XOMA Q3 2007 Earnings Call Transcript

Nov. 8.07 | About: XOMA Corporation (XOMA)

XOMA Ltd. (NASDAQ:XOMA)

Q3 2007 Earnings Call

November 8, 2007 8:30 a.m. ET

Executives

Greg Mann - Senior Director of IR

Steven Engle - Chairman and CEO

Alan Solinger - VP of Clinical Immunology

David Boyle - CFO

Analysts

Jason Napodano – Zachs

Aaron Lindberg - William Smith

Mike King - Rodman & Renshaw

Jason Kolbert - Susquehanna Capital

Joe Pantginis - Canaccord Adams

Operator

Good afternoon. Welcome to XOMA's Third Quarter, 2007Conference Call. At this time, all participants are in a listen-only mode.Later the company will hold a question-and-answer session and I will give youmore instructions at that time. As a reminder to all participants, thisconference is being recorded. Our host for today's call is Greg Mann, XOMA'sSenior Director of IR. Please go ahead, Greg.

Greg Mann

Good morning and welcome to XOMA's third quarter conferencecall. Earlier this morning XOMA filed its quarterly report on Form 10-Q withthe SEC for the quarter ended September 30, 2007 and issued a news release withthird quarter 2007 financials. Each document is available on the XOMA website, www.xoma.com.

Today's webcast can be accessed by XOMA's website and willbe available for replay until close of business on February 28, 2008. Thetelephone replay will be available beginning later this morning until close ofbusiness on November 23, 2007. Access numbers for the replay are listed in thenews release that we issued this morning.

Leading today's call will be Steven Engle, Chairman andChief Executive Officer; Dr. Alan Solinger, Vice President of ClinicalImmunology; and David Boyle, Chief Financial Officer.

Before beginning we wish to remind all listeners thatcertain statements made on the call today will be forward-looking. We havebased those statements on assumptions that may not prove to be accurate. XOMA'sactual results could differ materially from those we anticipate due to risksinherent in the biotechnology industry as well as for companies engaged inproduct development in a regulated market.

These risks include the success of our existingcollaborations, the marketing and sales efforts for RAPTIVA and LUCENTIS, thepotential regulatory approval of CIMZIA, our ability to enter into additionalarrangements, the size and timing of expenditures, the timing of clinicaltrials and other events, changes in our collaborative relationships and actionsby the Food and Drug Administration, international drug regulatory bodies andthe U.S. patent and trademark office are discussed in XOMA's Form 10-Q for thethird quarter 2007 filed today and in other SEC filings. Please consider suchrisks carefully before making any investment decisions.

I will now turn the call over to Steve Engle.

Steven Engle

Thank you, Greg. Good morning and thank you for joiningtoday's call. We are pleased and excited to report our third quarter 2007results. XOMA had an excellent quarter. In fact, it was the single bestquarterly performance in XOMA's history.

Revenues for the third quarter were greater than revenuesfor all prior quarterly and annual periods. David Boyle will speak in moredetail, but to be specific we had $43.1 million in revenues this quarter. Netincome was a positive $21.8 million and the [ending] cash is $47.6 million.

All areas of our business performed well, enhancing ourfinancial strength significantly. Royalty revenues grew. Our collaborationprograms made continued progress. Our bio-defense development activitiesadvanced, and we added a major player to our list of technology licensees. Weare well positioned to move forward as a premier therapeutic antibodydevelopment company.

Today's call will proceed as follows. I will begin with anupdate of our overall progress during the quarter, review our licensingagreement with Pfizer and say a few words about our strategy review process. Alanwill summarize the progress of XOMA 052 program, our proprietary anti IL-1 betaantibody. David will review third quarter's strong financial results andprovide updated guidance for 2007.

Let me review our recent highlights starting with XOMA 052.During the third quarter, we initiated two Phase I studies of XOMA 052 inpatients with Type 2 diabetes, one in the US and one in Europe. The XOMA 052 isa potent monoclonal antibody that interrupts inflammatory process via the IL-1pathway and that has the potential to reduce inflammation in a number ofdiseases. It was discovered and developed using XOMA's integrated antibodycapabilities and expertise.

With the start of the two studies, we are now speaking moreabout XOMA 052, something we had not discussed prior to April of this year.Alan will be discussing the details, but I would like to touch upon four keypoints important for understanding XOMA 052.

Based on the use of another IL-1 blocker in multiplediseases, we believe that our IL-1 blocker, XOMA 052, is likely to helppatients in several indications. We are running the studies in diabetes tostart because it is easier to enroll patients more quickly. As soon as we haveidentified a safe dose, we plan to begin testing the product in otherindications.

It is usually an advantage in biotech to have a drug thathas potential in several indications, as it raises the probability of successin treating patients and addressing a larger overall market. We call thishaving multiple shots on goals, which in soccer, is a good thing. Theseindications could include SJIA or systemic juvenile idiopathic arthritis, Type 2diabetes, gout and rheumatoid arthritis.

XOMA 052 targets are proven and well-understood diseasepathway, where the safety and effectiveness interrupting pathway have been demonstratedin the clinic and a drug has actually been approved. Researchers have beenclosely studying the IL-1 pathway for over 30 years. So a great deal is now alreadyknown about the IL-1 pathway in inflammatory disease and we've designed ourclinical program to build on this general body of knowledge.

