Encysive Pharmaceuticals (ENCY) 10-Q 2005 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	FOR QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
	OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 0-20117

ENCYSIVE PHARMACEUTICALS INC.

(Exact name of registrant as specified in its charter)

Delaware	13-3532643
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)

4848 Loop Central Drive, Suite 700, Houston, Texas	77081
(Address of principal executive office)	(Zip code)

(713) 796-8822

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yesþ Noo

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yesþ Noo

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yeso Noþ

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, exclusive of treasury shares, as of the latest practicable date.

Class	Outstanding at October 31, 2005
Common stock, $0.005 par value	58,424,489

ENCYSIVE PHARMACEUTICALS INC.

TABLE OF CONTENTS

	PAGE NO.
Part I.Financial Information
Item 1: Financial Statements (Unaudited)
Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004		1
Consolidated Statements of Operations and Comprehensive Loss for the three and nine months ended September 30, 2005 and 2004		2
Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and 2004		3
Notes to Consolidated Financial Statements		4
Item 2: Management’s Discussion And Analysis Of Financial Condition And Results Of Operations		10
Item 3: Quantitative And Qualitative Disclosures About Market Risk		21
Item 4: Controls And Procedures		21
Part II.Other Information
Item 1: Legal Proceedings		21
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds		21
Item 3: Defaults Upon Senior Securities		21
Item 4: Submission Of Matters To A Vote Of Security Holders		22
Item 5: Other Information		22
Item 6: Exhibits		22
SIGNATURES		23
Certification of CEO pursuant to Rule 13a-14(a)/Rule 15d-14(a)
Certification of CFO pursuant to Rule 13a-14(a)/Rule 15d-14(a)
Certification pursuant to 18 U.S.C. Section 1350
Certification pursuant to 18 U.S.C. Section 1350

ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

($ in thousands, except share and per share data)
(Unaudited)

	September 30,			December 31,
	2005			2004
ASSETS
Current assets:
Cash and cash equivalents	$	122,798		$	46,130
Short-term investments		23,961			22,971
Accounts receivable		2,740			4,816
Other current receivables		449			348
Prepaids		944			849
Total current assets		150,892			75,114
Equipment and leasehold improvements, net		4,955			5,107
Deferred debt origination costs, net of accumulated amortization of $370 and $—		4,293			—
Intangible and other assets, net of accumulated amortization of $553 and $474		472			551
Total assets	$	160,612		$	80,772
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,801		$	2,897
Accrued expenses		16,671			12,300
Deferred revenue		1,288			561
Total current liabilities		20,760			15,758
Deferred revenue		1,608			1,119
Long-term debt		130,000			1,730
Minority interest		—			628
Commitments and contingencies
Stockholders’ equity:
Preferred stock, par value $.005 per share. 5,000,000 shares authorized, none issued or outstanding		—			—
Common stock, par value $.005 per share. At September 30, 2005 150,000,000 shares authorized; 58,604,819 shares issued, 58,391,819 shares outstanding. At December 31, 2004, 75,000,000 shares authorized; 58,131,254 shares issued, 57,918,254 shares outstanding		293			291
Additional paid-in capital		303,588			300,906
Deferred compensation expense		(411	)		(129	)
Treasury stock, 213,000 shares		(1,602	)		(1,602	)
Accumulated other comprehensive income		—			189
Accumulated deficit		(293,624	)		(238,118	)
Total stockholders’ equity		8,244			61,537
Total liabilities and stockholders’ equity	$	160,612		$	80,772

See accompanying notes to consolidated financial statements

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ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS

($ in thousands, except share and per share data)
(Unaudited)

	Three Months Ended September 30,							Nine Months Ended September 30,
	2005			2004				2005			2004
Revenues:
Research agreements	$	—		$	—			$	—		$	1,521
Royalty income, net		2,643			2,307				7,643			6,059
License fees, milestones and grants		322			141				784			421
Total revenues		2,965			2,448				8,427			8,001
Expenses:
Research and development		16,248			16,540				49,929			40,682
General and administrative		5,922			2,573				16,501			7,723
Total expenses		22,170			19,113				66,430			48,405
Operating loss		(19,205	)		(16,665	)			(58,003	)		(40,404	)
Investment income, net		1,351			320				3,284			1,041
Interest expense		(975	)		(1	)			(2,122	)		(42	)
Loss from continuing operations		(18,829	)		(16,346	)			(56,841	)		(39,405	)
Gain (loss) on discontinued operations		—			(233	)			1,335			(601	)
Net loss		(18,829	)		(16,579	)			(55,506	)		(40,006	)
Other comprehensive income:
Foreign currency translation:
Unrealized (loss) gain		—			(182	)	��		—			82
Less: reclassification adjustment for gains included in net loss		—			—				(189	)		—
Comprehensive loss	$	(18,829	)	$	(16,761	)		$	(55,695	)	$	(39,924	)
Net loss per common share-basic and diluted	$	(0.32	)	$	(0.31	)		$	(0.96	)	$	(0.76	)
Weighted average common shares used to compute basic and diluted net loss per share		58,077,323			53,606,539				57,877,713			52,781,749

See accompanying notes to consolidated financial statements

2

ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

($ in thousands)
(Unaudited)

	Nine Months Ended September 30,
	2005			2004
Cash flows from operating activities:
Net loss from continuing operations	$	(56,841	)	$	(39,405	)
Adjustments to reconcile net loss from continuing operations to net cash used in operating activities:
Depreciation and amortization		813			546
Expenses paid with stock		666			586
Stock-based compensation expense		179			216
Loss on disposition of fixed assets		14			3
Amortization of debt issue costs		370			—
Amortization of discount/premium on investments		(15	)		89
Change in interest receivable included in short-term investments		(235	)		131
Change in operating assets and liabilities:
Accounts receivable		2,076			(528	)
Prepaids		(108	)		(568	)
Other current receivables		(265	)		460
Accounts payable and accrued expenses		4,962			5,438
Deferred revenue		1,216			(421	)
Net cash used in continuing operations		(47,168	)		(33,453	)
Net cash used in discontinued operations		(603	)		(1,006	)
Net cash used in operating activities		(47,771	)		(34,459	)
Cash flows from investing activities:
Purchases of equipment and leasehold improvements		(1,663	)		(567	)
Purchases of investments		(83,187	)		(43,860	)
Maturity of investments		82,447			29,898
Investing activities of discontinued operations		—			(15	)
Net cash used in investing activities		(2,403	)		(14,544	)
Cash flows from financing activities:
Proceeds from sale of common stock and option exercises		1,557			38,958
Debt issue costs		(4,663	)		—
Borrowing (repayment) of long-term debt		130,000			(6,000	)
Net cash provided by financing activities		126,894			32,958
Effect of exchange rate changes on cash		(52	)		(12	)
Net increase (decrease) in cash and cash equivalents		76,668			(16,057	)
Cash and cash equivalents at beginning of period		46,130			65,302
Cash and cash equivalents at end of period	$	122,798		$	49,245
Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	1,624		$	39
Non-cash transactions during the period:
Issuance of Common Stock for expenses	$	666		$	586
Stock-based compensation expense	$	179		$	216

See accompanying notes to consolidated financial statements

3

ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2005 (unaudited)

(1) Basis of Presentation

     The accompanying unaudited consolidated financial statements of Encysive Pharmaceuticals Inc., a Delaware corporation, and its subsidiaries (collectively referred to as the “Company” or “Encysive”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“USA”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. They do not include all information and notes required by accounting principles generally accepted in the USA for complete financial statements. It is recommended that these interim condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. Except as disclosed herein, there has been no material change in the information disclosed in the notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine-month periods ended September 30, 2005, are not necessarily indicative of the results that may be expected for any other interim period, or for the year ending December 31, 2005.

