News Column

XENETIC BIOSCIENCES, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

August 14, 2014

BUSINESS OVERVIEW

Management's discussion and analysis of our financial condition and results of operations ("MD&A") should be read in conjunction with the condensed consolidated financial statements and related footnotes.

The Company is a clinical stage biopharmaceutical company that is focused on the development of certain drug candidates for use in humans that incorporate the use of its patented and proprietary platform technologies that we believe will enable the creation of novel and next generation drug therapies.



Significant Transactions and Recent Developments

On January 23, 2014Xenetic Biosciences, Inc. (the "Company") acquired all of the issued and outstanding capital stock of Xenetic Biosciences (UK) Limited (formerly known as Xenetic Biosciences plc) ("Xenetic UK"), a company incorporated in England and Wales under the Companies Act of 1985 in 1996. The Company's acquisition of Xenetic UK (the "Acquisition") was consummated pursuant to a written plan, known as a Scheme of Arrangement, under Part 26 of the Companies Act 2006 of England and Wales (the "Scheme") dated as of November 21, 2013. The Scheme was approved by Order of the High Court of Justice, Chancery Division, in London (the "Court") on January 23, 2014. In its ruling, the Court considered the fairness of the transaction and determined that the terms and conditions of the issuance of new shares of common stock of the Company in exchange for the issued and outstanding shares of Xenetic UK were fair. Accordingly, the new shares of common stock of the Company issued as part of the Acquisition are "Exempted Securities" under Section 3(a)(10) of the Securities Act of 1933, as amended (the "Securities Act"). Pursuant to the Scheme, the Company exchanged 56 new shares of Company common stock for every whole 175 shares of Xenetic UK capital stock. This transaction resulted in Xenetic UK becoming a wholly owned subsidiary of the Company. An Agreement of Conveyance, Transfer and Assignment of Subsidiaries and Assumption of Obligations, previously executed on November 21, 2013 (the "Hive Out Agreement"), became effective upon closing of the Acquisition. Under the terms of the Hive Out Agreement, ten million shares of the Company's common stock held by General Sales & Leasing, Inc.'s former controlling shareholder, Oxbridge Technology Partners SA ("Oxbridge"), were canceled and returned to treasury. In exchange, Oxbridge acquired all issued and outstanding shares of both of our former operating subsidiaries, Shift It Media Co. and General Aircraft, Inc. In addition, Oxbridge has assumed any and all liabilities connected with the business being transferred and has indemnified the Company for any losses arising out of such liabilities. The Hive Out Agreement also required a payment to Oxbridge in the amount of US dollars ("$") 430,000. The $430,000 payment was made shortly after the closing of the Acquisition. As a result of the Hive Out Agreement, the Company's assets, liabilities, and continuing operations are now exclusively those of Xenetic UK. Please refer to the Company's 2013 Annual Report on Form 10-K filed on April 15, 2014 Part 1: Item 1 - Business, under the caption "Recent Developments", for further information regarding the Acquisition.



Board of Directors

We have recently appointed several experienced public company and industry experts to our Board. We have appointed a chairman, Mark Leuchtenberger, who has served as the CEO of two NASDAQ listed companies including a senior role at Biogen Idec, Inc. and Chairman of the Massachusetts Biotechnology Council. We have appointed a financial expert, Darlene Deptula-Hicks, to chair the audit committee. Ms. Deptula-Hicks is a Chief Financial Officer and has chaired the audit committees of several privately owned as well as US exchange traded companies. We have also appointed as an industry expert, Dr. Timothy CotÉ, who was instrumental in implementing the Orphan Drug Act and led the US Food and Drug Administration ("FDA") Office of Orphan Products Development from 2007 to 2011. Technology Overview The Company is currently in various stages of development with respect to its three core patented and proprietary technologies, these being, PolyXen® (for biologics), OncoHist™ (as a broad spectrum oncology therapy), and ImuXen® (for vaccines). 19



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The Company's three core technologies are summarized as follows:

PolyXen® An enabling technology that utilizes Polysialic Acid ("PSA"), a

biopolymer, consisting of a chain of sialic acids which is a



natural

constituent of the human body. PSA is designed to extend the



half-life

in circulation in the human body for a variety of existing drug molecules and, thereby, to create potentially superior next



generation

drug candidates. OncoHist™ A novel therapeutic platform that utilizes the properties of H1.3 for the development of drug candidates for the treatment of a broad range of cancer indications. OncoHist™, unlike many competing oncology therapies, is based on a molecule occurring naturally in the human body, in the cell nucleus, and is therefore expected to be less toxic and immunogenetic than other oncology therapies.