An approved drug called Kineret has been available topatients since 2001. Kineret blocks the IL-1 pathway and demonstrates thepotential of this drug development approach. There have been studies of thesuccessful use of Kineret in rheumatoid arthritis, SJIA, osteoarthritis, NOMID,(inaudible), gout, multiple myeloma and Type II diabetes. Because of thisinformation, we believe the probability of succeeding with our product is muchhigher than usual for a Phase I drug.

There are several reasons to believe that XOMA 052 will be abetter drug than Kineret. Although we will need to demonstrate this withclinical data, we believe that XOMA 052 could involve significantly lessfrequent dosing since it has a significantly higher binding affinity thanKineret. In addition, it targets the ligand which we believe, will require lessdrug to achieve a higher effect than Kineret.

Because the list of IL-1 mediated diseases includes certainacute conditions, we believe our development program may be able to show effectmore quickly. There are also several IL-1 mediated diseases that fall into theorphan disease category, where patients desperately need new therapy.

A single dose treatment may be able to demonstrate theactivity of XOMA 052 in some of these diseases. As a result, our clinicaltrials may be relatively short in duration and could provide data at an earlierdate.

Another major development of the third quarter was in thearea of technology licensing. We licensed our bacterial cell expression or BCEtechnology to Pfizer. Pfizer agreed to pay us $30 million in upfront cash forthe license plus future milestones from royalties on products developed ormanufactured using the technology.

As reflected in today's financial report, we recognized theentire $30 million payment in third quarter revenue as has been our practicefor BCE licensing arrangements in the past. We believe the agreement withPfizer is an important validation of XOMA's antibody technology platform. Weare pleased to have the world's largest pharmaceutical company join as one ofour 45 BCE licensees.

The BCE license to Pfizer highlights the power of ourtechnology position and XOMA's financial strength. It is worth noting that thecash payment of $30 million is roughly equivalent to our net revenues for thefull year of 2006. In addition little, if any, cost is directly involved withthe license fee revenue and the agreement keeps open the possibility ofadditional downstream revenue on all BCE-enabled products moving throughPfizer's massive development pipeline.

Pfizer has indicated that they have multiple products inlate-stage development derived from the use of our BCE technology. So we lookforward to Pfizer's success.

Regarding strategy, one of my first steps as CEO was toinitiate in concert with my executive team and the Board of Directors aninternal review of XOMA's long-term business strategy. I'm pleased to reportthat the review is advancing well and look forward to discussing it more fullylater in the fourth quarter.

This concludes my opening remarks. Dr. Alan Solinger willdiscuss some key aspects of our XOMA 052 program. I would note for you thatAlan's background includes being the lead medical director in the developmentof Rituxan at IDEC that he actually watched over and ensured the approval ofKineret, an IL-1 pathway product, and was also involved with Enbrel, both atAmgen. I'm very pleased to have a person with that much experience working onthis program with us. Alan?

Alan Solinger

Thank you, Steve. I would like to say a few words thismorning about why I believe XOMA 052 has such significant potential fortreating patients with debilitating inflammatory conditions.

First, as Steve mentioned, we have proof-of-concept for theIL-1 mediated pathway. Years of research and experience point to IL-1 as animportant mediator of inflammatory processes. When IL-1 levels get out ofcontrol patients experience diseases like rheumatoid arthritis, acute gout,systemic juvenile idiopathic arthritis, and diabetes. We already know that thepathway is central to the pathogenesis of several diseases. Kineret, anapproved drug, has validated this concept.

Second, we have reason to believe the blockade of IL-1 beta,the specific approach of XOMA 052 activity, is a superior mechanism of action.Although we must demonstrate this in clinical studies, we have reason tobelieve that this specific approach will provide superior results, compared toexisting therapies. Kineret and XOMA 052 are both designed to prevent thissignaling complex from forming, thereby shutting down the signaling process andreducing IL-1 levels. But they do this through very different mechanisms.

Kineret targets the IL-1 receptor. XOMA 052 blocks theligand. We believe that blocking IL-1 beta is a more efficient process andsuperior to what Kineret does. The Kineret mechanism works and provides strongproof of concept for XOMA 052's approach to targeting IL-1 beta. However, webelieve that sales of Kineret have been limited by two basic shortcomings thatXOMA 052 can address well.

The first shortcoming relates to the large number of IL-1receptors and the difficulty of blocking enough of them to reduce excess IL-1signaling. IL-1 receptors reside on nearly all the cells of the body so thereare an extremely large number of them. More importantly, the studies have shownthat approximately 95% of these receptors must be blocked to achieve ananti-inflammatory effect.

Rather than going after the receptor, XOMA 052 goes afterthe ligand. It is a potentially easier and more efficient approach. There ismuch less IL-1 beta than receptors in patients, on the order of 100 to 1000times less. Physiologically, IL-1 beta is a primary upstream mediator ofinflammatory response and we may only need to reduce IL-1 beta concentration slightlyin order to inhibit signaling.

