UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2015

or

For the transition period from __________to__________

Commission File No. 0-14710

XOMA Corporation

(Exact name of registrant as specified in its charter)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act of 1934).    Yes  o    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

XOMA CORPORATION

FORM 10-Q

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION

ITEM 1.  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

XOMA CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

The accompanying notes are an integral part of these condensed consolidated financial statements.

(Note 1) The condensed consolidated balance sheet as of December 31, 2014 has been derived from the audited consolidated financial statements as of that date included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

1

XOMA CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(unaudited)

(in thousands, except per share amounts)

The accompanying notes are an integral part of these condensed consolidated financial statements.

2

XOMA CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Description of Business

XOMA Corporation (“XOMA” or the “Company”), a Delaware corporation, combines a portfolio of clinical programs and research activities to develop innovative therapeutic antibodies that it intends to commercialize. XOMA focuses its scientific research on allosteric modulation, which offers opportunities for new classes of therapeutic antibodies to treat a wide range of human diseases. XOMA’s scientific research has produced six product candidates to treat diseases within the endocrine therapeutic area.  These include candidates from the XMet platform, which consists of several Selective Insulin Receptor Modulator antibodies that could offer new approaches in the treatment of metabolic diseases. The lead compound from the XMet platform, XOMA 358, is a fully human monoclonal allosteric modulating antibody that binds to insulin receptors and attenuates insulin action.  XOMA intends to investigate this compound as a novel treatment for non-drug-induced, endogenous hyperinsulinemic hypoglycemia (low blood glucose caused by excessive insulin produced by the body). In October 2015, the Company initiated a Phase 2 proof-of-concept study for XOMA 358 in patients with congenital hyperinsulinemia.  XOMA’s endocrine portfolio also includes a Phase 2 ready product candidate targeting the prolactin receptor as well as other preclinical or research stage programs.  XOMA is also engaged in Phase 3 development for gevokizumab, an interleukin-1β (“IL-1β”) modulating antibody, in pyoderma gangrenosum (“PG”), a rare ulcerative skin disease.  The Company’s products are presently in various stages of development and are subject to regulatory approval before they can be commercially launched.

On July 22, 2015, the Company announced the Phase 3 EYEGUARD-B study of gevokizumab in patients with Behçet’s disease uveitis, run by Les Laboratoires Servier and Institut de Recherches Servier (“Servier”), its partner for gevokizumab, did not meet the primary endpoint of time to first acute ocular exacerbation. In August 2015, XOMA announced its intention to end the EYEGUARD global Phase 3 program.  In September 2015, Servier notified XOMA of its intention to terminate the Amended and Restated Collaboration and License Agreement dated February 14, 2012, as later amended on November 4, 2014 and January 9, 2015 (the “Collaboration Agreement”), and return the gevokizumab rights to XOMA. Termination of the Collaboration Agreement will be effective on March 25, 2016. Servier and XOMA are in the process of closing down the EYEGUARD clinical sites in an orderly manner such that if any of the data is positive it may be useful in the future.  

Liquidity and Management Plans

The Company has incurred operating losses since its inception and had an accumulated deficit of $1.2 billion at September 30, 2015. Management expects operating losses and negative cash flows to continue for the foreseeable future. As of September 30, 2015, the Company had $32.0 million in cash and cash equivalents, which is available to fund future operations. On September 30, 2015, the Company entered into a license agreement with Novartis International Pharmaceutical Ltd. (“Novartis”) under which XOMA will receive a $37.0 million upfront license fee, which was reported as accounts receivable in the condensed consolidated balance sheet as of September 30, 2015 (see Note 4).  In addition, Novartis Vaccines and Diagnostics, Inc. (“NVDI”) amended the secured note agreement and extended the maturity date of the Company’s outstanding debt of $13.5 million, previously due on September 30, 2015, to September 30, 2020 (see Note 7). Taking into account the receipt of the $37.0 million license fee in October 2015, the deferral of $13.5 million in debt, and certain cost cutting measures enacted by the Company in the second half of 2015, the Company expects it has adequate funds to maintain operations for a period of at least 12 months following the end of the third quarter of 2015.  

2. Basis of Presentation and Significant Accounting Policies

Basis of Presentation

The condensed consolidated financial statements include the accounts of XOMA and its subsidiaries. All intercompany accounts and transactions among consolidated entities were eliminated during consolidation. The unaudited financial statements were prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. As permitted under those rules certain footnotes or other financial information can be condensed or omitted. These financial statements and related disclosures have been prepared with the assumption that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year. Accordingly, these statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, filed with the U.S. Securities and Exchange Commission (“SEC”) on March 11, 2015.

4

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

These financial statements have been prepared on the same basis as the Company’s annual financial statements and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, that are necessary for a fair statement of the Company’s financial information. The interim results of operations are not necessarily indicative of the results that may be expected for the full fiscal year or any other periods.

Use of Estimates

The preparation of financial statements in conformity with GAAP in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures. On an on-going basis, management evaluates its estimates including, but not limited to, those related to contingent warrant liabilities, revenue recognition, debt amendments, research and development expense, long-lived assets, restructuring liabilities, legal contingencies, derivative instruments and stock-based compensation. The Company bases its estimates on historical experience and on various other market-specific and other relevant assumptions that are believed 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 significantly from these estimates, such as the Company’s billing under government contracts and the Company’s accrual for clinical trial expenses. Under the Company’s contracts with the National Institute of Allergy and Infectious Diseases (“NIAID”), a part of the National Institutes of Health (“NIH”), the Company bills using NIH provisional rates and thus is subject to future audits at the discretion of NIAID’s contracting office. These audits can result in an adjustment to revenue previously reported which potentially could be significant. The Company’s accrual for clinical trials is based on estimates of the services received and efforts expended pursuant to contracts with clinical trial centers and clinical research organizations. Payments under the contracts depend on factors such as the achievement of certain events, successful enrollment of patients, and completion of portions of the clinical trial or similar conditions.

Reclassifications

Certain reclassifications of prior period amounts have been made to the financial statements and accompanying notes to conform to the current period presentation. These reclassifications had no impact on the Company’s previously reported net loss or cash flows. The Company early adopted Accounting Standards Update (“ASU”) 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”), effective January 1, 2015. As a result, debt issuance costs of $0.2 million as of December 31, 2014, have been reclassified from prepaid expenses and other current assets to interest bearing obligations – current in the accompanying condensed consolidated balance sheet as of December 31, 2014. The Company had no long-term debt issuance costs as of December 31, 2014.

Revenue Recognition

Revenue is recognized when the four basic criteria of revenue recognition are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured. The determination of criteria (2) is based on management’s judgments regarding whether a continuing performance obligation exists. The determination of criteria (3) and (4) are based on management’s judgments regarding the nature of the fee charged for products or services delivered and the collectability of those fees. Allowances are established for estimated uncollectible amounts, if any.

The Company recognizes revenue from its license and collaboration arrangements, contract services, product sales and royalties. Revenue arrangements with multiple elements are divided into separate units of accounting if certain criteria are met, including whether the delivered element has stand-alone value to the customer. Each deliverable in the arrangement is evaluated to determine whether it meets the criteria to be accounted for as a separate unit of accounting or whether it should be combined with other deliverables. In order to account for the multiple-element arrangements, the Company identifies the deliverables included within the arrangement and evaluates which deliverables represent separate units of accounting. Analyzing the arrangement to identify deliverables requires the use of judgment, and each deliverable may be an obligation to deliver services, a right or license to use an asset, or another performance obligation. The consideration received is allocated among the separate units of accounting based on their respective fair values and the applicable revenue recognition criteria are applied to each of the separate units. Advance payments received in excess of amounts earned are classified as deferred revenue until earned.

5

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

License and Collaborative Fees

Revenue from non-refundable up-front license, technology access or other payments under license and collaborative agreements where the Company has a continuing obligation to perform is recognized as revenue over the estimated period of the continuing performance obligation. The Company estimates the performance period at the inception of the arrangement and reevaluates it each reporting period. Management makes its best estimate of the period over which it expects to fulfill the performance obligations, which may include clinical development activities. Given the uncertainties of research and development collaborations, significant judgment is required to determine the duration of the performance period. This reevaluation may shorten or lengthen the period over which the remaining revenue is recognized. Changes to these estimates are recorded on a prospective basis.