ImuXen® A novel liposomal co-entrapment encapsulation technology designed to

create new vaccines and improve the use and efficacy of certain existing vaccines for use in the human body. The technology is



based

on the co-entrapment of the nominated antigen(s) in a liposomal vesicle, a design that is intended to maximize both cell and



immune

system mediated responses. All of the Company's current drug candidates are in the development stage and none has yet received regulatory approval for marketing in the US by the FDA or by any other applicable agencies in other countries.



Areas of Therapeutic Application

The nature of the core technologies is that they each have very broad potential application in the creation of potentially superior therapies in, respectively, the fields of biologics, oncology and vaccines. The Company believes that relocating its corporate headquarters to the US provides it with the best possible platform for it to promote and execute its business strategy as a public company striving to introduce new and improved therapies to the US and global patient population. The Company believes OncoHist™ has the potential to address a number of cancers with high mortality, e.g. Acute Myeloid Leukemia ("AML"). Our PolyXen® PSA technology lead candidates primarily focus on blood disorders. Our ErepoXen® drug candidate, designed to be a best in class anemia therapy, is currently in Phase II clinical trials in Australia and New Zealand. Our technology is also the subject of a license deal with Baxter International, Inc. for hemophilia. Our Business Strategy The Company intends to advance the clinical development of its drug candidates through a combination of conducting its own in-house research and through the use of the outside services of contract manufacturing and research organizations. The OncoHist™ drug candidate for AML has been granted orphan drug designation by the FDA. The Company expects to seek further orphan drug designations relating to this novel potentially ground-breaking cancer therapeutic over the next twelve months, working in concert with the Dana Farber Cancer Institute. The advancement of its drug candidates is dependent, in part, on several important co-development collaborations and strategic arrangements. Together with its collaborative partners, Baxter Healthcare SA and Baxter Healthcare Corporation (together referred to as "Baxter"), SynBio LLC ("SynBio"), a Russian pharmaceutical company and significant shareholder in the Company, OJSC ("Open Joint Stock Company") Pharmsynthez ("Pharmsynthez"), a Russian pharmaceutical company and Serum Institute of India Limited ("Serum Institute"), one of India's largest biotech companies and a shareholder in the Company, the Company is focused on developing its pipeline of next generation bio-therapeutics and novel orphan drugs in oncology based on the Company's PolyXen®, OncoHist™ and ImuXen® technology platforms. The Company's strategy is to develop its orphan drug candidates through to regulatory approval. The Company then plans to commercialize those orphan drug candidates. For the non-orphan drug candidates vested in its pipeline via its collaborations, e.g. ErepoXen® and a Multiple Sclerosis vaccine candidate, MyeloXen™, the Company intends to develop to a stage that will enable it to seek profitable out-licensing arrangements with major pharmaceutical companies for further development and eventual commercialization, in exchange for milestone payments and royalties from product sales. Its collaborative out-licensing agreements relating to the platforms are an integral part of its early-stage monetization strategy. Even with regard to its strategy of current and planned future co-development collaborations and out-licensing, the Company must raise significant additional capital in order to develop its drug candidates to the point of commercialization. 20

-------------------------------------------------------------------------------- The Company's management will regularly make evaluations in concert with the Company's Board of Directors as to when to seek additional working capital through various financing structures for the purpose of pursuing its business strategy. Although the Company is optimistic, there can be no assurance that it will be successful in raising additional working capital in the future. If not successful, the Company's business could be adversely affected.



Reliance on Principal Customer

Since August 2005, Baxter has been a principal customer of the Company, accounting for the substantial portion of the Company's revenue, through up-front payments and fee for services in prior years. In both current periods presented, there were no revenues earned under the existing Baxter arrangements. During the three and six months ended June 30, 2013, the Company earned $1 million related to Baxter arrangements.