The inconvenience of frequent daily dosing is the otherKineret disadvantage that XOMA 052 overcomes. Kineret must be administered inlarge daily doses, frequently associated with injection site reaction, in orderto achieve clinical effects. In contrast, we believe XOMA 052 may be able toprovide a much more desirable dosing regimen on the order of monthly orbimonthly treatment. XOMA 052's remarkable 300 femtomolar binding affinitymakes it a very efficient molecule for binding with a potential target.

Third, there is a strong support for the potential safety ofIL-1 blockade. Here again, we can draw from the clinical experience of Kineret.Kineret has been marketed for approximately seven years and has been in clinicaltrials for more than 13 years, while retaining an excellent safety profilecharacterized by lack of excessive opportunistic infections or malignancypotential.

Studies have shown that high dosing is also tolerated. Animalstudies also support the safety profile of the IL-1 blockade. Colonies of IL-1beta knock out mice. That is engineered mice, whose otherwise normal genes havebeen stripped of the code for expressing IL-1 beta, have been living andreproducing without IL-1 beta for more than 100 generations in 10 years. Themice are clinically normal and healthy. Blood, bones and auto-defense are fineunless exposed to extreme stress.

Again, we are very excited about the potential of XOMA 052to address multiple unmet medical needs and we are pleased to be in the clinicwith the product and look forward to reporting on continued progress of thestudies.

I will now turn the call over to David Boyle. David?

David Boyle

Thanks Alan. I think it's very clear that XOMA has had anoutstanding third quarter. This is a year in which the company has madeexcellent progress on many fronts, including important licensing agreements,clinical progress on our products, our antibody discovery collaborations, thebio-defense work for NIAID and improving financial results.

I will take a few minutes to highlight some of the financialresults that I think are most important to our investors. We released thirdquarter 2007, financial results and filed the 10-Q earlier today. Thosedocuments are available to you on our website and on the SEC's website.

We are pleased to report that XOMA's net income for thethird quarter was $21.8 million compared to a net loss of $10.8 million lastyear. For the first nine months of 2007, XOMA's net loss has been reduced to$2.4 million from $37.4 million last year.

Looking at the top line, we recorded $43.1 million inrevenues for the third quarter compared with $7.4 million in the third quarterof 2006. Year-to-date revenues increased to $69.5 million from $20.5 millionlast year. Obviously, the upfront payment of $30 million from the Pfizer BCElicense agreement has had a significant positive impact. But also, allcategories of revenue, including royalties and contract revenues, have almostdoubled for the first nine months of 2007 over 2006.

Worldwide sales of RAPTIVA in the third quarter of 2007 were$56 million, an increase of $15 million from the prior year's third quarter andLUCENTIS sales for the third quarter were $320 million, more than doubling fromthe $156 million in the same quarter last year.

We are increasing our guidance on the 2007 full year revenueforecast. We now expect to grow [2000] revenues 165% to 175% over the full year2006 revenues of $29.5 million. This compares with our previous guidance ofgrowth of 95% to 105%.

XOMA's R&D spending for the third quarter was $14.6million in the 2007 quarter compared with $12.7 million for the 2006 quarter.For the first nine months, R&D spending increased from $37 million in 2006to $47.9 million in 2007. These increases primarily reflects spending on ourdevelopment of XOMA 052 and other pipeline products, spending on the NIAID, Taligenand AVEO contracts and are spending in the Schering-Plough and Takedacollaborations.

We are updating our guidance for the full year 2007 forecastfor R&D expenses to grow between 30% and 35% per 2007 over the 2006 expenseat $52.1 million. This guidance is an increase of 5% on both ends of the rangefrom the previous guidance.

General and administrative expenses were $5.8 million in thethird quarter of 2007, increasing from $4.2 million in the same quarter lastyear. Year-to-date, G&A spending increased to $15.1 million from $13.6million last year. Previously, we provided guidance that G&A spending wouldbe flat to the $18.1 million spent in 2006. We now expect that 2007 G&Aspending will increase by approximately 10% to 20% as a result of certainpersonnel-related costs.

Under FASB 123R, we have recorded stock compensation expenseof approximately $1 million this quarter and $2.1 million for the year-to-datecompared to $0.2 million and $0.8 million for the respective periods of 2006.

Interest expense was $1.2 million for the third quarter of2007 compared to $1.7 million in the same period of 2006. The interest expensein the third quarter of 2007 consisted primarily of interest on the GoldmanSachs loan of about $800,000 and on the Novartis line of credit of $400,000. Interestexpenses related to the now retired convertible debt instrument were $6.5million in the first nine months of 2007 compared to $7.7 million for the sameperiod in 2006. We are confirming our previous guidance of a reduction of netinterest expense of about 10% for 2007 from the 2006 amount of $11.3 million.

At September 30, XOMA had outstanding debt consisting of$30.3 million on a 5-year term loan facility with Goldman Sachs and $18.9million of long-term debt with Novartis. At September 30, there was noconvertible debt outstanding as the last of the convertible notes wereconverted into common shares in the first quarter of 2007.

Cash, cash equivalents and short-term investments atSeptember 30, 2007 were $47.6 million compared with $46.4 million at December31, 2006. This figure excludes an additional $1.6 million of restricted cash asof September 30 related to the Goldman Sachs loan.

