UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR QUARTER ENDED SEPTEMBER 30, 2003
OR
[ ] 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
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
6700 West Loop South, 4th Floor, Bellaire, Texas 77401
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(Address of principal executive office) (Zip code)
(713) 796-8822
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
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(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.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
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 21, 2003
----- -------------------------------
common stock, $0.005 par value 44,606,942
ENCYSIVE PHARMACEUTICALS INC.
TABLE OF CONTENTS
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002 1
Consolidated Statements of Operations and Comprehensive Loss for the
three and nine months ended September 30, 2003 and 2002 2
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2003 and 2002 3
Notes to Consolidated Financial Statements 4
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 17
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 28
ITEM 4: CONTROLS AND PROCEDURES 28
PART II. OTHER INFORMATION
ITEM 1: Legal Proceedings 29
ITEM 2: Changes in Securities and Use of Proceeds 29
ITEM 3: Defaults Upon Senior Securities 29
ITEM 4: Submission of Matters to a Vote of Security Holders 29
ITEM 5: Other Information 29
ITEM 6: Exhibits and Reports on Form 8-K 29
SIGNATURES 30
ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2003 2002
----------------- ------------------
ASSETS
Current assets:
Cash and cash equivalents $ 21,512 $ 21,228
Short-term investments 21,206 26,533
Accounts receivable 1,399 1,098
Other current receivables 399 473
Receivable from related party under collaborative arrangement --- 393
Prepaids 493 1,482
----------------- ------------------
Total current assets 45,009 51,207
Long-term investments 5,021 20,244
Equipment and leasehold improvements, net 5,099 5,579
Other assets 683 762
----------------- ------------------
Total assets $ 55,812 $ 77,792
================= ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,700 $ 950
Accrued expenses 5,730 3,774
Deferred revenue from related party --- 591
Deferred revenue from unrelated parties 545 927
Payable to related party --- 2,664
Current maturity on long-term debt 4,000 ---
----------------- ------------------
Total current liabilities 11,975 8,906
Long-term debt, less current maturity 2,932 ---
Deferred revenue from related party --- 1,181
Deferred revenue from unrelated parties 1,835 3,019
Minority interest in Revotar 1,840 2,608
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, 2003
75,000,000 shares authorized; 44,794,942 shares issued.
At December 31, 2002, 75,000,000 shares authorized;
44,015,364 shares issued. 224 220
Additional paid-in capital 213,502 211,847
Deferred compensation expense (264) (223)
Treasury stock, 213,000 shares (1,602) (1,602)
Accumulated other comprehensive income 116 1
Accumulated deficit (174,746) (148,165)
----------------- ------------------
Total stockholders' equity 37,230 62,078
----------------- ------------------
Total liabilities and stockholders' equity $ 55,812 $ 77,792
================= ==================
See accompanying notes to consolidated financial statements
1
ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
($ IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
------------- ------------- -------------- --------------
Revenues:
Research agreements $ 761 $ 827 2,245 $ 2,654
Collaborative research and development from
Encysive, L.P. --- 286 664 772
Royalty income, net 1,382 676 3,642 2,481
License fees, milestones and grants 1,270 616 2,306 1,717
------------- ------------- ------------- -------------
Total revenues 3,413 2,405 8,857 7,624
------------- ------------- ------------- -------------
Expenses:
Research and development 8,586 5,286 19,109 16,107
Purchase of in-process research and development --- --- 8,363 ---
Equity in loss of Encysive, L.P. --- 1,838 2,386 6,305
General and administrative 2,840 2,041 7,252 6,803
------------- ------------- ------------- -------------
Total expenses 11,426 9,165 37,110 29,215
------------- ------------- ------------- -------------
Operating loss (8,013) (6,760) (28,253) (21,591)
Investment income, net 267 556 904 1,936
------------- ------------- ------------- -------------
Loss before minority interest (7,746) (6,204) (27,349) (19,655)
Minority interest in loss of Revotar 265 364 768 844
------------- ------------- ------------- -------------
Net loss (7,481) (5,840) (26,581) (18,811)
Other comprehensive gain or loss
Unrealized gain or (loss) on foreign currency translation (52) 64 115 208
------------- ------------- ------------- -------------
Comprehensive loss $ (7,533) $ (5,776) (26,466) $ (18,603)
============= ============= ============= =============
Net loss per common share-
basic and diluted $ (0.17) $ (0.13) (0.61) $ (0.43)
============= ============= ============= =============
Weighted average common shares used to compute
basic and diluted net loss per share 43,914,497 43,798,840 43,801,837 43,719,884
============= ============= ============= =============
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,
----------------------------------------------
2003 2002
--------------------- ----------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (26,581) $ (18,811)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 768 800
Equity in loss of Encysive, L.P. 2,386 6,305
Purchase of in-process research and development 8,363 -
Minority interest in loss of Revotar (768) (844)
Expenses paid with stock 356 257
Stock based compensation expense 400 260
Loss on disposition of fixed assets 2 -
Amortization of premium/discount on investments 183 93
Change in operating assets and liabilities:
Decrease in interest receivable included in short-term
and long-term investments 259 284
Increase in accounts receivable (301) (94)
Decrease in prepaids 990 7
Decrease in other current receivables 131 143
Decrease in receivable from related party under
collaborative arrangement 393 901
Increase (decrease) in current liabilities 2,634 (1,162)
Decrease in liability to related party (5,051) (7,097)
( Decrease) increase in deferred revenue from unrelated parties (1,565) 389
Decrease in deferred revenue from related party (136) (868)
--------------------- ----------------------
Net cash used in operating activities (17,537) (19,437)
--------------------- ----------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment and leasehold improvements (249) (2,049)
Grants received for purchases of equipment 185 167
Purchase of in-process research and development (4,000) -
Purchases of investments (12,953) (72,850)
Maturities of investments 33,062 102,985
--------------------- ----------------------
Net cash provided by investing activities 16,045 28,253
--------------------- ----------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings from minority shareholders of Revotar 905 -
Proceeds from sale of common stock and option and
warrant exercises, net 863 483
--------------------- ----------------------
Net cash provided by financing activities 1,768 483
Effect of exchange rate changes on cash 8 13
--------------------- ----------------------
Net increase in cash and cash equivalents 284 9,312
Cash and cash equivalents at beginning of period 21,228 10,086
--------------------- ----------------------
Cash and cash equivalents at end of period $ 21,512 $ 19,398
===================== ======================
Supplemental schedule of noncash financing activities:
Deferred compensation expense $ 211 $ 249
Issuance of Common Stock for expenses 356 257
Acquisition of equipment under capital leases - 34
Interest paid 76 2
===================== ======================
See accompanying notes to consolidated financial statements
3
ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003 (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, 2002. 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. 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, 2003 are not necessarily indicative of the results that may be
expected for any other interim period, or for the year ending December 31, 2003.
(2) ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
(a) Organization
The Company is a biopharmaceutical company focused on the discovery,
development and commercialization of novel synthetic small molecule
compounds for the treatment of a variety of cardiovascular, vascular and
related inflammatory 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. On July 25, 1994, the
Company acquired all of the outstanding common stock of
ImmunoPharmaceutics, Inc. ("IPI") in exchange for common stock, par value
$.005 per share (the "Common Stock"), of the Company. On June 6, 2000,
Encysive, through its wholly owned subsidiary, EP-ET, LLC, a Delaware
limited liability company, and ICOS Corporation, a Delaware Corporation,
("ICOS") entered into an agreement and formed ICOS-Texas Biotechnology
L.P., a Delaware limited partnership ("ICOS-TBC"), to develop and
globally commercialize endothelin-A receptor antagonists. Encysive and
ICOS were both 50% owners in ICOS-TBC until April 22, 2003, at which time
the Company purchased ICOS's share of ICOS-TBC and changed the name of
ICOS-TBC to Encysive, L.P. ("ELP"). The acquisition of ICOS's ownership
interest in ICOS-TBC is referred to herein as the "Acquisition." See Note
13. During the third quarter of 2000, Encysive formed Revotar
Biopharmaceuticals AG, a German corporation ("Revotar"), to conduct
research and development for novel small molecule compounds and to
develop and commercialize the Company's selectin antagonists. The Company
retained an approximately 55% interest in Revotar. 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 be
unsuccessful. Sales of the Company's first product for which it receives
royalty income, Argatroban, began during November 2000.
(b) Basis of Consolidation
The Company's consolidated financial statements include the accounts
of the Company, its wholly owned subsidiaries, IPI, ELP and EP-ET, LLC,
and its majority controlled subsidiary, Revotar. All material
intercompany balances and transactions have been eliminated.
