establish an estimate of expected term, we consider the vesting period and contractual period of the award and our historical experience of stock option exercises, post-vesting cancellations and volatility. To establish an estimate of forfeiture rate, we consider our historical experience of option forfeitures and terminations. The risk-free rate is based on the yield available on United States Treasury zero-coupon issues. We review our valuation assumptions quarterly and, as a result, it is likely we will change our valuation assumptions used to value stock-based awards granted in future periods. Stock-based compensation expense is recognized ratably over the requisite service period.


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Income Taxes

We account for uncertain tax positions in accordance with Accounting Standards Codification Topic 740, Income Taxes ("ASC 740"). The application of income tax law and regulations is inherently complex. Interpretations and guidance surrounding income tax laws and regulations change over time. As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in our financial statements.

ASC 740 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based upon the weight of available evidence, which includes our historical operating performance and carry-back potential, we have determined that total deferred tax assets should be fully offset by a valuation allowance.

Warrants

We have issued warrants to purchase shares of our common stock in connection with financing activities. We account for some of these warrants as a liability at fair value and others as equity at fair value. The fair value of the outstanding warrants is estimated using the Black-Scholes Model. The Black-Scholes Model requires inputs such as the expected term of the warrants, expected volatility and risk-free interest rate. These inputs are subjective and require significant analysis and judgment to develop. For the estimate of the expected term, we use the full remaining contractual term of the warrant. We base our estimate of expected volatility on our historical stock price volatility. The assumptions associated with contingent warrant liabilities are reviewed each reporting period and changes in the estimated fair value of these contingent warrant liabilities are recognized in other income (expense).

Results of Operations

Revenue

Total revenues for the years ended December 31, 2013, 2012, and 2011, were as
follows (in thousands):

                                         Year ended December 31,             2012-2013       2011-2012
                                                                             Increase        Increase
                                    2013          2012          2011        (Decrease)      (Decrease)
License and collaborative fees    $  11,028     $   5,727     $  17,991     $     5,301     $   (12,264 )
Contract and other revenue           24,423        28,055        40,205          (3,632 )       (12,150 )
Total revenues                    $  35,451     $  33,782     $  58,196     $     1,669     $   (24,414 )

License and Collaborative Fees

License and collaborative fee revenue includes fees and milestone payments related to the out-licensing of our products and technologies. The primary components of license and collaboration fee revenue in 2013 were $8.6 million in milestone payments relating to various out-licensing arrangements, including a $7.0 million milestone payment from Novartis, $0.8 million in upfront fees and annual maintenance fees relating to various out-licensing arrangements, and $1.6 million in revenue recognized related to the loan agreement with Servier.

The primary components of license and collaboration fee revenue in 2012 were $3.3 million in upfront fees and annual maintenance fees relating to various out-licensing arrangements, $1.4 million in revenue recognized related to the loan agreement with Servier, and $1.0 million recognized for six milestone payments.

The primary components of license and collaboration fee revenue in 2011 were $16.2 million in revenue recognized related to the collaboration and loan agreements with Servier to jointly develop and commercialize gevokizumab in multiple indications. In addition, we recognized two milestone payments for an aggregate amount of $1.0 million and $0.8 million in up-front fees and annual maintenance fees relating to various out-licensing arrangements.

The generation of future revenue related to license fees and collaborative arrangements is dependent on our ability to attract new licensees to our antibody and proprietary technologies and new collaboration partners. We expect an increase in license and collaboration fee revenue in 2014 compared to 2013 levels.

Contract and Other Revenue

Contract and other revenues include agreements where we provide contracted research and development services to our contract and collaboration partners, including Servier and NIAID. Contract and other revenues also include net product sales and royalties. The following table shows the activity in contract and other revenue for the years ended December 31, 2013, 2012, and 2011 (in thousands):


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                      Year ended December 31,            2012-2013       2011-2012
                                                         Increase        Increase
                   2013         2012         2011       (Decrease)      (Decrease)
Servier          $ 13,568     $ 14,529     $ 19,348     $      (961 )   $    (4,819 )
NIAID               9,098       11,191       18,781          (2,093 )        (7,590 )
Other               1,757        2,335        2,076            (578 )           259
Total revenues   $ 24,423     $ 28,055     $ 40,205     $    (3,632 )   $   (12,150 )

The 2013 decrease in contract and other revenue, as compared to 2012, was primarily due to the 2012 recognition of $2.0 million in revenue related to an adjustment to previously reported revenue from NIAID resulting from an audit by NIAID's contracting office. Also contributing to the decrease were decreases of $1.4 million in CMC activity and $0.6 million in gevokizumab clinical development activity under our collaboration with Servier, partially offset by a $0.9 million increase in partial funding received from Servier for the FDC1 Phase 3 trial.

The 2012 decrease in contract and other revenue, as compared to 2011, was primarily due to decreased activity under NIAID Contract No. HHSN272200800028C ("NIAID 3"). This decrease of $12.0 million in NIAID 3 revenue was partially offset by the recognition of $2.0 million in revenue related to an adjustment to previously reported revenue from NIAID resulting from an audit by NIAID's contracting office. This revenue, which was previously deferred, was recognized upon the completion of negotiations with and approval by the NIH in March 2012. Also partially offsetting the decreases in NIAID revenue was a $2.4 million increase in activity under Contract No. HHSN272201100031C ("NIAID 4"). The NIAID 4 contract was executed in October 2011. In addition, a reduction in CMC activity under the collaboration with Servier contributed to the decrease in contract and other revenue in 2012, as compared to 2011, partially offset by an increase in gevokizumab clinical development activity under the collaboration with Servier and the recognition of partial funding received from Servier for the FDC1 Phase 3 trial.

We expect contract and other revenue to decrease in 2014 compared to 2013 levels. Revenue generating activity related to our Servier contract is expected to be reduced due to the collaboration reaching the $50 million fully reimbursable cap for NIU expenses.

The following table shows the activity in deferred revenue for the years ended December 31, 2013, 2012, and 2011 (in thousands):

                                                Year ended December 31,
                                            2013         2012         2011
             Beginning deferred revenue   $  9,724     $ 13,234     $  18,130
             Revenue deferred                1,478        5,881        12,673
             Revenue recognized             (4,879 )     (9,391 )     (17,569 )
             Ending deferred revenue      $  6,323     $  9,724     $  13,234

We defer revenue until all requirements under our revenue recognition policy are met. In 2013, we deferred revenue from contracts including Servier and NIAID. In 2012 and 2011, we deferred revenue from contracts including Servier, NIH and Takeda.

We expect a significant portion of the $6.3 million in deferred revenue to be recognized in 2014 with the remainder to be earned during 2015. Future amounts may be affected by additional consideration received, if any, under existing or any future licensing or other collaborative arrangements as well as changes in the estimated period of obligation or services to be provided under the arrangements.

Research and Development Expenses

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