Jeffrey Buchalter, the Company’s then President and Chief Executive Officer, resigned for “good reason” (as defined in his employment agreement). We expensed $3.8 million related to Mr. Buchalter’s separation in the first quarter of 2010 and modified it slightly during the second quarter of 2010, as noted above, to $3.6 million. The total amount owing to Mr. Buchalter will be paid per the terms of his employment agreement in the third quarter of 2010.
Corporate restructuring costs associated with the 2009 workforce reduction amounted to $0.7 million during the first quarter of 2009. This represents severance and costs related to terminated employees in general and administrative areas as well as research and development.
n.m. – not meaningful
Net investment income was $0.8 million for the quarter ended June 30, 2010 compared to $1.2 million for the second quarter of 2009, down 30 percent. On a year-to-date basis, net investment income declined 16 percent to $1.8 million. Our current investments are more heavily weighted towards short maturities and reduced risk.
Interest expense, which includes amortization of deferred debt issue costs, was $1.5 million and $4.2 million for the three-month and six-month periods ended June 30, 2010 and $2.8 million and $6.0 million for the three-month and six-month periods ended June 30, 2009, respectively. The reduction in interest expense resulted from the declining balance of our 4% Convertible Senior Notes due in 2013.
During the first quarter of 2009, we repurchased $20.5 million principal amount of our 4% notes at a discount to par yielding a gain of $4.8 million (reflected in Other, net) exclusive of the write-off of related deferred debt offering costs of $0.3 million (reflected in interest expense).
During the three months and six months ended June 30, 2010, we recorded a net income tax benefit of approximately $0.2 million which primarily represents a Canadian transfer pricing refund. During the three months and six months ended June 30, 2009, we recorded no tax expense. No federal income tax provision was recorded for the three months and six months ended June 30, 2010 as the estimated annual effective tax rate is zero.
The amount reported as discontinued operations for the six months ended June 30, 2010 is comprised of the results of operations of the specialty pharmaceutical business for the period January 1 through January 29, 2010 of $3.6 million plus the gain realized on the sale of the specialty pharmaceutical business of $175.4 million. The cash purchase price was $300.0 million, working capital adjustments were approximately $8.0 million, and transaction costs
amounted to $5.0 million. We allocated $40.9 million of the total purchase price to the sale of in-process research and development. The net proceeds attributable to discontinued operations of $262.6 million, less the net carrying value of assets sold of $87.2 million, yielded the $175.4 million gain. In addition to the initial cash received in the transaction, we may receive an amount of up to $27.0 million based on certain success milestones. Furthermore, we may receive royalties of five to ten percent on incremental net sales above the baseline 2009 amount from the marketed specialty pharmaceutical products through 2014.
Liquidity and Capital Resources
Total cash reserves, which include cash, cash equivalents, short-term investments and marketable securities, were $504.0 million as of June 30, 2010, as compared to $199.7 million as of December 31, 2009. The increase was primarily attributable to the receipt of proceeds from the sale of our specialty pharmaceutical business in January 2010.
For the six months ended June 30, 2010, cash provided by operating activities was $40.5 million. Income from continuing operations in the first six months of 2010, adjusted for noncash and non-operating items, constituted approximately $27.4 million of positive cash flow. Changes in various working capital accounts comprised the remainder.
Investing activities generated approximately $304.6 million of cash in the first six months of 2010 compared to cash used in investing activities of $17.0 million during the first six months of 2009. The net proceeds from the sale of the specialty pharmaceutical business of $262.6 million (exclusive of the amount apportioned to the sale of in-process research and development reported in operating revenue) represented the largest source of cash. Maturities of, and net proceeds from, sales of investments accounted for the remainder.
