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 QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
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
- --------------------------------------------------------------------------------
(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 31, 2004
------------------------------ -------------------------------
Common stock, $0.005 par value 57,688,297
ENCYSIVE PHARMACEUTICALS INC.
TABLE OF CONTENTS
PAGE NO.
--------
Part I. Financial Information
Item 1: Financial Statements (Unaudited)
Consolidated Balance Sheets as of September 30, 2004, and December 31, 2003 1
Consolidated Statements of Operations and Comprehensive Loss for the
three and nine months ended September 30, 2004 and 2003 2
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2004 and 2003 3
Notes to Consolidated Financial Statements 4
Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Item 3: Quantitative and Qualitative Disclosures About Market Risk 22
Item 4: Controls and Procedures 22
Part II. Other Information
Item 1: Legal Proceedings 23
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds 23
Item 3: Defaults Upon Senior Securities 23
Item 4: Submission of Matters to a Vote of Security Holders 23
Item 5: Other Information 23
Item 6: Exhibits 23
SIGNATURES 24
ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2004 2003
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 49,245 $ 65,302
Short-term investments 31,912 11,218
Short-term investments pledged as collateral for letter of credit --- 7,011
Accounts receivable 2,362 1,834
Other current receivables 308 712
Prepaids 1,288 727
--------- ---------
Total current assets 85,115 86,804
Long-term investments 2,016 1,957
Equipment and leasehold improvements, net 4,799 4,980
Intangible and other assets, net of accumulated amortization of $447 and $368 578 657
--------- ---------
Total assets $ 92,508 $ 94,398
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,153 $ 2,404
Accrued expenses 9,360 5,904
Deferred revenue 561 561
Current maturity on long-term debt --- 6,000
--------- ---------
Total current liabilities 14,074 14,869
Deferred revenue 1,259 1,680
Long-term debt, less current maturity 1,587 1,610
Minority interest in Revotar 896 1,383
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, 2004
75,000,000 shares authorized; 57,893,231 shares issued, 57,680,231 shares
outstanding. At December 31, 2003, 75,000,000 shares authorized;
52,457,167 shares issued, 52,244,167 shares outstanding 289 262
Additional paid-in capital 299,495 259,761
Deferred compensation expense (186) (185)
Treasury stock, 213,000 shares (1,602) (1,602)
Accumulated other comprehensive income 160 78
Accumulated deficit (223,464) (183,458)
--------- ---------
Total stockholders' equity 74,692 74,856
--------- ---------
Total liabilities and stockholders' equity $ 92,508 $ 94,398
========= =========
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Revenues:
Research agreements $ --- $ 761 $ 1,522 $ 2,245
Collaborative research and development from
Encysive, L.P. --- --- --- 664
Royalty income, net 2,307 1,382 6,059 3,642
License fees, milestones and grants 276 1,270 1,227 2,306
------------ ------------ ------------ ------------
Total revenues 2,583 3,413 8,808 8,857
------------ ------------ ------------ ------------
Expenses:
Research and development 16,754 8,586 41,962 19,109
Equity in loss of Encysive, L.P. --- --- --- 2,386
Purchase of in-process research and development --- --- --- 8,363
General and administrative 2,893 2,840 8,120 7,252
------------ ------------ ------------ ------------
Total expenses 19,647 11,426 50,082 37,110
------------ ------------ ------------ ------------
Operating loss (17,064) (8,013) (41,274) (28,253)
Investment income, net 296 267 781 904
------------ ------------ ------------ ------------
Loss before minority interest (16,768) (7,746) (40,493) (27,349)
Minority interest in loss of Revotar 189 265 487 768
------------ ------------ ------------ ------------
Net loss (16,579) (7,481) (40,006) (26,581)
Other comprehensive income:
Unrealized (loss) gain on foreign currency translation (182) (52) 82 115
------------ ------------ ------------ ------------
Comprehensive loss $ (16,761) $ (7,533) $ (39,924) $ (26,466)
============ ============ ============ ============
Net loss per common share-
basic and diluted $ (0.31) $ (0.17) $ (0.76) $ (0.61)
============ ============ ============ ============
Weighted average common shares used to
compute basic and diluted net loss per share 53,606,539 43,914,497 52,781,749 43,801,837
============ ============ ============ ============
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,
-------------------------------
2004 2003
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(40,006) $(26,581)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 815 768
Equity in loss of Encysive, L.P. - 2,386
Purchase of in-process research and development - 8,363
Minority interest in loss of Revotar (487) (768)
Expenses paid with stock 586 356
Stock-based compensation expense 216 400
Loss on disposition of fixed assets 5 2
Amortization of premium / discount on investments 89 183
Change in operating assets and liabilities:
Interest receivable included in short-term and long-term investments 131 259
Accounts receivable (528) (301)
Prepaids (560) 990
Other current receivables 404 131
Receivable from Encysive, L.P. - 393
Accounts payable and accrued expenses 5,297 2,634
Payable to Encysive, L.P. - (5,051)
Deferred revenue from unrelated parties (421) (1,565)
Deferred revenue from related party - (136)
-------- --------
Net cash used in operating activities (34,459) (17,537)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment and leasehold improvements (582) (249)
Grant received for purchases of equipment - 185
Purchase of in-process research and development - (4,000)
Purchases of investments (43,860) (12,953)
Maturity of investments 29,898 33,062
-------- --------
Net cash (used in) provided by investing activities (14,544) 16,045
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock and option and
warrant exercises, net 38,958 863
Borrowings (Repayment) of long-term debt (6,000) 905
-------- --------
Net cash provided by financing activities 32,958 1,768
Effect of exchange rate changes on cash (12) 8
-------- --------
Net (decrease) increase in cash and cash equivalents (16,057) 284
Cash and cash equivalents at beginning of period 65,302 21,228
-------- --------
Cash and cash equivalents at end of period $ 49,245 $ 21,512
======== ========
Supplemental schedule of noncash financing activities:
Stock-based compensation expense $ 216 $ 400
Issuance of Common Stock for expenses 586 356
Interest paid 39 76
See accompanying notes to consolidated financial statements
3
ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004 (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, 2003. Except as disclosed herein,
there has been no material change in the information disclosed in the notes to
the consolidated financial statements included in the Company's Annual Report on
Form 10-K for the year ended December 31, 2003. 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, 2004, are not necessarily
indicative of the results that may be expected for any other interim period, or
for the year ending December 31, 2004.