License and collaboration agreements with certain third parties also provide for contingent payments to be paid to XOMA based solely upon the performance of the partner. For such contingent payments, revenue is recognized upon completion of the milestone event, once confirmation is received from the third party, provided that collection is reasonably assured and the other revenue recognition criteria have been satisfied. Milestone payments that are not substantive or that require a continuing performance obligation on the part of the Company 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 and Other Revenues

Contract revenue for research and development involves the Company providing research and development and manufacturing services to collaborative partners, biodefense contractors or others. Cost reimbursement revenue under collaborative agreements is recorded as Contract and Other Revenues and is recognized as the related research and development costs are incurred, as provided for under the terms of these agreements. 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 management’s 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.

Up-front fees associated with contract revenue are recorded as License and Collaborative Fees and are recognized in the same manner as the final deliverable, which is generally ratably over the period of the continuing performance obligation. Given the uncertainties of research and development collaborations, significant judgment is required to determine the duration of the arrangement.

Royalty revenue and royalty receivables are recorded in the periods these royalty amounts are earned, if estimable and collectability is reasonably assured. The royalty revenue and receivables recorded in these instances are based upon communication with collaborative partners or licensees, historical information and forecasted sales trends.

Research and Development Expenses

The Company expenses research and development costs as incurred. Research and development expenses consist of direct costs such as salaries and related personnel costs, and material and supply costs, and research-related allocated overhead costs, such as facilities costs. In addition, research and development expenses include costs related to clinical trials. From time to time, research and development expenses may include upfront fees and milestones paid to collaborative partners for the purchase of rights to in-process research and development. Such amounts are expensed as incurred.

The Company’s accrual for clinical trials is based on estimates of the services received and efforts expended pursuant to contracts with clinical trial centers and clinical research organizations. The Company may terminate these contracts upon written notice and is generally only liable for actual effort expended by the organizations to the date of termination, although in certain instances the Company may be further responsible for termination fees and penalties. The Company makes estimates of its accrued expenses as of each balance sheet date based on the facts and circumstances known to the Company at that time. Expenses resulting from clinical trials are recorded when incurred based, in part on estimates as to the status of the various trials.

Restructuring Costs

Restructuring costs, which primarily include termination benefits and contract termination costs, are recorded at estimated fair value. Key assumptions in determining the restructuring costs include the terms and payments that may be negotiated to terminate certain contractual obligations and the timing of employees leaving the Company.

6

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Warrants

The Company has issued warrants to purchase shares of its common stock in connection with financing activities. The Company accounts 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 Option Pricing Model (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, the Company uses the full remaining contractual term of the warrant. The Company determines the expected volatility assumption in the Black-Scholes Model based on historical stock price volatility observed on XOMA’s underlying stock. 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 revaluation of contingent warrant liabilities within the consolidated statements of comprehensive loss.

Concentration of Risk

Cash equivalents and receivables are financial instruments, which potentially subject the Company to concentrations of credit risk, as well as liquidity risk for certain cash equivalents, such as money market funds. The Company has not encountered any such liquidity issues during 2015.

The Company has not experienced any significant credit losses and does not generally require collateral on receivables. For the three and nine months ended September 30, 2015, two customers represented 57% and 20%, and 59% and 22% of total revenue, respectively. For the three and nine months ended September 30, 2014, three customers represented 19%, 21% and 41%, and 10%, 27% and 50% of total revenue, respectively. As of September 30, 2015 and December 31, 2014, one customer represented 94% and three customers represented 44%, 34% and 12% of the trade and other receivables balance, respectively.    

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued guidance codified in Accounting Standards Codification (“ASC”) 606, Revenue Recognition — Revenue from Contracts with Customers (“ASC 606”), which amends the guidance in ASC 605, Revenue Recognition. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued an accounting update to defer the effective date by one year for public entities for annual and interim periods beginning after December 15, 2017. Early adoption is permitted for periods beginning after December 15, 2016. Entities would have the option of using either a full retrospective or a modified retrospective approach to adopt this new guidance. The Company is currently evaluating the impact of the adoption of the standard on its condensed consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). This ASU introduces an explicit requirement for management to assess if there is substantial doubt about an entity’s ability to continue as a going concern, and to provide related footnote disclosures in certain circumstances. In connection with each annual and interim period, management must assess if there is substantial doubt about an entity’s ability to continue as a going concern within one year after the issuance date. Disclosures are required if conditions give rise to substantial doubt. ASU 2014-15 is effective for all entities in the first annual period ending after December 15, 2016. The Company is currently assessing the potential effects of this ASU on its condensed consolidated financial statements.

7

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

In April 2015, the FASB issued ASU 2015-03, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The Company early adopted ASU 2015-03 as of January 1, 2015, as permitted. There is no impact of early adoption of ASU 2015-03 on the condensed consolidated statements of comprehensive loss. The impact of early adoption on the condensed consolidated balance sheets for the periods presented is noted in the table below (in thousands):

3. Condensed Consolidated Financial Statements Detail

Net Loss Per Share of Common Stock

Basic net loss per share of common stock is based on the weighted average number of shares of common stock outstanding during the period. Diluted net loss per share of common stock is based on the weighted average number of shares of common stock outstanding during the period, adjusted to include the assumed conversion of certain stock options, restricted stock units (“RSUs”), and warrants for common stock. The calculation of diluted loss per share of common stock also requires that, to the extent the average market price of the underlying shares for the reporting period exceeds the exercise price of the warrants and the presumed exercise of such securities are dilutive to earnings (loss) per share for the period, adjustments to net income or net loss used in the calculation are required to remove the change in fair value of the warrants for the period. Likewise, adjustments to the denominator are required to reflect the related dilutive shares.

Potentially dilutive securities are excluded from the calculation of diluted net loss per share of common stock if their inclusion is anti-dilutive. The following table shows the weighted-average outstanding securities considered anti-dilutive and therefore excluded from the computation of diluted net loss per share of common stock (in thousands):

8

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

The following is a reconciliation of the numerators and denominators of the basic and diluted net loss per share of common stock (in thousands):

Cash and Cash Equivalents

As of September 30, 2015, cash and cash equivalents consisted of demand deposits of $20.0 million and money market funds of $12.1 million with maturities of less than 90 days at the date of purchase. As of December 31, 2014, cash and cash equivalents consisted of demand deposits of $10.8 million and money market funds of $67.6 million with maturities of less than 90 days at the date of purchase.

Accrued and Other Liabilities

Accrued and other liabilities consisted of the following (in thousands):

9

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Contingent Warrant Liabilities

In December 2014, in connection with a registered direct offering to select institutional investors, the Company issued two-year warrants to purchase up to an aggregate of 8,097,165 shares of XOMA’s common stock at an exercise price of $7.90 per share. These warrants contain provisions that are contingent on the occurrence of a change in control, which could conditionally obligate the Company to repurchase the warrants for cash in an amount equal to their fair value using the Black-Scholes Model on the date of such change in control. Due to these provisions, the Company accounts for the warrants issued in December 2014 as a liability at fair value. In addition, the estimated fair value of the liability related to the warrants is revalued at each reporting period until the earlier of the exercise of the warrants, at which time the liability will be reclassified to stockholders’ equity, or expiration of the warrants. As of December 31, 2014, 8,097,165 of these warrants were outstanding and had a fair value of $5.2 million. The Company revalued the warrants at September 30, 2015 using the Black-Scholes Model and recorded a $4.2 million decrease in the fair value as a gain in the revaluation of contingent warrant liabilities line of the Company’s condensed consolidated statements of comprehensive loss. The decrease in liability is primarily due to the decrease in the market price of XOMA’s common stock at September 30, 2015 as compared to December 31, 2014.  At September 30, 2015, 8,097,165 of these warrants were outstanding and had a fair value of $1.0 million.

