Item 7 –
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS OVERVIEW
We are a biopharmaceutical company focused on
progressing XCARTTM, 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.
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.
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.
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:
· 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.
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.
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:
Operating costs and expenses:
Other income (expense):
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.
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,
Outside services and Contract Research Organizations $ 2,497,190 $ 1,203,582
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.
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.
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
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.
ITEM 8 – FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm (PCAOB ID 688) F-1
Consolidated Balance Sheets as of December 31, 2021 and 2020 F-3
Notes to Consolidated Financial Statements F-7
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
To the Shareholders and Board of Directors of
Xenetic Biosciences, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated
balance sheets of Xenetic Biosciences, Inc. (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements
of comprehensive loss, stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2021, and
the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present
fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations
and its cash flows for each of the two years in the period ended December 31, 2021, in conformity with accounting principles generally
accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We
are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are
required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and
regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the
standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged
to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding
of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal
control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess
the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond
to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements.
Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating
the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below
are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to
the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our
especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion
on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions
on the critical audit matters or on the accounts or disclosures to which they relate.
Going Concern Assessment
Description of the Matter
As described in Note 1 to the consolidated financial
statements, management believes that the Company has sufficient funding available to it at the date of approval of these financial statements
and that it will be able to continue as a going concern for a period of at least twelve months from the date of these financial statements.
In making this assessment, management has considered the July 2021 private placement that resulted in approximately $11.5 million of net
proceeds, coupled with the Company’s existing resources.
We identified the Company’s assessment of
its ability to continue as a going concern and related disclosures as a critical audit matter. The Company prepared future cash flow forecasts
which involves judgement and estimation of key variables such as future expected revenue royalty proceeds and costs associated with progressing
XCART technology. Auditing the Company’s going concern assessment described above involves a high degree of auditor judgment to
assess the reasonableness of the cash flow forecasts and other assumptions used in the Company’s going concern analysis.
How We Addressed the Matter in Our Audit
We evaluated the assumptions used in the model
to estimate the future cash flows for the next twelve months from the date of our opinion by comparing assumptions used by management
against historical performance, budgets, and the Company’s strategic plans. We also assessed the key assumptions including those
pertaining to revenue royalty proceeds and the timing of significant payments in the cash flow forecast by comparing them to historical
data and the underlying agreements. We performed sensitivity analyses on key assumptions such as future expected costs to determine their
impact on the projections of future cash flows. Further, we assessed the Company’s disclosures with respect to its going concern
assessment.
Revenue Recognition over Royalty Revenue
Description of the Matter
As described in Note 3 to the consolidated financial
statements, the Company’s sources of revenue include royalty proceeds from a royalty agreement with a third-party based on potential
net sales of approved commercial pharmaceutical products which is based on estimated variable consideration. The Company must use significant
judgment to determine when the reported sales are reliably measurable, the Company has no remaining performance obligations, and all other
revenue recognition criteria are met. The Company’s policy is to recognize expected royalties as revenue when they are reliably
measurable, which is upon receipt of reports from the third-party. The Company typically receives these reports in the quarter subsequent
to the actual sublicensee sales.
The principal consideration for our determination
that performing procedures relating to revenue recognition, specifically related to management’s estimate of the potential net sales
as expected variable consideration, is a critical audit matter that requires significant judgment by management in determining the best
estimate of the amount of expected variable consideration. This in turn led to a high degree of auditor judgment, subjectivity and effort
in performing procedures and evaluating audit evidence related to management’s identification of expected variable consideration
within the royalty contract with the third-party and the judgments made by management used to estimate the best estimate of variable consideration.
How We Addressed the Matter in Our Audit
Addressing the matter involved performing procedures
and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures
included evaluating management’s best estimate of the potential net sales by the third-party to determine variable consideration.
These procedures also included, among others, (i) evaluating and testing the reasonableness of the significant assumptions used by management,
(ii) consideration of both historical or current trends, noting a relative lack of historical experience available in relation to expected
amounts and (iii) obtaining and vouching evidence including reports received from the third-party.
Marcum LLP
We have served as the Company’s auditor since 2015.
Boston, Massachusetts
March 22, 2022
XENETIC BIOSCIENCES, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
Current assets:
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Other long-term liabilities – 27,043
Commitments and contingencies (Note 13) – –
Stockholders' equity:
Preferred stock, 10,000,000 shares authorized
The accompanying notes are an integral part of
these consolidated financial statements.
XENETIC BIOSCIENCES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
FOR THE YEARS ENDED DECEMBER 31,
Revenue
Operating costs and expenses:
Asset impairment charges (Note 6) – (9,243,128 )
Other income (expense):
Basic and diluted net loss per share $ (0.55 ) $ (1.70 )
The accompanying notes are an integral part of
these consolidated financial statements.
