Significant Accounting Policies

Basis of Presentation

These consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“US GAAP”). In the opinion of management, the accompanying consolidated financial statements reflect all adjustments (consisting only of normal recurring items) considered necessary to present fairly the Company’s financial position at

September 30, 2017

and

December 31, 2016,

the results of its operations and comprehensive loss for the

nine

month periods ended

September 30, 2017

and

2016,

and the cash flows for the

nine

month periods ended

September 30, 2017

and

2016.

Basis of Consolidation

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

Use of Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported values of amounts in the financial statements and accompanying notes. Actual results could differ from those estimates.

Prior to its initial public offering on

April 15, 2015,

the Company utilized significant estimates and assumptions in determining the fair value of its common stock. The board of directors determined the estimated fair value of the Company’s common stock based on a number of objective and subjective factors, including the prices at which the Company sold shares of its common stock to

third

parties and external market conditions affecting the biotechnology industry sector. After the initial public offering, the fair market value is calculated by using the closing price of the Company’s common stock as reported by NASDAQ.

Research and Development Costs

All research and development costs are charged to expense as incurred. Research and development costs include salaries and personnel-related costs, consulting fees, fees paid for contract clinical trial research services, the costs of laboratory consumables, equipment and facilities costs, license fees and other external costs. Costs incurred to acquire licenses for intellectual property to be used in research and development activities with

alternative future use are expensed as incurred as research and development costs.

Nonrefundable advance payments for goods or services to be received in the future for use in research and development activities are deferred and capitalized. The capitalized amounts are expensed as the related goods are delivered or the services are performed.

Share-Based Compensation

The Company accounts for its share-based compensation awards in accordance with ASC Topic

718,

Compensation-Stock Compensation

(“ASC

718”

). ASC

718,

which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statements of operations based on their grant date fair values. For stock options granted to employees and to members of the board of directors for their services on the board of directors, the Company estimates the grant date fair value of each option award using the Black-Scholes option-pricing model. The use of the Black-Scholes option-pricing model requires management to make assumptions with respect to the expected term of the option, the expected volatility of the common stock consistent with the expected life of the option, risk-free interest rates and expected dividend yields of the common stock. For awards subject to service-based vesting conditions, the Company recognizes share-based compensation expense, equal to the grant date fair value of stock options on a straight-line basis over the requisite service period. The Company accounts for forfeitures as they occur rather than on an estimated basis.

Share-based compensation expense recognized for the

three

and

nine

months ended

September 30, 2017

and

2016

was included in the following line items on the Consolidated Statement of Operations (in thousands).

	Three Months Ended September 30,				Nine Months Ended September 30,
	2017		2016		2017		2016
Research and development	$	217	$	565	$	237	$	1,749
General and administrative		228		561		1,828		2,291
Total share-based compensation expense	$	445	$	1,126	$	2,065	$	4,040

The fair value of each option is estimated on the date of grant using the Black-Scholes method with the following assumptions:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016
Dividend yield		-			-			-			-
Expected volatility		67%			70%		65%	-	67%	65%	-	70%
Risk-free interest rate	1.90%	-	2.07%	1.09%	-	1.60%	1.83%	-	2.41%	1.09%	-	1.82%
Expected life (in years)	5.75	-	6.25	5.26	-	10.00	5.38	-	10	5	-	10
Weighted-average grant date fair value per share		$4.86			$8.50			$4.85			$7.09

Cash and Cash Equivalents

The Company considers highly liquid investments with a maturity of

three

months or less when purchased to be cash equivalents. Cash and cash equivalents consisted primarily of cash on deposit in U.S., German, Swiss, Japanese and Canadian banks. Cash and cash equivalents are stated at cost which approximates fair value.

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to credit risk consist primarily of cash and cash equivalents. The Company holds these investments in highly-rated financial institutions, and limits the amounts of credit exposure to any

one

financial institution. These amounts at times

may

exceed federally insured limits. The Company has

not

experienced any credit losses in such accounts and does

not

believe it is exposed to any significant credit risk on these funds. The Company has

off-balance sheet concentrations of credit risk, such as foreign currency exchange contracts, option contracts or other hedging arrangements.