4
(c) Cash, Cash Equivalents, Short-Term Investments and Long-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
original maturities of less than one year and greater than three months
at the purchase date. Long-term investments consist of debt securities
with a remaining maturity of one to four years. The Company classifies
all short-term and long-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
and long-term investments are stated at amortized cost plus accrued
interest. Interest income is accrued as earned. The Company evaluates the
carrying value of its securities by comparing the carrying values of the
securities to their market values. 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 were other than temporary, the Company would
record a loss and reduce the carrying value of such security to its fair
value. The Company has classified as restricted, cash deposited with a
bank as security for certain foreign exchange futures contracts. See Note
12. Of those securities classified as long-term investments, the Company
has pledged U.S. Government agency securities having a purchase price of
$3,000,000 and corporate securities having a purchase price of $4,011,000
as collateral for a letter of credit securing a note payable to ICOS. See
Note 13. Composition of short-term and long-term held-to-maturity
investments was as follows ($ in thousands):
As of September 30, 2003
---------------------------------------------------------------
Gross Gross Estimated
Short-term investments Amortized Unrealized Unrealized Fair
Held-to-maturity Cost Gains Losses Value
---------------- ------------- ------------- ------------ -----------
U.S. Government agency securities $ 6,047 $ 20 $ --- $ 6,067
Corporate commercial paper
and loan participations 9,077 50 (86) 9,041
Corporate debt securities 6,082 15 (8) 6,089
------------- ------------- ------------ -----------
Total short-term
held-to-maturity investments $ 21,206 $ 85 $ (94) $ 21,197
============= ============= ============ ===========
Gross Gross Estimated
Short-term investments Amortized Unrealized Unrealized Fair
Held-to-maturity Cost Gains Losses Value
---------------- ------------- ------------- ------------ -----------
U.S. Government agency securities $ 2,015 $ 3 $ --- $ 2,018
Corporate commercial paper
and Loan participations 2,005 52 (13) 2,044
Corporate debt securities 1,001 45 (3) 1,043
------------- ------------ -----------
Total long-term
held-to-maturity investments $ 5,021 $ 100 $ (16) $ 5,105
============= ============= ============ ===========
5
As of December 31, 2003
---------------------------------------------------------------
Gross Gross Estimated
Short-term investments Amortized Unrealized Unrealized Fair
Held-to-maturity Cost Gains Losses Value
---------------- ------------- ------------- ------------ -----------
U.S. Government agency
securities $ 4,017 $ 63 $ --- $ 4,080
Corporate commercial paper 20,231 --- (70) 20,161
Corporate debt securities 2,285 --- (13) 2,272
------------- ------------ -----------
Total short-term
held-to-maturity investments $ 26,533 $ 63 $ (83) $ 26,513
============= ============= ============ ===========
Gross Gross Estimated
Short-term investments Amortized Unrealized Unrealized Fair
Held-to-maturity Cost Gains Losses Value
---------------- ------------- ------------- ------------ -----------
U.S. Government agency
securities $ 12,102 $ 62 $ --- $ 12,164
Corporate commercial paper 5,052 126 --- 5,178
Corporate debt securities 3,090 65 (8) 3,147
------------- ------------- ------------ -----------
Total long-term
held-to-maturity investments $ 20,244 $ 253 $ (8) $ 20,489
============= ============= ============ ===========
(d) Equipment and Leasehold Improvements
Equipment and leasehold improvements are stated at cost less
accumulated depreciation and amortization. Depreciation of furniture and
equipment is provided on the straight-line method over the estimated
useful lives of the respective assets (3 to 10 years). Amortization of
leasehold improvements is provided on the straight-line method over the
remaining minimum lease term.
(e) Investment in Encysive, L.P.
Prior to the Acquisition, the Company accounted for the investment in
ELP using the equity method. Because the Company had no basis in the
technology transferred to ELP as the Company's original investment, the
Company did not record an amount for its original investment. The Company
recorded its share of the ELP loss as a liability to related party until
it funded its portion of the loss. Subsequent to the Acquisition, the
Company's consolidated financial statements include the accounts of ELP.
See Note 13.
(f) Research and Development Costs
All research and development costs are expensed as incurred and
include salaries of research and development employees, certain rent and
related building services, research supplies and services, clinical trial
expenses and other associated costs. Salaries and benefits charged to
research and development in the three-month periods ended September 30,
2003 and 2002 were approximately $2,090,000 and $2,421,000, respectively,
and the nine-month periods ended September 30, 2003 and 2002 were
approximately $6,674,000 and $6,979,000, respectively. Net purchase price
related to the acquisition of in-process research and development is
expensed as incurred.
6
(g) 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, 2003 and 2002, the weighted average common shares used to
compute basic and diluted net loss per common share totaled 43,914,497
and 43,798,840 shares, respectively. Weighted average common shares used
to compute basic and diluted net loss per common share for the nine-month
periods ended September 30, 2003 and 2002 were 43,801,837 and 43,719,884
shares, respectively. Securities convertible into Common Stock comprised
of stock options, warrants and unvested shares of restricted common stock
totaling 5,511,513 and 5,367,964 shares at September 30, 2003 and 2002,
respectively, were not used in the calculation of diluted net loss per
common share because the effect would have been antidilutive.
(h) Revenue Recognition
Revenue from service contracts is recognized as services are
performed. Royalty revenue is recognized as products are sold by a
licensee and the Company has received sufficient information to record a
receivable. The Company defers the recognition of milestone payments
related to contractual agreements that are still in the development stage
and for which the Company continues to have obligations under the
agreement. 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 the Company's
intellectual property are similarly deferred, and amortized into income
over the estimated development period of the licensed item or items. The
Company periodically evaluates its estimates of remaining development
periods, and adjusts the recognition of remaining deferred revenues over
the adjusted development period remaining. 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.
(i) Patent Application Costs
Costs incurred in filing for, defending and maintaining patents are
expensed as incurred.
(j) Use of Estimates
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets, 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 USA. Actual results could
differ from these estimates.
(k) Intangible Assets
Intangible assets, included in other assets, consisting of amounts
paid for products approved by the United States Food and Drug
Administration ("FDA"), are amortized on a straight-line basis over their
estimated useful lives. The Company periodically reviews the useful lives
of its intangible and long-lived assets, which may result in future
adjustments to the amortization periods. Related amortization expense for
each of the three-month periods ended September 30, 2003 and 2002 was
$27,000, and in the nine-month periods ended September 30, 2003 and 2002
was $80,000. Amortization of intangible assets is included in general and
administrative expense in the consolidated statements of operations and
comprehensive loss.
7
(l) Treasury Stock
Treasury stock is recorded at cost. Pursuant to a stock repurchase
program, the Company repurchased 213,000 shares during the year ended
December 31, 2001.
(m) Stock Based Compensation
At September 30, 2003, the Company has six stock-based compensation
plans for employees and non-employee directors, which are described more
fully in Note 4. 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. Net loss in the three and nine-months ended September
30, 2003 and 2002 included stock-based compensation expense as a result
of modifications made to certain options previously issued to retiring
employees, modification of certain warrants previously issued to a former
consultant, and the grant of shares of restricted common stock to certain
employees. 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. The following table illustrates the effect on
net loss and loss per share if the Company had applied the fair value
recognition provisions of FASB Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" to
stock-based employee compensation (amounts in thousands, except for per
share data).
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ --------------------------
2003 2002 2003 2002
------------ ---------- ----------- -----------
Net loss, as reported $ (7,481) $ (5,840) $ (26,581) $ (18,811)
Add: Stock-based employee
compensation expense
included in reported
Net loss 29 -- 57 178
Deduct: Total stock-based
employee compensation
expense determined
under fair value method
for all awards (556) (1,143) (2,367) (3,191)
------------ ---------- ----------- -----------
Pro forma net loss $ (8,008) $ (6,983) $ (28,891) $ (21,824)
============ ========== =========== ===========
Loss per share:
As reported, basic and
diluted $ (0.17) $ (0.13) $ (0.61) $ (0.43)
Pro forma, basic and diluted $ (0.18) $ (0.16) $ (0.66) $ (0.50)
The per-share weighted average fair value of stock options granted
during the three-month periods ended September 30, 2003 and 2002 was
$3.02 and $1.24, respectively, and in the nine-month periods ended
September 30, 2003 and 2002 was $1.02 and $3.44, 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,
-------------------------------- ---------------------------
2003 2002 2003 2002
------------- ------------ ----------- -----------
Expected dividend yield 0.0% 0.0% 0.0% 0.0%
Risk-free interest rate 3.1% 2.6% 2.6% 2.8%
Expected volatility 76.9% 70.3% 73.8% 74.3%
Expected life in years 4.63 4.00 4.50 4.54
8
(n) Income Taxes
The Company uses the asset and liability method of accounting for
income taxes. Under the asset and liability method, deferred tax assets
and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax bases
and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
(o) Impairment of Long-lived Assets
As circumstances dictate, the Company evaluates the recoverability of
its intangible and long-lived assets by comparing the projected
undiscounted net cash flows associated with such assets against their
respective carrying values. Impairment, if any, is based on the excess of
the carrying value over the fair value.
(p) New Accounting Pronouncements
In January 2003, the FASB issued FASB Interpretation ("FIN No. 46"),
"Consolidation of Variable Interest Entities." FIN No. 46 requires a
company to consolidate a variable interest entity if it is designated as
the primary beneficiary of that entity even if the company does not have
a majority of voting interests. A variable interest entity is generally
defined as an entity where its equity is unable to finance its activities
or where the owners of the entity lack the risk and rewards of ownership.
The adoption of FIN No. 46 by the Company did not have any impact upon
its financial condition or results of operations.