XENETIC BIOSCIENCES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Preferred Stock Common Stock Accumulated
Issuance of common stock to vendor – – 1,188 1 (1 ) – – – –
Exercise of purchase warrants – – 5,988 6 (6 ) – – – –
Issuance of common stock to vendor – – 7,153 7 (7 ) – – – –
The accompanying notes are an integral part of
these consolidated financial statements.
XENETIC BIOSCIENCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net loss to net cash used in operating activities:
Asset impairment charges – 9,243,128
Deferred income taxes – (2,918,518 )
Depreciation – 757
Gain on settlement with vendor – (143,639 )
Changes in operating assets and liabilities:
Accounts payable, accrued expenses and other liabilities 457,132 (378,111 )
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock and warrants 11,450,866 –
Net proceeds from issuance of common stock – 5,426,825
Proceeds from exercise of warrants 3,679 –
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest $ – $ –
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Right of use asset obtained in exchange for lease liability $ – $ 70,564
Issuance of common stock to vendor $ 7 $ 1
Issuance of common stock in connection with warrant buyout $ 41,070 $ –
Issuance of common stock from cashless exercise of purchase warrants $ 6 $ 229
The accompanying notes are an integral part of
these consolidated financial statements.
XENETIC BIOSCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company
Background
Xenetic Biosciences, Inc. (“Xenetic”
or the “Company”), incorporated in the state of Nevada and based in Framingham, Massachusetts, is a biopharmaceutical company
focused on progressing XCARTTM, a personalized Chimeric Antigen Receptor (“CAR”) T platform technology engineered
to target patient- and tumor-specific neoantigens. The Company is 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.
Additionally, Xenetic is leveraging its 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. Xenetic incorporates its patented
and proprietary technologies into drug candidates currently under development with biotechnology and pharmaceutical industry collaborators
to create what the Company believes will be the next-generation biologic drugs with improved pharmacological properties over existing
therapeutics.
The Company, directly or indirectly, through its
wholly-owned subsidiaries, Hesperix S.A. (“Hesperix”) and Xenetic Biosciences (U.K.) Limited (“Xenetic UK”), and
the wholly-owned subsidiaries of Xenetic UK, Lipoxen Technologies Limited (“Lipoxen”), Xenetic Bioscience, Incorporated and
SymbioTec, GmbH (“SymbioTec”), own various United States (“U.S.”) federal trademark registrations and applications
along with unregistered trademarks and service marks, including but not limited to XCART, OncoHistTM, PolyXen, ErepoXenTM, and
ImuXenTM, which are used throughout this Annual Report. All other company and product names may be trademarks of the respective companies
with which they are associated.
Going Concern and Management’s Plan
Management evaluates whether there are conditions
or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern
within one year after the date that the financial statements are issued. The Company has incurred substantial losses since its inception
and expects to continue to incur operating losses in the near-term. These factors raise substantial doubt about its ability to continue
as a going concern. The Company believes that it has 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, the
Company completed a $12.5 million private placement of the Company’s common stock, par value $0.001, resulting in approximately
$11.5 million of net proceeds to the Company. The Company believes that this financing, coupled with the Company’s existing resources,
will be adequate to fund the Company’s operations into the second quarter of 2023. However, the Company anticipates it may need
additional capital in the long-term to pursue its business initiatives. The terms, timing and extent of any future financing will depend
upon several factors, including the achievement of progress in its clinical development programs, its 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 its control. The capital markets for the biotech industry can be highly volatile, which make the terms, timing
and extent of any future financing uncertain.
2. Impact of COVID-19
During March 2020, a global pandemic was declared
by the World Health Organization related to the 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 2020 and 2021 and
into 2022, as federal, state and local governments reacted to the public health crisis with mitigation measures, creating significant
uncertainties in the U.S. economy. The Company continues to evaluate the effects of the COVID-19 pandemic on its business and while there
has been no significant impact to the Company’s operations to date, the Company at this time is uncertain of the impact this event
may have on the Company’s future operations. The extent to which the COVID-19 pandemic affects our business, operations and financial
results will depend on numerous evolving factors that we may not be able to accurately predict, and such uncertainty is expected to continue
for some time.
3. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements of the Company
include the accounts of Hesperix, Xenetic UK and Xenetic UK’s wholly-owned subsidiaries: Lipoxen, Xenetic Bioscience, Incorporated,
and SymbioTec. All material intercompany balances and transactions have been eliminated in consolidation.
Certain prior period amounts have been reclassified
to conform to the presentation for the current period.
Use of Estimates
The consolidated financial statements and accompanying
notes are prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). The preparation of the
financial statements in accordance with U.S. GAAP requires management to make estimates, judgments and assumptions that affect the reported
amounts of assets and liabilities, the reported amounts of revenue, costs and expenses in the financial statements and disclosures in
the accompanying notes. Actual results and outcomes may differ materially from management’s estimates, judgments and assumptions.
Functional Currency Change
The functional currency for the Company’s
foreign subsidiaries is the U.S. dollar. The functional currency of the Company’s UK-based subsidiaries changed from the British
Pound Sterling to the U.S. dollar when the Company relocated to the U.S. in 2014. The change in functional currency was applied on a prospective
basis. Therefore, any gains and losses that were previously recorded in accumulated other comprehensive income remain unchanged.
