n.m. – not meaningful
Spending on clinical trials is expected to increase during the latter half of 2006, due to anticipated enrollment this summer in a study related to the use of ONCASPAR in the treatment of Non-Hodgkins Lymphoma and certain solid tumor cancers.
Net investment income increased by $14.7 million to $15.8 million for the three months ended March 31, 2006 compared with $1.1 million for the three months ended March 31, 2005. The increase was principally due to the sale in January and February 2006 of our remaining 1,023,302 shares of Nektar Therapeutics, Inc. common stock which resulted in a net gain of $13.8 million and cash proceeds of $20.2 million.
Interest expense was $4.9 million for the three months ended March 31, 2006 and $5.0 million for the three months ended March 31, 2005 reflecting a decline in notes payable.
Other, net expense decreased to $0.3 million for the three months ended March 31, 2006, as compared to $1.4 million for the three months ended March 31, 2005. The March 2005 expense was higher due to costs associated with our holding of NPS Pharmaceuticals, Inc. (NPS) common stock and a related hedging instrument. We recognized a realized loss of $4.0 million on the maturation of the hedging instrument and sale of the underlying shares partially offset by a $2.4 million unrealized gain on the instrument.
During the three months ended March 31, 2006, we recorded a net tax expense of approximately $136,000 which represents state and foreign taxes payable. No U.S. income tax provision was recorded for the three months ended March 31, 2006 as the estimated annual effective tax rate is zero due to the uncertainty around our ability to utilize our net operating loss carryforwards. During the three months ended March 31, 2005, we recognized a tax benefit of approximately $1.8 million calculated at an estimated annual effective tax rate of 37%.
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Liquidity and Capital Resources
Total cash reserves, which include cash, cash equivalents, short-term investments and marketable securities, were $213.8 million as of March 31, 2006, as compared to $226.6 million as of December 31, 2005. The decrease is primarily due to the January payment to Sanofi-Aventis of $35.0 million relating to a reduction of ONCASPAR royalty rate. This was offset in part by the $20.2 million cash proceeds from the sale of Nektar common stock that we owned. We invest our excess cash primarily in United States government-backed securities and investment-grade corporate debt securities and auction rate securities.
Cash provided by operating activities totaled $3.5 million for the three months ended March 31, 2006 compared to cash used in operating activities of $5.1 million for the three months ended March 31, 2005. The favorable shift was almost entirely the result of improved operating income. Cash used in investing activities rose $31.9 million from $23.2 million to $55.1 million. This was due primarily to the January $35.0 million payment to Sanofi-Aventis for an ONCASPAR intangible asset.
As of March 31, 2006, we had $394.0 million of convertible subordinated notes outstanding. The notes bear interest at an annual rate of 4.5%. Interest is payable on January 1 and July 1 of each year. During the three-month periods ended March 31, 2006 and March 31, 2005, there were payments of interest of $8.9 million and $9.0 million, respectively. Accrued interest on the notes was $4.4 million as of March 31, 2006. The holders may convert all or a portion of the notes into common stock at any time on or before July 1, 2008. The notes are convertible into our common stock at a conversion price of $70.98 per share, subject to adjustment in certain events. The notes are subordinated to all existing and future senior indebtedness. We may redeem any or all of the notes at specified redemption prices, plus accrued and unpaid interest to the day preceding the redemption date. The notes will mature on July 1, 2008 unless converted earlier, redeemed at our option or redeemed at the option of the note holder upon a fundamental change, as described in the indenture for the notes. Neither we nor any of our subsidiaries are subject to any financial covenants under the indenture. In addition, neither we nor any of our subsidiaries are restricted under the indenture from paying dividends, incurring debt or issuing or repurchasing our securities.
Our current sources of liquidity are our cash reserves; interest earned on such cash reserves; short-term investments, marketable securities; sales of ABELCET, ADAGEN,ONCASPAR and DEPOCYT; royalties earned, which are primarily related to sales of PEG-INTRON; and contract manufacturing revenue. Based upon our currently 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; however, we may refinance or seek new financing prior to the maturity of our convertible subordinated notes in 2008.
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 seek additional financing, such as through future offerings of equity or debt securities or agreements with collaborators with respect to the development and commercialization of products, to fund future operations and potential acquisitions. We cannot assure you, however, that we will be able to obtain additional funds on acceptable terms, if at all.