In May 2003, the FASB issued Statement of Financial Accounting
Standards No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity," ("SFAS150"). The
Company's adoption of SFAS150 did not have a significant impact on its
financial condition or results of operations.
(q)Reclassifications
Certain reclassifications have been made to prior period financial
statements to conform to the September 30, 2003 presentation with no
effect on net loss or stockholders' equity previously reported.
(3) CAPITAL STOCK
The Company has reserved Common Stock for issuance as of September 30,
2003 as follows:
Stock option plans................................... 6,933,446
Warrants outstanding................................. 142,858
---------
Total shares reserved.......................... 7,076,304
=========
The Company's only warrants outstanding at September 30, 2003 include
142,858 warrants issued to Genentech in 1997. The Genentech warrants expire in
October 2004, and have an exercise price of $14.00 per share. In September 2003,
the Company settled a dispute with a former consultant and agreed to modify the
exercise price of certain warrants, issued to such former consultant in 1999, to
purchase 103,728 shares, from $4.25 per share to $2.25 per share. Those warrants
were then exercised in a cashless exercise,
9
pursuant to which the Company issued 67,261 shares and recorded stock based
compensation expense of approximately $207,000, which is included in general and
administrative expenses in the three and nine-month periods ended September 30,
2003.
Shareholders' Rights Plan
In January 2002, the Company adopted a shareholder rights plan under
which the Board of Directors declared a dividend of one preferred stock
purchase right ("Right") for each outstanding share of the Common Stock
held of record as of the close of business on January 22, 2002. Each
Right initially entitles a stockholder to purchase a one one-thousandth
fraction of a share of Preferred Stock - Junior Participating Series A
(the "Preferred Stock") for $55.00. Each such fraction of a share of
Preferred Stock has terms designed to make it essentially equivalent to
one share of Common Stock. The Rights will become exercisable only in the
event a person or group acquires 15% or more of the Common Stock or
commences a tender or exchange offer which, if consummated, would result
in that person or group owning 15% of the Common Stock. Prior to such an
event, the Rights will be evidenced by and traded in tandem with the
Common Stock.
If a person or group acquires a 15% or larger position in the
Company, each Right (except those held by the acquiring party) will then
entitle its holder to purchase fractional shares of Preferred Stock
having twice the value of the $55.00 exercise price, with each fractional
Preferred Share valued at the market price of the Common Stock. Also, if
following an acquisition of 15% or more of the Common Stock, the Company
is acquired by that person or group in a merger or other business
combination transaction, each Right would then entitle its holder to
purchase Common Stock of the acquiring company having a value of twice
the $55.00 exercise price. The effect will be to entitle the Company's
shareholders to buy stock in the acquiring company at 50% of its market
price.
The Company may redeem the Rights at $.001 per Right at any time on
or prior to the tenth business day following the acquisition of 15% or
more of its Common Stock by a person or group or commencement of a tender
offer for such 15% ownership. The Rights expire on January 2, 2012.
(4) STOCK OPTIONS
The Company applies Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations in
accounting for its plans and applies FASB Statement No. 123, Accounting for
Stock-Based Compensation, and related interpretations in reporting for its
plans.
A summary of stock options as of September 30, 2003, follows:
EXERCISE PRICE EXERCISED/ AVAILABLE
STOCK OPTION PLANS PER SHARE AUTHORIZED OUTSTANDING OTHER EXERCISABLE FOR GRANT
------------------ --------- ---------- ----------- ----- ----------- ---------
1990 Plan................. $ 1.38-$21.59 285,715 61,919 223,796 61,919 ---
1992 Plan................. $ 1.41-$21.59 1,700,000 438,338 1,261,662 438,338 ---
Director Plan............. $ 3.50-$ 4.54 71,429 19,954 51,475 19,954 ---
1995 Plan................. $ 0.93-$21.59 2,000,000 1,336,280 468,966 1,284,280 194,754
1995 Director Plan........ $ 1.38-$11.31 800,000 446,596 80,547 354,096 272,857
1999 Plan................. $ 0.93-$20.13 4,750,000 2,537,006 587,252 1,025,220 1,625,742
--------- --------- --------- --------- ----------
TOTALS............. 9,607,144 4,840,093 2,673,698 3,183,807 2,093,353
========= ========= ========= ========= ==========
In March 2002 the Company's new chief executive officer purchased 5,000
shares at market price and was awarded 50,000 shares of restricted Common Stock
out of the 1999 Plan. The awarded shares will vest after completion of three
years of service to the Company. The Company recorded deferred compensation
expense of $309,000, which is being recognized over the vesting period.
10
In January 2003, the Company issued 105,250 shares of restricted Common
Stock to non-officer employees remaining after a restructuring of the Company.
The shares will vest after completion of one year of service to the Company. The
Company recorded deferred compensation expense of $162,000, which is being
recognized over the vesting period. In March 2003, the Company issued options to
certain employees, subject to the approval of stockholders of a motion to
increase the authorized shares in the Amended and Restated 1999 Stock Incentive
Plan. The Company will record stock compensation expense for such options of
$186,000 over the vesting period.
In June 2003, the Company issued 15,000 shares of restricted Common
Stock to the new Vice President of Marketing. The shares will vest in 1/3
increments over three years based upon the hire date. The Company recorded
deferred compensation expense of $41,000, which is being recognized over the
vesting period.
In September 2003, the Company issued 10,000 shares of restricted
Common Stock to the new Chief Medical Officer. The shares will vest in 1/3
increments over three years based upon the hire date. The Company recorded
deferred compensation expense of $47,000, which is being recognized over the
vesting period.
In conjunction with the retirement of the Company's former chief
executive officer, the Company modified provisions regarding vesting and time to
exercise of certain stock options of the officer and recorded compensation
expense of approximately $173,000, which is included in general and
administrative expenses, during the nine months ended September 30, 2002.
(5) INCOME TAXES
The Company did not incur tax expense during the three and nine-month
periods ended September 30, 2003, due to operating losses and the related
increase in the valuation allowance.
(6) EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consist of the following (amounts in
thousands):
SEPTEMBER 30, 2003 DECEMBER 31, 2002
------------------- ------------------
Laboratory and office equipment $ 10,952 $ 10,667
Leasehold improvements 4,311 4,311
------------------- -----------------
15,263 14,978
Less accumulated depreciation and amortization 10,164 9,399
------------------- -----------------
$ 5,099 $ 5,579
=================== =================
(7) ENTITY-WIDE GEOGRAPHIC DATA
The Company operates in a single business segment that includes research
and development of pharmaceutical products. The following table summarizes the
Company's long-lived assets in different geographic locations (amounts in
thousands):
SEPTEMBER 30, 2003 DECEMBER 31, 2002
------------------- ------------------
Long-lived assets:
United States $ 4,491 $ 4,884
Germany 1,291 1,457
------------------- ------------------
Total $ 5,782 $ 6,341
=================== ==================
11
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
---- ---- ---- ----
Revenues:
United States $ 3,245 $ 2,308 $ 8,264 $ 7,390
Germany 168 97 593 237
----------------- ----------------- ----------------- -----------------
Total $ 3,413 $ 2,405 $ 8,857 $ 7,624
================= ================= ================= =================
(8) RESEARCH AGREEMENTS
Under the terms of the Company's agreement with ICOS-TBC, prior to the
Acquisition, the Company provided, and was reimbursed for, research and
development activities conducted on behalf of ELP. See Note 9 and Note 13.
The Company also receives reimbursement for certain research costs
pursuant to its agreements with Schering-Plough, GlaxoSmithKline ("GSK") (Note
9) and Revotar (Note 10).
(9) LICENSE AGREEMENTS
Mitsubishi Pharma Agreement
Encysive has entered into an agreement with Mitsubishi Pharma
Corporation, formerly Mitsubishi-Tokyo Pharmaceuticals, Inc.
("Mitsubishi") to license Mitsubishi's rights and technology relating to
Argatroban and to license Mitsubishi's own proprietary technology
developed with respect to Argatroban (the "Mitsubishi Agreement"). Under
the Mitsubishi Agreement, the Company has an exclusive license to use and
sell Argatroban in the U.S. and Canada for all specified indications. The
Company is required to pay Mitsubishi specified royalties on net sales of
Argatroban by the Company and its sublicensees after its commercial
introduction in the U.S. and Canada.
In May 2001, the Company received a $1.8 million payment (net of
tax) from Mitsubishi upon the initial enrollment of a patient in a
clinical trial evaluating Argatroban in stroke. The recognition of this
milestone payment was deferred and recognized monthly over the
development period, which was estimated to be the 56-month period ended
December 31, 2005. See Note 2(h). In the 2002 fourth quarter, the Company
released preliminary results of the stroke trial and reported it was
unlikely that the Company would proceed independently with Phase III
development. Because the Company continued to incur expenses associated
with the trial, such as data analysis, management determined it was
appropriate to continue to recognize the remaining deferred revenue over
the original deferral period. In each subsequent quarter, the Company
evaluated the appropriateness of continuing to recognize the remaining
deferred milestone. In the 2003 third quarter, management recognized the
remaining deferred revenue of approximately $870,000. This decision was
based upon several factors, including the likelihood of successfully
obtaining outside financial support for Phase III development and the
Company's capital resources compared with the capital requirements
necessary to complete the research and development.