(2) Organization and Significant Accounting Policies

(a) Organization

     Encysive is a biopharmaceutical company focused on the discovery, development and commercialization of novel synthetic small molecule compounds to address unmet medical needs. The Company’s research and development programs are predominantly focused on the treatment and prevention of interrelated diseases of the vascular endothelium and exploit its expertise in the area of the intravascular inflammatory process, referred to as the inflammatory cascade, and vascular diseases. Since its formation in 1989, the Company has been engaged principally in research and drug discovery programs and clinical development of certain drug compounds.

     The Company is presently working on a number of long-term development projects that involve experimental and unproven technology, which may require many years and substantial expenditures to complete, and which may or may not be successful. Sales of the Company’s first FDA-approved product, Argatroban, for which it receives royalty income, began during November 2000.

(b) Basis of Consolidation

     The Company’s consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries, ImmunoPharmaceutics, Inc. (“IPI”), a California corporation; Encysive, L.P. (“ELP”), a Delaware limited partnership; EP-ET, LLP, a Delaware limited partnership; and Encysive (UK) Limited, a private company located in the United Kingdom (UK). The Company’s consolidated financial statements for the year ended December 31, 2004, and those included in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2005, also included Revotar Biopharmaceuticals AG (“Revotar”), a German corporation, which was a majority-owned subsidiary until May 2005. In May 2005, the Company and the other shareholders of Revotar consummated a restructuring (the “Restructuring”) whereby the Company’s ownership of Revotar was initially reduced to approximately 14%. Subsequently, Revotar’s other stockholders purchased the Company’s remaining Revotar shares for nominal consideration. Following the Restructuring, the Company accounted for its investment in Revotar using the cost method. Financial statements included in this quarterly report on Form 10-Q for prior-year periods have been reclassified to reflect the Restructuring. For additional information about the Restructuring, see Note 8. All material intercompany balances and transactions have been eliminated.

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(c) Stock-Based Compensation

     At September 30, 2005, the Company had five stock-based compensation plans for employees and non-employee directors. The Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The Company’s results of operations for the three and nine-month periods ended September 30, 2005 and 2004, include stock-based compensation expense arising from the grant of shares of restricted common stock to employees and the recognition of deferred compensation expense arising from the grant of stock options in March 2003 to certain employees, which were subject to the approval of stockholders of an amendment to increase the authorized shares in the 1999 plan. The Company also recorded stock-based compensation expense in the three and nine months ended September 30, 2005, as a result of the grant of stock options to a consultant. No other stock-based employee compensation expense is reflected in net loss, however, as all options granted under those plans had an exercise price equal to the market price of the underlying Common Stock on the date of grant.

     In December 2004, the FASB issued Statement No. 123R, “Share-Based Payment” (“FAS 123R”), which requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using a fair-value based method and the recording of such expense in our consolidated statements of operations and comprehensive loss. The implementation of accounting provisions of FAS 123R has been delayed and will now be effective for annual reporting periods beginning after June 15, 2005. The Company is required to adopt FAS 123R in the first quarter of 2006. The pro forma disclosures previously permitted under FASB Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” (“FAS 123”) no longer will be an alternative to financial statement recognition. Although we have not yet determined whether the adoption of FAS 123R will result in amounts that are similar to the current pro forma disclosures under FAS 123, we are evaluating the requirements of FAS 123R and expect the adoption may have a significant adverse impact on our future consolidated statements of operations and comprehensive loss. The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of FAS 123 to stock-based employee compensation (dollars in thousands, except for per share data).

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2005			2004			2005			2004
Net loss, as reported	$	(18,829	)	$	(16,579	)	$	(55,506	)	$	(40,006	)
Add: Stock-based employee compensation expense Included in reported net loss		5			56			43			216
Deduct: Total stock-based Employee compensation expense determined under fair value method for all awards		(1,241	)		(1,037	)		(3,657	)		(2,625	)
Pro forma net loss	$	(20,065	)	$	(17,560	)	$	(59,120	)	$	(42,415	)
Loss per share:
As reported, basic and diluted	$	(0.32	)	$	(0.31	)	$	(0.96	)	$	(0.76	)
Pro forma, basic and diluted	$	(0.35	)	$	(0.33	)	$	(1.02	)	$	(0.80	)

     The per-share weighted average fair value of stock options granted during the three-month periods ended September 30, 2005 and 2004, was $6.07 and $5.23, respectively, and in the nine-

5

month periods ended September 30, 2005 and 2004, was $6.37 and $5.95, respectively, on the grant date using the Black-Scholes option pricing model with the following assumptions:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2005		2004		2005		2004
Expected dividend yield		0.0%		0.0%		0.0%		0.0%
Risk-free interest rate		4.0%		3.1%		4.1%		2.9%
Expected volatility		55.2%		69.6%		67.2%		73.6%
Expected life in years		4.52		4.47		4.91		4.82

(d) Debt Issue Costs

          The Company incurred costs, principally comprised of initial purchasers’ discounts and various legal and professional fees, of approximately $4,663,000 related to the issue of its 2.50% Convertible Senior Notes due 2012 (the “Notes”) in March 2005. Debt issue costs are deferred, and recognized from the issuance of the Notes through the date that the Company has the ability to call the Notes, March 20, 2010. Interest expense in the three and nine months ended September 30, 2005, includes approximately $167,000 and $370,000, respectively, in amortized debt issue costs. Remaining unamortized debt issue costs were approximately $4,293,000 at September 30, 2005. For additional information about the Notes, see Note 9.

(e) Use of Estimates

          Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ from these estimates.

(f) Reclassifications

     As discussed above in Note 2(b), certain reclassifications have been made to prior period financial statements to conform to the September 30, 2005, presentation with no effect on net loss or stockholders’ equity previously reported.