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 March 31, 2006, we were not involved in any SPE transactions.
Contractual Obligations
Our major outstanding contractual obligations relate to our operating leases, inventory purchase commitments, convertible debt, and license agreements with collaborative partners.
In January 2006, we terminated our development and supply agreement entered into in June 2003 with, and returned our rights to ATG-Fresenius S to, Fresenius Biotech. The development and supply agreement with Fresenius Biotech provided us with exclusive development and distribution rights in the U.S. and Canada for a new formulation of the polyclonal antibody preparation, ATG-Fresenius S. Subsequently, in April 2006, Fresenius Biotech and Nabi Biopharmaceuticals announced an agreement to advance the ongoing clinical development of ATG-Fresenius S. The clinical trial is currently being transitioned to Nabi Biopharmaceuticals.
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Since December 31, 2005, there have been no other 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 Transition Report on Form 10-K for the six months ended December 31, 2005.
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 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 March 31, 2006 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
Revenues from product sales and contract manufacturing revenue are recognized when title passes to the customer, generally at the time of shipment. For product sales, we also recorded a provision at the time of shipment for estimated future credits, chargebacks, sales discounts, rebates and returns. These sales provision accruals, except for rebates which are recorded as a liability, are presented as a reduction of the accounts receivable balances. We continually monitor the adequacy of the accruals by comparing the actual payments to the estimates used in establishing the accruals.
Effective January 1, 2006, we changed our third-party distributor for three of our four products; ABELCET, ONCASPAR and DEPOCYT. For ABELCET, our new third-party distributor ships product to the same wholesalers as prior to the change and the wholesalers then resell the product to the end-users. We continue to recognize revenues for ABELCET at the time of sale to the wholesaler. The distribution process for ONCASPAR and DEPOCYT has changed. We previously sold the products to a specialty distributor and recorded sales at that time. The distributor then sold the products to the end-user. Now, sales are recorded when ONCASPAR and DEPOCYT are shipped by our new third-party distributor directly to the end-user. The orders may be placed by either the end-user or by a wholesaler representing the end-user. For our fourth product, ADAGEN, our distribution process remains the same. ADAGEN continues to be sold directly to a specialty distributor who then sells the product to end-users. We continue to recognize revenue for ADAGEN upon sale to the specialty distributor.
In addition to the new distributor handling the indicated products on our behalf, it also maintains the related accounts receivable system for us and records sales, cash receipts and certain adjustments. We provide chargeback payments to wholesalers based on their sales to members of buying groups at prices determined under a contract between us and the member. Administrative fees are paid to buying groups based on the total amount of purchases by their members. We estimate the amount of the chargeback that will be paid using (a) distribution channel information obtained from certain of our wholesalers, which allows us to determine the amount and expiry of inventory in the distribution channel and (b) historical trends, adjusted for current changes. The settlement of the chargebacks generally occurs within three months after the sale to the wholesaler. We regularly analyze the historical chargeback trends and make adjustments to recorded reserves for changes in trends.
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In addition, state agencies that administer various programs, such as the U.S. Medicaid programs, receive rebates. Medicaid rebates and administrative fees are recorded as a liability and a reduction of gross sales when we record the sale of the product. In determining the appropriate accrual amount, we use (a) distribution channel information obtained from certain of our wholesalers, which allows us to determine the amount and expiry of inventory in the distribution channel, (b) our historical Medicaid rebate and administrative fee payments by product as a percentage of our historical sales and (c) any significant changes in sales trends. Current Medicaid rebate laws and interpretations, and the percentage of our products that are sold to Medicaid patients are also evaluated. Factors that complicate the rebate calculations are the timing of the average manufacturer pricing computation, the lag time between sale and payment of a rebate, which can range up to nine months, and the level of reimbursement by state agencies.