ICOS Corporation Partnership
On June 6, 2000, ICOS and the Company entered into the ELP limited
partnership agreement. The partnership seeks to develop and globally
commercialize ET(A) receptor antagonists. As a result of the Company's
contribution of technology, ELP paid a license fee to the Company in June
2000. Prior to the Acquisition, the license fee was being amortized over
the estimated development period of the licensed technology. In July
2001, the Company earned a milestone as a result of the achievement of an
objective defined in the partnership agreement. Prior to the Acquisition,
the Company was recognizing the revenue associated with the milestone
over the expected development period.
12
Deferred revenue of $1,637,000, arising from previous payments
received by the Company from ELP for a license fee and milestones, was
recognized as an offset to the purchase price, resulting in a charge for
the purchase of in-process research and development of $8,363,000. See
Note 13.
Schering-Plough Research Collaboration and License Agreement
On June 30, 2000, the Company and Schering-Plough ("Schering")
entered into a worldwide research collaboration and license agreement to
discover, develop and commercialize VLA-4 antagonists. VLA-4 antagonists
represent a new class of compounds that has shown promise in multiple
preclinical animal models of asthma. The primary focus of the
collaboration will be to discover orally available VLA-4 antagonists as
treatments for asthma. Schering and the Company agreed to extend
Schering's support of the research collaboration to a fourth year,
through June 30, 2004.
GSK Product Development, License and CoPromotion Agreement
In connection with the Company's development and commercialization of
Argatroban, in August 1997, Encysive entered into a Product Development,
License and CoPromotion Agreement with GSK (the "GSK Agreement") whereby
GSK was granted exclusive rights to work with the Company in the
development and commercialization of Argatroban in the U.S. and Canada
for specified indications
(10) FOREIGN SUBSIDIARY
During the third quarter of 2000, Encysive formed Revotar to conduct
research and development of novel small molecule compounds and to develop and
commercialize selectin antagonists. Upon formation, Revotar received certain
development and commercialization rights to the Company's selectin antagonist
compounds as well as rights to certain other Encyisve research technology.
Revotar also received approximately $5 million in funding from three German
venture capital funds. The Company retained ownership of approximately 55% of
the outstanding common stock of Revotar and has consolidated the financial
results of Revotar into its consolidated financial statements. Since the
development and commercialization rights contributed by the Company to Revotar
had no basis for financial reporting purposes, the Company assigned no value to
its contribution of intellectual property rights. The minority interest in
Revotar at September 30, 2003 and December 31, 2002, was $1,840,000 and
$2,608,000, respectively. The Company's consolidated net loss for the
three-month periods ended September 30, 2003 and 2002 was reduced by $265,000
and $364,000, respectively, for the Revotar minority shareholders' interest in
Revotar's losses. Consolidated net loss for the nine-month periods ended
September 30, 2003 and 2002 was reduced by $768,000 and $844,000, respectively,
for the Revotar minority shareholders' interest.
Revotar has been awarded research grants from the German government, and
earned approximately $168,000 and $97,000 during the three-month periods ended
September 30, 2003 and 2002, respectively, which is included in license fees,
milestones and grants. German government research grants of $593,000 and
$234,000 were earned by Revotar in the nine-month periods ended September 30,
2003 and 2002, respectively and included in license fees, milestones and grants.
In addition to the research grants discussed above, Revotar received
grants from the German government to purchase certain research equipment,
totaling $185,000 and $167,000 in the nine months ended September 30, 2003 and
2002, respectively. The equipment grants are being recognized into income over
the estimated useful life of the assets.
The Company and the other stockholders of Revotar have executed an
agreement to provide approximately $4.5 million in unsecured loans, of which the
Company's commitment will be approximately $3.4 million. The terms of the loans
require quarterly interest payments and repayment of all principal on or before
April 1, 2007. The interest rate for the first two years will be seven percent,
after which the interest rate will be reset to the U.S. prime rate plus 2.5% if
such rate is higher than seven percent. Pursuant to such agreement, the Company
has advanced approximately $2,237,000 to Revotar as of September 30, 2003. As of
September 30, 2003, the minority shareholders of Revotar have advanced
approximately $932,000 to Revotar. Revotar's management has informed the Company
that they anticipate
13
Revotar will borrow the remaining commitment from the minority shareholders in
the fourth quarter of 2003, and the remaining commitment from the Company of
approximately $1.1 million in the first quarter of 2004. The loan from the
Company is denominated in U.S. dollars. To mitigate the risk of fluctuations in
foreign currency exchange rates, Revotar entered into a forward contract with a
bank to fix the exchange rate at which it will borrow the remaining loan
commitment, and recorded gains on forward contracts of $4,000 and $62,000 in the
three and nine months ended September 30, 2003, respectively.
As part of the agreement to form Revotar, the Company and the other
initial investors agreed to issue rights to purchase common stock of Revotar
held by them to Aqua Partners LLC ("Aqua"), which assisted in the formation of
Revotar. The shareholders have signed an agreement that provides Aqua with the
option to acquire up to 3.26% of the shares owned by each shareholder for a
total amount of approximately $540,000, payable to the shareholders.
(11) 401(k) PLAN
The Company has a 401(k) plan under which all employees with three months
of service are eligible to participate and may contribute up to 60% of their
compensation, with a maximum contribution of $12,000 per employee in 2003. Under
the terms of the Economic Growth and Tax Relief Reconciliation Act, employees
aged 50 or older may contribute an additional $2,000 to the 401(k) Plan in 2003,
such additional contribution would be eligible for employer matching. The
Company provides a matching contribution of $0.50 on the dollar of employee
contributions up to 6% of salaries. Charges to operating expense for employer
match during the three-month periods ended September 30, 2003 and 2002 were
approximately $37,000 and $52,000, respectively. During the nine-month periods
ended September 30, 2003 and 2002 charges to operating expense for employer
match were $123,000 and $155,000, respectively.
(12) COMMITMENTS AND CONTINGENCIES
(a) Foreign Currency Exchange Risk
The Company is exposed to market risk primarily from changes in
foreign currency exchange rates.
The Company has a majority-owned subsidiary in Germany and
consolidates the results of operations into its consolidated financial
results. Although not significant to date, the Company's reported assets,
liabilities, expenses and cash flows from this subsidiary are exposed to
changing exchange rates. The Company, accordingly, included an unrealized
loss of $52,000 and an unrealized gain of $64,000, respectively, in its
comprehensive loss for the three-month periods ended September 30, 2003
and 2002, and unrealized gains of $115,000 and $208,000 in the nine-month
periods ended September 30, 2003 and 2002, respectively. The Company had
an intercompany receivable from its German subsidiary at September 30,
2003 and December 31, 2002; however, this amount is denominated in U.S.
dollars and is not exposed to exchange risk. Revotar's management has
informed the Company that Revotar anticipates that it will borrow the
remaining commitment from its minority shareholders in the fourth quarter
of 2003, and the remaining commitment from the Company of approximately
$1.1 million in the first quarter of 2004. Loans by the Company to
Revotar are denominated in U.S. dollars. To mitigate the risk of
fluctuations in foreign currency exchange rates, Revotar entered into a
forward contract with a bank to fix the exchange rate at which it will
borrow the remaining loan commitment. Revotar recorded gains of $4,000
and $62,000 in the three and nine months ended September 30, 2003 on
forward contracts. The Company contracts with entities in other areas
outside the U.S. and these transactions are denominated in a foreign
currency. To date, the currencies of these other countries 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 which have been or may be deemed to be
14
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. The Company is
presently involved in a legal action, which is not expected to have a
material adverse effect upon the results of operations or financial
condition of the Company.
(13) ACQUISITION
On April 22, 2003, the Company and ICOS executed a purchase and sale
agreement (the "Acquisition Agreement") pursuant to which the Company purchased
the partnership interest of ICOS and its subsidiaries in ELP. The partnership
had no assets other than its rights to the in-process research and development
of the endothelin receptor antagonist program. Under the Agreement, the Company
agreed to pay to ICOS a purchase price of $10,000,000, of which $4,000,000 was
paid on April 22, 2003. The remaining $6,000,000 is subject to a secured
promissory note (the "Note") which requires a payment of $4,000,000 on April 22,
2004, and a payment of $2,000,000 on October 22, 2004. The outstanding principal
balance of the Note shall accrue interest at a rate which approximates the
three-month London interbank offering rate for U.S. Dollars ("LIBOR") plus 1.5%.
The interest rate was established on April 22, 2003 at approximately 2.82%, and
then was adjusted on the first business day of July to approximately 2.78%. The
next LIBOR adjustment days are the first business days of October and January.
Interest is payable on or before the tenth day after each LIBOR Adjustment Date.
The Company's obligations under the Note are secured with an irrevocable standby
letter of credit, for which the Company has pledged marketable securities with
an amortized cost of $7,011,000.