Fair Value Measurements

The Company follows ASC Topic

820,

Fair Value Measurements and Disclosures

, which establishes a fair value hierarchy for those instruments measured at fair value that distinguishes between assumptions based on market date (observable inputs) and the Company’s own assumptions (unobservable inputs). The hierarchy consists of

three

levels:

•

Level

1—Unadjusted

quoted prices in active markets for identical assets or liabilities.

•

Level

2—Quoted

prices for similar assets and liabilities in active markets, quoted prices in markets that are

not

active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability.

•

Level

3—Unobservable

inputs that reflect the Company’s own assumptions about the assumptions market participants would use in pricing the asset or liability in which there is little, if any, market activity for the asset or liability at the measurement date.

September 30, 2017

and

December 31, 2016,

the Company did

not

have any assets or liabilities that are measured at fair value on a recurring basis. The carrying amounts reflected in the balance sheets for cash and cash equivalents, prepaid expenses and other current assets, accounts payable, and accrued expenses approximate their fair values at

September 30, 2017

and

December 31, 2016,

due to their short-term nature.

Property and Equipment

Property and equipment, which consists of land, construction in process, furniture and fixtures, computers and office equipment, scientific equipment, leasehold improvements, vehicles and building are stated at cost and depreciated over the estimated useful lives of the assets, with the exception of land and construction in process which are

not

depreciated, using the straight line method. The useful lives are as follows:


• Furniture and fixtures	7 years

• Office equipment	5 years

• Leasehold improvements	Shorter of asset’s useful life or remaining lease term

• Scientific equipment	5 years

• Vehicles	5 years

• Building	39 years

Costs of major additions and betterments are capitalized; maintenance and repairs, which do

not

improve or extend the life of the respective assets, are charged to expense as incurred. Upon retirement or sale, the cost of the disposed asset and the related accumulated depreciation are removed from the accounts and the resulting gain or loss is recognized.

Impairment of Long-Lived Assets

The Company periodically evaluates its long-lived assets for potential impairment in accordance with ASC Topic

360,

Property, Plant and Equipment

. Potential impairment is assessed when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset

may

not

be recovered. Recoverability of these assets is assessed based on undiscounted expected future cash flows from the assets, considering a number of factors, including past operating results, budgets and economic projections, market trends and product development cycles. If impairments are identified, assets are written down to their estimated fair value. The Company has

not

recognized any impairment through

September 30, 2017.

Foreign Currency Transactions

Certain transactions are denominated in a currency other than the Company’s functional currency of the U.S. dollar, and the Company generates assets and liabilities that are fixed in terms of the amount of foreign currency that will be received or paid. At each balance sheet date, the Company adjusts the assets and liabilities to reflect the current exchange rate, resulting in a translation gain or loss. Transaction gains and losses are also realized upon a settlement of a foreign currency transaction in determining net loss for the period in which the transaction is settled.

Comprehensive Income (Loss)

ASC Topic

220,

Comprehensive Income

, requires that all components of comprehensive income (loss), including net income (loss), be reported in the financial statements in the period in which they are recognized. Comprehensive income (loss) is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources, including unrealized gains and losses on investments and foreign currency translation adjustments.

Segment and Geographic Information

Operating segments are identified as components of an enterprise for which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision making group, in making decisions on how to allocate resources and assess performance. The Company’s chief operating decision maker is the Chief Executive Officer. The Company and the chief operating decision maker view the Company’s operations and manage its business as

one

operating segment. Substantially all of the Company’s operations are in the U.S. geographic segment.

Net Loss Per Share

Net loss per share (“EPS”) is computed by dividing net loss by the weighted average number of common shares outstanding during each period. Diluted EPS is computed by dividing net loss by the weighted average number of common shares and common share equivalents outstanding (if dilutive) during each period. The number of common share equivalents, which include stock options, is computed using the treasury stock method.

Subsequent Events

The Company considered events or transactions occurring after the balance sheet date but prior to the date the consolidated financial statements are available to be issued for potential recognition or disclosure in its consolidated financial statements. We have evaluated subsequent events through the date of filing this Form

-Q.

Recent Accounting Pronouncements

February 2016,

the FASB issued ASU

No.

2016

02,

“Leases.” ASU

2016

requires companies that lease assets to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in its balance sheet. The pronouncement will also require additional disclosures about the amount, timing and uncertainty of cash flows arising from leases. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after

December 15, 2018,

and early adoption is permitted. Management is currently evaluating the impact of this pronouncement on XBiotech’s consolidated financial statements.