The following is a summary of reductions of gross sales accrued as of March 31, 2006 and December 31, 2005 (in thousands):
| | | March 31,
2006 | | December 31, 2005 | |
| | |
|
| |
|
| |
| Accounts Receivable Reductions | | | | | | | |
| Chargebacks | | $ | 4,317 | | $ | 3,717 | |
| Cash Discounts | | | 272 | | | 202 | |
| Other (including returns) | | | 1,426 | | | 1,304 | |
| | |
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| |
|
| |
| Total | | $ | 6,015 | | $ | 5,223 | |
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|
| |
| Accrued Liabilities | | | | | | | |
| Medicaid Rebates | | $ | 1,347 | | $ | 1,832 | |
| Administrative Fees | | | 272 | | | 286 | |
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| |
|
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| Total | | $ | 1,619 | | $ | 2,118 | |
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There were no revisions to the estimates for gross to net sales adjustments that would be material to income from operations for the three months ended March 31, 2006.
We have inventory management agreements with three of our major wholesalers. These agreements provide that the wholesalers maintain inventory levels at no more than six selling weeks.
Royalties under our license agreements with third parties are recognized when reasonably estimable 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. Beginning with the quarter ended December 31, 2005, notification from the third party licensee of the royalties earned under the license agreement became 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. Other fees and royalties received from third parties using our technology are recorded as the earnings process is completed. Non-refundable milestone payments that represent the completion of a separate earnings process are recognized as revenue when earned, upon the occurrence of contract-specified events and when the milestone has substance. Non-refundable payments received upon entering into license and other collaborative agreements where we have continuing involvement are recorded as deferred revenue and recognized ratably over the estimated service period.
Income Taxes
Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. 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 on net deferred tax assets is provided for when it is more likely than not that some portion or all of the deferred tax assets will not be realized. We believe, based on future projections, that it is more likely than not that our net deferred tax assets, including our net operating losses from operating activities and stock option exercises, will not be realized.
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Available-for-Sale Securities
We assess the carrying value of our available-for-sale securities in accordance with FASB Staff Position (FSP) 115-1, “The Meaning of Other-Than-Temporary Impairment and its application to Certain Investments.” An impairment write-down is recorded when a decline in the value of an investment is determined to be other-than-temporary. These determinations involve a significant degree of judgment and are subject to change as facts and circumstances change.
Long-Lived Assets
Long-lived assets, including amortizable intangible assets are tested for impairment in accordance with the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. This testing is performed when an impairment indicator is present. An impairment indicator is one or more event or circumstance that may be indicative of possible impairment such as a significant adverse change in legal factors or in business climate, a current period operating loss combined with a history of operating losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset or asset group.
SFAS No. 144 testing for the recoverability of amortizable intangible assets is performed initially by comparing the carrying amount of the asset to the future undiscounted net cash flows to be generated by the assets. If the undiscounted net cash flow stream exceeds the carrying amount, no further analysis is required. However, if this test shows a negative relationship, the fair value of the intangible assets must be estimated and we would record an impairment charge for any excess of the carrying amount over the fair value. These evaluations involve amounts that are based on management’s best estimates and judgment. Actual results may differ from these estimates.
Share-Based Payment
We account for share-based compensation in accordance with SFAS 123R, “Share-Based Payment.” SFAS 123R establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services and requires that the compensation cost relating to share-based payment transactions be recognized in the financial statements, measured by the fair value of the equity or liability instruments issued, adjusted for estimated forfeitures. Until we have developed sufficient reliable Enzon-specific information, we are using an industry average for purposes of estimating forfeitures of share-based payments. As stratified data are developed, they will be compared to the initial average and the rate will be adjusted, as deemed necessary.
Options or stock awards issued to non-employees and consultants are recorded at their fair value as determined in accordance with SFAS No. 123R and EITF No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” and recognized over the related vesting or service period.
Fair value of share-based payments is determined using the Black-Scholes valuation model which employs weighted average assumptions for expected volatility of the Company’s stock, expected term until exercise of the options, the risk free interest rate, and dividends, if any. Expected volatility is based on historical Enzon stock price information.
We have elected the modified prospective transition method which requires that compensation costs be recorded, as earned, for all unvested stock options and restricted stock awards and restricted stock units outstanding at July 1, 2005.