(2) ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
(a) Organization
Encysive is a biopharmaceutical company focused on the discovery,
development and commercialization of novel synthetic small molecule
compounds 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.
The Company is presently working on a number of long-term
development projects that involve experimental and unproven technology,
which may require many years and substantial expenditures to complete, and
which may or may not be successful. Sales of the Company's first
FDA-approved product, 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, ImmunoPharmaceutics, Inc.
("IPI"), a California corporation, Encysive, L.P. ("ELP"), a Delaware
limited partnership, EP-ET, LLP, a Delaware limited partnership, Encysive
(UK) Limited, a private company located in the United Kingdom (UK), and
its majority controlled subsidiary, Revotar Biopharmaceuticals AG
("Revotar"), a German corporation. All material intercompany balances and
transactions have been eliminated.
(c) Stock-Based Compensation
At September 30, 2004, the Company has six stock-based compensation
plans for employees and non-employee directors. The Company accounts for
those plans under the recognition and measurement principles of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. The Company's results of
operations for the three-month periods ended September 30, 2004 and 2003,
and the nine-month periods ended September 30, 2004 and 2003, included
$57,000 and $29,000, respectively, and $216,000 and $120,000,
respectively, in stock-based compensation expense arising from the grant
of shares of restricted common stock to employees and the recognition of
deferred compensation expense arising
4
from the grant of stock options in March 2003 to certain employees, which
were subject to the approval of stockholders of an amendment to increase
the authorized shares in the 1999 plan. The three- and nine-month periods
ended September 30, 2003 included $207,000 in stock-based compensation
expense associated with the modification of certain warrants. 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 (dollars
in thousands, except for per share data).
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- --------------------
2004 2003 2004 2003
-------- ------- -------- --------
Net loss, as reported $(16,579) $(7,481) $(40,006) $(26,581)
Add: Stock-based employee
compensation expense
included in reported
net loss 56 309 216 400
Deduct: Total stock-based
employee compensation
expense determined
under fair value method
for all awards (1,037) (810) (2,625) (2,684)
-------- ------- -------- --------
Pro forma net loss $(17,560) $(7,982) $(42,415) $(28,865)
======== ======= ======== ========
Loss per share:
As reported, basic and diluted $ (0.31) $ (0.17) $ (0.76) $ (0.61)
Pro forma, basic and diluted $ (0.33) $ (0.18) $ (0.80) $ (0.66)
The per-share weighted average fair value of stock options granted
during the three-month periods ended September 30, 2004 and 2003, was
$5.23 and $3.02, respectively, and in the nine-month periods ended
September 30, 2004 and 2003 was $5.95 and $1.02, 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,
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Expected dividend yield 0.0% 0.0% 0.0% 0.0%
Risk-free interest rate 3.1% 3.1% 2.9% 2.6%
Expected volatility 69.6% 76.9% 73.6% 73.8%
Expected life in years 4.47 4.63 4.82 4.50
(3) CAPITAL STOCK
The Company has reserved Common Stock for issuance as of September 30,
2004, as follows:
Stock option plans................................... 7,852,101
Warrant outstanding.................................. 142,858
---------
Total shares reserved............................. 7,994,959
5
At September 30, 2004, the Company's only outstanding warrant is a warrant
to purchase 142,858 shares issued to Genentech in 1997. The Genentech warrant
expired in October 2004 and had an exercise price of $14.00 per share.
(4) 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 remaining
maturities of less than one year and original maturities 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 was other than temporary, the Company would
record a loss and reduce the carrying value of such security to its fair value.