Since the only asset acquired was in-process research and development,
the Company recorded a charge for in-process research and development of
$10,000,000 less unamortized deferred revenues of $1,637,000. The unamortized
deferred revenues of $1,637,000 relate to the previous payments received from
ELP that were being amortized into income over the estimated remaining
development period. Due to the short-term nature of the Note and the associated
interest rate, the Note was not discounted when calculating the in-process
research and development charge.
Following the Acquisition, the Company changed the name of ICOS-TBC to
Encysive, L.P. The Company's consolidated financial statements include the
accounts of ELP.
15
The following pro forma summary of operations for the three and
nine-month periods ended September 30, 2003 and 2002 are based upon the
historical financial statements of the Company and ELP after giving effect to
the Acquisition, as if the combination had occurred on January 1, 2002.
Pro Forma Summary of Operations
Amounts in thousands (except per share data)
Three Months Ended September 30, 2003 Three Months Ended September 30, 2002
------------------------------------- -------------------------------------
Pro Forma Pro Forma
Historical Adjustment Pro Forma Historical Adjustment Pro Forma
---------- ---------- --------- ---------- ---------- ---------
Total Revenues $ 3,413 -- $ 3,413 $ 2,405 $ (574) $ 1,831
Net Loss (7,481) -- (7,481) (5,840) (2,126) (7,966)
=========== ========== =========== ===========
Net loss per
common share-
basic and diluted (0.17) (0.17) (0.13) (0.18)
Nine Months Ended September 30, 2003 Nine Months Ended September 30, 2002
------------------------------------ ------------------------------------
Pro Forma Pro Forma
Historical Adjustment Pro Forma Historical Adjustment Pro Forma
---------- ---------- --------- ---------- ---------- ---------
Total Revenues $ 8,857 $ (800) $ 8,057 $ 7,624 $ (1,635) $ 5,989
Net Loss (26,581) 8,227 (18,354) (18,811) (7,168) (25,979)
=========== ========== =========== ===========
Net loss per
common share-
basic and diluted (0.61) (0.42) (0.43) (0.59)
Pro forma adjustments include eliminating the $8,363,000 charge for
purchase of in-process research and development upon the Acquisition,
elimination of intercompany revenues between the Company and ELP, elimination of
recognition of license fee and milestones received by the Company from ELP, and
recognition of ICOS's share of partnership expenses in the three and nine-month
periods ended September 30, 2003 and 2002.
16
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, 2003 AND SEPTEMBER 30, 2002
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, 2002, and our
condensed consolidated financial statements and the related notes to the
financial statements included in this Quarterly Report on Form 10-Q.
Since our inception in 1989, we have primarily devoted our resources to
funding drug discovery, research and development. We are a biopharmaceutical
company focused on the discovery, development and commercialization of novel,
synthetic, small molecule compounds for the treatment of a variety of
cardiovascular, vascular and related inflammatory diseases. We believe that
synthetic, small molecule therapeutics have several advantages over protein and
peptide based large molecules. Small molecules generally are not immunogenic,
can typically be protected with composition-of-matter patents and can be
produced by conventional lower cost pharmaceutical manufacturing methods. Our
research and development programs are focused on inhibitors (also referred to as
antagonists or blockers) that can interrupt certain disease processes. Our
programs seek to address unmet medical needs in cardiovascular diseases,
thrombocytopenia, pulmonary arterial hypertension, heart failure and
inflammatory diseases such as asthma.
In the biopharmaceutical industry, a substantial percentage of the
profits generated from successful drug development are typically retained by the
entity directly involved in the sales and marketing of the drug. Licensing our
drug candidates to a third party who will complete development and provide sales
and marketing resources in exchange for upfront payments, milestone payments and
a royalty on sales may reduce some of our risks, particularly for diseases
outside our strategic interest or in territories outside of the United States
and Canada.
In June 2000, we established ICOS-TBC, a 50/50-owned limited
partnership with ICOS to develop and commercialize endothelin receptor
antagonists, including sitaxsentan and TBC3711. In January 2003, ICOS announced
that they had reached a conclusion that joint development of the endothelin
receptor antagonist program should not continue, and in April 2003, we purchased
the partnership interest of ICOS in ICOS-TBC for a purchase price of $10
million, and changed the name of the partnership to Encysive, L.P.. Following
the Acquisition, as discussed below, we intend to continue the development of
the endothelin receptor antagonist program. Our strategy for managing our
capital requirements includes seeking to license rights to sitaxsentan for
select markets, while preferably retaining North American rights.
APPROVED DRUGS IN COMMERCIAL MARKET
ARGATROBAN
Argatroban was approved by the FDA in 2000 and is indicated for
prophylaxis or treatment of thrombosis in patients with heparin-induced
thrombocytopenia ("HIT") and for use in HIT patients undergoing percutaneous
coronary intervention ("PCI".) Argatroban was approved in Canada in 2002 for use
as anticoagulant therapy in patients with heparin-induced thrombocytopenia
syndrome. During 2002, we completed initial studies to evaluate the use of
Argatroban in hemodialysis patients and in PCI. The drug is being marketed in
the U.S. and Canada by GSK and has been on the market in the U.S. and Canada
since November 2000 and June 2002, respectively. GSK is our development,
manufacturing and marketing partner for Argatroban.
17
GSK currently markets Argatroban and enjoys market exclusivity pursuant
to the Waxman/Hatch Act that provides protection from competition until June 30,
2005. We received a formal Written Request from FDA to conduct a study with
Argatroban in pediatric patients. Upon completion of this study, we will be
eligible for an additional six months of market exclusivity. Argatroban is
currently marketed in a formulation that is covered under a formulation patent
that expires in 2010. Following expiration of Waxman/Hatch protection, it is
possible that generic manufacturers may be able to produce Argatroban without
violating the formulation or process patents. The composition of matter patent
on Argatroban has expired. The Company has access to other patents held by
Mitsubishi, however, these are not being utilized currently.
RESEARCH AND DEVELOPMENT PROGRAMS
Presently, we have four major product development programs.
Endothelin Antagonist Program. We are developing sitaxsentan, an endothelin(A)
receptor antagonist, or ET(A), for the treatment of pulmonary arterial
hypertension ("PAH"). During June 2000, ELP was formed to develop and
commercialize ET(A) receptor antagonists. During 2002, ELP successfully
completed STRIDE 1, a Phase IIb/III pivotal clinical trial in pulmonary arterial
hypertension with sitaxsentan. TBC3711, a second generation ET(A), has
previously completed Phase I clinical trials and may be developed for
cardiovascular or other diseases. We have initiated a pivotal Phase III trial in
PAH, "STRIDE 2." STRIDE 2 will be of 18 weeks duration and will test two doses
of sitaxsentan (100 mg and 50 mg), versus placebo, dosed once daily in a double
blind fashion. In addition, a randomized bosentan (Tracleer(TM)) arm will be
included. Bosentan is currently the only approved endothelin antagonist
available. In June 2003, we received a Special Protocol Assessment from the FDA
confirming that STRIDE 2, together with the results of STRIDE 1 and planned
supportive trials will be sufficient for filing a new drug application ("NDA").
We anticipate enrollment will complete in the spring of 2004 with results
available in the second half of 2004. We anticipate that the NDA submission may
occur between the end of year 2004 and first quarter of 2005.
Thrombosis. During 2002, we completed a Phase II human clinical trial for
Argatroban as a mono-therapy treatment for acute ischemic stroke. The clinical
trial met the primary endpoint based on safety and showed positive results in
the secondary safety endpoint. In light of a lack of a positive overall efficacy
trend and the high risk and high costs associated with stroke trials, it is
unlikely that we will proceed independently with a full Phase III program.
Currently, Argatroban is being evaluated in a clinical trial in combination with
recombinant tissue Plasminogen Activator (rt-PA) as a new approach to the
treatment of acute ischemic stroke by an investigator at the University of Texas
Medical School at Houston.
Vascular Inflammation Program. Revotar, our majority owned German affiliate
located in Berlin is developing a selectin antagonist, bimosiamose, for the
treatment of asthma, psoriasis and atopic dermatitis. The intravenous form of
the drug demonstrated positive anti-inflammatory effects in Phase II clinical
trials. Revotar was formed during 2000, to further the development of this
program. Revotar completed Phase I clinical trials for asthma utilizing an
inhaled form of bimosiamose. A Phase IIa clinical trial with an inhaled form of
bimosiamose was completed in the second quarter of 2003 and positive preliminary
results were released in August 2003. A Phase IIa clinical trial in psoriasis
and atopic dermatitis commenced during the fourth quarter of 2003, using a
topical formulation. A Phase IIa proof-of-concept clinical trial in psoriasis,
completed during 2002 with an injectable form of bimosiamose, indicated a
potential for efficacy. We are also conducting research with respect to other
cell adhesion molecules including vascular cell adhesion molecule, or VCAM,
junctional adhesion molecules, or JAM 2/3 and several integrins including very
late antigen 4, or VLA-4, (alpha)4(beta)7 and others to develop antagonists for
the treatment of asthma, rheumatoid arthritis, multiple sclerosis, restenosis
and inflammatory bowel disease.