(3) Capital Stock

     In March 2005, the Company issued the Notes in the principal amount of $130,000,000. As the Notes are convertible into the Company’s common stock, the Company has reserved 9,322,001 shares for issuance upon conversion, including 213,000 treasury shares. For additional information about the Notes, see Note 9. The Company has reserved Common Stock for issuance as of September 30, 2005, as follows:

Stock option plans	8,849,832
2.50% Convertible Senior Notes due 2012	9,322,001
Total shares reserved	18,171,833

(4) Cash, Cash Equivalents, and Short-Term Investments

     Cash equivalents are considered to be those securities or instruments with original maturities, when purchased, of three months or less and are recorded at cost. Short-term investments consist of debt securities with remaining maturities of less than one year and original maturities greater than three months at the purchase date. The Company classifies all short-term investments as held-to-maturity. Held-to-maturity securities are those securities in which the Company has the ability and intent to hold the security until maturity. Short-term investments are stated at amortized cost plus accrued interest. Interest income is accrued as earned. The Company evaluates the carrying value of

6

its securities by comparing the carrying value of the securities to their market value. In the event that the fair value of a security were to decline below its carrying cost, and in the opinion of management such decline was other than temporary, the Company would record a loss and reduce the carrying value of such security to its fair value.

Investments at September 30, 2005, and December 31, 2004, were as follows (dollars in thousands):

	September 30, 2005
			Gross		Gross
Short-term investments	Amortized		Unrealized		Unrealized			Estimated
Held-to-maturity	Cost		Gains		Losses			Fair Value
Corporate commercial paper and loan participations	$	21,945	$	—	$	(9	)	$	21,936
US Government agency securities		2,016		—		(20	)		1,996
Total short-term held-to-maturity investments	$	23,961	$	—	$	(29	)	$	23,932

			December 31, 2004
			Gross		Gross
Short-term investments	Amortized		Unrealized		Unrealized			Estimated
Held-to-maturity	Cost		Gains		Losses			Fair Value
U.S. Government agency securities	$	2,006	$	—	$	(21	)	$	1,985
Corporate commercial paper		19,964		14		(46	)		19,932
Corporate debt securities		1,001		—		(1	)		1,000
Total short-term held-to-maturity investments	$	22,971	$	14	$	(68	)	$	22,917

(5) Net Loss per Common Share

     Basic net loss per common share is calculated by dividing the net loss by the weighted average number of common and common equivalent shares outstanding during the period. For the three-month periods ended September 30, 2005 and 2004, the weighted average common shares used to compute basic and diluted net loss per common share totaled 58,077,323 and 53,606,539, respectively. The weighted average common shares used to compute basic and diluted net loss per common share totaled 57,877,713 and 52,781,749, respectively, for the nine-month periods ended September 30, 2005 and 2004. Securities convertible into Common Stock comprised of stock options, shares of common stock reserved for issuance upon conversion of the Notes and unvested shares of restricted common stock totaling 14,860,799 and 5,346,837 shares at September 30, 2005 and 2004, respectively, were not used in the calculation of diluted net loss per common share because the effect would have been antidilutive.

(6) Income Taxes

     The Company did not incur tax expense (benefit) during the three and nine-month periods ended September 30, 2005 and 2004, due to operating losses and the related increase in the valuation allowance.

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(7) Entity-Wide Geographic Data

     The Company operates in a single business segment that includes research and development of pharmaceutical products. As a result of the Restructuring, all of the Company’s operations are currently located within the United States. While the Company has conducted clinical trials in countries other than the United States, the management of those trials has been administered by unrelated third parties. See Note 8 for additional information about the Restructuring.

     The Company’s revenues are primarily derived from two entities, each of whom represents a significant percentage of total revenues. The following table summarizes the Company’s sources of revenues from its principal customers (dollars in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2005		2004		2005		2004
Entities:
GSK	$	2,643	$	2,307	$	7,643	$	6,059
Schering-Plough		322		141		784		1,942
Total	$	2,965	$	2,448	$	8,427	$	8,001

(8) Foreign Subsidiary

     In April 2005, the stockholders of Revotar agreed to restructure Revotar’s capitalization. Under the terms of the Restructuring, Revotar’s stockholders other than the Company contributed additional funds to Revotar, and the Company’s ownership was reduced to approximately 14% of the outstanding common stock of Revotar. Revotar’s other stockholders subsequently purchased the remaining shares of Revotar common stock owned by the Company for nominal consideration. Upon the funding of Revotar by the other stockholders, the Company licensed its worldwide rights to bimosiamose and certain follow-on compounds to Revotar for which it could receive substantial future royalty payments from Revotar in the event that these compounds are subsequently approved and commercialized, or licensed to a third party. Further, the Company agreed to cancel its outstanding loan, and accrued interest thereon, of approximately $3.7 million. The transaction became effective in May 2005, upon contribution of the additional capital by Revotar’s other stockholders. Following the completion of the Restructuring, the Company’s consolidated financial statements no longer include the results of Revotar. The Company recorded a gain of approximately $1.7 million upon its disposal of Revotar, which is included in the amount reported under the caption “Gain (loss) on discontinued operations” in the Company’s financial statements for the nine-month period ended September 30, 2005.

     Prior to the Restructuring, Revotar had assets of approximately $1.0 million, and liabilities, not including the note payable to Encysive, of approximately $2.5 million. During the nine-month period ended September 30, 2005, Revotar’s revenues were approximately $0.1 million, and reported loss, before minority interest, was approximately $0.8 million.

(9) Long-Term Debt

     In March 2005, the Company issued $130,000,000 in Notes, due 2012. The Company will pay 2.50% interest per annum on the Notes on March 15 and September 15 of each year.

     Holders of the Notes may convert the Notes into shares of common stock at any time prior to the maturity date of the Notes at a conversion rate of 71.7077 shares of common stock per $1,000 principal amount of Notes, which is equal to an initial conversion price of approximately $13.95 per share, subject to adjustment as set forth in the indenture governing the Notes. In the event of certain types of fundamental changes, the Company will increase the number of shares issuable upon conversion or, in lieu thereof, the Company may in certain circumstances elect to adjust the conversion rate and related conversion obligation so that the Notes are convertible into shares of the acquiring or surviving company, or at the option of the Company, the Company may elect to pay the additional value represented by an increase in the conversion

8

rate in cash to holders electing to convert their Notes. On or after March 20, 2010, the Company may redeem some or all of the Notes for cash at 100% of the principal amount plus accrued interest, if the trading price of the Company’s common stock exceeds 140% of the conversion price of the Notes then in effect for at least 20 trading days within a period of 30 consecutive trading days ending on the trading day prior to the date on which the redemption notice is mailed. Upon the occurrence of a fundamental change meeting certain conditions, holders of the Notes may require the Company to repurchase for cash all or part of their Notes.