In March 2012, in connection with an underwritten offering, the Company issued five-year warrants to purchase 14,834,577 shares of XOMA’s common stock at an exercise price of $1.76 per share. These warrants contain provisions that are contingent on the occurrence of a change in control, which could conditionally obligate the Company to repurchase the warrants for cash in an amount equal to their fair value using the Black-Scholes Model on the date of such change in control. Due to these provisions, the Company accounts for the warrants issued in March 2012 as a liability at fair value. In addition, the estimated liability related to the warrants is revalued at each reporting period until the earlier of the exercise of the warrants, at which time the liability will be reclassified to stockholders' equity, or expiration of the warrants. At December 31, 2014, warrants to purchase 12,109,418 shares were outstanding and had a fair value of $26.7 million. During the nine months ended September 30, 2015, warrants to purchase 2,524,265 of common stock were exercised, of which 2,523,515 were cashless exercises, resulting in an issuance of 1,410,474 shares of common stock. The Company revalued the warrants immediately prior to the exercise dates and recognized $2.2 million as a gain from the revaluation of contingent warrant liabilities. The remaining balance of $3.6 million was reclassified from contingent warrant liabilities to stockholders’ (deficit) equity on the condensed consolidated balance sheet due to the exercise of the warrants. The Company revalued the remaining warrants at September 30, 2015 using the Black-Scholes Model and recorded a $20.0 million decrease in the fair value as a gain in the revaluation of contingent warrant liabilities line of the Company’s condensed consolidated statements of comprehensive loss. This decrease in liability is primarily due to the decrease in the market price of XOMA’s common stock at September 30, 2015 compared to December 31, 2014. At September 30, 2015, 9,585,153 of the warrants were outstanding and had a fair value of $3.1 million.

In February 2010, in connection with an underwritten offering, the Company issued five-year warrants to purchase 1,260,000 shares of XOMA’s common stock at an exercise price of $10.50 per share. The warrants contain provisions that are contingent on the occurrence of a change in control, which could conditionally obligate the Company to repurchase the warrants for cash in an amount equal to their fair value using the Black-Scholes Model on the date of such change in control. Due to these provisions, the Company accounted for the warrants as liabilities at fair value. At December 31, 2014, all of these warrants were outstanding and their fair value was de minimis. All of these warrants expired unexercised in February 2015.

4. Collaborative and Other Agreements

Novartis

On September 30, 2015 (the “Effective Date”), the Company and Novartis entered into a license agreement (the “License Agreement”) pursuant to which the Company granted Novartis an exclusive, world-wide, royalty-bearing license to the Company’s anti-transforming growth factor beta (TGFβ) antibody program (the “Program”). Under the terms of the License Agreement, Novartis will have worldwide rights to the Program and will be solely responsible for the development and commercialization of antibodies and products containing antibodies arising from the Program. Within ninety (90) days of the Effective Date, the Company is required to transfer certain proprietary know-how, materials and inventory relating to the Program to Novartis.  

10

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Under the License Agreement, the Company received a $37.0 million upfront fee. The Company is also eligible to receive up to a total of $480.0 million in development, regulatory and commercial milestones. Any such payments will be treated as  contingent consideration and recognized as revenue when they are achieved, as the Company has no performance obligations under the License Agreement beyond the initial 90-day period. No milestone payments have been received as of September 30, 2015. The Company is also eligible to receive royalties on sales of licensed products, which are tiered based on sales levels and range from a mid-single digit percentage rate to up to a low double-digit percentage rate. Novartis’ obligation to pay royalties with respect to a particular product and country will continue for the longer of the date of expiration of the last valid patent claim covering the product in that country, or ten years from the date of the first commercial sale of the product in that country.

The License Agreement contains customary termination rights relating to material breach by either party. Novartis also has a unilateral right to terminate the License Agreement on an antibody-by-antibody and country-by-country basis or in its entirety on one hundred eighty days’ notice.

The Company identified the following performance deliverables under the License Agreement: (i) the license, (ii) regulatory services to be delivered within 90 days from the Effective Date and (iii) transfer of materials, process and know-how, also to be delivered within 90 days from the Effective Date. The Company considered the provisions of the multiple-element arrangement guidance in determining how to recognize the revenue associated with these deliverables. The Company determined that none of the deliverables have standalone value and therefore has accounted for them as a single unit of account. The Company will recognize the upfront payment as revenue over the period XOMA expects to complete its obligations under the arrangement, which is expected to occur within the 90-day period specified in the License Agreement. As of September 30, 2015, the Company recorded the $37.0 million upfront fee in the trade and other receivables and the deferred revenue – current line items within the consolidated balance sheet as the amount was contractually due from Novartis upon signing of the License Agreement, but the cash had not been received nor had the revenue been earned as of that date.

In connection with the execution of the License Agreement, XOMA and NVDI executed an amendment to their Amended and Restated Research, Development and Commercialization Agreement dated July 1, 2008, as amended, relating to anti-CD40 antibodies (the “Collaboration Agreement Amendment”). Pursuant to the Collaboration Agreement Amendment, the parties agreed to reduce the royalty rates that XOMA is eligible to receive on sales of Novartis’ clinical stage anti-CD40 antibodies. These royalties are tiered based on sales levels and now range from a mid-single digit percentage rate to up to a low double-digit percentage rate. In addition, XOMA and NVDI amended the note agreement to extend the maturity date of the note from September 30, 2015 to September 30, 2020 (see Note 7). All other terms of the Amended and Restated Research, Development and Commercialization Agreement remained unchanged.

Servier

In December 2010, the Company entered into a license and collaboration agreement (“Collaboration Agreement”) with Servier, to jointly develop and commercialize gevokizumab in multiple indications. Under the terms of the agreement, Servier has worldwide rights to cardiovascular disease and diabetes indications and has rights outside the United States and Japan to all other indications, including non-infectious intermediate, posterior or pan-uveitis (“NIU”), Behçet’s disease uveitis, pyoderma gangrenosum, and other inflammatory and oncology indications. Under this agreement, Servier funded all activities to advance the global clinical development and future commercialization of gevokizumab in cardiovascular-related diseases and diabetes.  Also, Servier funded the first $50.0 million of gevokizumab global clinical development and chemistry, manufacturing and controls expenses related to the three pivotal clinical trials under the EYEGUARD program.  All remaining expenses related to these three pivotal clinical trials are shared equally between Servier and the Company. For the three months ended September 30, 2015 and 2014, the Company recorded revenue of $0.2 million and $0.6 million, respectively, from this Collaboration Agreement. For the nine months ended September 30, 2015 and 2014, the Company recorded revenue of $1.1 million and $2.6 million, respectively, from this Collaboration Agreement.

On January 9, 2015, concurrent with a loan amendment (see Note 7), the Company and Servier entered into Amendment No. 2 to the Collaboration Agreement (“Collaboration Amendment”).  Under the Collaboration Agreement, the Company was eligible to receive up to approximately €356.5 million in the aggregate in milestone payments if the Company re-acquired cardiovascular and/or diabetes rights for use in the United States, and approximately €633.8 million in aggregate milestone payments if the Company did not re-acquire those rights. Under the Collaboration Amendment, the Company was eligible to receive up to €341.5 million in the aggregate in milestone payments in the event the Company re-acquired the cardiovascular and/or diabetes rights for use in the United States and approximately €618.8 million if the Company did not re-acquire those rights. The milestone reductions were related to a low prevalence indication for which Servier would not have pursued development had these payments been required. All other terms of the Collaboration Agreement remained unchanged.  

11

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

On September 28, 2015, Servier notified XOMA of its intention to terminate the Collaboration Agreement, as amended and return the gevokizumab rights to XOMA. The termination will be effective on March 25, 2016 and does not result in a change to the maturity date of the Company’s loan with Servier (see Note 7). As the Company will no longer be required to provide services to Servier under the Collaboration Agreement, the Company will amortize the remaining deferred revenue through March 25, 2016. As of September 30, 2015, the Company has classified the remaining deferred revenue balance associated with the terminated Collaboration Agreement of $1.4 million as current on the condensed consolidated balance sheet, as the Company expects to recognize this amount as revenue in the period from September 30, 2015 to March 25, 2016.

Symplmed Pharmaceuticals

In July 2013, the Company transferred the development and commercialization rights of Prestalia® to Symplmed Pharmaceuticals (“Symplmed”). On January 26, 2015, Symplmed announced that the Food and Drug Administration (“FDA”) approved PRESTALIA® (perindopril arginine and amlodipine) tablets, originally licensed from Servier by XOMA, for the treatment of hypertension. In July 2015, Symplmed announced it has initiated commercial sales of PRESTALIA. Pursuant to the transfer agreement with Symplmed, the Company is eligible to receive royalties of 3% to 10% on any potential sales of PRESTALIA in the United States.  Royalties on sales of PRESTALIA were immaterial for the quarter ended September 30, 2015.