Composition of cash and investments was as follows (dollars in thousands):
September 30, 2004 December 31, 2003
------------------ -----------------
Cash and cash equivalents:
Demand and money market accounts $ 1,102 $ 1,043
Corporate commercial paper 48,143 64,259
-------------- --------------
Total cash and cash equivalents $ 49,245 $ 65,302
============== ==============
Investments at September 30, 2004, and December 31, 2003, were as follows
(dollars in thousands):
As of September 30, 2004
------------------------------------------------------------
Gross Gross Estimated
Short-term investments Amortized Unrealized Unrealized Fair
Held-to-maturity Cost Gains Losses Value
---------------- --------- ---------- ---------- ---------
Corporate commercial paper
and loan participations $ 30,911 $ 23 $ (20) $ 30,914
Corporate debt securities 1,001 -- -- 1,001
--------- --------- --------- ---------
Total short-term
held-to-maturity investments $ 31,912 $ 23 $ (20) $ 31,915
========= ========= ========= =========
As of September 30, 2004
------------------------------------------------------------
Gross Gross Estimated
Long-term investments Amortized Unrealized Unrealized Fair
Held-to-maturity Cost Gains Losses Value
---------------- --------- ---------- ---------- ---------
U.S. Government agency
securities $ 2,016 $ -- $ (24) $ 1,992
--------- ----------- --------- ---------
Total long-term
held-to-maturity investments $ 2,016 $ -- $ (24) $ 1,992
========= =========== ========= =========
6
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 $ 2,010 $ -- $ (9) $ 2,001
Corporate commercial paper 10,057 19 (2) 10,074
Corporate debt securities 6,162 -- (61) 6,101
---------- ---------- ---------- ----------
Total short-term
held-to-maturity investments $ 18,229 $ 19 $ (72) $ 18,176
========== ========== ========== ==========
As of December 31, 2003
--------------------------------------------------------
Gross Gross Estimated
Long-term investments Amortized Unrealized Unrealized Fair
Held-to-maturity Cost Gains Losses Value
--------------------- ---------- ---------- ---------- ---------
Corporate commercial paper $ 956 $ 36 $ -- $ 992
Corporate debt securities 1,001 -- (1) 1,000
---------- ---------- ---------- ---------
Total long-term
held-to-maturity investments $ 1,957 $ 36 $ (1) $ 1,992
========== ========== ========== =========
(5) NET LOSS PER COMMON SHARE
Basic net loss per common share is calculated by dividing the net loss by
the weighted average number of common and common equivalent shares outstanding
during the period. For the three- and nine-month periods ended September 30,
2004, the weighted average common shares used to compute basic and diluted net
loss per common share totaled 53,606,539 and 52,781,749, respectively. For the
three- and nine-month periods ended September 30, 2003, the weighted average
common shares used to compute basic and diluted net loss per common share
totaled 43,914,497 and 43,801,837, respectively. Securities convertible into
Common Stock comprised of stock options, warrants and unvested shares of
restricted common stock totaling 5,346,837 and 5,511,513 shares at September 30,
2004 and 2003, respectively, were not used in the calculation of diluted net
loss per common share because the effect would have been antidilutive.
(6) INCOME TAXES
The Company did not incur tax expense (benefit) during the three- and
nine-month periods ended September 30, 2004 and 2003, due to operating losses
and the related increase in the valuation allowance.
(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 (dollars in
thousands):
7
SEPTEMBER 30, 2004 DECEMBER 31, 2003
------------------ -----------------
Long-lived assets:
United States $ 4,345 $ 4,327
Germany 1,032 1,310
---------------- ----------------
Total $ 5,377 $ 5,637
================ ================
The following table summarizes the Company's revenues in different
geographic locations (dollars in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------------------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
------------- ------------- ------------- -------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
Revenues:
United States $ 2,448 $ 3,245 $ 8,001 $ 8,264
Germany 135 168 807 593
---------- ---------- ---------- ----------
Total $ 2,583 $ 3,413 $ 8,808 $ 8,857
========== ========== ========== ==========
The Company's revenues are primarily derived from several entities, each
of whom represents a significant percentage of total revenues. The following
table summarizes the Company's sources of revenues from its principal entities
(dollars in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------------------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
------------- ------------- ------------- -------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
Entities:
GSK $ 2,307 $ 1,382 $ 6,059 $ 3,643
Schering-Plough 141 901 1,942 2,665
Encysive, L.P. -- -- -- 811
Mitsubishi -- 962 -- 1,145
Other 135 168 807 593
------------ ----------- ---------- ----------
Total $ 2,583 $ 3,413 $ 8,808 $ 8,857
============ =========== ========== ==========
(8) FOREIGN SUBSIDIARY
The Company owns approximately 55 percent of the outstanding common stock
of Revotar and has consolidated the financial results of Revotar into its
consolidated financial statements. The minority interest in Revotar at September
30, 2004, and December 31, 2003, was $896,000 and $1,383,000, respectively. The
Company's consolidated net loss for the three-month periods ended September 30,
2004 and 2003, was reduced by $189,000 and $265,000, respectively, and for the
nine-month periods ended September 30, 2004 and 2003, was reduced by $487,000
and $768,000, respectively, for the Revotar minority shareholders' interest in
Revotar's losses.
Revotar has received research grants from the German government and earned
approximately $135,000 and $168,000 during the three-month periods ended
September 30, 2004 and 2003, respectively, which is included in license fees,
milestones and grants. During the nine-month periods ended September 30, 2004
and 2003, Revotar received grants of $807,000 and $593,000, respectively.