     The Notes are senior unsecured obligations and rank equally in right of payment with any senior unsecured indebtedness that the Company may incur in the future. The Notes will be effectively subordinated to all future secured indebtedness and all existing and future liabilities of the Company’s subsidiaries, including trade payables and senior in right of payment to any future subordinated indebtedness that the Company may incur.

     The Company was a party to a note arising from its acquisition of the partnership interest of ICOS Corporation in ELP in April 2003. On March 31, 2004, the Company prepaid its remaining $6,000,000 obligation under the note plus accrued interest of $38,000.

(10) Commitments and Contingencies

(a) Foreign Currency Exchange Risk

     The Company is exposed to market risk primarily from changes in foreign currency exchange rates. Although not material to our operations, we were exposed to an increased risk of fluctuating foreign exchange rates during the three and nine months ended September 30, 2005, as a result of the increasing weakness of the U.S. dollar and our increased clinical trial activity in areas outside the U.S. Historically, we have not hedged any of these foreign currency exchange risks except at Revotar. The following describes the nature of this risk that we believe is not material to us. We have contracts with entities in other areas outside the U.S. that are denominated in a foreign currency. To date, these currencies have not fluctuated materially.

(b) Other contingencies

     Like other biopharmaceutical companies, the Company is subject to other contingencies, including legal proceedings and claims arising out of its business that cover a wide range of matters, including, among others, environmental matters, contract and employment claims, and product liability. The Company may be involved in legal actions from time to time. The Company has used various substances in its research and development that have been or may be deemed to be hazardous or dangerous, and the extent of its potential liability, if any, under environmental, product liability and workers’ compensation statutes, rules, regulations and case law is unclear.

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Item 2.

ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Three and Nine Months Ended September 30, 2005, and September 30, 2004

OVERVIEW

     The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes to the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2004, and with the consolidated financial statements and related notes to the financial statements included elsewhere in this Form 10-Q. This discussion contains forward-looking statements based on current expectations that are subject to risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. When used in this discussion, the words “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. Our actual results and the timing of events could differ materially from those anticipated or implied by the forward-looking statements discussed here as a result of various factors, including, among others, those set forth under the “Cautionary Note Regarding Forward-Looking Statements” in our Annual Report on Form 10-K for the year ended December 31, 2004. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this report. Except as required by law, we undertake no obligation to update any of the forward-looking statements in this discussion after the date of this report.

     Encysive is a biopharmaceutical company engaged in the discovery, development and commercialization of novel, synthetic, small molecule compounds to address unmet medical needs. Our research and development programs are predominantly focused on the treatment and prevention of interrelated diseases of the vascular endothelium and exploit our expertise in the area of the intravascular inflammatory process, referred to as the inflammatory cascade, and vascular diseases. We have successfully developed one FDA-approved drug, Argatroban, for the treatment of heparin-induced thrombocytopenia, or HIT, which is marketed by GlaxoSmithKline plc, or GSK. Our lead drug candidate, Thelin™ (sitaxsentan sodium) is an endothelin receptor antagonist that has successfully completed pivotal Phase III clinical trials for the treatment of pulmonary arterial hypertension, or PAH, and is under review by the FDA and the European Medicines Agency (“EMEA”). In addition, we have earlier stage clinical product candidates in development including TBC3711, a next generation endothelin receptor antagonist. Bimosiamose has been licensed to and is being developed by Revotar Biopharmaceuticals AG, or Revotar, which was formerly a majority-owned subsidiary. In May 2005, we substantially revised our licensing agreement with Revotar and completed a capital restructuring of Revotar. For more information, see Note 8 to the financial statements included herein.

     In March 2005, we issued $130 million of 2.50% Convertible Senior Notes, or the Notes, due 2012. For additional information about the Notes, see Note 9 to the consolidated financial statements included herein.

Thelin™ — for the treatment of Pulmonary Arterial Hypertension

     We recently completed the pivotal Phase III clinical trials of Thelin™, an oral small molecule for the treatment of PAH and we submitted a New Drug Application, or NDA, in May 2005. The U.S. Food and Drug Administration (FDA) informed the Company that Encysive’s NDA for Thelin™ was filed on July 23, 2005, under a standard review classification. The FDA Prescription Drug User Fee Act (PDUFA) target action date for Thelin™ is March 24, 2006. We also submitted a Marketing Authorization Application (MAA) with the EMEA during July 2005. Additionally, during 2004, we obtained orphan drug designation for Thelin™ from both the FDA and the European Commission. Orphan drug designation in the U.S. grants exclusivity to Thelin™ for seven years. For us to market Thelin™ in Europe, we will

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need to demonstrate that Thelin™ is not chemically similar to bosentan, or meets certain other criteria. We have received a preliminary opinion of the EMEA that Thelin™ is not chemically similar to bosentan, but final notification has not been received. If we are successful, Thelin™ will have exclusivity in Europe for 10 years. We believe that Thelin™ is not chemically similar to bosentan, as well as meeting other criteria for differentiation.

     We have worldwide commercialization rights to Thelin™. We plan to build specialty sales forces for the commercialization of Thelin™ in North America and Europe. We are still evaluating alternative commercialization plans for the rest of the world.

Argatroban

     Argatroban, licensed from Mitsubishi Pharma Corporation (“Mitsubishi”) and developed in North America by Encysive, is a synthetic direct thrombin inhibitor approved by the FDA in 2000. It is indicated for prophylaxis or treatment of thrombosis for patients with HIT, a profound allergic reaction to anticoagulation therapy with heparin, and for use in HIT patients undergoing precutaneous coronary intervention. Argatroban was approved in Canada in 2002 for use as an anticoagulant therapy in patients with HIT syndrome. GSK markets Argatroban in the U.S. and Canada, and had Hatch-Waxman market exclusivity in the U.S. until June 2005. In June 2005, we filed a supplemental NDA for the use of Argatroban in pediatric patients, which could have prolonged Hatch-Waxman exclusivity in the U.S. to the end of 2005. The filing has been reviewed and our request for additional exclusivity has been denied. We have access to a formulation patent, which expires in 2014, and a process patent that expires in 2017. We are not aware of any regulatory submissions by other parties for generic compounds which could compete with Argatroban. In the three and nine months ended September 30, 2005, Encysive earned royalties from the sales of Argatroban totaling $2.6 million and $7.6 million, respectively. See “Outlook for 2005,” below, for additional information about our plans and expectations for the remainder of 2005.

Other Development Programs

     The Company’s research and development programs include plans to develop oral Thelin™ more broadly in PAH and to explore indications beyond PAH. In addition, we are working on plans to conduct a dose-ranging study in PAH or another indication with TBC3711, a more potent and selective ET(A) receptor antagonist with an improved metabolic profile, pre-clinically. The Company also has intravenous formulations available for both Thelin™ and TBC3711.