5. Fair Value Measurements

Fair value is defined as the exchange price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The accounting guidance for fair value establishes a framework for measuring fair value and a fair value hierarchy that prioritizes the inputs used in valuation techniques. The accounting standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value, which are the following:

Level 1 – Observable inputs, such as quoted prices in active markets for identical assets or liabilities.

Level 2 – Observable inputs, either directly or indirectly, other than quoted prices in active markets for similar assets or liabilities, that are not active or other inputs that are not observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities; therefore, requiring an entity to develop its own valuation techniques and assumptions.

The following tables set forth the Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014 as follows (in thousands):

12

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

During the nine month period ended September 30, 2015 there were no transfers between Level 1, Level 2, or Level 3 assets or liabilities reported at fair value on a recurring basis and the valuation techniques used did not change compared to the Company’s established practice.

The estimated fair value of the foreign exchange options as of September 30, 2015 was zero.  The estimated fair value of the foreign exchange options at September 30, 2015, and December 31, 2014, was determined using readily observable market inputs from actively quoted markets obtained from various third-party data providers. These inputs, such as spot rate, forward rate and volatility have been derived from readily observable market data, meeting the criteria for Level 2 in the fair value hierarchy. The change in the fair value is recorded in the other income (expense), net line of the condensed consolidated statements of comprehensive loss.  

The estimated fair value of the contingent warrant liabilities at September 30, 2015, and December 31, 2014, was determined using the Black-Scholes Model, which requires inputs such as the expected term of the warrants, volatility and risk-free interest rate. These inputs are subjective and generally require analysis and judgment to develop. The Company’s common stock price represents a significant input that affects the valuation of the warrants. The change in the fair value is recorded as a gain or loss in the revaluation of contingent warrant liabilities line of the condensed consolidated statements of comprehensive loss.

The estimated fair value of the contingent warrant liabilities was estimated using the following range of assumptions at September 30, 2015, and December 31, 2014:

The following table provides a summary of changes in the fair value of the Company’s Level 3 financial liabilities for the nine months ended September 30, 2015 (in thousands):

13

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

The fair value of the Company’s outstanding interest bearing obligations is estimated using the net present value of the payments, discounted at an interest rate that is consistent with market interest rates, which is a Level 2 input. The carrying amount and the estimated fair value of the Company’s outstanding interest bearing obligations at September 30, 2015, and December 31, 2014, are as follows (in thousands):

6. Restructuring Charges

On July 22, 2015, the Company announced the Phase 3 EYEGUARD-B study of gevokizumab in patients with Behçet’s disease uveitis, run by Servier, did not meet the primary endpoint of time to first acute ocular exacerbation.  In August 2015, XOMA announced its intention to end the EYEGUARD global Phase 3 program.  On August 21, 2015, the Company, in connection with its efforts to lower operating expenses and preserve capital while continuing to focus on its endocrine product pipeline, implemented a restructuring plan (the “2015 Restructuring”) that included a workforce reduction resulting in the elimination of 58 positions throughout all areas of the Company (of which, 38 were employee terminations and 20 were open positions).  On September 29, 2015, the Company terminated an additional five employees who were notified on that date.  The identified persons will cease to be employees of the Company upon completion of the 60-day notification period required by the California Worker Adjustment and Retraining Notification Act.

During the three months ended September 30, 2015, the Company recorded charges of $2.2 million related to severance, other termination benefits and outplacement services in connection with the workforce reduction. The Company expects to incur an additional $0.3 million restructuring charge in the fourth quarter of 2015 related to severance, other termination benefits and outplacement services related to notified employees who will continue to perform services to the Company during the fourth quarter of 2015. Finally, the Company recognized an additional restructuring charge of $0.4 million in contract termination costs, which primarily include costs in connection with the discontinuation of the EYEGUARD studies. For the nine months ended September 30, 2014, the Company recorded charges of $84,000 for final facility costs related to restructuring activities initiated in 2012.

Of the $2.9 million total expenses associated with the restructuring activities in the third quarter of 2015, the Company expects to pay approximately $2.7 million by December 31, 2015, with the remaining amount to be paid by May 2016. The Company may also incur other material charges not currently contemplated due to events that may occur as a result of, or associated with, the restructuring. In addition, these charges do not reflect changes expected to occur as a result of the Company’s strategic actions related to XOMA’s manufacturing and biodefense operations (see Note 10).  

The outstanding restructuring liabilities are included in accrued and other liabilities on the condensed consolidated balance sheet. As of September 30, 2015, the components of these liabilities are shown below (in thousands):

7. Long-Term Debt and Other Financings

Novartis Note

In May 2005, the Company executed a secured note agreement (the “Note Agreement”) with NVDI, which was due and payable in full in June 2015. Under the Note Agreement, the Company borrowed semi-annually to fund up to 75% of the Company’s research and development and commercialization costs under its collaboration arrangement with Novartis, not to exceed $50.0 million in aggregate principal amount. Interest on the principal amount of the loan accrued at six-month LIBOR plus 2%, which was equal to

14

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

2.44% at September 30, 2015. At the Company’s election, the semi-annual interest payments could be added to the outstanding principal amount, in lieu of a cash payment, as long as the aggregate principal amount did not exceed $50.0 million. The Company made this election for all interest payments. Loans under the Note Agreement were secured by the Company’s interest in its collaboration with NVDI, including any payments owed to it thereunder. Pursuant to the terms of the arrangement as restructured in November 2008, the Company did not make any additional borrowings under the Novartis note.

In June 2015, the Company and NVDI agreed to extend the maturity date of the Note Agreement from June 21, 2015, to September 30, 2015 (the “June 2015 Extension Letter”).

On September 30, 2015, concurrent with the execution of the License Agreement with Novartis as discussed in Note 4, XOMA and NVDI executed an amendment to the June 2015 Extension Letter (the “Secured Note Amendment”). Pursuant to the Secured Note Amendment, the parties further extended the maturity date of the June 2015 Extension Letter from September 30, 2015 to September 30, 2020, and eliminated the mandatory prepayment previously required to be made with certain proceeds of pre-tax profits and royalties. In addition, upon achievement of a specified development and regulatory milestone, the then-outstanding principal amount of the note will be reduced by $7.3 million rather than the Company receiving such amount as a cash payment. All other terms of the original Note Agreement remain unchanged. The note, as amended, bears interest based on the six-month LIBOR plus 2%, or 2.44% as of September 30, 2015.

As of September 30, 2015, the outstanding principal balance under this Secured Note Amendment was $13.5 million and was included in interest bearing obligations – long term in the accompanying condensed consolidated balance sheet. As of December 31, 2014, the outstanding principal balance under this arrangement was $13.4 million and was included in interest bearing obligations – current in the accompanying condensed consolidated balance sheet.

Servier Loan Agreement

In December 2010, in connection with the Collaboration Agreement entered into with Servier, the Company executed a loan agreement with Servier (the “Servier Loan Agreement”), which provided for an advance of up to €15.0 million. The loan was fully funded in January 2011, with the proceeds converting to approximately $19.5 million. The loan is secured by an interest in XOMA’s intellectual property rights to all gevokizumab indications worldwide, excluding certain rights in the U.S. and Japan. Interest is calculated at a floating rate based on a Euro Inter-Bank Offered Rate (“EURIBOR”) and subject to a cap. The interest rate is reset semi-annually in January and July of each year. The interest rate for the initial interest period was 3.22% and has been reset semi-annually ranging from 2.31% to 3.83%. Interest for the six-month period from mid-January 2015 through mid-July 2015 was reset to 2.16%. Interest is payable semi-annually. Interest for the six-month period from mid-July 2015 through mid-January 2016 was reset to 2.05%. In January 2015 and July 2015, the Company made payments of $0.2 million in accrued interest to Servier.

On January 9, 2015, Servier and the Company entered into Amendment No. 2 (“Loan Amendment”) to the Servier Loan Agreement initially entered into on December 30, 2010 and subsequently amended by a Consent, Transfer, Assumption and Amendment Agreement entered into as of August 12, 2013. The Loan Amendment extended the maturity date of the loan from January 13, 2016 to three tranches of principal to be repaid as follows: €3.0 million on January 15, 2016, €5.0 million on January 15, 2017, and €7.0 million on January 15, 2018. All other terms of the Loan Agreement remain unchanged. The loan will be immediately due and payable upon certain customary events of default. The Company determined that the Loan Amendment resulted in a loan modification.  In connection with the Loan Amendment, the Company incurred debt issuance costs of approximately $6,000 that were included in interest expense for the nine months ended September 30, 2015.