In addition to the research grants discussed above, Revotar has received
grants from the German government to purchase certain research equipment, which
are being recognized in income over the estimated useful life of the assets.
8
The Company and the other stockholders of Revotar executed an agreement to
provide approximately $4.5 million in unsecured loans, of which the Company's
commitment was 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 was seven percent, after which
the interest rate will be reset to the U.S. prime rate plus 2.5 percent if such
rate is higher than seven percent. Pursuant to such agreement, the Company has
advanced its full commitment of approximately $3.4 million to Revotar as of
September 30, 2004. During 2003, the minority shareholders of Revotar advanced
approximately $1.5 million to Revotar. The loan from the Company is denominated
in U.S. dollars and is eliminated in consolidation. Neither Encysive nor the
minority shareholders have any obligation to advance additional funds to
Revotar. We believe that Revotar's existing funds, and the remaining commitment
under the loan agreement and proceeds under German government scientific grants,
will be sufficient to fund Revotar into the first quarter of 2005. In order to
continue to operate beyond that time, Revotar will need to seek additional
funding through collaborative arrangements and/or through public or private
financings in the future. We cannot assure you that such funding will be
available on acceptable terms. Revotar is actively seeking a partner, or
partners, to develop the inhaled indications of bimosiamose. If Revotar is
unable to obtain additional funding, Revotar will no longer be able to continue
its operations, and may have to consider various methods of maximizing
shareholder value, including the sale or liquidation of its assets to its
stockholders or third parties.
(9) LONG-TERM DEBT
The Company was a party to a note arising from its acquisition of the
partnership interest of ICOS Corporation in ELP in April 2003. The note required
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 accrued interest
at a rate which approximated the three-month London interbank offering rate for
U.S. dollars ("LIBOR") plus 1.5 percent. The Company's obligations under the
note were secured with an irrevocable standby letter of credit for which the
Company pledged marketable securities with an amortized cost of $7,011,000. On
March 31, 2004, the Company prepaid its remaining $6,000,000 obligation under
the note plus accrued interest of $38,000, and the pledged marketable securities
were returned to the Company.
As of September 30, 2004, Revotar owes its minority shareholders
approximately $1.6 million (see Note 8).
(10) 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 unrealized
losses of $182,000 and $52,000, respectively, in its comprehensive loss
for the three-month periods ended September 30, 2004 and 2003,
respectively, and unrealized gains of $82,000 and $115,000, respectively,
in the nine-month periods ended September 30, 2004 and 2003. The Company
had an intercompany receivable from its German subsidiary at September 30,
2004 and December 31, 2003; however, this amount is denominated in U.S.
dollars and is not exposed to exchange risk. Loans by the Company to
Revotar are denominated in U.S. dollars. 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
9
liability. The Company may be involved in legal actions from time to time.
The Company has used various substances in its research and development
that have been or may be deemed to be hazardous or dangerous, and the
extent of its potential liability, if any, under environmental, product
liability and workers' compensation statutes, rules, regulations and case
law is unclear.
10
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, 2004, AND SEPTEMBER 30, 2003
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, 2003, and with the
consolidated financial statements and related notes to the financial statements
included elsewhere in this Form 10-Q. This discussion contains forward-looking
statements based on current expectations that are subject to risks and
uncertainties, such as statements of our plans, objectives, expectations and
intentions. When used in this discussion, the words "expect," "anticipate,"
"intend," "plan," "believe," "seek," "estimate" and similar expressions are
intended to identify forward-looking statements, although not all
forward-looking statements contain these identifying words. Our actual results
and the timing of events could differ materially from those anticipated or
implied by the forward-looking statements discussed here as a result of various
factors, including, among others, those set forth under the "Cautionary Note
Regarding Forward-Looking Statements" in our Annual Report on Form 10-K for the
year ended December 31, 2003. You should not place undue reliance on these
forward-looking statements, which speak only as of the date of this report.
Except as required by law, we undertake no obligation to update any of the
forward-looking statements in this discussion after the date of this report.
Encysive is a biopharmaceutical company engaged in the discovery,
development and commercialization of novel, synthetic, small molecule compounds
to address unmet medical needs. Our research and development programs are
predominantly focused on the treatment and prevention of interrelated diseases
of the vascular endothelium and exploit our expertise in the area of the
intravascular inflammatory process, referred to as the inflammatory cascade, and
vascular diseases. We have successfully developed one FDA-approved drug,
Argatroban, for the treatment of heparin-induced thrombocytopenia, ("HIT"),
which is marketed by GlaxoSmithKline plc, ("GSK"). Our lead drug candidate,
Thelin(TM) (sitaxsentan sodium) is an endothelin receptor antagonist in Phase
III clinical trials for the treatment of pulmonary arterial hypertension
("PAH"). In addition, we have earlier stage clinical product candidates in
development including TBC3711, a next generation endothelin receptor antagonist,
and bimosiamose, being developed by our majority-owned German affiliate,
Revotar.
Thelin(TM)
Thelin(TM) is being developed as a treatment for PAH, a life-threatening
disease characterized by the constriction of blood vessels leading to the lungs.