Net cash provided by operating activities was $22.6 millionfor the third quarter compared to net cash used in operating activity to $10.1million in the prior year third quarter. Net cash provided for in operationsfor the first nine months of 2007 was $7.4 million compared with $28.6 millionused in the first nine months of 2006.

Cash used in operations for 2007 includes -- excuse me,provided for operations -- from operations in 2007 includes a one-time paymentof $5.2 million related to the [make hold] provision of the convertible notesand $1.4 million related to the semiannual interest payments on the convertiblenotes, both in the first quarter of 2007.

As we have previously stated, with the full conversion ofthe notes, the $6.6 million cash expense will not be present in futurequarters. We are updating XOMA's full year forecast for cash used in operationsto be less than 15% of the $33.3 million used in 2006.

Our previous guidance was that we expected cash used in operationsto decrease to about 50% or to less than 50% of the 2006 amount. In addition toour cash and liquid investments position, XOMA continue to have an importantline of credit with Novartis, which we may use to fund 75% of our cost shareobligation in our joint development work with them and which carries attractiveterms.

At September 30, we had $31 million remaining available onthis credit line. XOMA considers its cash and financial resources adequate forthe long term, subject to the risk factors noted in the 10-Q. On a short-termbasis, our cash position may increase by the establishment of new and progresson existing antibody collaboration arrangements, service contracts andlicensing agreements.

In the normal course of our business we may have discussionsongoing with several potential collaboration partners, contract developmentservice customers, and technology licensees. We want to remind you that theguidance we have provided amounts to a prediction of the future, and as such isbased on a variety of assumptions and assessments of the probabilities associatedwith the various future events, any of which could turn out to be incorrect. So,we caution you to take into account the risk factors described earlier as wellas those described in our public filings.

We look forward to closing a strong 2007 year with acontinued focus to building value for our shareholders. I will now hand thecall back over to Steve Engle for some concluding remarks. Steve?

Steven Engle

Thank you, Dave. All areas of XOMA's business performed at ahigh level this quarter. Our collaboration activities, the Novartis,Schering-Plough, Takeda and others continued moving forward. Gross salesrevenues from RAPTIVA and LUCENTIS continued to grow. Our bio-defensedevelopment activities were on track. We licensed our BCE technology to Pfizer.

Each of these areas contributed to a quarter of strongrevenue growth. We are also very excited about XOMA 052 and its potential tobenefit patients in a variety of diseases. The two Phase I studies started inthe third quarter were important milestones for the company, and we lookforward to the programs continued progress in 2008.

This concludes our prepared remarks for today. Operator,would you please review instructions for the question and answer session?

Question-and-AnswerSession

Operator

(Operator Instructions). Our first question comes from theline of Joe Pantginis with Canaccord Adams. Please, proceed with your question.

Joe Pantginis -Canaccord Adams

Hi guys. Good morning. Congratulations on the financialprogress.

Steven Engle

Thanks Joe. We appreciate it.

Joe Pantginis -Canaccord Adams

First, I would just like to ask a couple of questions then Iwill jump back into queue. For 052 I know it's early, obviously, in thedevelopment pathway, but can you share with us again, your commercial strategysurrounding the pipeline? I'm sorry, surrounding 052? And then, secondly, Iknow in the press release and then you mentioned it today, you are currently inyour strategic review of the company. And one of the statements that was madewas, you know, potentially looking to increase growth of internal pipeline. Ijust wanted to know if you have any more visibility on that? And then I willjump back in. Thanks.

Steven Engle

No problem, Joe. On the second question, I think we will betalking about that more once we finish with our strategic review. So if youwill allow me we will get through that and get back to you in the next fewweeks. On the first question, as far as commercial, can you just provide alittle more clarity specifically, what were you looking for on thecommercial --.

Joe Pantginis -Canaccord Adams

Sure. I mean how long you take a partnering strategy -- howfar do you want to take it in different indications before you exploreopportunities?

Steven Engle

Right, well, as you can understand, being in Phase I withsomething to go in multiple indications, some of which are chronic, and some ofwhich are acute; and then also some of which are large markets and some ofwhich are orphan. There is a lot of possibilities here. So our idea is ingeneral, that as you look at the big indications you are going to be thinkingabout how you are going to fund large long trials and developments processes.

On the other hand when you look at these orphan drugindications or the indications like gout, where a single dose of Kineret can beshown to have a positive impact on patients, even though gout would be a largeindication, you may already get signals from it that would be very positive. So,there are still some decisions we have to make there and we haven't completelygone one way or the other and it is fairly complex. Again, it will come down towhat kind of results we get out of the studies and then which indication wedecide to proceed with first.

Joe Pantginis -Canaccord Adams

Okay. Thanks. I will jump back in the queue.

Operator

Thank you. Our next question comes from the line of JasonKolbert with Susquehanna Capital. Please, proceed with your question.

Jason Kolbert -Susquehanna Capital

Good morning guys. Thanks for the update andcongratulations. Really great quarter.

Steven Engle

Thank you, Jason.

Jason Kolbert -Susquehanna Capital

Just would like to ask Alan a question about finding themaximum tolerated dose on XOMA 052 given its very long half-life. What doesthat process look like and if that is kind of the 1-A part of the trial, whatmight the 1-B look like given the opportunity to look at other signals indiabetic?