Net cash provided by financing activities was $3.7 million in the first six months of 2010 compared to net cash used in financing activities of $15.9 million in the first six months of 2009. Proceeds from the exercise of employee stock options generated approximately $25.3 million of cash inflow during the first six months of 2010. This inflow was offset, in part, by $18.1 million of expenditures to repurchase shares of the Company’s common stock on the open market as part of the share repurchase program initiated in December of 2009. In the first quarter of 2009, $15.6 million of cash was expended to repurchase $20.5 million principal amount of our 4% notes.
As of June 30, 2010, we had outstanding $134.5 million of convertible senior notes that bear interest at an annual rate of 4%. The sale of our specialty pharmaceutical business constituted a fundamental change under the indenture for the notes, which triggered a change in the conversion rate from 104.712 shares per $1,000 principal amount of notes to 116.535 shares per $1,000 principal amount of notes during the period January 29, 2010 to March 4, 2010. During this period, $115.6 million principal amount of the notes were converted into approximately 13.5 million shares of our common stock. Subsequent to March 4, 2010, the original conversion rate of 104.712 shares per $1,000 principal amount is again in effect. Interest is payable on June 1 and December 1 for the 4% notes. Accrued interest on the notes was $0.4 million and $0.8 million, respectively, as of June 30, 2010 and December 31, 2009.
Our current sources of liquidity are our cash reserves; interest earned on such cash reserves and royalties earned - primarily related to sales of PEGINTRON. Net proceeds from the sale of our specialty pharmaceutical business was approximately $303.0 million. Our board of directors is in the process of determining the funding needs for the continuing operation of our business and evaluating various options to return value derived from the sale of our specialty pharmaceutical business to our stockholders. Based upon our current planned research and development activities and related costs and our current sources of liquidity, we anticipate our current cash reserves and expected cash flow from operations will be sufficient to meet our capital and operational requirements for the near future. While we believe that our current sources of liquidity will be adequate to satisfy our capital and operational needs for the near future, we will likely need to obtain additional capital before any of our product candidates that are currently under development are approved for marketing. We may seek such additional funding through agreements with potential collaborators or by accessing the capital markets. We cannot assure you, however, that we will be able to obtain additional funds on acceptable terms, if at all.
We continue to evaluate the possible sale of our PEGINTRON royalty stream.
21
Off-Balance Sheet Arrangements
As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (SPE), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow limited purposes. As of June 30, 2010, we were not involved in any SPE transactions.
Our 4% notes payable are convertible into shares of our common stock at a conversion price of $9.55 per share and pose a reasonable likelihood of potential significant dilution. The maximum potential dilutive effect of conversion of the 4% notes at the current conversion price is 14.1 million shares. Notes payable are discussed in greater detail in Liquidity and Capital Resources above and in the notes to our condensed consolidated financial statements.
In addition, stock options to purchase 5.2 million shares of our common stock at a weighted average exercise price of $12.60 per share and 0.3 million restricted stock units were outstanding at June 30, 2010 that represent additional potential dilution.
Contractual Obligations
Our major outstanding contractual obligations relate to our operating leases, convertible debt and license agreements with collaborative partners.
During the first quarter of 2010, $115.6 million principal amount of our 4% notes were converted into shares of the Company’s common stock.
Other than the note conversion, there have been no material changes with respect to our contractual obligations as disclosed under Management’s Discussion and Analysis of Financial Condition and Results of Operations - Contractual Obligations in our Annual Report on Form 10-K for the year ended December 31, 2009.
Critical Accounting Policies and Estimates
A critical accounting policy is one that is both important to the portrayal of a company’s financial condition and results of operations and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
Our condensed consolidated financial statements are presented in accordance with accounting principles that are generally accepted in the United States. All professional accounting standards effective as of June 30, 2010 have been taken into consideration in preparing the consolidated financial statements. The preparation of the consolidated financial statements requires estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. Some of those estimates are subjective and complex, and, consequently, actual results could differ from those estimates. The following accounting policies have been highlighted as significant because changes to certain judgments and assumptions inherent in these policies could affect our consolidated financial statements.