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. Among the factors that could cause actual results, events or developments to differ materially are decisions by regulatory authorities regarding whether and when to approve our regulatory applications as well as their decisions regarding labeling and other matters that could affect the commercial potential of Enzon's products and:
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| • | The risk that there will be a decline in sales of one or more of our marketed products or products sold by others from which we derive royalty revenues. Such sales declines could result from increased competition, loss of patent protection, pricing and/or regulatory constraints. |
| • | The risk that we will not achieve success in our research and development efforts including clinical trials conducted by us or by our collaborative partners. |
| • | The risk that we will be unable to obtain critical compounds used in the manufacture of our products, or one of our key suppliers will experience manufacturing problems or delays. |
| • | The risk that we will fail to obtain adequate financing to meet our future capital and financing needs. |
| • | The risk that key personnel will leave the company. |
A more detailed discussion of these and other factors that could affect results is contained in our filings with the U.S. Securities and Exchange Commission, including our Transition Report on Form 10-K for the six-month period ended December 31, 2005. 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 Enzon undertakes no duty to update this information.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
The following discussion about our exposure to market risk of financial instruments contains forward-looking statements. Actual results may differ materially from those described.
Our holdings of financial instruments are comprised of debt securities and time deposits. All such instruments are classified as securities available-for-sale. We do not invest in portfolio equity securities or 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. We typically invest the majority of our investments in the shorter-end of the maturity spectrum, and at March 31, 2006 all of our holdings were in instruments maturing in four years or less.
The table below presents the principal amounts and related weighted average interest rates by year of maturity for our investment portfolio as of March 31, 2006 (in thousands):
| | | | 2006 | | | 2007 | | | 2008 | | | 2009 | | | Total | | | Fair
Value | |
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| Fixed Rate | | $ | 129,888 | | $ | 27,121 | | $ | 7,600 | | $ | 25,359 | | $ | 189,968 | | $ | 188,873 | |
| Average Interest Rate | | | 2.70 | % | | 3.65 | % | | 4.10 | % | | 4.44 | % | | 3.12 | % | | | |
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| | | $ | 129,888 | | $ | 27,121 | | $ | 7,600 | | $ | 25,359 | | $ | 189,968 | | $ | 188,873 | |
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Our 4.5% convertible subordinated notes in the principal amount of $394.0 million due July 1, 2008 have fixed interest rates. The fair value of the notes was approximately $367.4 million and $356.1 million at March 31, 2006 and December 31, 2005, respectively. The fair value of fixed interest rate convertible notes is affected by changes in interest rates and by changes in the price of our common stock.
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Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures.
Our management, under the direction of our Chief Executive Officer and Chief 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 March 31, 2006. Based on the evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of March 31, 2006.
Changes in Internal Controls
There were no changes in our internal controls over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
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Part II OTHER INFORMATION
Item 6. Exhibits
(a) Exhibits required by Item 601 of Regulation S-K.
| | Exhibit
Number | | Description | | Reference
No. |
|
| |
| |
|
|
| | 3(i) | | Restated Certificate of Incorporation | | (1 | ) |
| | 3(ii) | | By-laws, as amended | | (2 | ) |
| | 4.1 | | Rights Agreement dated May 17, 2002 between the Company and Continental Stock Transfer Trust Company, as rights agent | | (3 | ) |
| | 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 | | (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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| (1) | Previously filed as an exhibit to the Company’s Transition Report on Form 10-K for the six months ended December 31, 2005. |
| | |
| (2) | Previously filed as an exhibit to the Company’s Current Report on Form 8-K filed on May 22, 2002 and incorporated herein by reference thereto. |
| | |
| (3) | Previously filed as an exhibit to the Company’s Form 8-A12G (File No. 000-12957) filed with the Commission on May 22, 2002 and incorporated herein by reference thereto. |
| | |
| (4) | Previously filed as an exhibit to the Company’s Form 8-A12G/A (File No. 000-12957) filed with the Commission on February 20, 2003 and incorporated herein by reference thereto. |
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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.
| | | |
| ENZON PHARMACEUTICALS, INC. |
| | | (Registrant) |
| | | |
| | By: | /s/ Jeffrey H. Buchalter |
| | | Jeffrey H. Buchalter |
| | | President and Chief Executive Officer |
| | (Principal Executive Officer) |
| | | |
| Date: May 3, 2006 | By: | /s/ Craig A. Tooman |
| | | Craig A. Tooman |
| | | Executive Vice President, Finance |
| | | and Chief Financial Officer |
| | | (Principal Financial Officer) |
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