     In addition to Thelin™, TBC3711and Argatroban, we have a number of projects in late preclinical development. The Company’s next clinical candidates may be an intravenous or oral vasoactive antagonist or an oral antagonist for an inflammatory disease target. It is anticipated that we may submit two Investigational New Drug Applications next year.

     In April 2005, the stockholders of Revotar agreed to restructure Revotar’s capitalization in an arrangement referred to as the “Restructuring.” As a result, we are no longer funding any drug development activities at Revotar. For additional information about the Restructuring, see Note 8 to the consolidated financial statements included herein.

     We have entered into a worldwide research collaboration and license agreement with Schering-Plough Corporation and Schering-Plough LTD (collectively “Schering-Plough”), to discover, develop and commercialize VLA-4 antagonists. Schering-Plough has informed us that they have completed pre-clinical development with TBC4746, an oral VLA-4 antagonist. In March 2005, the initiation of clinical studies by Schering-Plough triggered a milestone payment to us. VLA-4 is a potential target in the inflammatory cascade taking place within the vasculature. TBC4746 has the potential to address a number of diseases, including asthma and multiple sclerosis. Additionally, on June 30, 2004, Schering-Plough ended their funding of our research on a follow-on compound pursuant to the research agreement.

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Encysive’s Research Programs

     Our research efforts are concentrated on targets within the vasculature, and the potential indications of our drug candidates include cardiovascular diseases and a potentially wide variety of inflammatory diseases involving two complementary sets of targets. The first set of targets relate to vascular G-protein coupled receptors (“GPCRs”). Historically, GPCRs have been some of the most amenable targets for developing commercially successful pharmaceuticals, such as beta-blockers, antihistamines, and most anti-psychotics and anti-depressants. Endothelin receptors, targeted by Thelin™ and TBC3711, are examples of GPCRs.

     Encysive also has developed expertise in pharmacologically intervening in the intravascular inflammatory cascade, representing a second set of intravascular targets. Bimosiamose and TBC4746 are examples of drug candidates that we designed to target two distinct steps in this cascade, the selectins and VLA-4, respectively. Some of the targets in this cascade are GPCRs. Thus, our focus on endothelial cell and related vascular biology has opened up a broad range of disease targets with high, unmet medical need.

Critical Accounting Policies

Revenue Recognition

• We recognize revenue from service contracts as services are performed.

• Royalty revenue is recognized as products are sold by a licensee and we have received sufficient information to record a receivable. Our royalty revenue is based on net sales of product, that is, sales net of discounts, returns and allowances. We have estimated a percentage of gross sales, based on recent experience, as an allowance for future returns, however there can be no assurance that our estimate will be accurate. We believe, however, that differences between estimated and actual future returns will not have a material effect upon our results of operations or financial condition.

• Revenue from collaborative research and development activities is recognized as services are performed.

• We defer the recognition of milestone payments related to contractual agreements that are still in the development stage. Such deferred revenues are amortized into income over the estimated remaining development period. Milestone payments received under contractual agreements that have completed the development stage are evaluated and either recognized into income when earned or amortized over a future period depending upon whether or not the Company continues to have obligations under the terms of the arrangement.

• License fees received under the terms of licensing agreements for our intellectual property are similarly deferred and amortized into income over the estimated developmental period of the licensed item or items.

• Revenue from grants is recognized as earned under the terms of the related grant agreements, typically as expenses are incurred.

     Amounts received in advance of services being performed under contracts are recorded as deferred revenue and recognized as services are performed. We periodically evaluate our estimates of remaining development periods and adjust the recognition of remaining deferred revenues over the adjusted development period remaining. At September 30, 2005, remaining deferred revenue was approximately $2.9 million, of which we expect to recognize approximately $1.3 million over the next twelve months. A future change in our estimate of development periods could accelerate or decelerate the timing of future recognition of deferred revenue.

Stock Options

     We apply Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations (“APB 25”) in accounting for our stock option plans and apply FASB Statement No. 123, “Accounting for Stock-Based Compensation,” and related interpretations (“FAS

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123”) in reporting for our stock option plans. APB 25 utilizes the “intrinsic value” of stock options, defined as the difference between the exercise price of an option and the market price of the underlying share of common stock on the “measurement date,” which is generally the date of grant. Since the exercise price of employee stock options issued under our plans is set to match the market price of our Common Stock, there is generally no compensation expense recognized upon grant of employee stock options. Options granted to non-employees, if any, are valued at the fair value of the option, as defined by FAS 123, utilizing the Black-Scholes option pricing model. We record compensation expense for the fair value of options granted to non-employees. The pro forma effect of recognizing the fair value of stock option grants to employees on our consolidated results of operations is discussed in Note 2(c), Stock-Based Compensation.

     In December 2004, the FASB issued Statement No. 123R, “Share-Based Payment” (“FAS 123R”), which requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using a fair-value based method and the recording of such expense in our consolidated statements of operations and comprehensive loss. The implementation of accounting provisions of FAS 123R has been delayed and will now be effective for annual reporting periods beginning after June 15, 2005. We are required to adopt FAS 123R in the first quarter of 2006. The pro forma disclosures previously permitted under FAS 123 no longer will be an alternative to financial statement recognition. See Note 2(c) to the notes to the consolidated financial statements for the pro forma net loss and net loss per share amounts, for the three and nine months ended September 30, 2005 and 2004, as if we had used a fair-value based method similar to the methods required under FAS 123R to measure compensation expense for employee stock option awards. Although we have not yet determined whether the adoption of FAS 123R will result in amounts that are similar to the current pro forma disclosures under FAS 123, we are evaluating the requirements of FAS 123R and expect the adoption may have a significant adverse impact on our future consolidated statements of operations and comprehensive loss.

Drug Manufacturing and Packaging

     Costs arising from the manufacturing and packaging of drug product, which is intended for use in clinical trials, are recognized as incurred and included in research and development expenses. Upon receiving regulatory approval for marketing of Thelin™, the costs arising from the manufacturing and packaging of Thelin will be capitalized and reported as inventory.

Costs Related to Issue of Long-Term Debt

     Costs incurred in the issuance of the Notes, primarily comprised of initial purchasers’ discounts, legal and other professional fees have been deferred, and will be amortized and reported as a component of interest expense during the periods beginning with the issuance date to the date that we have the ability to call the debt.

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Results of Operations

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our operating results have fluctuated significantly during each quarter and year and we anticipate that such fluctuations, which are largely attributable to varying research and development commitments and expenditures, will continue for the next several years. We have been unprofitable to date and expect to incur substantial operating losses for the next several years as we invest in product research and development, preclinical and clinical testing, commercialization expenses related to Thelin™ and regulatory compliance. We have sustained net losses of approximately $293.6 million from the date of our inception to September 30, 2005. We have primarily financed our operations to date through a series of private placements and public offerings of our common stock, the sale of Notes and several collaborative agreements with third parties to jointly pursue product research and development. See “Liquidity and Capital Resources” below. See also “Additional Risk Factors” in Item 1 “Business” in our Annual Report on Form 10-K for the year ended December 31, 2004.