Upon issuance, the loan had a stated interest rate lower than the market rate based on comparable loans held by similar companies, which represents additional value to the Company. The Company recorded this additional value as a discount to the carrying value of the loan amount, at its fair value of $8.9 million. The fair value of this discount, which was determined using a discounted cash flow model, represents the differential between the stated terms and rates of the loan, and market rates. Based on the association of the loan with the collaboration arrangement, the Company recorded the offset to this discount as deferred revenue.

The loan discount is amortized to interest expense under the effective interest method over the remaining life of the loan. The loan discount balance at the time of the Loan Amendment was $1.9 million, which is being amortized over the remaining term of the Loan Amendment.  The Company recorded non-cash interest expense resulting from the amortization of the loan discount of $0.2 million and $0.5 million, for the three months ended September 30, 2015 and 2014, respectively. The Company recorded non-cash interest expense resulting from the amortization of the loan discount of $0.5 million and $1.4 million, for the nine months ended September 30, 2015 and 2014, respectively. At September 30, 2015 and December 31, 2014, the net carrying value of the loan was

15

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

$15.6 million and $16.2 million, respectively. For the three and nine months ended September 30, 2014, the Company recorded unrealized foreign exchange losses of $0.2 million related to the re-measurement of the loan discount. For the three and nine months ended September 30, 2015, the Company recorded an unrealized foreign exchange gain of $17,000 and an unrealized foreign exchange loss of $0.2 million, respectively, related to the re-measurement of the loan discount.

On September 28, 2015, Servier terminated the Collaboration Agreement with the required 180-day notice and none of the acceleration clauses were triggered; therefore, the termination of the Collaboration Agreement had no impact on the loan balance as of September 30, 2015.            

The outstanding principal balance under this loan was $16.9 million and $18.2 million, using a euro to US dollar exchange rate of 1.124 and 1.216, as of September 30, 2015 and December 31, 2014, respectively. The Company recorded an unrealized foreign exchange loss of $0.2 million and an unrealized foreign exchange gain of $1.4 million, respectively, for the three and nine months ended September 30, 2015. The Company recorded unrealized foreign exchange gains of $1.4 million and $1.6 million for the three and nine months ended September 30, 2014, related to the re-measurement of the loan.

General Electric Capital Corporation (“GECC”) Term Loan

In December 2011, the Company entered into a loan agreement (the “GECC Loan Agreement”) with GECC, under which GECC agreed to make a term loan in an aggregate principal amount of $10.0 million (the “Term Loan”) to the Company, and upon execution of the GECC Loan Agreement, GECC funded the Term Loan.

In connection with the GECC Loan Agreement, the Company issued to GECC unregistered warrants that entitle GECC to purchase up to an aggregate of 263,158 unregistered shares of XOMA common stock at an exercise price equal to $1.14 per share. These warrants were exercisable immediately upon issuance and have a five-year term expiring in December 2016.

In connection with a September 27, 2012 amendment of the GECC Loan Agreement, the Company issued to GECC unregistered stock purchase warrants, which entitle GECC to purchase up to an aggregate of 39,346 shares of XOMA common stock at an exercise price equal to $3.54 per share. These warrants were exercisable immediately upon issuance and have a five-year term expiring in September 2017.

The Company allocated the aggregate initial proceeds of the GECC Term Loan between the warrants and the debt obligation based on their relative fair values.  The fair value of the warrants issued to GECC was determined using the Black-Scholes Model. The fair value of the warrants with the GECC Loan Agreement and the subsequent September 27, 2012 amendment had fair values of $0.2 million and $0.1 million, respectively, and were recorded as a discount to the debt obligation, which was amortized over the term of the loan using the effective interest method. The warrants are classified in permanent equity on the condensed consolidated balance sheets.

The GECC Term Loan was paid in full on February 27, 2015, when Hercules Technology Growth Capital, Inc. (“Hercules”) and the Company entered into a loan and security agreement (the “Hercules Term Loan”), under which the Company borrowed $20.0 million. The Company used a portion of the proceeds under the Hercules Term Loan to repay GECC’s outstanding principle balance, final payment fee, prepayment fee, and accrued interest totaling $5.5 million.  A loss on extinguishment of $0.4 million from the payoff of the GECC Term Loan was recognized as interest expense during the nine months ended September 30, 2015.

Hercules Term Loan

On February 27, 2015 (“Closing Date”), the Company entered into the Hercules Term Loan as described above.  The Hercules Term Loan has a variable interest rate that is the greater of either (i) 9.40% plus the prime rate as reported from time to time in The Wall Street Journal minus 7.25%, or (ii) 9.40%. The payments under the Hercules Term Loan are interest only until one month prior to July 1, 2016. The interest-only period will be followed by equal monthly payments of principal and interest amortized over a 30-month schedule through the scheduled maturity date of September 1, 2018. As security for its obligations under the Hercules Term Loan, the Company granted a security interest in substantially all of its existing and after-acquired assets, excluding its intellectual property assets.

If the Company prepays the loan prior to the loan maturity date, it will pay Hercules a prepayment charge, based on a prepayment fee equal to 3.00% of the amount prepaid, if the prepayment occurs in any of the first 12 months following the Closing Date, 2.00% of the amount prepaid, if the prepayment occurs after 12 months from the Closing Date but prior to 24 months from the Closing Date, and 1.00% of the amount prepaid if the prepayment occurs after 24 months from the Closing Date. The Hercules Term Loan includes customary affirmative and restrictive covenants, but does not include any financial maintenance covenants, and also includes standard events of default, including payment defaults. Upon the occurrence of an event of default, a default interest rate of an additional 5% may

16

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

be applied to the outstanding loan balances, and Hercules may declare all outstanding obligations immediately due and payable and take such other actions as set forth in the Hercules Term Loan.

The Company incurred debt issuance costs of $0.5 million in connection with the Hercules Term Loan. The Company will be required to pay a final payment fee equal to $1.2 million on the maturity date, or such earlier date as the term loan is paid in full. The debt issuance costs and final payment fee are being amortized and accreted, respectively, to interest expense over the term of the term loan using the effective interest method. The Company recorded non-cash interest expense resulting from the amortization of the debt issuance costs and accretion of the final payment of $0.1 million and $0.3 million for the three and nine months ended September 30, 2015, respectively.

In connection with the Hercules Term Loan, the Company issued unregistered warrants that entitle Hercules to purchase up to an aggregate of 181,268 unregistered shares of XOMA common stock at an exercise price equal to $3.31 per share. These warrants were exercisable immediately and have a five-year term expiring in February 2020. The Company allocated the aggregate proceeds of the Hercules Term Loan between the warrants and the debt obligation. The fair value of the warrants issued to Hercules of $0.5 million was determined using the Black-Scholes Model and was recorded as a discount to the debt obligation. The debt discount is being amortized over the term of the loan using the effective interest method. The warrants are classified in stockholders’ equity on the condensed consolidated balance sheets.

The Company evaluated the Hercules Term Loan in accordance with accounting guidance for derivatives and determined there was de minimis value to the identified derivative features of the loan at inception and September 30, 2015.

As of September 30, 2015, the outstanding principal balance of the Hercules Term Loan was $20.0 million.

Aggregate future principal, final payment fees and discounts of the Company’s total interest bearing obligations - long-term as of September 30, 2015, are as follows (in thousands):

Interest Expense

Amortization of debt issuance costs and discounts are included in interest expense. Interest expense in the condensed consolidated statements of comprehensive loss for the three and nine months ended September 30, 2015 and 2014, relates to the following debt instruments (in thousands):

17

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

8. Legal Proceedings, Commitments and Contingencies

Collaborative Agreements, Royalties and Milestone Payments

The Company is obligated to pay royalties, ranging from 0.5% to 5% of the selling price of certain licensed components and up to 40% of any sublicense fees to various universities and other research institutions based on future sales or licensing of products that incorporate certain products and technologies developed by those institutions.

In addition, the Company has committed to make potential future “milestone” payments to third parties as part of licensing and development programs. Payments under these agreements become due and payable only upon the achievement of certain developmental, regulatory and/or commercial milestones. Because it is uncertain if and when these milestones will be achieved, such contingencies, aggregating up to $76.5 million (assuming one product per contract meets all milestones events) have not been recorded on the accompanying condensed consolidated balance sheets. The Company is unable to determine precisely when and if payment obligations under the agreements will become due as these obligations are based on milestone events, the achievement of which is subject to a significant number of risks and uncertainties.