Alan Solinger

Thanks for the question. It's a very good one. I would saythat really, our approach isn't necessarily to find the maximum tolerated doseas much as to find an effective dose that gives us enough of a biologicalsignal that we can move on into the other additional indications whilecontinuing with our plans for the Type II diabetes trials. I think that in thecase of most biologics, it is sometimes very difficult to find a maximumtolerated dose clinically.

You end up – really, ending up looking at more volume ofdrug given, cost of goods. So, I don't think those will be the kinds of issueswe will be dealing with. We are really looking for biologic activity thatindicates that we have the right track in our program so we can move into theseadditional indications that very seriously need intervention.

Jason Kolbert -Susquehanna Capital

And on the 1-B side of it, Alan, what kind of indicatorswould you be looking for in diabetes?

Alan Solinger

I think the standard ones accepted by most regulatoryagencies certainly are items such as glycoslated hemoglobin, sometimes called hemoglobinA1c, changes in the fasting blood sugar levels and various functionalcapabilities of the pancreas that we can look at during the course of ourtrials.

Jason Kolbert -Susquehanna Capital

And one last question is --

Steven Engle

I'm sorry, let me just step in for one second because I wantto make sure you get an additional part to that question. Alan, maybe you couldtalk about what is being measured in the study.

Alan Solinger

In the current trials, we are not only looking at specificitems related to diabetes, such as blood sugars, hemoglobin A1c, C-peptide, butwe are also looking at inflammatory mediators and inflammatory indicators thatwould show us that the mechanism of action of our drug is what we anticipatedshould be by our excellent modeling systems. Though we are looking at thingssuch as sed rate, C-reactive protein, various levels of cytokines such as IL-6and we will be looking at the clinical manifestations as well. But for theearly readings, we will be looking more at the biologic indicators.

Jason Kolbert -Susquehanna Capital

Can you help us with a timeline on how long it will take forthe Phase I part of the trial to play out?

Steven Engle

Alan, could I speak to that for just a second?

Alan Solinger

Certainly.

Steven Engle

So what we're doing is a dose escalation study and so thequestion is when do you arrive at the right dose? We have put into the studywhich is on clintrials.gov, if you would like to look at the details. Basically,six dose levels and those we would expect to take somewhere between six andeight weeks apiece based on the kind of enrollment that we are experiencing.

So you can multiply that out and if you had to go throughall six and then look at the data, you would be talking about having theinformation to talk about in the third quarter of 2008. Now our hope of courseis that one of the doses that occurs earlier in the group will be the dose wecan take forward. But at any rate for planning purposes, I think you got toknow that that could be the time period and we will hope that it actually showsup sooner.

Jason Kolbert -Susquehanna Capital

Thanks guys. I will jump back in the queue.

Operator

Thank you. Our next question comes from the line of ChristopherJames with Rodman & Renshaw. Please, proceed with your question.

Mike King - Rodman& Renshaw

Hey guys. It's Mike King with Chris.

Steven Engle

Hi, Mike. How are you?

Mike King - Rodman& Renshaw

Congratulations as well. I just wanted to -- could we get anupdate on the HCD122 please? It seems like things have been fairly quiet therefor a while. I just wondered when we might get another update from Novartis?

Steven Engle

Alan?

Alan Solinger

At the present time, there will be an oral presentation onHCD122 at the ASH meeting in early December. In this, we will discuss some ofthe data from the ongoing trials as well as data from preclinical.

Mike King - Rodman& Renshaw

Can you maybe more specific about the nature of that, Alan?

Alan Solinger

I believe the abstract will be going online very shortly andI think because of the embargo placed on abstracts to those meetings, I reallycan't say much about the specifics.

Mike King - Rodman& Renshaw

I guess the other question is -- I got on the call late andso I haven't had a chance to really examine the income statement, but X the 30million that you booked for the Pfizer license fee, it looks like your revenueswere down modestly sequentially. A) Am I correct in that? And B) Can you talkabout what the contributors were to that?

Steven Engle

We will be happy to have David.

David Boyle

I'll take this. The revenues may have been downsequentially. There's a couple of things going on, but the primary thing isthat we do have actually a plant shutdown in the third quarter of the year,which means that some of the revenues from our contract work are less duringthe quarter during that shutdown period and that is basically it.

Mike King - Rodman& Renshaw

So would that be licensed in collaborative, Dave, orcontract?

David Boyle

In contract.

Mike King - Rodman& Renshaw

And can I just ask you because again, I don't have thebreakdown here. Can you give -- oh, I see, with $7.4 million okay versus 9.7 inthe second? Okay, so that was a major contribution?

David Boyle

Yes.

Mike King - Rodman& Renshaw

Okay. Thank you. I'll get back in queue.

Steven Engle

Mike, just one other thing. I think we are aware of is thatwe do believe that the people at Novartis are looking to begin programs for thenon-oncology space, particularly the autoimmune. So we are looking forward tohearing about those plans in the upcoming future.

Mike King - Rodman& Renshaw

Do you know what the nature of that would be, Steve?

Steven Engle

Alan, can you say anymore?