Three and nine month periods ended September 30, 2005 and 2004

Revenues

     Total revenues increased $0.5 million in the three months ended September 30, 2005, compared with the three months ended September 30, 2004. This increase is primarily due to an increase in royalties earned on sales of Argatroban by GSK of $0.3 million in the quarter ended September 30, 2005, compared with the quarter ended September 30, 2004, due to higher sales of Argatroban. License fees, milestones and grants in the quarters ended September 30, 2005 and 2004, was comprised of the recognition of a license fee and milestones received from Schering-Plough. The current-year period also includes amounts attributable to a milestone payment received from Schering-Plough in March 2005.

     Total revenues in the nine-month period ended September 30, 2005, increased $0.4 million, compared with the nine months ended September 30, 2004. This increase is primarily due to an increase in royalties on sales of Argatroban of $1.6 million in the nine months ended September 30, 2005, compared to the nine-month period ended September 30, 2004, due to higher sales of Argatroban in the current-year period. As discussed above, funding from Schering-Plough under the research agreement ended June 30, 2004, and the nine month period ended September 30, 2004, included approximately $1.5 million in such funding. License fees, milestones and grants in the nine-month periods ended September 30, 2005 and 2004, was comprised of the recognition of a license fee and milestones received from Schering-Plough. The current-year period also includes amounts attributable to a milestone payment received from Schering-Plough in March 2005.

Research and Development Expense

     Research and development expenses were comparable in the three-month periods ended September 30, 2005 and 2004. Research and development expense in the three months ended September 30, 2004, included costs associated with the collection and analysis of data from STRIDE-6, which completed enrollment in June 2004, and costs associated with continued enrollment in STRIDE-2, STRIDE 2-X and STRIDE-3. In the three months ended September 30, 2005, patients were continuing to be enrolled in STRIDE-3 and we continued to incur expenses related to STRIDE 2-X, which completed patient enrollment in September 2005. However, the expenses associated with the submission of our regulatory filings were incurred earlier in the year.

     Research and development expense in the nine-month period ended September 30, 2005, increased $9.2 million, compared with the nine months ended September 30, 2004. Thelin™ development costs increased approximately $5.5 million in the current-year period. The increase is primarily due to costs associated with the STRIDE-2X and STRIDE-3 clinical trials and costs associated with the preparation of

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the NDA for Thelin™ in May 2005 and the MAA submission in July 2005. Employee costs also increased in the current-year period due to hiring additional staff, primarily in the clinical development and regulatory affairs departments, in 2005 and to the effect of our new compensation plan, as discussed below in “Total Operating Expenses.”

     STRIDE-2 completed enrollment in September 2004 and we released top-line results in February 2005. We submitted an NDA with the FDA in May 2005. We also submitted an MAA with the EMEA in July 2005. Additionally, during 2004, we obtained orphan drug designation for Thelin™ from both the FDA and the European Commission. In September 2005, we released preliminary top-line results of STRIDE-2X. We are continuing to enroll patients in STRIDE 3, a long-term safety study, and also expect to incur significant expenses for activities such as data management and analysis as we review the results of the STRIDE clinical trials. We also have incurred significant expenses necessary to prepare our NDA submission in the U.S. and for our MAA submission in Europe. Accordingly, we expect research and development expenses for 2005 to significantly exceed expenses incurred in the comparable prior-year periods. See “Outlook for 2005” below for additional information about our plans and expectations for 2005.

General and Administrative Expense

     General and administrative expense in the three months ended September 30, 2005, increased $3.3 million compared with the three months ended September 30, 2004, primarily due to the establishment of the corporate infrastructure necessary to support commercialization of Thelin™ in the U.S. and Europe, assuming regulatory approval.

     General and administrative expense in the nine months ended September 30, 2005, increased $8.8 million compared with the nine months ended September 30, 2004. Employee costs due to additional staff and to the effect of our new compensation plan increased approximately $2.7 million in the nine months ended September 30, 2005.

     We anticipate that general and administrative expenses in 2005 will significantly exceed expenses incurred in the comparable prior-year periods. For example, we expect significant increases in employee costs due to the expected hiring of additional management and staff, and the recent hiring of a chief financial officer, general counsel and vice president of sales. See “Outlook for 2005,” below, for additional information about our plans and expectations for 2005.

Total Operating Expenses

     Historically, the Company has awarded an annual stock option grant to each employee as a long-term incentive. The pending adoption of FAS123R and mandatory expensing of stock options, however, resulted in our re-evaluation of that practice, particularly as to whether stock options were the most appropriate and effective vehicle to provide incentives to employees. In June 2005, the Company adopted a compensation plan (the “Plan”) for employees of the Company. The Plan establishes grade levels for each employee and provides for the payment of cash bonuses and, for employees who are at or above a threshold grade level in the salary structure, a long-term incentive, payable in restricted common stock. The Plan also provides for a grant of restricted common stock to each new employee upon commencement of employment and eligibility for each employee to earn an annual cash bonus. In addition, certain senior and other key employees are eligible to receive stock options. Management believes that the cost of the Plan beginning in 2006 will approximate the compensation costs that would have been incurred under the Company’s previous compensation plan; however, the reported cost in year 2005 will be higher, as cash bonuses are substituted for stock options. For additional information about the impact of the Plan, refer to “Research and Development Expense” and “General and Administrative Expense,” above.

     Total operating expenses in the three months ended September 30, 2005, increased $3.1 million compared to the three months ended September 30, 2004, primarily due to Thelin™ pre-commercialization activities discussed above. Total operating expenses in the nine months ended September 30, 2005, increased $18.0 million, compared to the nine months ended September 30, 2004. The increase is primarily

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due to higher research and development expenses and to Thelin™ pre-commercialization activities, as discussed above.

Operating Loss

     Operating loss in the three months ended September 30, 2005, increased $2.5 million compared with the three months ended September 30, 2004, due to increased operating expenses in the three months ended September 30, 2005. Operating loss in the nine months ended September 30, 2005, increased $17.6 million compared with the nine months ended September 30, 2004, due to higher operating expenses in the current year period.

     As discussed in “Outlook for 2005,” below, we expect operating losses in the remainder of 2005 to exceed comparable periods in 2004.

Interest Expense

     Interest expense of $1.0 million and $2.1 million in the three and nine-month periods ended September 30, 2005, is primarily due to the issuance of the Notes. Interest expense in the three months ended September 30, 2004, was primarily due to the interest attributed to certain immaterial capital leases for office equipment. Interest expense in the nine months ended September 30, 2004, was primarily due to the $6 million note payable resulting from the acquisition of ELP, which was repaid in March 2004.