Legal Proceedings

On July 24, 2015, a purported securities class action lawsuit was filed in the United States District Court for the Northern District of California (Case No. 3:15-cv-3425) against the Company, its Chief Executive Officer and its Chief Medical Officer.  The complaint asserts that all defendants violated Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and SEC Rule 10b-5, by making materially false or misleading statements regarding the Company’s EYEGUARD-B study between November 6, 2014 and July 21, 2015. The plaintiffs also allege that Messrs. Varian and Rubin violated Section 20(a) of the Exchange Act.  The plaintiffs seek class certification, an award of unspecified compensatory damages, an award of reasonable costs and expenses, including attorneys’ fees, and other further relief as the Court may deem just and proper. Based on a review of the allegations, the Company believes that the plaintiffs’ allegations are without merit, and intends to vigorously defend against the claims. Currently, the Company does not believe that the outcome of this matter will have a material adverse effect on its business or financial condition, although an unfavorable outcome could have a material adverse effect on its results of operations for the period in which such a loss is recognized. The Company cannot reasonably estimate the possible loss or range of loss that may arise from this lawsuit.

On July 29, 2015, Medpace, Inc. (“Medpace”) filed a claim against the Company in the Ohio Court of Common Pleas, Hamilton County.  The complaint seeks to recover payment for services allegedly provided by Medpace to the Company during 2012-2013 in connection with preparation of a new drug application and seeks damages of approximately $465,000 (inclusive of claimed contractual pre-judgment interest). On August 24, 2015, XOMA filed its answer to the complaint and the parties are currently taking discovery. The Company expects that is likely it will be able to settle with Medpace for an amount less than $465,000 and recorded an accrual for the anticipated amount in the third quarter of 2015.  

On October 1, 2015, a stockholder purporting to act on the behalf of the Company, filed a derivative lawsuit in the Superior Court of California for the County of Alameda, purportedly asserting claims on behalf of the Company against certain of officers and the members of board of directors of the Company, captioned Silva v. Scannon, et al. The lawsuit asserts claims for breach of fiduciary duty, corporate waste and unjust enrichment based on the dissemination of allegedly false and misleading statements related to the Company’s EYEGUARD-B study.  The plaintiff is seeking unspecified monetary damages and other relief, including reforms and improvements to the Company’s corporate governance and internal procedures.  Management believes the allegations have no merit and intends to vigorously defend against the claims. Currently, the Company does not believe that the outcome of this matter will have a material adverse effect on its business or financial condition, although an unfavorable outcome could have a material adverse effect on its results of operations for the period in which such a loss is recognized. The Company cannot reasonably estimate the possible loss or range of loss that may arise from this lawsuit.

9. Stock-based Compensation

In the nine months ended September 30, 2015, the Board of Directors of the Company approved grants under the Company’s Long Term Incentive Plan for options to purchase an aggregate of 1,790,722 shares and an aggregate of 1,694,932 RSUs to certain employees of the Company. The stock options vest monthly over four years, and the RSUs vest annually over three years, in equal increments.

18

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

In May 2015, the Company’s stockholders approved the Employee Stock Purchase Plan (the “2015 ESPP”). Under the 2015 ESPP, the Company reserved 300,000 shares of common stock for issuance as of its effective date of July 1, 2015, subject to adjustment in the event of a stock split, stock dividend, combination or reclassification or similar event. The 2015 ESPP allows eligible employees to purchase shares of the Company’s common stock at a discount through payroll deductions of up to 10% of their eligible compensation, subject to any plan limitations. The 2015 ESPP provides for six-month offering periods ending on May 31 and November 30 of each year, with the exception of the first offering period, which lasts from July 1, 2015 through November 30, 2015, as transition from the Company’s legacy employee stock purchase plan.  At the end of each offering period, employees are able to purchase shares at 85% of the lower of the fair market value of the Company’s common stock on the first trading day of the offering period or on the last day of the offering period.

The Company recognizes compensation expense for all stock-based payment awards made to the Company’s employees, consultants and directors based on estimated fair values. Compensation expense is recognized from the grant date to the earlier of the retirement-eligible date or the vesting date.  The valuation of stock option awards is determined at the date of grant using the Black-Scholes Model. This model requires inputs such as the expected term of the option, expected volatility and risk-free interest rate. To establish an estimate of expected term, the Company considers the vesting period and contractual period of the award and its historical experience of stock option exercises, post-vesting cancellations and volatility. The estimate of expected volatility is based on the Company’s historical volatility. The risk-free rate is based on the yield available on U.S. Treasury zero-coupon issues. The forfeiture rate impacts the amount of aggregate compensation for both stock options and RSUs. To establish an estimate of forfeiture rate, the Company considers its historical experience of option forfeitures and terminations.

The fair value of the stock options granted during the three and nine months ended September 30, 2015 and 2014, was estimated based on the following weighted average assumptions:

Stock option activity for the nine months ended September 30, 2015, was as follows:

The valuation of RSUs is determined at the date of grant using the closing stock price.

19

XOMA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Unvested RSU activity for the nine months ended September 30, 2015, is summarized below:

The following table shows total stock-based compensation expense for stock options, RSUs and ESPP in the condensed consolidated statements of comprehensive loss for the three and nine months ended September 30, 2015 and 2014 (in thousands):

10. Subsequent Events

On November 4, 2015, XOMA and Nanotherapeutics Inc. (“Nanotherapeutics”) entered into an asset purchase agreement (the “Nanotherapeutics Purchase Agreement”), pursuant to which Nanotherapeutics agreed, subject to the terms and conditions set forth in the Nanotherapeutics Purchase Agreement, to acquire XOMA’s biodefense business and related assets (including, subject to regulatory approval, certain contracts with the U.S. government), and to assume certain liabilities of XOMA (the “Transaction”).  As part of the Transaction, the parties will, subject to the terms and conditions of the asset purchase agreement and the satisfaction of certain conditions, enter into an intellectual property license agreement (the “License Agreement”), pursuant to which XOMA agreed to license to Nanotherapeutics, subject to the terms and conditions set forth in the License Agreement, certain intellectual property rights related to the purchased assets, in consideration for up to a cash payment of $1.5 million, 23,008 shares of common stock of Nanotherapeutics and additional milestone-based payments and royalties. The Nanotherapeutics Purchase Agreement is expected to close by December 31, 2015.

On November 5, 2015, XOMA and Agenus West, LLC, a wholly-owned subsidiary of Agenus Inc. (“Agenus”), entered into an asset purchase agreement (the “Agenus Purchase Agreement”), pursuant to which Agenus agreed, subject to the terms and conditions set forth in the Agenus Purchase Agreement, to acquire XOMA’s manufacturing facility in Berkeley, California, together with certain related assets, including certain intellectual property related to the purchased assets under an intellectual property license agreement, and to assume certain liabilities of XOMA, in consideration for the payment to XOMA of up to $5.0 million in cash and the issuance to XOMA of shares of Agenus’s common stock having an aggregate value of up to $1.0 million.  The Agenus Purchase Agreement is expected to close by December 31, 2015.

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ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to them. In some cases you can identify forward-looking statements by words such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “potential,” “intend” and similar expressions intended to identify forward-looking statements. Examples of these statements include, but are not limited to, statements regarding: the implications of interim or final results of our clinical trials, the progress of our research programs, including clinical testing, the extent to which our issued and pending patents may protect our products and technology, our ability to identify new product candidates, the potential of such product candidates to lead to the development of commercial products, our anticipated timing for initiation or completion of our clinical trials for any of our product candidates, our future operating expenses, our future losses, our future expenditures for research and development, the sufficiency of our cash resources, our ability to receive potential milestones and/or  royalty payments under collaboration agreements and the timing of receipt of those payments, the timing and adequacy of cost-cutting measures, and our ability to defend against claims that may be made in litigation. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us and described in Part II, Item 1A of this Quarterly Report on Form 10-Q and our other filings with the SEC. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from those we expect. Except as required by law, we assume no obligation to update these forward-looking statements, whether as a result of new information, future events or otherwise.