Our Technologies

PolyXen®

PolyXen® is a platform technology based on the concept of polysialylation. PSA is a polymer chain composed of sialic acids linked together. Sialic acid is found on the external membrane of a number of cell types in the body. In addition, it is a natural component expressed on the external membrane on a number of bacterial types. The chain of sialic acid molecules can be anywhere from 4 to over 200 individual sialic acid molecules in length. The Company uses the linear form of PSA called colominic acid. It is a natural, hydrophilic polymer isolated from a bacterial strain of E. coli K1. This natural glycan is negatively charged, non-toxic and is biodegradable. The PSA chain is extensively purified from large-scale bacterial cultures under Current Good Manufacturing Practices conditions, modified to specified sizes and then attached to defined sites on the therapeutic. Both the site of attachment and the length of the PSA chain can enhance the properties of the therapeutic. The major effect of PSA addition to a therapeutic is to change the apparent hydrodynamic radius of the molecule. This physical alteration then changes a number of the biological characteristics of the therapeutic. The most noticeable, and perhaps the most relevant, is an extension of the lifetime of the therapeutic in blood circulation. This is due to the increase in the size of the drug which results in a decrease in the clearance rate of the molecule in the kidney by glomerular filtration. In addition, studies have shown changes in other biological characteristics such as protease sensitivity and temperature sensitivity. An added benefit is that the conjugated molecules are less viscous in solution than comparable other technologies, providing the potential for easier injections and fewer injection site reactions. Furthermore, we believe that adding PSA to an existing marketed drug may allow for patent extension, thereby potentially creating a patent-protected next generation candidate. The current standard for certain biologic delivery agents is methyl Polyethylene Glycol ("PEG") which is attached similarly to therapeutics. The mode of action between PSA and PEG is similar, increasing the apparent size of the molecule and thereby increasing the circulating time of the drug in the blood. PEGylation is a proven technology that can offer advantages in terms of pharmacokinetics and pharmacodynamics for therapeutics over non-modified, first generation molecules. There are a number of PEG-modified molecules on the market, in clinical trials and under development. However, PEGylation is considered to have limitations, such as non-biodegradability and, at high doses, may thereby result in intra-cellular accumulation, potentially leading to vacuole formation in the cells. In contrast, because PSA is a chain of sialic acids, which are natural constituents of the human body, it is biodegradable into individual sialic acid units. In addition, PEG in many cases has been shown to be immunogenic when coupled to proteins and can activate the complement system. PEG has also demonstrated limitations on a few select molecules. Polysialylation has to date been shown to be non-immunogenic and has demonstrated greater versatility and fewer limitations in the context of early-stage development relative to PEG. We believe PSA may provide the advantages of PEG without many of its disadvantages, offering a potential advance over PEG molecules.



OncoHist™

OncoHist™ is based on research covered under our patent portfolio related to novel functions of histones. Histone H1 has strong anti-proliferative properties against cancer cells of different histological origin. This has been demonstrated extensively for hematologic malignancies, such as leukemias, lymphomas, and myelomas, and also for tumors from other tissues. Susceptibility of cells to the cytotoxic effect of histones is determined by the ability of histone H1 to selectively destabilize the tumor cell membrane, which results in cell death. A novel form of the molecule was developed by the Company and a patent filed for the protection of the new chemical entity, N-bis-met-histone 1.3 (OncoHist™) in use against cancer, providing patent protection at least until 2027. 21 -------------------------------------------------------------------------------- The activity of the new molecule was tested on 58 tumor cell lines derived from various tissues. Hematopoietic tumor cell lines were found to be among the most sensitive cell lines. The mechanism of action appears to be novel, involving the binding of OncoHist™ to the cell membrane, which is completely different than that of other therapeutic agents on the market for hematopoietic cancers. Confirmatory work on this mode of action with more detailed analyses is being completed by Dana-Farber Cancer Institute ("Dana-Farber"). Hematopoietic tumor lines resistant to current chemotherapeutic agents have shown sensitivity to OncoHist™. In laboratory research work, the compound was tested at the National Cancer Institute in 60 human cancer cell lines from different tissue samples and showed high cytotoxic efficacy throughout, which would suggest a broad acting oncolytic potential. OncoHist™'s potency and potential to inhibit growth of cells from various histological origins were confirmed through in-vitro testing against the US National Cancer Institute 60 ("NCI-60"). OncoHist™ was awarded orphan drug designation (Orphan Medicinal Product Designation ("OMPD")) for treatment of AML by the European Commission in December 2007 and by the FDA in October 2008. OncoHist™ was awarded an additional OMPD status for Acute Lymphocytic Leukemia ("ALL") by the European Medicines Agency (the "EMA"). A Phase I-II trial to evaluate the safety and tolerability of OncoHist™ was conducted in 2008 at Saarland University, in Germany with 22 AML patients. Tolerability and safety results were favorable with indications of the drug being immunologically safe. Clinical effects were noted in seven patients with three partial remissions. Most notably, two patients who had received two treatment cycles each experienced stabilization of their disease for 7 and 17 months. A clinical trial with 120 AML patients has been performed in clinical centers in the Russian Federation. The aim of this trial was to examine the potential benefits of OncoHist™ in combination with standard therapy: cytarabine with mitoxantrone. A Non-Hodgkins Lymphoma ("NHL") safety trial has been successfully completed in Russia. As an integral part of the Company's strategy, we intend to await later stage clinical data on NHL to determine whether to progress this candidate into US FDA trials. Based upon our analysis of data from the AML trial performed in the Russian Federation, and data developed in Germany at Saarland University, the Company has determined to commence pre-clinical animal studies which are underway in the US in support of a planned phase 1/IIa IND filing with the FDA in late 2014 or early 2015. ImuXen® ImuXen® is a patented platform technology based on the concept of simultaneous delivery of multiple Active Pharmaceutical Ingredients ("APIs") as antigens within the same liposome. The liposomes are composed of lipids that encapsulate an aqueous core. The APIs can be trapped in the core, be associated with the lipids, or both. Proteins, peptides, nucleic acids, polysaccharides and live or inactivated infectious agents can all be used as an API with the same liposome. Both the size and the lipid composition can be controlled which affects the biological properties of the liposome. Manufacturing involves the passive entrapment of the vaccine APIs by freeze drying commercially available liposomes with the antigens of interest. Having multiple APIs formulated with the same liposome allows simultaneous delivery of the antigens to the same antigen-presenting cell. This may allow a more efficient immune response to all the agents presented. In addition, it is possible that multiple vaccines can be delivered with a single injection. Relevant pre-clinical studies have indicated a reduction in the dose required, a reduction in the number of doses required and a faster immune response time. This efficient immune response also may allow for use of antigens that traditionally give a poor antibody response. A Phase I/II clinical trial to treat Relapsing Remitting Multiple Sclerosis and Secondary Progressive Multiple Sclerosis is in progress in the Russian Federation. Peptides corresponding to antigenic sections of basic myelin protein were encapsulated within liposomes to be used as the therapeutic agent (MyeloXen™). Administration of MyeloXen™ to patients has occurred and follow-up monitoring is in progress. As an integral part of the Company's strategy, we await later stage clinical data on MyeloXen™ to determine whether to progress this candidate into FDA trials and eventual out-licensing.