We base our estimates, to the extent possible, on historical experience. Historical information is modified as appropriate based on current business factors and various assumptions that we believe are necessary to form a basis for making judgments about the carrying value of assets and liabilities. We evaluate our estimates on an ongoing basis and make changes when necessary. Actual results could differ from our estimates.
Revenues
Royalties under our license agreements with third parties are recognized when reasonably determinable and earned through the sale of the product by the licensee net of future credits, chargebacks, sales discount rebates and refunds and collection is reasonably assured. Notification from the third-party licensee of the royalties earned under the license agreement is the basis for royalty revenue recognition. This information is generally received from the licensees in the quarter subsequent to the period in which the sales occur.
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Income Taxes
Under the asset and liability method of accounting for income taxes, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is provided for when it is more likely than not some portion or all of the deferred tax assets will not be realized. As of June 30, 2010, we believe, based on future projections, that it is more likely than not that our net deferred tax assets, will not be realized. We recognize the benefit of an uncertain tax position that we have taken or expect to take on the income tax returns we file if it is more likely than not we will be able to sustain our position.
Share-Based Payment
Compensation cost, measured by the fair value of the equity instruments issued, adjusted for estimated forfeitures, is recognized in the financial statements as the respective awards are earned. The impact that share-based payment awards will have on our results of operations is a function of the number of shares awarded, vesting and the trading price and fair value of our stock at date of grant or modification. Fair value of share-based payments is determined using the Black-Scholes valuation model which employs weighted average assumptions for expected volatility of our stock, expected term until exercise of the options, the risk free interest rate, and dividends, if any. Expected volatility is based on our historical stock price information.
Recently Issued Accounting Standards, Not Adopted as of June 30, 2010
Milestone Method of Revenue Recognition – Pursuant to a final consensus of the Emerging Issues Task Force of the Financial Accounting Standards Board ratified on March 31, 2010, guidance is provided for determining when milestone payments received in conjunction with research and development efforts performed may be recognized. The guidance is effective no later than the third quarter of 2010 with early adoption permitted. We are evaluating the new guidance which is to be implemented prospectively and do not believe that adoption of the guidance will have a material effect on our results of operations, financial position or cash flows.
Factors That May Affect Future Results
There are forward-looking statements contained herein, which can be identified by the use of forward-looking terminology such as the words “believes,” “expects,” “may,” “will,” “should”, “potential,” “anticipates,” “plans” or “intends” and similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results, events or developments to be materially different from the future results, events or developments indicated in such forward-looking statements. Such factors include, but are not limited to:
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| • | The risk that we will not achieve success in our research and development efforts, including clinical trials conducted by us or our collaborative partners. |
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| • | The risk that we will experience operating losses for the next several years. |
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| • | The risk that there will be a decline in sales of one or more of the products sold by others from which we derive royalty revenues. |
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| • | Decisions by regulatory authorities regarding whether and when to approve our regulatory applications. |
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| • | The risk that we will fail to obtain adequate financing to meet our future capital and financing needs. |
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| • | The risk that key personnel will leave our company. |
A more detailed discussion of these and other factors that could affect our results is contained below and in our filings with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2009. These factors should be considered carefully and readers are cautioned not to place undue reliance on such forward-looking statements. No assurance can be given that the future results covered by the forward-looking statements will be achieved. All information contained herein is as of the date of this report and we do not intend to update this information.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
The majority of our holdings of financial instruments consists of corporate debt securities classified as securities available-for-sale. Apart from custodial accounts related to our Executive Deferred Compensation Plan, we do not invest in portfolio equity securities. We do not invest in commodities or use financial derivatives for trading purposes. Our debt security portfolio represents funds held temporarily pending use in our business and operations. We manage these funds accordingly. We seek reasonable assuredness of the safety of principal and market liquidity by investing in rated fixed income securities while at the same time seeking to achieve a favorable rate of return. Our market risk exposure consists principally of exposure to changes in interest rates. Our holdings are also exposed to the risks of changes in the credit quality of issuers the majority of which are rated A or better. We typically invest the majority of our investments in the shorter-end of the maturity spectrum.