Foreign Currency
Transactions
Realized and unrealized gains and losses resulting
from foreign currency transactions arising from exchange rate fluctuations on balances denominated in currencies other than the functional
currencies are recognized in “Other income (expense)” in the consolidated statements of comprehensive loss. Monetary assets
and liabilities that are denominated in a currency other than the functional currency are re-measured to the functional currency using
the exchange rate at the balance sheet date and gains or losses are recorded in the consolidated statements of comprehensive loss.
Fair Value of Financial Instruments
Accounting Standards Codification (“ASC”)
Topic 820, Fair Value Measurement, defines fair value as the price that would be received to sell an asset or be paid to transfer
a liability in an orderly transaction between market participants at the measurement date. The Company applies the following fair value
hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy
upon the lowest level of input that is available and significant to the fair value measurement. Level 1 inputs are quoted prices in active
markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 utilizes
quoted market prices in markets that are not active, broker or dealer quotations or alternative pricing sources with reasonable levels
of price transparency. Level 3 inputs are unobservable inputs for the asset or liability in which there is little, if any, market activity
for the asset or liability at the measurement date. As of December 31, 2021 and 2020, the carrying amount of certain of the Company’s
financial instruments approximates fair value due to their short maturities. See Note 8, Fair Value Measurements, for discussion
of the Company’s fair value measurements.
Cash
The Company considers all highly liquid investments
with maturities of 90 days or less from the date of purchase to be cash equivalents. Investments with original maturities of greater than
90 days from the date of purchase but less than one year from the balance sheet date are classified as short-term investments, while investments
with maturities of one year or beyond from the balance sheet date are classified as long-term investments. Management determines the appropriate
classification of its cash equivalents and investment securities at the time of purchase and re-evaluates such determination as of each
balance sheet date. The Company maintains cash primarily with one major financial institution that management believes is of high credit
quality. The carrying amount of cash equivalents approximate their fair value due to the short-term nature of these instruments.
Property and Equipment
The Company records property and equipment at
cost less accumulated depreciation. Expenditures for major renewals and improvements which extend the life or usefulness of the asset
are capitalized. Items of an ordinary repair or maintenance nature are charged directly to operating expense as incurred. The Company
calculates depreciation using the straight-line method over the estimated useful lives of the assets:
Schedule of Estimated Useful Life of Assets
Asset Classification Estimated Useful Life
Office and computer equipment 3 years
Leasehold improvements 5 years or the remaining term of the lease, if shorter
Furniture and fixtures 5 years
The Company eliminates the cost of assets retired
or otherwise disposed of, along with the corresponding accumulated depreciation, from the related accounts, and the resulting gain or
loss is reflected in the results of operations.
Indefinite-Lived Intangible Assets
Acquired indefinite-lived intangible assets consisted
of in-process research and development (“IPR&D”) related to the Company’s business combination with SymbioTec, which
was recorded at fair value on the acquisition date. At acquisition, we generally determine the fair value of intangible assets, including
IPR&D, using the “income method.” IPR&D intangible assets are considered indefinite-lived intangible assets and are
not amortized until completion or abandonment of the associated research and development efforts. Substantial additional research and
development may be required before the Company’s IPR&D reaches technological feasibility. Upon completion of the IPR&D project,
the IPR&D assets will be amortized over their estimated useful lives.
IPR&D is not amortized but is reviewed for
impairment at least annually or when events or changes in the business environment indicate the carrying value may be impaired. The
Company also has the option to first assess qualitative factors to determine whether the existence of events or circumstances
leads the Company to determine that it is more likely than not (that is, a likelihood of more than 50%) that the acquired IPR&D is
impaired. If the Company chooses to first assess the qualitative factors and it is determined that it is not more likely than not acquired
IPR&D is impaired, the Company is not required to take further action to test for impairment. The Company also has the option to bypass
the qualitative assessment and perform only the quantitative impairment test, which the Company may choose to perform in some periods
but not in others.
The impairment loss, if any, is measured as the
excess of the carrying value of the intangible asset over its fair value. The Company historically had performed its annual impairment
review as of October 1. The Company determined that IPR&D was impaired during the year ended December 31, 2020. See Note 6 Indefinite-Lived
Intangible Assets and Other Long-Term Assets.
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 to assumptions
could potentially lead to impairment. The Company believes its estimates and assumptions are reasonable and otherwise consistent with
assumptions market participants would use in their estimates of fair value. However, if future results are not consistent with the Company’s
estimates and assumptions, then the Company may be exposed to an impairment charge, which could be material. Use of different estimates
and judgments could yield materially different results in the Company’s analysis and could result in materially different asset
values or expense.
Impairment of Long-Lived Assets
The Company reviews long-lived assets to be held
and used, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount
of the assets or asset group may not be fully recoverable. No such impairments were recorded during the years ended December 31, 2021
and 2020.