Critical Accounting Estimates

The preparation of our financial statements in conformity with US GAAP requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amount of expenses during the reporting period. On an ongoing basis, we evaluate management's estimates that are based on historical experience and on various other assumptions that we believe to be 22 -------------------------------------------------------------------------------- reasonable under the circumstances. The result of these evaluations forms the basis for making judgments about the carrying values of assets and liabilities and the reported amount of expenses that are not readily apparent from other sources. Because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material. There has been no material change to our critical accounting estimates since those critical accounting estimates described in our Annual Report on Form 10-K filed on April 15, 2014. RESULTS OF OPERATIONS



The comparison of our historical results of operations for the fiscal quarter ended June 30, 2014 to the fiscal quarter ended June 30, 2013 is set forth below:

Quarter Ended Quarter Ended



Increase Percentage

Description June 30, 2014 June 30, 2013 (Decrease) Change Revenue $ - $ 1,000,000$ (1,000,000 ) 100.0 % Cost of revenue - - - - Gross profit - - - -



Operating costs and expenses:

Research and development 1,032,681 956,410 76,271 8.0 % General and administrative 1,607,210 1,075,993 531,217 49.4 % Loss from operations (2,639,891 ) (1,032,403 ) (1,607,488 ) 155.7 % Loss on disposal of subsidiaries - - - Other income (expense) (128,186 ) 85,239 (213,425 ) 250.4 % Interest income 10,698 9,465 1,233 13.0 % Interest (expense) (1,489 ) (632 ) (857 ) 135.6 % (118,977 ) 94,072 (213,049 ) Net loss $ (2,758,868 )$ (938,331 )$ (1,820,537 ) 194.0 % Revenue Revenue decreased to $0 for the quarter ended June 30, 2014 from $1,000,000 in the comparable quarter in 2013. Revenue for the quarter ended June 30, 2013 is comprised of a single transaction of an upfront non-refundable license fee in the amount of $1 million received from Baxter. We did not record any upfront license fee revenue from Baxter during the quarter ended June 30, 2014.



Cost of Revenue

The Company incurred no cost of revenue for the quarters ended June 30, 2014 and June 30, 2013.

Research and Development



The Company engages in independent research and development ("R&D") in connection with its various technologies.

The total R&D spend by subsidiary location for the quarters ended June 30, 2014 and 2013 is set forth in the table below:

Quarter ended, Subsidiary Location June 30, 2014 June 30, 2013 United States $ 737,954 $ 80,294 United Kingdom 294,239 873,415 Germany 488 2,701