This constriction leads to very high blood pressure in the pulmonary arteries as
the heart struggles to pump blood to the lungs. PAH patients suffer from extreme
shortness of breath and, as the disease progresses, are less able to perform the
daily activities of living. Over time, PAH leads to right ventricular failure
(heart failure) and death. PAH may be a primary condition, perhaps caused by
genetic factors, or secondary to other diseases like autoimmune diseases (such
as scleroderma or lupus), congenital heart disease, HIV infection or cirrhosis
of the liver. PAH is an orphan disease (defined in the U.S. as a prevalence of
less than 200,000 patients) that industry research analysts estimate to afflict
approximately 80,000 to 100,000 individuals worldwide, many of whom are children
and young women.
In 2002, we successfully completed and announced results of our
Sitaxsentan To Relieve ImpaireD Exercise in Pulmonary Arterial Hypertension
("STRIDE-1") Phase IIb/III pivotal study in PAH with Thelin(TM). We have
initiated and have completed enrollment in a Phase III pivotal clinical trial,
STRIDE 2. In June 2003, we received a Special Protocol Assessment ("SPA"), which
is a binding written agreement between a clinical trial sponsor and the FDA on
the design of pivotal trials, confirming that, if successful,
11
\
the STRIDE 2 trial results, together with the results from STRIDE 1 and planned
supportive trials, will be sufficient for the submission to the FDA of
Thelin(TM)'s New Drug Application ("NDA").
STRIDE 2 is a trial that enrolled 246 patients with Class II-IV PAH, as
classified by the World Health Organization ("WHO"), of primary or secondary
causes. STRIDE 2 is of 18 weeks duration and tests two doses of Thelin(TM) (100
mg and 50 mg), versus a dose of placebo, dosed once daily in a double-blind
fashion. In addition, a randomized bosentan arm is included. The primary
endpoint of STRIDE 2 is six-minute walk distance, and secondary endpoints
include change in functional class, shortness of breath and the occurrence of
clinical deterioration events. In September 2004, we announced that enrollment
had closed. Top-line data is expected to become available in February 2005, and
we anticipate that the NDA will be submitted to the Food and Drug Administration
in April 2005.
In June 2004, we completed enrollment of patients in STRIDE-6, a
randomized double-blind safety and efficacy study of Thelin(TM) in patients with
PAH who have failed bosentan therapy. STRIDE-6 enrolled 48 patients, 35 of which
had discontinued bosentan therapy for lack of efficacy and 13 for reasons
related to safety. Of the 35 patients discontinuing bosentan therapy for lack of
efficacy, 33% in the Thelin(TM) 100 mg group and 10% in the Thelin(TM) 50 mg
group improved. Continued deterioration was noted in 20% of the 100mg group and
15% of the 50 mg group. The remaining patients were considered unchanged.
Of the 13 patients who discontinued bosentan treatment due to safety, 12
were for liver function abnormalities and one for rash. One patient who had
developed liver function abnormalities after one month of bosentan treatment
increased to more than 3 times the upper limit of normal after 12 weeks of
treatment with 100 mg of Thelin(TM). This patient has been discontinued from
therapy.
Adverse events occurred with similar frequency with both Thelin(TM) doses.
The most frequent adverse events occurring in 4 or more patients include nausea,
fatigue, edema, headache, and upper respiratory tract infection. One patient in
the 50 mg group admitted to the study for clinical deterioration died. This
patient had received Thelin(TM) for 17 days and then bosentan for a further 12
days prior to dying from progressive pulmonary hypertension.
In September 2004, clinical data was presented from a single-center
11-patient trial, also in bosentan failure, with results similar to those
encountered in STRIDE-6. In July 2004, we announced that enrollment had closed
in STRIDE-4, a Phase III, randomized, double-blind, placebo-controlled safety
and efficacy study of Thelin(TM) treatments in patients with PAH. We anticipate
that top-line data for STRIDE-4 will be available on or around the end of 2004.
In October 2004, the European Commission designated Thelin(TM) as an
orphan medicinal product for the treatment of PAH and chronic thromboembolic
pulmonary hypertension.
We have worldwide commercialization rights to Thelin(TM). Upon regulatory
approval, we intend to commercialize Thelin(TM) in North America through our own
specialty sales force. Although we had previously announced our intention to
seek a marketing partner for the rest of the world, in June 2004, we announced
our intention to reserve all marketing rights to Thelin(TM). We believe it is
advantageous to allow the market to continue to grow globally before making a
final decision on any marketing plans outside North America. While we are
considering the option of marketing the product on our own worldwide, we intend
to leave our options open and continually re-assess the situation as we move
closer to commercialization.
Argatroban
Argatroban, licensed from Mitsubishi Pharma Corporation ("Mitsubishi") and
developed in North America by Encysive, is a synthetic direct thrombin inhibitor
approved by the FDA in 2000. It is indicated for prophylaxis or treatment of
thrombosis for patients with HIT, a profound allergic reaction to
anticoagulation therapy with heparin, and for use in HIT patients undergoing
precutaneous coronary intervention. Argatroban was approved in Canada in 2002
for use as an anticoagulant therapy in patients
12
with HIT syndrome. GSK markets Argatroban in the U.S. and Canada, and has Waxman
Hatch market exclusivity in the U.S. until June 2005. A pediatric study is
underway, which could prolong exclusivity in the U.S. to the end of 2005. In
fiscal year 2003, Encysive earned royalties from the sales of Argatroban
totaling $5.4 million and expects to earn royalties of $7.5 to $8.5 million in
fiscal year 2004. Royalties from the sales of Argatroban were approximately $6.1
million in the nine months ended September 30, 2004.
