XNCR

Business Context and Reporting Period

Xencor, Inc. is a clinical-stage biopharmaceutical company focused on discovering and developing engineered monoclonal antibodies using its proprietary XmAb technology platform. The company modifies the Fc domain of antibodies to enhance immune inhibitory activity, cytotoxicity, or half-life. This Form 10-K covers the fiscal year ended December 31, 2013. During this period, Xencor completed its Initial Public Offering (IPO) on December 3, 2013, raising approximately $72.5 million in net proceeds.

Key Financial Metrics

Note: The 2013 Net Loss includes a non-cash $48.6 million loss on the settlement of convertible notes exchanged for preferred stock. Excluding this item, the operating loss was approximately $10.5 million.

Material Changes vs. Prior Period

• Liquidity Transformation: Cash and cash equivalents increased from $2.3 million in 2012 to $78.0 million in 2013, driven primarily by the IPO and a concurrent private placement of Series A-1 preferred stock.
• Revenue Growth: Total revenue increased 7% to $10.2 million. Milestone revenue rose significantly to $5.6 million (from $3.6 million in 2012), largely due to a $3.0 million payment from MorphoSys AG upon the initiation of Phase 2 trials.
• Expense Increase: R&D expenses increased 34% to $17.0 million, reflecting the advancement of lead candidates XmAb5871 (Phase 1b/2a) and XmAb7195 (preclinical/IND preparation).
• Capital Structure: All outstanding convertible preferred stock and convertible promissory notes were converted to common stock in connection with the IPO, eliminating the mezzanine equity and debt liabilities present in 2012.

Guidance, Outlook, and Risks

Outlook and Milestones

• XmAb5871 (Autoimmune): Phase 1b/2a trial in rheumatoid arthritis is ongoing. Preliminary data expected in H2 2014. Phase 2b proof-of-concept trial planned for H1 2015.
• XmAb7195 (Asthma/Allergy): Investigational New Drug (IND) application expected in H1 2014, followed by Phase 1a trial initiation.
• XmAb5574/MOR208 (Oncology): Partner MorphoSys is conducting Phase 2 trials in B-cell acute lymphoblastic leukemia (B-ALL) and non-Hodgkin lymphomas (NHL).
• Cash Runway: Management believes current cash resources are sufficient to fund operations through the end of 2016.

Risks and Contingencies

• Internal Controls: The company identified a material weakness in internal control over financial reporting related to revenue recognition for partnership agreements and the misapplication of GAAP regarding timing. Remediation efforts are underway.
• Profitability: The company has incurred losses since inception and expects to continue incurring significant losses as it advances clinical trials. It has no products approved for commercial sale.
• Regulatory Approval: Success depends on obtaining FDA approval for biologics, a process that is costly, time-consuming, and uncertain.
• Partnership Dependence: Future revenue relies heavily on milestone payments and royalties from partners (Amgen, MorphoSys, etc.), which are contingent on clinical and commercial success.

Investor Verification Checklist

• Revenue Recognition: Verify the remediation of the material weakness regarding revenue recognition for complex partnership agreements.
• Cash Burn Rate: Monitor quarterly cash usage against the stated runway to end of 2016, given the high cost of clinical trials.
• Clinical Trial Data: Track the release of preliminary data for XmAb5871 (expected H2 2014) and the successful filing of the IND for XmAb7195 (expected H1 2014).
• Partnership Milestones: Confirm the achievement of development milestones by partners (Amgen, MorphoSys) to trigger future payments.
• Section 382 Limitations: Assess the impact of the ownership change from the IPO on the company's ability to utilize its significant net operating loss (NOL) carryforwards.