The following discussion and analysis should be read in conjunction with the unaudited financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and with the audited consolidated financial statements and related notes thereto included as part of our Annual Report on Form 10-K for the year ended December 31, 2014.

Overview

XOMA Corporation (“XOMA”), a Delaware corporation, discovers and develops innovative antibody-based therapeutics. Several of our antibodies have unique properties due to their interaction at allosteric sites on a specific protein rather than the orthosteric, or active, sites. The compounds are designed to either enhance or diminish the protein’s activity as desired.  We believe allosteric-modulating antibodies may be more selective or offer a safety advantage in certain disease indications when compared to more traditional modes of action.

In August 2015, we announced our strategic initiative to focus efforts on advancing the assets in our extensive portfolio of compounds that could treat a variety of endocrine diseases.  We currently have six assets in our endocrine franchise portfolio, three of which were developed utilizing our proprietary XOMA Metabolism, or XMet, platform. The XMet platform is highly novel as the antibodies bind to different sites on the insulin receptor than currently marketed drugs and includes separate classes of allosteric modulating antibodies that either activate the insulin receptor, XMetA, or deactivate the insulin receptor, XMetD. The product candidates derived from the XMet platform that we intend to advance are:

This portfolio of antibodies represents potential new therapeutic approaches to the treatment of diabetes and several rare diseases that have insulin involvement.  Our endocrine portfolio also includes a Phase 2-ready product candidate, XOMA 213, targeting the prolactin receptor, and hyperprolactinemia, and multiple research-stage programs. Our product candidates are presently in various stages of development and are subject to regulatory approval before they can be commercially launched.

21

XOMA 358 is a fully human monoclonal allosteric modulating antibody that binds to insulin receptors and attenuates insulin action. We intend to investigate this compound as a novel treatment for non-drug-induced, endogenous hyperinsulinemic hypoglycemia (low blood glucose caused by excessive insulin produced by the body).  In March 2015, we presented positive Phase 1 data on XOMA 358 at ENDO 2015, the Endocrine Society's annual meeting. Results of the study, in which 14 healthy volunteers received XOMA 358 and 5 received placebo, showed XOMA 358 reduced insulin sensitivity and decreased glucose disposal after exogenous insulin injection. In the study, XOMA 358 appeared to be well tolerated, with no serious adverse events observed.  In June 2015, we were granted Orphan Drug Designation for XOMA 358 by the FDA for the treatment of congenital hyperinsulinism (“HI”), a hereditary disease resulting in lack of insulin regulation and profound hypoglycemia that can result in seizures, brain damage, and in rare cases, death.  In October 2015, we initiated a single-dose Phase 2 proof-of-concept study of XOMA 358 in patients with HI.  In addition, we intend to initiate a single-dose Phase 2 proof-of-concept study in patients who experience hyperinsulinism post bariatric surgery.  We believe a therapy that safely and effectively mitigates insulin-induced hypoglycemia has the potential to address a significant unmet therapeutic need for certain rare medical conditions associated with hyperinsulinism.     

XOMA 129 is a highly potent Fab fragment with negative allosteric modulation of the insulin receptor.  We believe XOMA 129 could offer clinicians a therapy that has rapid onset, improved efficacy and optimal duration of therapy to treat patients with acute severe hypoglycemia wherein currently available therapies are inadequate.

XOMA 159, a high-affinity, fully human monoclonal antibody, allosterically binds to and activates the insulin receptor (“INSR”). XOMA 159 is a potential treatment for rare disorders that result in severe insulin resistance (“SIR”). Insulin resistance (“IR”) is generally defined by the reduced ability of insulin to lower blood glucose, usually resulting in compensatory hyperinsulinemia. IR is a common obesity-related metabolic problem that is associated with chronic disorders, such as Type 2 diabetes, atherosclerosis, polycystic ovarian syndrome, and hepatic steatosis. In contrast, SIR often results from single gene defects in insulin signaling called “insulin receptoropathies.” The disorders arising from genetic insulin receptoropathies range from extreme pediatric conditions, such as Donohue Syndrome (“DS”) and Rabson Mendenhall Syndrome, to conditions, such as severe "type A" IR and "HAIR-AN" (hyperandrogenism, insulin resistance, and acanthosis nigricans). Current treatment of patients with insulin receptoropathies is inadequate. Managing these patients is extremely challenging and largely focuses on employing high-dose insulin sensitizers, such as metformin and pioglitazone, and delivery of high concentrations of exogenous insulin.  Since XOMA 159 acts at a site of INSR distinct from insulin, we believe it has the potential to restore additional INSR function and address unmet need.

XOMA 213 (formerly LFA 102) is a first-in-class allosteric inhibitor of prolactin action that was discovered by us under our collaboration with Novartis AG (“Novartis,” formerly Chiron Corporation).  It is a humanized IgG1-Kappa monoclonal antibody that binds to the extracellular domain of human prolactin receptor with high affinity at an allosteric site relative to prolactin.  The compound has been shown to inhibit prolactin-mediated signaling, and it is potent and similarly active against rodent, monkey, and human prolactin receptors.  We exercised our right to bring the product back into our portfolio to develop it for diseases of hyperprolactinemia.  Prolactinoma is a condition of benign tumors on the pituitary gland.  It leads to sexual dysfunction, infertility, and osteoporosis.  Existing therapies are poorly tolerated in 20 percent of the 140,000 patients in the United States.  Another indication we intend to pursue is anti-psychotic-induced hyperprolactinemia, a side effect seen in patients treated with commonly used antipsychotics, antidepressants, and pain medications.  As patients exhibit the same signs and symptoms as prolactinoma, compliance with anti-psychotic therapies is poor.  Currently available therapies to address these side effects can worsen psychosis.    

We have multiple ongoing research programs focused on endocrine indications.  One is an anti-parathyroid receptor program.  Hyperparathyroidism results in significant hypercalcemia causing fatigue, loss of appetite, confusion, nausea, and muscle weakness.  While most can be treated surgically, 10 percent of the patient population does not respond to surgery.  We are in the process of selecting the lead compound to move into pre-clinical testing.  Another research program is focused on the adrenal corticotropic hormone (“ACTH”).  Inappropriate secretion of ACTH leads to excess cortisol, which can lead to Cushing's Disease. We have identified potent ACTH inhibitors and are testing for in vivo activity in preclinical models.

We also are continuing our Phase 3 development activities for gevokizumab (IL-1 beta modulating antibody) in pyoderma gangrenosum (“PG”), a rare ulcerative skin disease that is a specific indication under the umbrella of diseases known as neutrophilic dermatoses.  Patients experience painful expanding skin ulcers that have a significant impact on their quality of life.  The U.S. Food and Drug Administration (“FDA”) granted Orphan Drug status for gevokizumab in PG.

On July 22, 2015, we announced that the Phase 3 EYEGUARD-B study of gevokizumab in patients with Behçet’s disease uveitis did not meet the primary endpoint of time to first acute ocular exacerbation. In August 2015, we announced our intention to end the EYEGUARD global Phase 3 program.  Servier, our gevokizumab development partner, and we are in the process of closing down the EYEGUARD clinical sites in an orderly manner such that if any of the data is positive it may be useful in the future.  In September 2015, Servier notified us of its intention to terminate our collaboration and license agreement, and Servier will return all gevokizumab rights to us. We will regain worldwide rights to gevokizumab on March 25, 2016.

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Significant Developments in the First Three Quarters of 2015

Novartis Agreements

On June 19, 2015, we and Novartis agreed to extend the maturity date of our secured note agreement with Novartis from June 21, 2015 to September 30, 2015. All other terms of the note agreement remained unchanged.

On September 30, 2015, we and Novartis entered into a license agreement pursuant to which we have granted to Novartis an exclusive, world-wide, royalty-bearing license to XOMA’s anti-TGFβ program. Under the terms of the license agreement, we received $37.0 million in the form of an upfront payment and are eligible to receive up to $480.0 million if all development, regulatory, and commercial milestones are met. In addition, we are eligible to receive royalties on product sales that range from the mid-single digits to the low double digits. In connection with this license agreement, Novartis has agreed to extend the maturity date on the approximately $13.5 million of outstanding debt under our secured note agreement, which bears interest at the six-month LIBOR plus 2%, to September 30, 2020. We have also agreed to reduce our royalty rate associated with sales of Novartis' clinical stage anti-CD40 antibodies. All other terms of the 2004 collaboration agreement remained unchanged.