Other Development Programs
In addition to Thelin(TM) and Argatroban, we have a number of projects in
clinical and preclinical development. TBC3711, a next generation ET(A) receptor
antagonist, has completed Phase I clinical development for the treatment of PAH.
TBC3711 is more selective and more potent than Thelin(TM).
Our majority-owned German affiliate, Revotar, is developing bimosiamose, a
selectin antagonist discovered in Encysive's laboratories, which is designed to
block inflammatory cells from leaving the vascular space to travel to tissue
sites of inflammation. Revotar recently completed Phase IIa clinical trials
evaluating the use of topical bimosiamose for the treatment of psoriasis and
atopic dermatitis. An inhaled version of bimosiamose has completed a 12-patient
proof-of-concept study in asthma that demonstrated a statistically significant
improvement in the late asthmatic response, the same target addressed by inhaled
steroid use in asthma. Revotar is seeking a licensing partner for inhaled
bimosiamose.
We have entered into a worldwide research collaboration and license
agreement with Schering-Plough Corporation and Schering-Plough LTD (collectively
"Schering-Plough"), to discover, develop and commercialize VLA-4 antagonists.
Schering-Plough is in the final stages of pre-clinical development with TBC4746,
an oral VLA-4 antagonist. If this work is successful, the next development step
would be for Schering-Plough to initiate studies in human volunteers. VLA-4 is a
potential target in the inflammatory cascade taking place within the
vasculature. TBC4746 has the potential to address a number of diseases,
including asthma and multiple sclerosis. Additionally, on June 30, 2004,
Schering-Plough ended their funding of our research on a follow-on compound
pursuant to the research agreement.
Encysive's Research Programs
Our research efforts are concentrated on targets within the vasculature,
and the potential indications of our drug candidates include cardiovascular
diseases and a potentially wide variety of inflammatory diseases involving two
complementary sets of targets. The first set of targets relate to vascular
G-protein coupled receptors ("GPCRs"). Historically, GPCRs have been some of the
most amenable targets for developing commercially successful pharmaceuticals,
such as beta-blockers, antihistamines, and most anti-psychotics and
anti-depressants. Endothelin receptors, targeted by Thelin(TM) and TBC3711, are
examples of GPCRs.
Encysive also has developed expertise in pharmacologically intervening in
the intravascular inflammatory cascade, representing a second set of
intravascular targets. Bimosiamose and TBC4746 are examples of drug candidates
that we designed to target two distinct steps in this cascade, the selectins and
VLA-4, respectively. Some of the targets in this cascade are GPCRs. Thus, our
focus on endothelial cell and related vascular biology has opened up a broad
range of disease targets with high, unmet medical need.
CRITICAL ACCOUNTING POLICIES
Revenue Recognition
- We recognize revenue from service contracts as services are
performed.
- Royalty revenue is recognized as products are sold by a licensee and
we have received sufficient information to record a receivable. Our
royalty revenue is based on net sales of product, that is, sales net
of discounts, returns and allowances. We have estimated a percentage
of gross sales, based on recent experience, as an allowance for
future returns, however there can be no assurance that our estimate
will be accurate. We believe, however, that differences between
13
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, 2004, remaining deferred revenue was
approximately $1.8 million, of which we expect to recognize approximately $0.6
million over the next twelve months. A future change in our estimate of
development periods could accelerate or decelerate the timing of future
recognition of deferred revenue.
Stock Options
We apply Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations ("APB 25") in accounting for
our stock option plans and apply FASB Statement No. 123, "Accounting for
Stock-Based Compensation," and related interpretations ("FAS 123") in reporting
for our stock option plans. APB 25 utilizes the "intrinsic value" of stock
options, defined as the difference between the exercise price of an option and
the market price of the underlying share of common stock on the "measurement
date," which is generally the date of grant. Since the exercise price of
employee stock options issued under our plans is set to match the market price
of our Common Stock, there is generally no compensation expense recognized upon
grant of employee stock options. Options granted to non-employees, if any, are
valued at the fair value of the option, as defined by FAS 123, utilizing the
Black-Scholes option pricing model. We record compensation expense for the fair
value of options granted to non-employees. The pro forma effect of recognizing
the fair value of stock option grants to employees on our consolidated results
of operations is discussed in Note 2(c), Stock-Based Compensation.
Drug Manufacturing and Packaging
Costs arising from the manufacturing and packaging of drug product, which
is intended for use in clinical trials, are recognized as incurred and included
in research and development expenses.
14
RESULTS OF OPERATIONS
The preparation of financial statements in conformity with accounting
principles generally accepted in the USA requires us to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Our operating results have fluctuated significantly during
each quarter and year and we anticipate that such fluctuations, which are
largely attributable to varying research and development commitments and
expenditures, will continue for the next several years. We have been
unprofitable to date and expect to incur substantial operating losses for the
next several years as we invest in product research and development, preclinical
and clinical testing and regulatory compliance. We have sustained net losses of
approximately $223.5 million from the date of our inception to September 30,
2004. 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 "Liquidity and Capital Resources" below. See also
"Additional Risk Factors" in Item 1 "Business" in our Annual Report on Form 10-K
for the year ended December 31, 2003.