Alan Solinger

We are still in discussions as far as what these non-oncologyindications may be, but I think because of the literature out there in theplace where CD40 might fit in, it could be in the anti-inflammatory andautoimmune diseases as well as a large number of other inflammation-mediatedprocesses. And there is also likely to be further word on some additionaloncology indications that we're looking at.

Mike King - Rodman& Renshaw

So who's the most likely party to the relationship thatwould announce that? Would that be Novartis in the form of an analyst update orquarterly call? Would that be XOMA when the agreements have been put in place?

Steven Engle

Dave, do you have a --?

David Boyle

Right. Well, let me just sort of go back. With respect tothe non-oncology indications, I just want to revisit that our initialcollaboration with Chiron was exclusive to their oncology so actually goinginto non-oncology indication requires that we revisit that agreement withNovartis, something that, of course, we are both interested in doing.

So you would expect probably an announcement from us ifthere are any developments on that front. With respect to the clinical trialsongoing in the collaboration, we have typically kept investors up-to-date as towhat is happening. We've suggested in oncology from the additional likelyfuture indications and we will keep you updated as those trials initiate.

Mike King - Rodman& Renshaw

Okay. I appreciate that. And in fact, it brings up the otherquestion about the nature of the relationship and the need for XOMA to continueto invest dollar for dollar. I know that has been a work in progress for awhile as it is all bound up in the discussions about additional indications andsuch. Is that all going to get resolved in kind of one package?

Steven Engle

That would be a reasonable expectation and a fair hope, Iwould say.

Mike King - Rodman& Renshaw

Dave, if I might just again, on the operation side. I noticethat you had a fairly large sequential increase in G&A. So maybe you couldspeak to that. And I feel also, that R&D expense was down sequentially, socan you give us a sense of what is going on the spending side?

David Boyle

I can and there are a couple of things that I want tohighlight in particular. Let me talk about R&D first. We did have asignificant credit of $2.8 million from one of our collaborators that wasrecorded in the quarter, and that was actually noted in the financials, relatedto some cost around that collaboration. So that had a very positive impact andit is basically why there is the sequential decrease in R&D.

With respect to G&A we had certain personnel-relatedcost including the CEO transition which we are extremely pleased about, thathave increased G&A sequentially for the quarter and those have beencommented on in the Q.

Mike King - Rodman& Renshaw

Okay. Fine. Thanks so much for helping me out there.

Steven Engle

You are welcome.

Operator

Thank you. Our next question comes from the line of AaronLindberg with William Smith. Please, proceed with your question.

Aaron Lindberg -William Smith

Thanks. A couple of quick follow-ups there. The plant isback online now. That's just the annual shutdown that happens during Q3?

David Boyle

Yes, we do a couple of shutdowns for cleaning andcalibration during the year. I mean, this is just basically, normal maintenanceperiods that we have scheduled for the plant.

Aaron Lindberg -William Smith

Do the Novartis discussions include trial design?

Steven Engle

We actually, of course participate with Novartis in all ofour joint committees and teams in terms of trial design, discussions and allthe development programs and I might invite Alan to comment a little bit moreabout this specifically since he is our project team leader for HCD122.

Alan Solinger

Yes, we have regular teleconferences, face-to-face meetingsto discuss design and ongoing issues with our trials. So this is a verycollaborative agreement. We take a very active part in discussions and designof the trial setting.

Aaron Lindberg -William Smith

Would it be fair to characterize the negotiations withNovartis to be just ongoing for all quarters at this point from when youeliminated the exclusivity on oncology up till today it's just been a continualprocess until you had a resolution?

Steven Engle

I think that's a fair statement. I might just say that wehave a very positive collaboration with Novartis and relationship and feel itis going very well. You know we have expressed interest as have they indeveloping the non-oncology side of HCD122 which we think could be a great potentialbenefit to both parties and we are exploring that in recent discussions.

Aaron Lindberg -William Smith

When do you expect the 629 trials to begin?

Steven Engle

629 trials, we are actually as part of these strategicreview taking a look at the indications and we will update you on that as we goforward probably with part of the strategic review early next year.

Aaron Lindberg -William Smith

Is it possible that you don't start the trial?

Steven Engle

We haven't made final decisions around development of thatproduct. I think what we have said is that we are looking at a number ofsuperficial skin infections for that product. I think there are some veryinteresting indications available because of the nature of the product,including that bugs don't develop resistance to it. So we are looking at anumber of indications and I think if we complete that review as part of ourstrategy, we will give you more guidance around what to expect.

David Boyle

We apologize but we can't give you quite as much clarityuntil we finish the process. I hope that is easy to understand.

Aaron Lindberg -William Smith

The two compounds that are kind of being most heavilyscrutinized there, 629 and NEUPREX?

David Boyle

All the compounds are being scrutinized and certainlyNEUPREX and 629 are getting their share.

Aaron Lindberg -William Smith

Then have you set new targets into the Takeda collaborationduring Q3?

David Boyle

We haven't typically in the past commented on the number ofproject and/or targets in any specific collaboration. I think we will probablystick to that for now.

Aaron Lindberg -William Smith

Okay. And then can you comment on the enrollment so far inthe 052 trial?