Total research and development expense $ 1,032,681 $

956,410 23

-------------------------------------------------------------------------------- Overall, our corporate R&D expenses for the quarter ended June 30, 2014 increased by approximately $76,000, or 8% to $1,032,681 from $956,410 in the comparable quarter in 2013. As reflected in the above table, the location of research activities is being migrated into the United States, under the overall authority, direction and control of Lipoxen Technologies Limited ("Lipoxen"). As reflected in the table, the US-based subsidiary research expenditures are up approximately 819% while UK-based subsidiary research expenditures are down approximately 66%. This is consistent with the opening of a US-based lab and closing down the UK-based lab in the fourth quarter of 2013. The June 30, 2014UK-based R&D expense is comprised principally of approximately $88,000 in remaining UK-based salaries and wages and approximately $195,000 in payments to Contract Research Organizations ("CRO") while the US-based R&D for the same period is comprised principally of approximately $124,000 in salaries and wages, $461,000 in payments to CRO's and other external service providers, $40,000 in rents, utilities and maintenance, and approximately $19,000 in lab consumables. The June 30, 2013 UK-based R&D expense is comprised principally of approximately $303,000 in salaries and wages, $441,000 in payments to CRO's and approximately $64,000 in rent expense while the US-based R&D expense for the same period is comprised principally of $50,000 of salaries and wages, approximately $10,000 of consultants and approximately $9,000 in stock based compensation.



The US-based expenditures include expenditures paid to CRO's where the underlying research is being supervised in the US under the overall authority, direction and control of Lipoxen.

The table below sets forth the R&D costs incurred by the Company, by category of expense, for the quarters ended June 30, 2014 and 2013:

Quarter ended, Category of Expense June 30, 2014



June 30, 2013

Salaries and wages $ 212,139 $



389,927

Share-based compensation expense 15,573



15,219

Outside services and Contract Research Organizations 655,847 469,440 Rent 23,400 62,791 Lab consumables 19,068 8,637 Other 106,654 10,396



Total research and development expense $ 1,032,681 $

956,410 24



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Research and Development by Subsidiary Location

During the second half of 2013 we began the process of relocating our R&D laboratory facilities to the US, leading to a gradual reduction in salaries and wages, rent expenses and non-program specific related costs incurred in the UK, with a corresponding increase in costs incurred in the US. As reflected in the above table, there is a trend towards the use of increased outside services and CRO's over in-house staffing.



Research and Development by Category of Expense

Salaries and Wages

In aggregate, salaries and wages reflect a decrease of approximately 46%, which is related to the reduction of the UK-based research personnel by the end of 2013 without a corresponding proportionate increase in US-based research personnel through June 30, 2014. Along with the reduced salaries and wages, the relocation of our R&D laboratory facilities has resulted in a shift in the subsidiary location in which the expense is incurred.



Outside Services and CRO Costs

This item is substantially related to CRO and consultant costs, approximately $578,000 and $441,000 for quarters ended June 30, 2014 and 2013, respectively, incurred in connection with the Company's PSA-EPO ErepoXen® human clinical trials being conducted in Australia under the supervision of the US-based subsidiary and in preclinical work being performed in connection with the Company's OncoHist™ AML program in furtherance of a planned IND filing in late 2014 or early 2015. The PSA-EPO costs vary from quarter to quarter depending on the progress of the trials and number of patient enrolled in the study. The change in expense from the quarter ended June 30, 2014 over the quarter ended June 30, 2013 is related to normal fluctuations in the level of activity during the course of the study. Rent During the quarter ended June 30, 2013, the Company operated from two sites in London, a laboratory facility, which has since been closed, and a general and administrative office. As of December 31, 2013 the London laboratory facility was completely closed down with its equipment being sold, disposed or transferred to the US-based laboratory. For the quarter ended June 30, 2014, the Company incurred no R&D rent in London and a full quarter of R&D rent in the US resulting in overall lower rent expenses compared to the quarter ended June 30, 2013. Lab Consumables



The increase in lab consumables expense is correlative to bringing the new lab in the US online and up to the needs of the ongoing research projects.

Other

The increase in other expense results from the net aggregate change of all other miscellaneous R&D costs including approximately $25,000 in computer equipment, support and software, $10,000 in travel and lodging, a one-time $30,000 staff recruiting charge and a net of approximately $31,000 of other general R&D expenses.



General and Administrative

General and administrative expenses increased by approximately $531,000, or 49% for the quarter ended June 30, 2014 to $1.61 million from $1.08 million in the comparable quarter in 2013. The most significant drivers of the change were increases of approximately $178,000 in accounting fees, $309,000 in legal fees, $94,000 in regulatory fees, $70,000 in investor relations, $46,000 in travel, and $42,000 in directors and officers insurance incurred during the quarter ended June 30, 2014 primarily associated with the Company's strategic decision to move from a UK-based, London AIM quoted organization, to a US-based, publicly traded company, as described in the "Significant Transactions and Recent Developments" section of Management's Discussion and Analysis. There were no costs associated with this strategic decision during the comparable quarter in 2013. These increases were offset in part by decreases charges for independent contractors and share-based compensation in the amounts of approximately $194,000 and $68,000, respectively. 25



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Other Income (Expense)