Investment Income

     Investment income in the three and nine-month periods ended September 30, 2005, increased approximately $1.0 million and $2.2 million, respectively, compared with the three and nine months ended September 30, 2004, as we invested proceeds received upon issuance of the Notes in March 2005.

Gain (loss) on discontinued operations

     The results of Revotar, which was formerly a majority-owned subsidiary, have been reclassified as discontinued operations as a result of the Restructuring. We recorded a gain of approximately $1.7 million upon the Restructuring, which was partially offset by Revotar’s losses during the nine months ended September 30, 2005.

Liquidity and Capital Resources

     We have financed our research and development activities and other operations primarily through public and private offerings of our Common Stock and the Notes and from funds received through our collaborations, research agreements and partnerships. We also have received royalty revenue from sales of Argatroban.

     Cash, cash equivalents and investments in marketable securities, including accrued interest thereon, was $146.8 million at September 30, 2005, compared with $69.1 million at December 31, 2004. We used $47.2 million in cash in continuing operations during the nine months ended September 30, 2005, compared to $33.5 million during the nine months ended September 30, 2004. Cash used in discontinued operations declined $0.6 million in the nine months ended September 30, 2005, compared to the nine months ended September 30, 2004, as Revotar was disposed of in May 2005. In March 2005, we received a $2 million milestone payment from Schering Plough which is included in deferred revenue at September 30, 2005. The primary operating uses of cash in the 2005 and 2004 periods were to fund our general operating expenses and the ongoing research and development programs, reduced by cash received from investment income, milestones, and research payments from our collaborative partners.

     Investing activities are primarily comprised of our investments in debt securities. Cash is generated from investing activities when marketable securities mature and the resulting cash is utilized primarily to fund operating activities. Cash used in investing activities during the nine months ended September 30,

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2005, was primarily comprised of the investment of funds received from our sale of Notes in March 2005, purchases of equipment, and the build-out of a new office facility for the clinical development, regulatory, sales and marketing, finance and accounting, and executive staffs. Cash used in investing activities during the nine months ended September 30, 2004, was primarily comprised of the investment of funds from our sale of common stock in September 2004 and the purchase of equipment.

     Cash provided by financing activities of $126.9 million during the nine months ended September 30, 2005, included net proceeds of $125.3 million from the sale of the Notes in March 2005 and approximately $1.6 million in proceeds from the exercise of employee stock options. Cash provided by financing activities of $33.0 million during the nine months ended September 30, 2004, included net proceeds of $35.6 million from the sale of 4.6 million shares of our common stock in a public offering in September 2004 and approximately $3.4 million in proceeds from the exercise of employee stock options, partially offset by the repayment of a $6.0 million note arising from our acquisition of ELP.

Material Commitments

     Our material contractual obligations are comprised of (i) amounts borrowed through the issue of the Notes, (ii) obligations under our operating lease agreements and (iii) a contingent obligation to pay the other party of a research agreement a termination fee in the event that we elect to terminate the project prior to completion. In addition, we have signed a long-term purchase agreement for the manufacturing and supply of Thelin™; however, our obligations under the agreement are contingent upon receiving regulatory approval for the marketing of Thelin™ in the U.S.

     As of September 30, 2005, the Company had contractual obligations as follows (Dollars in thousands):

			Less than		1-3		3-5		After 5
Contractual Obligations	Total		1 year		years		years		years
Long-term debt	$	130,000	$	—	$	—	$	—	$	130,000
Operating leases		4,002		1,715		1,828		459		—
Purchase obligations		246		246		—		—		—
Total	$	134,248	$	1,961	$	1,828	$	459	$	130,000

Outlook for 2005

Royalties	$	10.6 to $11.4 million
Revenues (including royalties)	$	11.2 to $12.5 million
Expenses	$	89.0 to $95.0 million
Net loss	$(75) to $(84) million
Cash and investments at year-end	$	110 to $115 million

     For a number of reasons discussed elsewhere in this Form 10-Q, we cannot estimate, with a reasonable degree of certainty, total completion costs or dates of completion of our ongoing research and development projects. See also “Additional Risk Factors” in Item 1 “Business” in our Annual Report on Form 10-K for the year ended December 31, 2004, and “Longer-Term Outlook,” below.

     These expectations are based upon various assumptions, which are subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those projected. Among these risks, trends and uncertainties are timing and cost of our clinical trials, attainment of research and clinical goals and milestones of product candidates, and sales levels of Argatroban. While we do not sell Argatroban, our revenues include a royalty from GSK, which is based on sales and will, accordingly, vary with sales. Our actual royalty revenues could vary from our assumptions to the extent that the actual sales of Argatroban differ from assumed levels.

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     Projected revenues contain continued amortization of deferred license fees and milestones previously received from Schering-Plough, which are being deferred over the estimated development period of the respective compound or program. We periodically review our estimates of development periods and actual recognized revenues could increase or decrease to the extent that we increase or decrease our estimated development periods.

     Projected operating expenses are based upon our current expectations for the year. We have assumed additional staff and other costs necessary to prepare for regulatory filing in the U.S. as well as in the rest of the world. Increased projected operating expenses also reflect higher overall patient enrollment in some of the clinical and other supporting trials. We have assumed additional clinical trial work for Thelin™ in additional indications. Our projected expenses also include basic research efforts on our other programs and levels of administrative support we believe to be necessary. General and administrative expenses are assumed to be significantly greater than in previous years, as we intend to build the infrastructure necessary to support eventual commercialization of Thelin™ in North America and Europe, assuming that we receive regulatory approval. We are still evaluating alternative commercialization strategies for the rest of the world. If we decided to market Thelin™ throughout the rest of the world, we could incur significant additional expenses.

     Projected investment income assumes that the rate of return on invested funds will be approximately 3.9% on an average of approximately $130��million in funds available for investment throughout the remainder of the year.

     Projected interest expense is comprised of interest on the Notes, plus a portion of deferred debt issue costs.

     The range of estimated net loss is based upon our projected revenues and expenses, as discussed above.

Longer-Term Outlook

     We expect to incur substantial research and development expenditures as we design and develop biopharmaceutical products for the prevention and treatment of cardiovascular and other diseases. We anticipate that our operating expenses will significantly increase in subsequent years because:

• We have begun to incur significant commercialization expenses for Thelin™. These costs include:

– market research;

– hiring a general counsel, vice president of sales and other key staff personnel;

– hiring a qualified marketing and field sales force in the U.S., Canada and Europe;

– establishing appropriate infrastructure to support field sales force;

– preparation and production of educational and promotional materials;

– hiring personnel to administer reimbursement from government and private third-party payers; and

– establishing manufacturing, warehousing and distribution processes for our products.

• We expect to incur significant expenses in conjunction with additional clinical trial costs for Thelin™ and expect to begin to incur costs for clinical trials related to additional compounds. These costs include:

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– hiring personnel to direct and carry out all operations related to clinical trials;

– hospital and procedural costs;

– services of a contract research organization; and

– purchasing and formulating large quantities of the compound to be used in such trials.