EYEGUARD-B Study and Servier Agreement

On May 28, 2015, we announced that the gevokizumab Phase 3 EYEGUARD-B study, sponsored by Servier, reached its target exacerbation event as specified in the study design. The objective of the first part of this study was to demonstrate the superiority of gevokizumab, as compared to placebo, on top of the current standard of care (immunosuppressant therapy and oral corticosteroids) in reducing the risk of Behçet's disease uveitis exacerbations and to assess the safety of gevokizumab. On July 22, 2015, we announced the Phase 3 EYEGUARD-B study did not reach its primary endpoint of time to first acute ocular exacerbation. On September 28, 2015, Servier notified XOMA of its intention to terminate our collaboration and license agreement and return the gevokizumab rights to XOMA. The termination of the collaboration and license agreement will be effective on March 25, 2016.  

Restructuring

On August 21, 2015, in connection with our efforts to lower operating expenses and preserve capital while continuing to focus on our product pipeline, we implemented a workforce reduction of 58 positions throughout all areas of the Company. These reductions were comprised of 38 employee terminations and 20 open positions.  On September 29, 2015, we terminated an additional five employees who were notified on that date. The identified persons will cease to be employees of the Company upon completion of the 60-day notification period required by the California Worker Adjustment and Retraining Notification Act. In addition, we cancelled our contracts with clinical manufacturing organizations following the discontinuation of our EYEGUARD-B and EYEGUARD-E studies. This workforce reduction does not reflect changes expected to occur as a result of our strategic actions related to XOMA’s manufacturing and biodefense operations.

XOMA 358

In March 2015, we announced that we successfully completed the Phase 1 clinical study of XOMA 358, a fully human, allosteric monoclonal antibody that attenuates both the binding of insulin to its receptor and downstream insulin signaling.  We have presented the data at the ENDO 2015 meeting and at the American Diabetes Association’s 75^th Scientific Sessions.  XOMA 358 is being evaluated for the treatment of non-drug-induced, endogenous hyperinsulinemic hypoglycemia.

In June 2015, we announced that we have been granted Orphan Drug Designation for XOMA 358 by the FDA for the treatment of congenital hyperinsulinism, a hereditary disease resulting in lack of insulin regulation and profound hypoglycemia that can result in seizures and brain damage.

In October 2015, we initiated a single-dose Phase 2 proof-of-concept study of XOMA 358 in patients with congenital hyperinsulinism.  In addition, we intend to initiate a single-dose Phase 2 proof-of-concept study in patients who experience hyperinsulinism post bariatric surgery.  

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Hercules Term Loan

In February 2015, we entered into a loan and security agreement with Hercules Technology Growth Capital, Inc. (the “Hercules Term Loan”), under which we borrowed $20.0 million. We used a portion of the proceeds under the Hercules Term Loan to repay the General Electric Capital Corporation (“GECC”) outstanding principle balance, final payment fee, prepayment fee, and accrued interest amounts totaling $5.5 million and plan to use the remaining proceeds for general corporate purposes.  

Servier Loan Amendment

On January 9, 2015, we entered into Amendment No. 2 to our loan agreement with Servier, initially entered into on December 30, 2010, and subsequently amended by a Consent, Transfer, Assumption and Amendment Agreement entered into as of August 12, 2013. Amendment No. 2 modified the maturity date of the loan from January 13, 2016 to three tranches of principal to be paid as follows: €3.0 million on January 15, 2016, €5.0 million on January 15, 2017 and €7.0 million on January 15, 2018. All other terms of the Servier Loan Agreement remained unchanged.

Licensing

In January 2015, Symplmed announced that the FDA approved PRESTALIA®, originally licensed by us from Servier and later transferred to Symplmed.  As a result, we are eligible to receive royalties of 3% to 10% on any potential sales of PRESTALIA in the United States. In July 2015, Symplmed announced it has initiated commercial sales of PRESTALIA.  Royalties on sales of PRESTALIA were immaterial for the quarter ended September 30, 2015.

Results of Operations

Revenues

Total revenues for the three and nine months ended September 30, 2015 and 2014, were as follows (in thousands):

License and Collaborative Fees

License and collaborative fees include fees and milestone payments related to the out-licensing of our products and technologies. The decrease in license and collaborative fee revenue for the three months ended September 30, 2015, as compared to the same period of 2014, was due to the $1.5 million decrease in milestone payments relating to out-licensing arrangements and $0.3 million decrease in revenue recognized related to the loan agreement with Servier. The decrease in license and collaborative fee revenue for the nine months ended September 30, 2015, as compared to the same period of 2014, was due to the $1.9 million decrease in milestone payments relating to out-licensing arrangements and $0.9 million decrease in revenue recognized related to the loan agreement with Servier. The generation of future revenues related to license and other collaborative fees is dependent on our ability to attract new licensees and new collaboration partners to our antibody technologies, or the achievement of milestones by our existing licensees.

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Contract and Other Revenues

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 revenues for the three and nine months ended September 30, 2015 and 2014 (in thousands):

Our revenue from NIAID decreased for the three and nine months ended September 30, 2015 due to reduced activity under our existing NIAID contracts. The decrease in revenue from Servier for the three and nine months ended September 30, 2015 was due primarily to a decrease in reimbursements from Servier under our collaboration agreement.  

We expect license revenue to increase in 2015 as compared with 2014 levels based on the expected recognition of $37.0 million of revenue in the fourth quarter of 2015 related to the upfront payment received under the license agreement entered into with Novartis in September 2015.

Research and Development Expenses

Biopharmaceutical development includes a series of steps, including in vitro and in vivo preclinical testing, and Phase 1, 2 and 3 clinical studies in humans. Each of these steps is typically more expensive than the previous step, but actual timing and the cost to us depends on the product being tested, the nature of the potential disease indication and the terms of any collaborative or development arrangements with other companies or entities. After successful conclusion of all of these steps, regulatory filings for approval to market the products must be completed, including approval of manufacturing processes and facilities for the product. Our research and development expenses currently include costs of personnel, supplies, facilities and equipment, consultants, other third-party costs and expenses related to preclinical and clinical testing.  

Research and development expenses were $17.6 million and $57.3 million for the three and nine months ended September 30, 2015, compared with $20.2 million and $61.4 million for the same periods in 2014. The decrease of $2.6 million for the three months ended September 30, 2015, as compared to the same period of 2014 was primarily due to a decrease of $1.5 million in salaries and related expenses and a decrease of $1.1 million in clinical trial costs primarily due to the termination of the EYEGUARD global Phase 3 program. The decrease of $4.1 million for the nine months ended September 30, 2015, as compared to the same period of 2014 was primarily due to a decrease of $3.8 million in internal and external manufacturing costs, a decrease of $0.4 million in clinical trial costs due to the termination of the EYEGUARD global Phase 3 program and a decrease of $0.7 million in salaries and related expenses, partially offset by an increase of $1.0 million in consulting services.

Salaries and related personnel costs are a significant component of research and development expenses. We recorded $6.6 million and $24.3 million in research and development salaries and employee-related expenses for the three and nine months ended September 30, 2015, as compared with $8.1 million and $25.0 million for the same period in 2014. The decrease of $1.5 million for the three months ended September 30, 2015, as compared to the same period of 2014 was due primarily to a $0.9 million decrease in salaries and related personnel costs, primarily due to the restructuring activities in the third quarter of 2015, and a $0.7 million decrease in stock-based compensation, which is a non-cash expense. The decrease of $0.7 million for the nine months ended September 30, 2015, as compared to the same period of 2014 was due primarily to a $0.2 million decrease in salaries and related personnel costs and a $0.5 million decrease in stock-based compensation, which is a non-cash expense.  The decreases in stock-based compensation for the three and nine months ended September 30, 2015, included $0.2 million related to the reversal of expense for forfeitures of stock awards related to our restructuring activities in the third quarter of 2015.

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Our research and development activities can be divided into earlier-stage programs and later-stage programs. Earlier-stage programs include molecular biology, process development, pilot-scale production and preclinical testing. Later-stage programs include clinical testing, regulatory affairs and manufacturing clinical supplies. The costs associated with these programs are summarized below (in thousands):

Our research and development activities can also be divided into those related to our internal projects and those projects related to collaborative and contract arrangements. The costs related to internal projects versus collaborative and contract arrangements are summarized below (in thousands):