We have signed a collaboration and license agreement for the VLA-4 program with
Schering-Plough and have received a milestone payment from Schering-Plough for
nominating a compound as a clinical candidate. Additionally, we are conducting
research on backup VLA-4 antagonists for Schering-Plough under this agreement.
Schering-Plough and Encysive have agreed to extend the research agreement for
another year, through June 2004.
18
Vascular Disease. Many disease processes involve changes in blood vessels and
heart tissue. There are numerous mediators, like endothelin, which may
contribute to the development of these diseases. Several of these act though
G-protein coupled receptors, GPCRs, to carry out their action. We are conducting
research on GPCRs to identify inhibitors which could be useful in treating
diseases including congestive heart failure, CHF, ischemic stroke and acute
myocardial infarction.
RESULTS OF OPERATIONS
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, 2003, remaining deferred revenue was
approximately $2.4 million, of which we expect to recognize approximately $0.5
million over the next 12 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 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
19
to employees on our consolidated results of operations is discussed in Note
2(m), Stock Based Compensation.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions that affect the reported amounts of assets,
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.
GENERAL
Our operating results have fluctuated significantly during each
quarter, 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 and regulatory compliance. We may
initiate certain commercial activities in the future, which could contribute to
future operating losses. We have sustained net losses of approximately $174.7
million from the date of our inception to September 30, 2003. We have primarily
financed our operations to date through a series of private placements and
public offerings of our Common Stock and several collaborative agreements with
third parties to jointly pursue product research and development. See discussion
of "Liquidity and Capital Resources" below. See also "Additional Risk Factors"
in Item 1 "Business" of our Annual Report on Form 10-K for the year ended
December 31, 2002.
THREE AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2003 AND 2002
In April 2003, we acquired the interest of ICOS in ELP. Of the $10
million purchase price, $4 million was paid at closing, and the remaining $6
million is subject to the terms of a note to ICOS requiring a $4 million payment
in April 2004 and a $2 million payment in October 2004. Deferred revenue of $1.6
million, arising from previous payments received by us from ELP for a license
fee and milestones, was recognized as an offset to the purchase price, resulting
in a charge for the purchase of in-process research and development of $8.4
million in the second quarter of 2003.
From its inception in June 2000 through December 31, 2002, we and ICOS
shared equally in the costs of ELP. ICOS informed us, however, that it had
reached the conclusion that joint development of the endothelin receptor
antagonist program through ELP should not continue. As a result, from January
2003 until the Acquisition, we agreed to be responsible for 100% of the costs of
ELP under the terms of a letter agreement, which expired upon the Acquisition.
From its inception in June 2000 through March 31, 2003, we accounted
for our investment in ELP under the equity method. As a result of the
Acquisition, we now include the accounts of ELP in our consolidated financial
statements. A result of the consolidation of ELP into our financial statements
is that the revenue item, "Collaborative research and development from Encysive,
L.P." and the expense item, "Equity in loss of Encysive, L.P." are eliminated
and the operating expenses of ELP are included in our operating expenses.
We have included, in Note 13 to the condensed consolidated financial
statements, a pro forma statement of operations which adjusts our historical
results for the three and nine months ended September 30, 2003 and 2002 to
reflect such results as if the Acquisition had occurred at the beginning of
2002. Although the pro forma results do not necessarily indicate what actual
results would have occurred had the Acquisition happened earlier, they do give
an indication of the impact of the Acquisition on the reported historical
results, and the trends in our business unrelated to the effects of the
Acquisition.
20
REVENUES
Revenues increased to $3,413,000 from $2,405,000 in the three months
ended September 30, 2003 as compared with the three months ended September 30,
2002. Pro forma revenues in the three months ended September 30, 2003 increased
to $3,413,000 from $1,831,000 in the three months ended September 30, 2002. The
difference between historical and pro forma revenues in the comparable three
month periods is the elimination of $286,000 in "Collaborative research and
development from Encysive, L.P." and $288,000 in license fee and milestone
revenues arising from the amortization of a license fee and milestones
previously received from ELP. Pro forma revenues have increased in the third
quarter of 2003 compared to the third quarter of 2002 due to increased royalty
income on sales of Argatroban partially offset by decreased research agreement
income. Royalties in the three months ended September 30, 2003 increased
$706,000, or approximately 104%, due to increased sales of Argatroban. In 2002,
GSK created a hospital based sales force and initiated programs to increase
sales effort on Argatroban in the U.S. and Canada that we believe could have a
positive effect on our royalties from GSK. License fees, milestones and grants
increased $654,000, or approximately 106%, in the three months ended September
30, 2003 compared with the three months ended September 30, 2002. In the current
year period we determined it was appropriate to recognize the remaining deferred
milestone payment which had previously been received from Mitsubishi, totaling
approximately $870,000. See Note 9.
Revenues in the nine months ended September 30, 2003 increased to
$8,857,000 from $7,624,000 in the nine months ended September 30, 2002. Pro
forma revenues increased to $8,057,000 from $5,989,000 in the nine months ended
September 30, 2003 compared with the nine months ended September 30, 2002. The
difference between historical and pro forma revenues is the elimination of
$664,000 and $772,000 in "Collaborative research and development from Encysive,
L.P." in the 2003 and 2002 periods, respectively, and the elimination of
$136,000 and $863,000 in license fee and milestone revenues in the 2003 and 2002
periods, respectively. Royalty income increased $1,161,000, or approximately
47%, in the nine months ended September 30, 2003 compared with the nine months
ended September 30, 2002 due to higher sales of Argatroban by GSK, as discussed
above. Research agreement revenues decreased $409,000, or approximately 15%, for
the same reasons as discussed above. Pro forma license fees, milestones and
grants increased $1,316,000, or approximately 154%, due to the recognition of
the deferred milestone payment from Mitsubishi and the receipt of a milestone
payment from Schering-Plough in June 2002.
RESEARCH AND DEVELOPMENT EXPENSE
The endothelin receptor antagonist program has been conducted within
ELP from its inception in June 2000. Prior to December 31, 2002, we included our
50% share of ELP's losses in our financial results under the caption equity in
loss of ELP. As discussed above, ICOS informed us that it had reached the
conclusion that joint development of the endothelin receptor antagonist program
through ELP should not continue. As a result, from January 2003 until the
Acquisition, we agreed to be responsible for 100% of the costs of ELP under the
terms of a letter agreement, which expired upon the Acquisition. Development
costs for the endothelin receptor antagonist program during the three months
ended September 30, 2003 of $4,366,000 were included in our research and
development expenses as a result of the Acquisition and consolidation of ELP. In
the nine months ended September 30, 2003, research and development costs of the
endothelin receptor antagonist program were $9,670,000, of which $7,284,000 was
included in our research and development expenses, and $2,386,000 was reported
as equity in loss of ELP. In the three and nine-month periods ended September
30, 2002, comparable endothelin receptor antagonist program expenses were
$3,676,000 and $12,610,000, respectively, and reported as our 50% share as
equity in loss of ELP. During the three and nine months ended September 30,
2003, ELP began incurring research and development expenses in relation to
STRIDE-2, a final pivotal study in PAH. In the 2002 periods, ELP's research and
development expenses consisted primarily of costs for the STRIDE-1 trial of
sitaxsentan in pulmonary arterial hypertension ("PAH"), which was completed in
2002.
Research and development expenses in the three months ended September
30, 2003 were $8,586,000, compared with $5,286,000 in the three months ended
September 30, 2002. In the third quarter of 2003 the development expenses for
the endothelin receptor antagonist program were $4,366,000 and are
21
included in research and development expense, as discussed above. Our share of
the endothelin receptor antagonist program for the third quarter of 2002 was
$1,838,000 and it was reported as equity in loss of ELP. After taking into
consideration the effect of consolidating the endothelin receptor antagonist
program, other research and development expenses of $4,220,000 in third quarter
of 2003 decreased $1,066,000, or approximately 20%, compared with the third
quarter of 2002. In January 2003, we announced a reduction of headcount,
primarily in the areas of basic exploratory biology, early stage target
identification and support functions.
Research and development expenses in the nine months ended September
30, 2003 was $19,109,000, compared with $16,107,000 in the nine months ended
September 30, 2002. Research and development expense in the nine months ended
September 30, 2003 included $7,284,000 of development expenses for the
endothelin receptor antagonist program, as a result of the Acquisition and
consolidation of ELP. Our share of the endothelin receptor antagonist program
expenses incurred prior to the Acquisition were $2,386,000 and $6,305,000 in the
nine months ended September 30, 2003 and 2002, respectively, and were reported
as equity in loss of ELP. After taking into consideration the effect of
consolidating the endothelin receptor antagonist program, other research and
development expenses in the nine months ended September 30, 2003 of $11,825,000
decreased $4,282,000, or approximately 27%, compared to the nine months ended
September 30, 2002. Clinical trials costs (other than for the endothelin
receptor antagonist program) declined $2,493,000 in the current year compared to
last year, as we were conducting several trials, primarily ARGIS-I for
Argatroban in stroke during the 2002 period. As a result of the January 2003
restructuring, we incurred a restructuring charge of approximately $.5 million,
primarily comprised of severance benefits paid to terminated employees, which is
included in research and development expense in the nine months ended September
30, 2003. We believe that research and development expenses in the remaining
period of 2003 will continue to be higher than in the comparable 2002 periods,
as costs associated with the endothelin receptor antagonist program are
incurred.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expenses in the three months ended September
30, 2003 and 2002 were $2,840,000 and $2,041,000, respectively. General and
administrative expenses in the three months ended September 30, 2003 included
$233,000 in patent legal expenses for the endothelin receptor antagonist
program, as a result of the Acquisition and consolidation of ELP. General and
administrative expense in the current year period includes a charge of $207,000
in non-cash stock based compensation expense associated with the modification of
warrants. The increase in general and administrative expense in the current
period, other than the effect of consolidating ELP and the modification of
warrants, is primarily due to increased insurance costs, recruiting and
relocation associated with the hiring of a new vice president of marketing, and
commissions on Argatroban due to higher sales.