David Boyle

That is not something that we have been publicly updating onand as there is important data available. We will make that available, but as Steveand Alan have indicated, the time frame for getting data from that trial issometime out into next year.

Steven Engle

But I think also, just to clarify from my comments andAlan's regarding the study itself indicating that a six to eight weeks to gothrough a dose level. You can already draw conclusions about where we are inthe process and it may differ as we go along to say on enrollment as long as itstays in that general frame, then that's the way we will keep reporting thingsat this point.

Aaron Lindberg -William Smith

Okay. Can you tell me when exactly the European trialstarted?

Steven Engle

A press release was --

David Boyle

It was at the last press release and we will get the datefor you --

Aaron Lindberg -William Smith

Slightly after the US trial?

David Boyle

Yes.

Steven Engle

Yes.

Aaron Lindberg -William Smith

And then, what did you buy for $6.5 million? The fixedassets purchase there, just looked like PP&E only went up $1 million in thequarter.

David Boyle

The $6.5 million fixed assets is year to date and I mean,frankly, there are number of things around that as you might anticipate some ofthe equipments that support antibody discovery in the preclinical areasrelatively costly. We continue to do things for both the pilot and the GMPmanufacturing plant. We have also added a facility next door, where we have movedsome of our people into, relatively smaller expenditure, but it is a number oftypical things and just moving our business forward. There is no one, sort of tosay, large chunk out of that $6.5 million that is specific to anything.

Aaron Lindberg - WilliamSmith

Okay. So, it's scattered about. I didn’t know it'syear-to-date, but still year-to-date looks like the PP&E just went up $2million. So, the lion share that's scattered amongst other things?

Steven Engle

Right.

David Boyle

By the way, the announcement date for the start of this trialwas September 12.

Aaron Lindberg -William Smith

Thank you. One last question for you, given the strong Q3, doyou anticipate minimal licensing and collaborative revenues in Q4?

David Boyle

I think you would have to think in terms of the relativeterms. You wouldn’t expect to see the same thing happen this quarter, whetherwe’ll some probably it's hard to tell when you are getting closer to the end ofthe year. Sometimes the end of the year works for you and people close thingout because they want to take care of them and sometimes they float on overinto the first quarter. So, we will try and keep you aware of it, as it happens.

Aaron Lindberg -William Smith

Okay. I will jump back in queue, thanks.

Steven Engle

Thank you very much.

Operator

Thank you. Our next question comes from the line of JosephNapodano with Zachs. Please, proceed with your questions.

Jason Napodano -Zachs

Hey guys, it’s Jason. I am wondering if you could talk alittle bit about the discussions with scientific advisors at the EMEA as far asthe new practice?

Steven Engle

Alan?

Alan Solinger

Yes, thanks Jason. At the present time, we are doing ongoingdiscussions with the EMEA related to the various aspects of the submission. So,this is an iterative type of process that will get us closer to being able tomake a decision on how to proceed. Those discussions are going well, but as youprobably are aware that you take some time since they are iterative and thenthere is a lot of back and forth. So, this can involve anything from looking atthe clinical data, manufacturing issues, labeling, follow-on discussions. Atthe present time, I think the best thing to say is that it's proceeding asscheduled.

Steven Engle

Okay. And I would just add that when Alan says that it'sproceeding well, he means the process is going well, because it is sequentialand iterative. We don’t know the answer till we get there. It is exceptionalcircumstances and I have been through this at my last company and you will notknow until you get to the end of it where you are to be aware of that place.

Jason Napodano -Zachs

Got you. How would you say the investigators (inaudible) aregoing?

Steven Engle

Alan?

Alan Solinger

I would say that they are certainly going as anticipated bythe investigators. The data is coming in any moment as expected and so, becausemany of these are investigator-initiated studies, we don’t necessarily havemuch influence on the enrolment rates. But, we are in close contact with theprincipal investigators and I think that data should be forthcoming in severalof those trials.

Jason Napodano -Zachs

Got you. Let me ask about your government work. I think thisis something that you guys are focusing pretty heavily on beginning of the yearand last year. But now there seems to be a lot of activity with in-housepipeline, which is great. But I am wondering as far as government work isgoing, are you guys still focusing on growing the government business?

Alan Solinger

Yes Jason, as you know we've already had two major contractsleft in 2005 and 2006 and we are now working on the third one. So, we believewe have a good reputation with the government on time, on budget. We also thinkwe have to write contacts and interactions to grow this into a more significantpiece. There are two ways to do that of course with the government business.One would be the stock piling of drugs such as (inaudible) and then we've seenone or two companies do that quite effectively.

We obviously need to get through our clinical work to getthere. In the meantime then, we are looking for the R&D payment revenues tous for the work being done to move that as well as some of the other projectsforward. We do think in the next three to five years this could be a muchlarger business and then from that point of view we still see it as a proprietarypipeline piece and so we do see it as a key part of generating revenues becauseit's high margin profits over the longer term

Jason Napodano -Zachs

And you think you have sufficient manufacturing capacity to continueto grow that business?