The table below presents the principal amounts or adjusted cost basis and related weighted average interest rates of our marketable debt securities, excluding those related to our Executive Deferred Compensation Plan, by year of maturity (twelve-month intervals ending June 30 of the year indicated) as of June 30, 2010 (in thousands):
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| | 2011 | | 2012 | | 2013 | | After
2014 | | Total | | Fair Value | |
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Fixed Rate | | $ | 34,515 | | $ | 57,825 | | $ | 7,202 | | $ | — | | $ | 99,542 | | $ | 100,149 | |
Average Interest Rate | | | 5.8 | % | | 4.28 | % | | 1.95 | % | | | | | 4.64 | % | | | |
Variable Rate | | | — | | | — | | | — | | | 891 | | | 891 | | | 319 | |
Average Interest Rate | | | | | | | | | | | | 2.35 | % | | 2.35 | % | | | |
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| | $ | 34,515 | | $ | 57,825 | | $ | 7,202 | | $ | 891 | | $ | 100,433 | | $ | 100,468 | |
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Our convertible notes payable outstanding have fixed interest rates. Accordingly, the fair values of the respective issues will fluctuate as market rates of interest rise or fall. Fair values are also affected by changes in the price of our common stock. Our 4% Convertible Senior Notes in the principal amount of $134.5 million are due June 1, 2013 and have a fair value of $156.9 million at June 30, 2010.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures.
Our management, under the direction of our Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the Exchange Act)) as of June 30, 2010. Based on the evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that our disclosure controls and procedures were effective as of June 30, 2010.
Changes in Internal Controls
There were no changes in our internal controls over financial reporting as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, during the period covered by this report that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
As reported in a Current Report on Form 8-K filed by us on July 8, 2010, Craig A. Tooman our Executive Vice President of Finance and Chief Financial Officer tendered his resignation from our company effective July 23, 2010. On July 8, 2010, Mark L. Ogden, a financial consultant to Enzon since 2005, was appointed as acting Vice President of Finance and Principal Financial Officer. As of the date of the filing of this Quarterly Report on Form 10-Q, we do not believe that this change has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.
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Part II OTHER INFORMATION
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009.
We depend on key personnel and may not be able to retain these employees or recruit additional qualified personnel, which would harm our business; our chief executive officer and chief financial officer recently resigned and we currently do not have a chief executive officer or chief financial officer.
Because of the specialized scientific nature of our business, we are highly dependent upon qualified research and development scientists, technical and managerial personnel, including our President of Research and Development. There is intense competition for qualified personnel in the pharmaceutical field. Therefore, we may not be able to attract and retain the qualified personnel necessary for the development of our business. Although we have an employment agreement with our President of Research and Development, our ability to continue to retain him, as well as other senior executives or key managers is not assured.
Effective February 22, 2010, Jeffrey Buchalter resigned as our President and Chief Executive Officer. Our board of directors established an executive committee to serve as a search committee for a new Chief Executive Officer. On February 22, 2010, the executive committee appointed Ralph del Campo as our Chief Operating Officer and designated him as Principal Executive Officer and Dr. Ivan Horak as President of Research and Development. Mr. del Campo had been serving as our Executive Vice President, Technical Operations and Dr. Horak had been serving as our Executive Vice President, Research and Development and Chief Scientific Officer. However, we currently do not have a Chief Executive Officer.
Effective July 23, 2010, Craig A. Tooman resigned as our Executive Vice President of Finance and Chief Financial Officer. On July 8, 2010, Mark L. Ogden, a financial consultant to Enzon since 2005, was appointed as acting Vice President of Finance and Principal Financial Officer following Mr. Tooman’s departure. Our executive committee will conduct a search for a permanent Chief Financial Officer.