General and administrative expenses in the nine months ended September
30, 2003 and 2002 were $7,252,000 and $6,803,000, respectively. General and
administrative expenses in the nine months ended September 30, 2003 included
$605,000 in patent legal expenses for the endothelin receptor antagonist
program, as a result of the Acquisition and consolidation of ELP. After
considering the effect of the Acquisition and the modification of certain
warrants, discussed above, other general and administrative expenses decreased
$363,000 in the current year. The remaining decrease in general and
administrative expenses is primarily due to reduced salary and wages expense
because of the retiring chief executive officer, partially offset by the
increase commissions, non-cash stock based compensation expense, insurance and
recruiting and relocating expenses, as discussed above.
22
TOTAL OPERATING EXPENSE
Total operating expenses in the three months ended September 30, 2003
increased $2,261,000 compared to the three months ended September 30, 2002. As
discussed above, we believe that research and development expenses in the
remaining months of 2003 will continue to be higher than in the comparable
periods of 2002, primarily due to costs associated with the endothelin receptor
antagonist program. Total operating expenses in the nine months ended September
30, 2003 increased $7,895,000 compared to the nine months ended September 30,
2002. The 2003 period included a one-time charge of $8,363,000 for purchase of
in-process research and development as a result of the Acquisition, however, and
after taking this charge into consideration, other expenses declined $468,000,
or approximately 2%, compared with the nine months ended September 30, 2003.
OPERATING LOSS
Operating loss in the three months ended September 30, 2003 increased
$1,253,000 compared with the three months ended September 30, 2002, primarily
due to the costs associated with the endothelin receptor antagonist program. In
the nine months ended September 30, 2003 operating loss increased $6,662,000
compared to the nine months ended September 30, 2002, primarily due to the
$8,363,000 charge as discussed above.
Investment income in the three and nine months ended September 30, 2003
declined $289,000 and $1,032,000 compared to the three and nine months ended
September 30, 2002, respectively. The decline is primarily due to lower levels
of funds available for investment in the current year periods.
The minority interest in the loss of Revotar in the three and nine
month periods decreased $99,000 and $76,000, respectively, primarily as a result
of reduced spending at Revotar in the 2003 periods.
Net loss in the three months ended September 30, 2003 increased
$1,641,000 compared with the three months ended September 30, 2002, primarily
due to the increased costs associated with the endothelin receptor antagonist
program, as discussed above. Pro forma net loss decreased $485,000 due to higher
pro forma revenues in the 2003 period. Net loss in the nine months ended
September 30, 2003 increased $7,770,000 primarily due to the $8,363,000 charge
for in-process research and development upon the Acquisition. Pro forma net loss
decreased $7,625,000 due to higher revenues and decreased expenses in the pro
forma results. See Note 13.
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 from funds received through our collaborations, research agreements and
partnerships. We also have received royalty revenue from sales of Argatroban. In
September 2003 we filed a shelf registration covering $50 million of Common
Stock and once it becomes effective we may enter the market to raise additional
capital if the need arises. We have not conducted any offerings in 2003, and
have relied on our cash balances from prior offerings and our revenues to fund
operations, with the result that our cash balance has decreased in 2003.
Cash, cash equivalents and investments in marketable securities,
including accrued interest thereon, was $47,739,000 at September 30, 2003,
compared with $68,005,000 at December 31, 2002. We used $17,537,000 in cash in
operating activities, during the nine months ended September 30, 2003, compared
to $19,437,000 used in cash in operating activities during the nine months ended
September 30, 2002. The decreased use of cash for operating activities in the
current year period is primarily due to lower operating expenses, excluding the
$8,363,000 charge for purchase of in-process research and development.
Cash generated by investing activities primarily reflects the maturity
of invested funds which are used to fund our cash requirements for operating
activities. Investing activities generated $16,045,000 during the nine months
ended September 30, 2003, compared to $28,253,000 in the nine months ended
September 30, 2002. Purchases of equipment and leasehold improvements decreased
$1,800,000 in the
23
current year, as a result of programs implemented by management to conserve
cash. Other than expenditures for purchases of equipment and leasehold
improvements, investing activities consist of a $4,000,000 payment to ICOS upon
the Acquisition and purchases of and maturities of investments. Revotar has
received grants from the German government for purchases of certain capital
equipment items, totaling $185,000 and $167,000 in the nine months ended
September 30, 2003 and 2002, respectively, which are recognized into income over
the estimated useful lives of the assets.
Cash flows from financing activities in the nine months ended September
30, 2003 increased $1,285,000, compared to the nine months ended September 30,
2002. Proceeds from option exercises for 2003 increased $380,000, compared to
2002. The Company and the other stockholders of Revotar have executed an
agreement to provide approximately $4.5 million in unsecured loans. As of
September 30, 2003, the minority shareholders of Revotar have advanced
approximately $905,000 to Revotar.
Material Commitments
As a result of the Acquisition, as discussed in Note 13 to the
financial statements included herein, we have made a payment to ICOS of $4
million on April 22, 2003 and agreed to pay $4 million in April 2004 and $2
million in October 2004. The Note is secured with an irrevocable standby letter
of credit for which we have pledged marketable securities with an amortized cost
of $7,011,000. Pledged securities will be released to us by the bank as payments
are made on the Note.
Our only other material contractual commitments are comprised of a loan
commitment to Revotar and office and laboratory facility leases. We and the
minority shareholders of Revotar have committed to lend Revotar, on an unsecured
basis, approximately $4.5 million, of which our commitment is approximately $3.4
million. The terms of the loans require quarterly interest payments and
repayment of all principal on or before April 1, 2007. Our portion of the loan
is denominated in U.S. dollars at an interest rate of seven percent fixed for
the first two years and resets to the greater of seven percent or U.S. prime
plus two and one-half percent on April 1, 2004. As of September 30, 2003, we
have advanced $2,237,000 to Revotar under our loan commitment, and we expect to
lend our remaining commitment of $1.2 million in the first quarter of 2004.
Revotar's management has informed us that under German law, they are unable to
make interest payments to shareholders because they have insufficient capital
which, we believe, will not have a material effect on our results of operations
or financial condition. Revotar will need to seek additional funding through
collaborative arrangements and/or through public or private financings in the
future. If it is not successful, Revotar will be unable to repay our loans. A
likely result of additional financings would be to reduce our ownership
percentage in Revotar.
We had long-term obligations under our office and laboratory leases and
note payable as follows ($ in thousands):
Less than 1-3 4-5 After 5
Contractual Obligations Total 1 year years years years
- ----------------------- ----- ------ ----- ----- -----
Operating Leases $ 4,873 $ 1,616 $ 3,126 $ 131 ---
Long-term Debt 6,932 4,000 2,000 932 ---
Outlook for 2003
In connection with the Acquisition, we announced guidance for 2003 as
follows:
Net sales of Argatroban by GSK............... $30.0 to $35.0 million
Revenues..................................... $10.0 to $11.5 million
Expenses (1)................................. $50.0 to $53.0 million
Investment income............................ $0.8 to $1.0 million
Estimated net loss........................... $39.0 to $42.0 million
Cash and investments at year-end 2003........ $30.0 to $32 million
(1) Expenses net of minority interest in Revotar and include a charge of
$8.4 million related to the Acquisition.
24
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. We have assumed that sales trends of Argatroban over the previous
year will continue. 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
GSK's actual net sales of Argatroban differ from assumed levels.
As a result of the Acquisition, our projected revenues do not include
any revenues associated with ELP beyond the amount recognized through March 31,
2003. Projected revenues contain continued amortization of deferred license fees
and milestones previously received from Schering-Plough, Mitsubishi and ELP,
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 decrease or increase our estimated development periods. We have taken
into consideration the renewal of our research agreement with Schering-Plough
for an additional year, through June 30, 2004.
Projected operating expenses are based upon our approved operating
budget for the year, adjusted to take into consideration the effect of the
Acquisition. After the Acquisition, we became responsible for all development
costs of the endothelin receptor antagonist program. We have not assumed
significant changes in numbers of employees during year 2003, and other budgeted
items remained unchanged from previously projected amounts. Our budgeted
expenses also include basic research efforts on our other programs, and levels
of administrative support we believe to be necessary.
Projected investment income assumes that the rate of return on invested
funds of approximately 2% on an average of approximately $50 million in funds
available for investment throughout the year.