• There may be additional costs in future periods related to Argatroban in complying with ongoing FDA requirements.

• Our administrative costs and costs to commercialize our products will increase as our products are further developed and marketed.

     Unless we receive regulatory approval for Thelin™, we will not be able to achieve profitability for the foreseeable future. Notwithstanding revenues which may be produced through sales of Thelin™, if approved, we may need to secure additional funds to continue our operations including the required levels of research and development to reach our long-term goals. Estimates of our future capital requirements will depend on many factors, including:

• expenses and risks associated with clinical trials to expand the indications for Thelin™;

• continued scientific progress in our drug discovery programs;

• the magnitude of these programs;

• progress with preclinical testing and clinical trials;

• the time and costs involved in obtaining regulatory approvals;

• the costs involved in filing, prosecuting and enforcing patent claims;

• competing technological and market developments and changes in our existing research relationships;

• our ability to maintain and establish additional collaborative arrangements; and

• effective commercialization activities and arrangements.

     We could seek such additional funding through public or private equity or debt financings including utilizing our effective shelf registration statement, through collaborative arrangements and/or through bank debt. We intend to commercialize Thelin™ in North America and Europe through our own specialty sales force, assuming regulatory approval. We are still evaluating alternative commercialization strategies for the rest of the world. If we decided to market Thelin™ throughout the rest of the world, we could incur significant additional expenses.

Off-Balance Sheet Arrangements

     We have not engaged in off-balance sheet financing arrangements.

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Impact of Inflation and Changing Prices

     The pharmaceutical research industry is labor intensive and wages and related expenses increase in inflationary periods. The leases of space and related building services for our Houston office and laboratory facilities each contain clauses that escalate rent and related services each year based on the increase in building operating costs and the increase in the Houston Consumer Price Index, respectively. To date, inflation has not had a significant impact on our operations.

Cautionary Note Regarding Forward-Looking Statements

     This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements represent our management’s judgment regarding future events. In many cases, you can identify forward-looking statements by terminology such as ‘‘may,’’ ‘‘will,’’ ‘‘should,’’ ‘‘could,’’ ‘‘plan,’’ ‘‘expect,’’ ‘‘anticipate,’’ ‘‘estimate,’’ ‘‘believe,’’ ‘‘predict,’’ ‘‘intend,’’ ‘‘potential,’’ or ‘‘continue,’’ or the negative of these terms or other words of similar import although some forward-looking statements are expressed differently. All statements, other than statements of historical fact, included in and incorporated by reference into this Form 10-Q regarding our financial position, business strategy and plans or objectives for future operations are forward-looking statements. Without limiting the broader description of forward-looking statements above, we specifically note that statements regarding our estimate of the sufficiency of our existing capital resources, our ability to raise additional capital to fund cash requirements for future operations, timelines for initiating new clinical trials, planned announcements of clinical data, the possibility of obtaining regulatory approval, our ability to manufacture and sell any products, potential drug candidates, their potential therapeutic effect, market acceptance or our ability to earn a profit from sales or licenses of any drug candidate, our ability to discover new drugs in the future, and our ability to establish future collaborative arrangements are all forward-looking in nature. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot give any assurance that such expectations reflected in these forward-looking statements will prove to have been correct, and you should be aware that results and events could differ materially and adversely from those contained in the forward-looking statements due to a number of factors, including:

• our failure to achieve positive results in clinical trials or receive required regulatory approvals;

• competitive factors;

• our failure to successfully commercialize our products;

• our inability to manufacture our products;

• variability of our revenue;

• our ability to enter into future collaborative agreements;

• uncertainty regarding our patents and patent rights;

• compliance with current or prospective governmental regulation;

• technological change; and

• general economic conditions.

     You should read these forward-looking statements carefully because they discuss our expectations about our future performance, contain projections of our future operating results or our future financial condition, or state other “forward-looking” information. You should be aware that the occurrence of any of the events described in “Business,” “Additional Risk Factors,’’ “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in our Annual Report on Form 10-K for the fiscal year ended December 31, 2004, could substantially harm our business, results of operations and financial condition and that upon the occurrence of any of these events, the trading price of our common stock could decline, and you could lose all or part of your investment.

     All subsequent written and oral forward-looking statements attributable to us or to persons acting on our behalf are expressly qualified in their entirety by the applicable cautionary statements. We cannot guarantee any future results, levels of activity, performance or achievements. Except as required by law, we undertake no obligation to update any of the forward-looking statements in this Form 10-Q after the date of this Form 10-Q.

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     As used in this Form 10-Q, the words “we,” “our,” “us,” “Encysive,” and the “Company” refer to Encysive Pharmaceuticals Inc., its predecessors and subsidiaries, except as otherwise specified. This Form 10-Q may contain trademarks and service marks of other companies.

Item 3.Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Exchange Risk

     The Company is exposed to market risk primarily from changes in foreign currency exchange rates. Although not material to our operations, we were exposed to an increased risk of fluctuating foreign exchange rates during the three and nine months ended September 30, 2005, as a result of the increasing weakness of the U.S. dollar and our increased clinical trial activity in areas outside the U.S. Historically, we have not hedged any of these foreign currency exchange risks except at Revotar. The following describes the nature of this risk that is not believed to be material to us. We have contracts with entities in other areas outside the U.S. that are denominated in a foreign currency. To date, these currencies have not fluctuated materially.

Item 4.Controls and Procedures

Evaluation of Disclosure Controls and Procedures

     As of the end of the period covered by this report, our management carried out an evaluation, with the participation of our principal executive officer (the “CEO”) and our acting principal financial officer (the “CFO”), of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based on those evaluations, the CEO and CFO concluded:

     (i) that our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure; and

     (ii) that our disclosure controls and procedures are effective.

Changes in Internal Controls Over Financial Reporting

     There have been no changes in our internal controls over financial reporting during the period covered by this report that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

     None

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     None.

Item 3. Defaults Upon Senior Securities

     None

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Item 4. Submission of Matters to a Vote of Security Holders

     None

Item 5. Other Information

     None.

Item 6. Exhibits

Exhibit No.	Description
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) / Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) / Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.
32.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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ENCYSIVE PHARMACEUTICALS INC.

November 8, 2005

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, on the 8th day of November 2005.

ENCYSIVE PHARMACEUTICALS INC.
By:	/s/ Bruce D. Given, M.D.
	Bruce D. Given, M.D.
	President and Chief Executive Officer
By:	/s/ Stephen L. Mueller
	Stephen L. Mueller
	Vice President, Finance and Administration Secretary and Treasurer
	(Acting Principal Financial and Accounting Officer)

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INDEX TO EXHIBITS

Exhibit No.	Description
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) / Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) / Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.
32.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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