Other income decreased by $213,425, or approximately 250.4%, from an income of $85,239 to an expense of $128,186 in connection with foreign currency exchange gains and losses. Interest Income Interest income increased by $1,233, or approximately 13%, to $10,698 for the quarter ended June 30, 2014 from $9,465 in the comparable quarter in 2013. The increase is related to increases in average cash balances maintained in interest bearing accounts. Interest Expense Interest expense increased by $857 for the quarter ended June 30, 2014 from $632 in the comparable quarter in 2013. The interest expense is related to a financing arrangement with the landlord of the Company's office and lab lease in the US, which commenced in January 2014. 26



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The comparison of our historical results of operations for the six months ended June 30, 2014 to the six months ended June 30, 2013 is set forth below:

Six Six Months Ended Months Ended Increase Percentage Description June 30, 2014 June 30, 2013 (Decrease) Change Revenue $ - $ 1,000,000$ (1,000,000 ) 100.0 % Cost of revenue - - - - Gross profit - 1,000,000 (1,000,000 ) 100.0 % Operating costs and expenses: Research and development 1,597,571 1,576,916 20,655 1.3 % General and administrative 4,001,415 1,957,927 2,043,488 104.4 % Loss from operations (5,598,986 ) (2,534,843 ) (3,064,143 ) 120.9 % Loss on disposal of subsidiaries (1,069,675 ) - (1,069,675 ) 100.0 % Other income (expense) (162,607 ) 201,355 (363,962 ) 180.8 % Interest income 11,742 20,181 (8,439 ) 41.8 % Interest expense (2,373 ) (632 ) (1,741 ) 275.5 % (1,222,913 ) 220,904 (1,443,817 ) Net loss $ (6,821,899 )$ (2,313,939 )$ (4,507,960 ) 194.8 % Revenue Revenue decreased to $0 for the six months ended June 30, 2014 from $1,000,000 in the six months ended June 30, 2013. Revenue for the six months ended June 30, 2013 is comprised of a single transaction consisting of an upfront non-refundable license fee in the amount of $1 million received from Baxter. We did not record any upfront license fee revenue from Baxter during the six months ended June 30, 2014. Cost of Revenue



The Company incurred no cost of revenue for the six months ended June 30, 2014 and June 30, 2013.

Research and Development



The Company engages in independent R&D in connection with its various technologies.

The total R&D spend by subsidiary location for the six months ended June 30, 2014 and 2013 is set forth in the table below:

Six months ended, Subsidiary Location June 30, 2014 June 30, 2013 United States $ 1,160,665 $ 383,298 United Kingdom 435,842 1,185,512 Germany 1,064 8,106



Total research and development expense $ 1,597,571$ 1,576,916

Overall, corporate R&D expenses for the six months ended June 30, 2014 increased by approximately $21,000, or only 1.3% to $1,597,571 from $1,576,916 in the six months ended June 30, 2013. However, as reflected in the above table, the trend in expenditures is away from the UK and into the US. US-based expenditures increased 202% while UK-based expenses decreased by approximately 63%. This is consistent with the opening of a US-based lab and closing down the UK-based lab in the fourth quarter of 2013. The US-based expenditures include expenditures paid to CRO's where the underlying research is being supervised in the US under the overall authority, direction and control of Lipoxen. 27



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The table below sets forth the R&D costs incurred by the Company, by category of expense, for the six months ended June 30, 2014 and 2013:

Six months ended, Category of Expense June 30, 2014



June 30, 2013

Salaries and wages $ 376,567 $



636,466

Share-based compensation expense 30,993



36,677

Outside services and Contract Research Organizations 938,509 716,778 Rent 31,804 127,382 Lab consumables 59,032 32,399 Other 160,666 27,214 Total research and development expense $ 1,597,571$ 1,576,916 28



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Research and Development by Subsidiary Location

During 2013 we began the process of transitioning our R&D laboratory facilities to the US, leading to a reduction in salaries and wages, rent expenses and non-program specific related costs incurred in the UK, with a corresponding increase in costs incurred in the US.

Research and Development by Category of Expense

Salaries and Wages

In aggregate, salaries and wages reflect a decrease of approximately 41%, which is related to the reduction of the UK-based research personnel by the end of 2013 without a corresponding proportionate increase in US-based research personnel during the first six months of 2014. Along with the reduced salaries and wages, the relocation of our R&D laboratory facilities has resulted in a shift in the subsidiary location in which the expense is incurred.