Cash and investments at year-end is projected based upon our projected
sources and uses of cash during the year. In projecting our end of year cash and
investment balances, we have not assumed additional financing, or collaborative
arrangements other than those in place at this time.
The range of estimated net loss is based upon our projected revenues
and expenses, as discussed above.
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
"Additional Risk Factors" in Item 1, "Business" of our annual report on Form
10-K for the year ended December 31, 2002, and "Longer-Term Outlook," below.
Longer-Term Outlook
We expect to continue 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 increase in subsequent years because:
- we expect to incur significant expenses in conjunction with
additional clinical trial costs for sitaxsentan and research and
clinical trial costs for development of bimosiamose and expect to
begin to incur cost for clinical trials related to additional
compounds. These costs include:
- hiring personnel to direct and carry out all operations related
to clinical trials;
- hospital and procedural costs;
- services of contract research organizations; and
- purchasing and formulating large quantities of the compound to
be used in such trials.
25
- There will be additional costs in future periods related to
Argatroban in complying with ongoing FDA requirements and possible
clinical trial expenditures for additional therapeutic
indications.
We have been unprofitable to date and expect to incur operating losses
for the next several years as we invest in product research and development,
preclinical and clinical testing and regulatory compliance. We will require
substantial additional funding to complete the research and development of our
product candidates, to establish commercial scale manufacturing facilities, if
necessary, to fund the $6 million required future payments to ICOS and to market
our products. Estimates of our future capital requirements will depend on many
factors, including:
- market acceptance and commercial success of Argatroban;
- expenses and risks associated with clinical trials to expand the
use of Argatroban and the approval of sitaxsentan;
- possible emergence of generic competition;
- 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.
Subject to these factors, we anticipate that our existing capital
resources and other revenue sources, should be sufficient to fund our cash
requirements through the end of the third quarter of 2004. We anticipate that we
will need to secure additional funds to continue the required levels of research
and development to complete the development and submit an NDA for sitaxsentan
and to reach our other current long-term goals. We anticipate that the NDA
submission may occur between the end of year 2004 and first quarter of 2005. We
intend to seek such additional funding through collaborative arrangements and/or
through public or private financings, if required. Our strategy for managing our
capital requirements includes seeking to license rights to sitaxsentan for
select markets, while preferably retaining North American rights. There can be
no assurances that such funding or licensing arrangements will be available on
acceptable terms. As we review our research and development programs, we may
also consider various measures to reduce our costs in order to more effectively
utilize our capital resources.
Off-Balance Sheet Arrangements
We do not engage in off-balance sheet financing arrangements.
HAZARDOUS MATERIALS AND ENVIRONMENTAL MATTERS
Our research and development processes involve the controlled use of
hazardous materials, chemicals and radioactive materials and produce waste
products. We are subject to federal, state and local laws and regulations
governing the use, manufacture, storage, handling and disposal of hazardous
materials
26
and waste products. Although we believe that our safety procedures for handling
and disposing of hazardous materials comply with the standards prescribed by
laws and regulations, the risk of accidental contamination or injury from these
materials cannot be eliminated completely. In the event of an accident, we could
be held liable for any damages that result. This liability could exceed our
resources or not be covered by our insurance. Although we believe that we are in
compliance in all material respects with applicable environmental laws and
regulations, there can be no assurance that we will not be required to incur
significant costs to comply with environmental laws and regulations in the
future. There can also be no assurance that our operations, business or assets
will not be materially adversely affected by current or future environmental
laws or regulations.
IMPACT OF INFLATION AND CHANGING PRICES
The pharmaceutical research industry is labor intensive, and wages and
related expenses increase in inflationary periods. The lease of space and
related building services for the Houston facility contains a clause that
escalates 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, as amended (the
"Exchange Act"). All statements other than statements of
historical fact included in and incorporated by reference into
this Form 10-Q are forward-looking statements. These
forward-looking statements include, without limitation, statements
regarding our estimate of the sufficiency of our existing capital
resources and our ability to raise additional capital to fund cash
requirements for future operations, and regarding the
uncertainties involved in the drug development process and the
timing of regulatory approvals required to market these drugs.
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.
When used in this Form 10-Q, 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. Because these
forward-looking statements involve risks and uncertainties, actual results could
differ materially from those expressed or implied by these forward-looking
statements for a number of important reasons, including those discussed under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
You should read these 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. Before you invest in our Common Stock, you should
be aware that the occurrence of any of the contingent factors described herein
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations - Liquidity and Capital Resources" and described under "Additional
Risk Factors" in our Annual Report on Form 10-K for the year ended December 31,
2002 could substantially harm our business, results of operations and financial
condition. 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.
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.
27
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
FOREIGN CURRENCY EXCHANGE RISK
We are exposed to market risk primarily from changes in foreign
currency exchange rates. The following describes the nature of this risk that is
not believed to be material to us.
We have a majority-owned subsidiary in Germany and consolidate the
results of operations into our consolidated financial results. Although not
significant to date, our reported assets, liabilities, expenses and cash flows
from this subsidiary are exposed to changing exchange rates. We, accordingly,
included an unrealized loss of $52,000 and an unrealized gain of $64,000,
respectively, in our comprehensive loss for the three-month periods ended
September 30, 2003 and 2002, and an unrealized gain of $115,000 and $208,000 in
the nine-month periods ended September 30, 2003 and 2002, respectively. We had
an intercompany receivable from our German subsidiary at September 30, 2003 and
December 31, 2002; however, this amount is denominated in U.S. dollars and is
not exposed to exchange risk. We contract with entities in other areas outside
the U.S. and these transactions are denominated in a foreign currency. To date,
the currencies of these other countries have not fluctuated materially. At this
time, management has not deemed it cost effective to engage in a program of
hedging the effect of foreign currency fluctuations on our operating results
using derivative financial instruments.
To mitigate the risk of fluctuations in foreign currency exchange
rates, Revotar entered into a forward contract with a bank to fix the exchange
rate at which it will borrow the remaining loan commitment from us, discussed
above, and recorded gains on such forward contracts of $4,000 and $62,000 in the
three and nine months ended September 30, 2003, respectively.
ITEM 4. CONTROLS AND PROCEDURES
As of the date of the end of the period covered by this report, we
carried out an evaluation, under the supervision and with the participation of
management, including our President and Chief Executive Officer, and our Vice
President of Finance and Administration, of the effectiveness of the design and
operation of our disclosure controls and procedures pursuant to Rule 13a-15 of
the Exchange Act. Based upon that evaluation, our President and Chief Executive
Officer and our Vice President of Finance and Administration concluded that our
disclosure controls and procedures are effective, providing management with
material information relating to the Company that is required to be included in
our reports filed or submitted under the Exchange Act on a timely basis. There
have been no significant 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, the Company's internal
control over financial reporting.
28
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Five reports on Form 8-K were filed during the quarter ended September
30, 2003. A report on Form 8-K was filed on July 3, 2003 which amended a report
on Form 8-K dated April 23, 2003 regarding the purchase and sale agreement of
ICOS-Texas Biotechnology, L.P. A report on Form 8-K dated August 5, 2003 was
filed regarding Encysive's majority-owned German affiliate, Revotar
Biopharmaceuticals AG, reporting positive data in asthma with small molecule
selectin antagonist. A report on Form 8-K dated August 13, 2003 was filed
regarding the company's financial results for second quarter 2003. A report on
Form 8-K dated August 20, 2003 was filed regarding the filing of a shelf
registration statement on form S-3 with the SEC. A report on Form 8-K dated
September 11, 2003 was filed regarding a press release announcing Terrance C.
Coyne as Vice President of Clinical Development and Chief Medical Officer.
EXHIBIT NO. DESCRIPTION
- ---------- -----------
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-15(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-15(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.
10.1 Termination Agreement dated as of September 10, 2003, made by and
between Encysive Pharmaceuticals Inc. and Terrance C. Coyne, M.D.,
incorporated by reference to exhibit 99.2 to Report on Form 8-K
(Commission File No. 000-20117) dated September 11, 2003.
10.2 Termination Agreement dated as of June 2, 2003, made by and
between Encysive Pharmaceuticals Inc. and Derek J. Maetzold,
incorporated by reference to exhibit 99.3 to Report on Form 8-K
(Commission File No. 000-20017) dated September 11, 2003.
29
ENCYSIVE PHARMACEUTICALS INC.
NOVEMBER 6, 2003
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 12th day of November, 2003.
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
(Principal Financial and Accounting Officer)
30
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
- ----------- -----------
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-15(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-15(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.
10.1 Termination Agreement dated as of September 10, 2003, made by and
between Encysive Pharmaceuticals Inc. and Terrance C. Coyne, M.D.,
incorporated by reference to exhibit 99.2 to Report on Form 8-K
(Commission File No. 000-20117) dated September 11, 2003.
10.2 Termination Agreement dated as of June 2, 2003, made by and
between Encysive Pharmaceuticals Inc. and Derek J. Maetzold,
incorporated by reference to exhibit 99.3 to Report on Form 8-K
(Commission File No. 000-20117) dated September 11, 2003.