In April 2003, we acquired the interest of ICOS Corporation in ELP in a
transaction also referred to as the "Acquisition." Of the $10 million purchase
price, $4 million was paid at closing and the remaining $6 million was subject
to the terms of a note to ICOS, which required a $4 million payment in April
2004 and a $2 million payment in October 2004. The Company prepaid its remaining
$6 million obligation under the note on March 31, 2004.
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 all 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. The
consolidation of ELP into our financial statements results in the elimination of
the revenue item, "Collaborative research and development from Encysive, L.P.,"
and the expense item, "Equity in loss of Encysive, L.P.," from our financial
statements and the inclusion of operating expenses of ELP in our operating
expenses.
THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003
REVENUES
Total revenues decreased $0.8 million in the three months ended September
30, 2004, compared with the three months ended September 30, 2003. As discussed
above, funding from Schering-Plough under the research agreement ended June 30,
2004; however the quarter ended September 30, 2003, included approximately $0.8
million in such funding. Royalties earned on sales of Argatroban by GSK
increased $0.9 million in the quarter ended September 30, 2004, compared with
the quarter ended September 30, 2003. In the three months ended September 30,
2003, we determined it was appropriate to recognize the remaining deferred
milestone payment which had previously been received from Mitsubishi Pharma
Corporation, also referred to as Mitsubishi, totaling approximately $0.9
million.
Total revenues in the nine-month periods ended September 30, 2004 and
2003, were comparable. Royalties on sales of Argatroban by GSK increased $2.4
million due to higher sales in the current year period. Revenues in the
nine-months ended September 30, 2003, however, included $0.7 million of
collaborative research and development from ELP. As discussed above, in the
periods following the Acquisition, the operating results of ELP are included in
our operating results and, accordingly, collaborative research and development
from ELP and certain license fee and milestone revenues have
15
been eliminated in consolidation. Revenues in the three- and nine-month periods
ended September 30, 2004, and September 30, 2003, included research funding from
Schering-Plough; such funding ended on June 30, 2004. As discussed above,
license fees, milestones and grants in the nine months ended September 30, 2003
included approximately $0.9 million resulting from the recognition of remaining
deferred revenue arising from a milestone payment which had previously been
received from Mitsubishi. As discussed above, as funding from Schering-Plough
under the research agreement ended June 30, 2004, thus research agreement
revenues declined approximately $0.9 million in the nine-month period ended
September 30, 2004, compared with the nine months ended September 30, 2003.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense in the three-month period ended September
30, 2004, increased $8.2 million, compared with the three months ended September
30, 2003, primarily due to the costs associated with the ongoing Thelin(TM)
development program. Thelin(TM) development costs increased $8.3 million in the
current quarter, compared to the quarter ended September 30, 2003.
Research and development expense in the nine-month period ended September
30, 2004, increased $22.9 million, compared with the nine months ended September
30, 2003, primarily due to expenses of the Thelin(TM) development program. Of
the increase, $22.1 million is attributable to the Thelin(TM) development
program.
In September 2004, we announced that enrollment in STRIDE 2 had closed and
anticipate that the NDA will be submitted to the FDA in April 2005. We are
continuing to enroll patients in STRIDE 3, a long-term safety study and also
expect to incur significant expenses for activities such as data management and
analysis as we review the results of the STRIDE clinical trials. Accordingly, we
expect research and development expenses for the remainder of 2004 to
significantly exceed expenses incurred in the comparable prior-year periods.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense in the three months ended September 30,
2004 and 2003, was comparable at $2.9 million and $2.8 million, respectively. In
the nine months ended September 30, 2004, general and administrative expense was
$8.1 million, compared with $7.3 million in the nine months ended September 30,
2003. The increase in general and administrative expense in the current year
periods is primarily due to increased staff, travel, and other costs associated
with our preparation for the future commercialization of Thelin(TM). We believe
general and administrative expense throughout the remainder of 2004 will
continue to be higher than in the comparable 2003 periods, due to costs of
preparing for the commercialization of Thelin(TM) in anticipation of receiving
regulatory approval.
EQUITY IN LOSS OF ENCYSIVE, L.P.
As discussed above, prior to the Acquisition we accounted for our
investment in Encysive, L.P. using the equity method, and recorded our share of
its loss as "Equity in Loss of Encysive, L.P." In the periods following the
Acquisition, the expenses of ELP are included in our consolidated results of
operations.
PURCHASE OF IN-PROCESS RESEARCH AND DEVELOPMENT
The results of the nine-month periods ended September 30, 2003, included a
charge of $8.4 million resulting from the Acquisition.
TOTAL OPERATING EXPENSES
Total operating expenses in the three months ended September 30, 2004,
increased $8.2 million compared to the three months ended September 30, 2003,
due to higher research and development expenses, discussed above.
16
Total operating expenses in the nine months ended September 30, 2004,
increased $13.0 million compared with the nine months ended September 30, 2003.