Outside Services and CRO Costs

This item is substantially related to CRO and consultant costs, approximately $924,000 and $687,000 for six months ended June 30, 2014 and 2013, respectively, incurred in connection with the Company's ongoing PSA-EPO ErepoXen® human clinical trials being conducted in Australia under the supervision of the US-based subsidiary and in preclinical work being performed in connection with the Company's OncoHist™ AML program in furtherance of a planned IND filing in late 2014 or early 2015. The PSA-EPO costs vary from quarter to quarter depending on the progress of the trials and number of patients enrolled in the study. The change in expense from the six months ended June 30, 2014 over the six months ended June 30, 2013 is related to normal fluctuations in the level of activity during the course of the study.



Rent

During the six months ended June 30, 2013, the Company operated from two sites in London, a laboratory facility, which has since been closed, and a general and administrative office. As of December 31, 2013 the London laboratory facility was completely closed down with its equipment being sold, disposed or transferred to the US-based laboratory. For the six months ended June 30, 2014, the Company incurred no R&D rent in London and six months of R&D rent in the US resulting in overall lower rent expenses compared to the six months ended June 30, 2013. Lab Consumables



The increase in lab consumables expense is correlative to bringing the new lab in the US online and up to the needs of the ongoing research projects.

Other

The increase in other expense results from the net aggregate change of all other miscellaneous R&D costs, including approximately $36,000 in computer equipment, support and software, approximately $16,000 in travel and lodging, approximately $11,000 in repairs and maintenance, approximately $14,000 in depreciation, a one-time $30,000 staff recruiting charge and a net of approximately $26,000 in other general R&D expenses. 29



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General and Administrative

General and administrative expenses increased by approximately $2.04 million, or 104.4%, for the six months ended June 30, 2014 to $4.0 million from $1.96 million in the comparable six months in 2013. The most significant drivers of the change were increases of approximately $237,000 in salaries, wages, employee fringe benefits and related taxes, $651,000 in accounting and tax professional fees, $525,000 in legal fees, $94,000 in regulatory fees, $73,000 in corporate insurances and $132,000 in investor relations fees incurred during the six months ended June 30, 2014 associated with the Company's strategic decision to move from a UK-based, London AIM quoted, organization, to a US-based, publicly traded company. There were no costs associated with this strategic decision during the comparable six months in 2013. Charges for salaries included in general and administrative expenses increased for the six months ended June 30, 2014 over the six months ended June 30, 2013 due to the hiring of additional general and administrative staff at the Company's Lexington, MA location and charges related to the severance payments of several UK-based employees. In addition, charges for share-based compensation included in general and administrative expenses increased approximately $210,000 for the six months ended June 30, 2014 over the six months ended June 30, 2013, which is primarily related to the accelerated vesting of the 2012 Joint Share Ownership Plan awards in the first quarter of 2014.



Loss on Disposal of Subsidiaries

The loss on disposal of subsidiaries in the amount of $1,069,675 for the six months ended June 30, 2014 arose in connection with the Hive Out Agreement in January 2014. Pursuant to the Hive Out Agreement the Company received ten million outstanding shares of its common stock in exchange for 100% of the outstanding common stock of the subsidiaries and cash in the amount of $430,000. The six months ended June 30, 2013 had no comparable transaction. The Company does not currently intend to dispose of any other subsidiaries in the near future.



Interest Income

Interest income decreased by $8,439, or approximately 41.8%, to $11,742 for the six months ended June 30, 2014 from $20,181 during the six months ended June 30, 2013. The decrease is related to decreases in average cash balances maintained in interest bearing accounts.



Interest Expense

Interest expense increased by $1,741 for the six months ended June 30, 2014 to $2,373 from $632 during the six months ended June 30, 2013. The increase in interest expense is related to a financing arrangement with the landlord of the Company's office and lab lease in the US, which commenced in January 2014.