The loss of the services of one or a combination of our senior executives, particularly our President of Research and Development, as well as the failure to recruit additional key research and development scientists, technical and managerial personnel, particularly a new chief executive officer and chief financial officer, in a timely manner, could have an adverse effect on our business.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Common Stock
In the second quarter of 2010, we repurchased shares of our Common Stock as set forth in the following table:
ISSUER PURCHASES OF EQUITY SECURITIES
| | | | | | | | | | | | | | |
Period | | | (a) Total
Number of
Shares
Purchased | | (b) Average Price
Paid per Share | | (c) Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs (1) | | (d) Maximum
Number (or
Approximate
Dollar Value) of
Shares that May
Yet Be
Purchased
Under the Plans
or Programs | |
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April 1 – April 30, 2010 | | | 563,665 | | $ | 10.47 | | | 563,665 | | $ | 36,244,000 | |
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May 1 – May 31, 2010 | | | 445,452 | | | 10.29 | | | 445,452 | | | 31,661,000 | |
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June 1 – June 30, 2010 | | | 179,911 | | | 10.50 | | | 179,911 | | | 29,771,000 | |
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Total | | | 1,189,028 | | $ | 10.41 | | | 1,189,028 | | $ | 29,771,000 | |
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25
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| (1) | Share repurchase program announced December 3, 2009 whereby Enzon’s board of directors authorized the repurchase of up to $50.0 million of its outstanding shares of common stock. Through June 30, 2010, the Company had repurchased 1,943,234 shares at an average cost of $10.41 per share for a total expenditure of $20,229,000. |
Item 4. (Removed and Reserved)
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Item 6. Exhibits
(a) Exhibits required by Item 601 of Regulation S-K.
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Exhibit
Number | | | Description | | | Reference
No. |
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3.1 | | | Amended and Restated Certificate of Incorporation dated May 18, 2006, together with that Certificate of Amendment to the Amended and Restated Certificate of Incorporation dated July 13, 2010. | | * | |
3.2 | | | Amended and Restated By-laws effective July 13, 2010. | | * | |
4.1 | | | Rights Agreement dated May 17, 2002 between the Company and Continental Stock Transfer & Trust Company, as rights agent. | | (1) | |
4.2 | | | First Amendment to the Rights Agreement, dated as of February 19, 2003 between the Company and Continental Stock Transfer & Trust Company, as rights agent. | | (2) | |
4.3 | | | Second Amendment to the Rights Agreement, dated as of January 7, 2008 between the Company and Continental Stock Transfer & Trust Company, as rights agent. | | (3) | |
10.1 | | | Amendment No. 2 dated June 18, 2010 to Amended and Restated Severance Agreement with Ralph del Campo dated November 6, 2007. | | (4) | |
31.1 | | | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | | * | |
31.2 | | | Certification of Principal Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | | * | |
32.1 | | | Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | | * | |
32.2 | | | Certification of Principal Accounting Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | | * | |
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| * | Filed herewith. |
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| Referenced exhibit was previously filed with the Commission as an exhibit to the Company’s filing indicated below and is incorporated herein by reference to that filing: |
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(1) | Form 8-A12G (File No. 000-12957) filed May 22, 2002. |
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(2) | Form 8-A12G/A (File No. 000-12957) filed February 20, 2003. |
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(3) | Current Report on Form 8-K filed January 8, 2008. |
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(4) | Current Report on Form 8-K filed June 18, 2010. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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| ENZON PHARMACEUTICALS, INC. |
| | (Registrant) |
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Date: August 9, 2010 | By: | /s/Ralph del Campo |
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| | Ralph del Campo |
| | Chief Operating Officer |
| | (Principal Executive Officer) |
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Date: August 9, 2010 | By: | /s/Mark L. Ogden |
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| | Mark L. Ogden |
| | Vice President, Finance |
| | (Principal Financial Officer and |
| | Principal Accounting Officer) |
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