Steven Engle

Where we are at, we are fine. Obviously, as we begin toanticipate a real buildup, then we begin to ship things as necessary and we arelooking at all sorts of alternatives there

Jason Napodano -Zachs

Okay and may be just one last question guys. You talkedabout I think Pfizer said -- I think you guys have mentioned in a presentationthat Pfizer has 14 biotherapeutic products in mid to late stages. Any ideaabout when we will start to hear what some of these products are?

Steven Engle

I am sorry, say last part. When the --

Jason Napodano -Zachs

When we will hear more about those products, specificallywhat the products are?

Steven Engle

I think we probably are not going to see [surprises] that we-- we will let you know as soon as we know. It's one of those things trying toget the information out and it’s the same problem that the analysts have ingeneral of trying to find out from the big companies exactly what is going oninside the pipeline. And so, we will try to do that, but it is notstraightforward just because of their approach to how they want to disclosethings about their pipeline.

Jason Napodano -Zachs

Okay guys. Thanks a lot. I appreciate it.

Operator

Thank you. Our next questioncomes from the line of Joe Pantginis with Canaccord Adams. Please, proceed withyour question.

Joe Pantginis - Canaccord Adams

Hi guys. My follow-ups wereanswered. Thanks a lot.

Steven Engle

Okay. Thank you.

Operator

Thank you. Our next questioncomes from the line of Aaron Lindberg with William Smith. Please, proceed withyour question.

Aaron Lindberg -William Smith

Thank you. Can you describe the progresson the Lexicon collaboration?

Steven Engle

Okay. Lexicon collaboration continuesto move forward very positively -- frankly excellent relationship, we have somevery complementary capabilities. We will reiterate some things that we've saidbefore that these are early stage projects. There are relatively higher risksand they are very novel interesting targets, but also potentially high rewardedif we are successful. They do continue moving forward, but they are good ways awayfrom the clinic, and there is nothing more specific that we are actually ableto communicate to you at this time.

Aaron Lindberg -William Smith

Okay. We haven't heard anythingon that for a while or so. In relation to the contract with NIAID, at thispoint there has been no revenue; you are still finalizing the details, is thatcorrect?

Steven Engle

Yes.

Alan Solinger

That's correct on the NIAID contract.

Aaron Lindberg -William Smith

Okay. And then do you anticipaterevenue in Q4 from them?

David Boyle

Probably not at this point. We arenot absolutely sure but, in the guidance, I did not include revenue from thatcontract in Q4.

Aaron Lindberg -William Smith

Okay. And then do you expect tomake similar size transferable payments on your Goldman facility in Q4(inaudible) maybe in Q3?

David Boyle

Actually, Goldman has the optionto draw down from the restricted cash only twice a year and that happensactually in Q1 and Q3. So there will be no principal payments made on Goldmanin Q4, just mechanistically, that cannot happen.

Aaron Lindberg -William Smith

Okay. Can you just review the mechanism around that for us? Iknow that they've got the ability to draw -- I guess, I thought that you guysalso have the ability to make prepayments on that as you [talk to us].

Steven Engle

We can do within certain limitations something we would notat this point choose to do. They do mechanistically every six months, I believeit's in March and September. Have the opportunity to draw down of course, theinterests do, but also principal payments for excess amount of that maybe inthe restricted cash which is derived from the royalty payment stream. Ashappened in September, though, when they elect not to do that that cash thengets returned to the XOMA unrestricted cash and that really is Goldman's call.

Aaron Lindberg -William Smith

Okay. On interest expense, you said that you had expectedinterest expense for the full year to be like 10% lower than ' 06?

David Boyle

Yeah.

Aaron Lindberg -William Smith

Okay. Can you tell me what you expected for -- it looks likethen you would have a pretty large interest expense in Q4, just year-to-date Ithink the interest expense is really like $4.2 million.

David Boyle

Well, year-to-date net interest expense is about $9 million.Keep in mind that within that we had about $6.6 million in Q1 that was relatedto the convertible debt. [multiple speakers]. So, I mean, if you take that out and youcertainly look at our last quarter where we had net interest expense, we had actuallyabout $1.2 million in expense and about $3 million in income and less than amillion (inaudible) that out you get a better idea of what Q4 is likely to be.

Aaron Lindberg -William Smith

Okay, yeah no primarily (inaudible) there. Last question doyou believe there are additional other companies that may take significant BCElicense like Pfizer, maybe companies that are using the BCE in development right now, the license that beforethey commercialize the product will need to have one?

Steven Engle

Well, let me just say that we expect to continue to licensethat technology as we've suggested in the call we are continuing discussionswith a number of potential collaboration partners and licensees of ourtechnology.

Alan Solinger

There are several large companies that have not taken alicense that we believe probably should. So, we will target those companiesaggressively to continue seeing revenues come out of this area. And then, ofcourse, there may be smaller companies and so forth along the way.

Aaron Lindberg -William Smith

Perfect, thank you.

Steven Engle

Thank you.

Operator

Thank you. There are no further questions at this time. Iwould like to turn the floor back over to management for closing comments.

Steven Engle

We again, are just very excited about the progress thisquarter. I hope you are too and we think we've got even bigger things to see inthe coming months. So, please stay tuned. Thank you.

Operator

Ladies and gentlemen, this does conclude today's conference.You may disconnect your lines at this time. Thank you for your participation.

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