Liquidity and Capital Resources

We estimate that as of the date of the filing of this Form 10-Q we have working capital available to fund our current business plan to the middle of the first quarter of 2015. Recent developments relating to the supply of clinical material are causing the Company to bring forward a major pre-clinical program spend in order to achieve what management considers to be a pivotal clinical milestone in the development of a key product candidate. Our ability to execute on our business plan, including the continuation and/or expansion of our drug development programs, is dependent on our ability to raise additional working capital, through debt (convertible or otherwise), by means of an equity-based instrument, or a combination thereof. This estimated timeline is based on the Company's revised plan of an accelerated level of research and development spending, mainly with external service providers (principally, Contract Research and Contract Manufacturing Organizations) in order that clinical and pre-clinical programs meet planned development milestones, especially for our OncoHist™ program. As a result of such increased spending levels and, given the available working capital as of the date of the filing of this Form 10-Q, a continuation as planned on these programs will cause the Company to have depleted its working capital during the first quarter of 2015. However, the Company believes that it is in the best interests of its shareholders to meet the revised expenditure plans and that every effort is made to raise the capital necessary to proceed as currently planned. Management is currently engaged in discussions with investment bankers and other finance providers with the goal of raising capital before the end of this calendar year. The amount of capital we plan to raise in that timeframe will determine to what extent we will be able to fund and/or accelerate our development programs. Although we are optimistic about our ability to raise additional working capital, we do not presently have any commitments. There can be no assurance at this time that we will be successful in doing so, or that, if we are successful, we will be able to do so on commercially reasonable terms. If we are unsuccessful in raising capital, our development plans for our drug candidates and our shareholder value will be adversely affected. 30 -------------------------------------------------------------------------------- At June 30, 2014 and December 31, 2013 we had working capital of approximately $6.2 million and $1.7 million, respectively. At June 30, 2014 we had approximately $7.6 million in cash and $2.1 million in total current liabilities. As of December 31, 2013 we had cash and current liabilities of $4.8 million and $3.6 million, respectively. Our working capital decreased during the six months ended June 30, 2014 from our net loss of approximately $6.8 million and cash used in operating activities of approximately $7.1 million that includes significant costs incurred in connection with the Acquisition and the relocation of the Company's laboratory facilities to the US. Working capital was increased from the sale of our common stock to Baxter Healthcare SA resulting in net proceeds of $10 million in January 2014. Please refer to Part II, Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds in this Quarterly Report on Form 10-Q for further information about this sale of our common stock.



Cash Flows Used in Operating Activities

Cash flows used in operating activities for the six months ended June 30, 2014 totaled approximately $7.1 million, which includes a net loss of approximately $6.8 million, partially offset by $1.5 million in non-cash charges for share-based compensation and loss on disposal of subsidiaries and reduced by approximately $1.8 million in net increase in account receivable and reductions in accounts payable and accrued expenses. The $7.1 million includes cash expenses of approximately $1.26 million in salaries, wages, employee fringe benefits and related taxes, including scientific staff, $766,000 in professional consultants approximately $938,000 in program-specific clinical development costs, $864,000 in legal fees and $700,000 in accounting and tax consultants, $451,000 in regulatory, investor relations and travel expenses and $106,000 in corporate insurances. Cash flows used in operating activities for the six months ended June 30, 2013 totaled approximately $1.8 million, which includes a net loss of approximately $2.3 million, partially offset by approximately $0.2 million in non-cash charges and also by approximately $0.3 million net decrease in accounts received and increases in accounts payable and accrued expenses. The $1.8 million includes cash expenses of approximately $1.28 million in salaries, wages, employee fringe benefits and related taxes, including scientific staff, $512,000 in professional consultants approximately $717,000 in program-specific clinical development costs, $336,000 in legal fees and $49,000 in accounting and tax consultants, $126,000 in regulatory, investor relations and travel expenses and $33,000 in corporate insurances.



We expect our 2014 cash used in operating activities to be higher than comparable periods in 2013 predominantly as a result of planned increased spending on R&D activities including outside services and CRO's, partially offset by expected reductions in legal and professional fees. Since there are no milestone receipts expected to fall due during 2014, we do not expect any significant cash sources to be derived from revenues in 2014.

Cash Flows from Investing Activities

Cash flows used in investing activities included $430,000, net, paid out in connection with the Hive Out Agreement for the six months ended June 30, 2014.

For the six months ended June 30, 2013, there were no significant cash sources or uses from investing activities.

31



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Cash Flow from Financing Activities

For the six months ended June 30, 2014 we raised $10 million in financing activities from the sale of approximately 10.7 million shares of common stock to Baxter Healthcare SA. We also raised approximately $102,000 from proceeds in connection with the exercise of approximately 1.98 million stock options by our Chief Executive Officer in January 2014. There were no cash flows from financing activities in the six-month period ended June 30, in 2013.



Off Balance Sheet Arrangements

The Company has no off balance sheet financing arrangements. The Company has two facility lease obligations and written employment agreements with three key employees.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standard Board (FASB) issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09"). ASU 2014-09 supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and most industry-specific guidance. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. This guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, under either full or modified retrospective approach. Early application is not permitted. The Company is currently evaluating the impact of this new standard on its revenue recognition policy. We have considered other recent accounting pronouncements and concluded that they are either not applicable to our business, or that no material effect is expected on the consolidated financial statements as a result of future adoption.



Available Information

Our website address is www.xeneticbio.com. The information in, or that can be accessed through, our website is not part of this Quarterly Report on Form 10-Q. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and amendments to those reports are available, free of charge, on or through our website as soon as practicable after we electronically file such forms, or furnish them to, the U.S. Securities and Exchange Commission (the "SEC"). The public may read and copy any materials we file with the SEC at the SEC'sPublic Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operations of the Public Reference Room can be obtained by calling 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding our filings at www.sec.gov. 32



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