After adjusting for the costs of the Acquisition, operating expenses increased
$21.3 million in the nine months ended September 30, 2004. The increase in the
nine-month periods is attributable to costs associated with the Thelin(TM)
development program. As discussed above, we believe that operating expenses in
the remainder of 2004 will continue to be higher than the comparable 2003
periods primarily due to costs associated with Thelin(TM) development and
commercialization.
OPERATING LOSS
Operating loss in the three months ended September 30, 2004, increased
$9.1 million compared with the three months ended September 30, 2003 due to
lower revenues and higher research and development expenses in the three months
ended September 30, 2004.
Operating loss in the nine months ended September 30, 2004, increased
$13.0 million compared to the nine months ended September 30, 2003. After
adjusting for the $8.4 million charge resulting from the Acquisition, operating
loss in the nine months ended September 30, 2004, increased $21.4 million. The
increased loss is due to increased research and development costs related to
Thelin(TM) development program.
As discussed above, we expect operating losses throughout the remainder of
2004 to exceed comparable periods in 2003 due to costs associated with the
Thelin(TM) development and commercialization.
INVESTMENT INCOME
Investment income in the three- and nine-month periods ended September 30,
2004 and 2003, was comparable.
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.
Cash, cash equivalents and investments in marketable securities, including
accrued interest thereon, was $83.2 million at September 30, 2004, compared with
$85.5 million at December 31, 2003. We used $34.5 million in cash in operating
activities during the nine months ended September 30, 2004, compared to $17.5
million during the nine months ended September 30, 2003. The primary operating
uses of cash in the 2004 and 2003 periods were to fund our general operating
expenses and the ongoing research and development programs conducted by
Encysive, Revotar and ELP, reduced by cash received from investment income,
milestones, and research payments from our collaborative partners.
Investing activities are primarily comprised of our investments in debt
securities. Cash is generated from investing activities when marketable
securities mature, and the resulting cash is utilized primarily to fund
operating activities. Cash used in investing activities during the nine months
ended September 30, 2004, was primarily comprised of the investment of funds
received from our public offerings of common stock in December 2003 and
September 2004 and purchases of equipment. Cash provided by investing activities
during the nine months ended September 30, 2003, was primarily comprised of the
maturity of investments, the proceeds of which were used to fund operating
activities.
Cash provided by financing activities of $33.0 million during the nine
months ended September 30, 2004, included net proceeds of $35.6 million from the
sale of 4.6 million shares of our common stock in a public offering in September
2004 and approximately $3.4 million in proceeds from the exercise of employee
stock options, partially offset by the payment of $6.0 million to ICOS to repay
a note arising
17
from our acquisition of its partnership interest in ELP. Cash provided by
financing activities during the nine months ended September 30, 2003 included
$0.9 million borrowings by Revotar from its minority shareholders, and $0.9
million in proceeds from the exercise of employee stock options.
Material Commitments
Our material contractual obligations are comprised of (i) amounts borrowed
by Revotar from its minority shareholders (see Note 8), (ii) obligations under
our operating lease agreements and (iii) a contingent obligation to pay the
other party of a research agreement a termination fee in the event that we elect
to terminate the project prior to completion.
As of September 30, 2004, the Company had contractual obligations as
follows ($ in thousands):
Less than 1-3 4-5 After 5
Total 1 year years years years
Contractual Obligations
Long-term debt $ 1,587 -- $ 1,587 -- --
Operating leases 4,406 $ 1,548 2,858 -- --
Purchase obligations 424 424 -- -- --
---------- ---------- ---------- ------ -------
Total $ 6,417 $ 1,972 $ 4,445 -- --
Outlook for 2004
Previously, we had announced plans to license rights for marketing
Thelin(TM) outside North America. In June 2004, we announced our intention to
reserve all marketing rights to Thelin(TM). As a result of this change in
strategy, we expect to incur additional development costs, including but not
limited to costs associated with regulatory filings in countries outside North
America. Additionally, during the first nine months of 2004, we elected to
accept patients beyond our original expectations in certain of the clinical
trials and added additional human pharmacology studies. Our revised outlook for
2004 expenses, below, reflects such additional Thelin(TM) development costs.
Royalty revenues during the first nine months of 2004 have exceeded our
original expectations, due to higher than expected sales of Argatroban by GSK.
We have, accordingly, revised our expectation for royalty revenues to reflect
more recent trends.
Original Outlook Revised Outlook
---------------- ---------------
Royalties................................. $ 6.7 to $7.6 million $ 7.5 to $8.5 million
Revenues (including royalties)............ $ 9.0 to $10.0 million $ 10.0 to $11.0 million
Expenses (net of Revotar minority
interest)................................. $ 55.0 to $58.0 million $ 64.0 to $67.0 million
Investment income......................... $ 0.8 to $1.0 million $ 0.8 to $1.0 million
Net loss.................................. $ (46.0) to $(48.0) million $ (54.0) to $(57.0) million
Cash and investments at year end.......... $ 32.0 to $34.0 million $ 60.0 to $62.0 million
For a number of reasons discussed elsewhere in this Form 10-Q, we cannot
estimate, with a reasonable degree of certainty, total completion costs or dates
of completion of our ongoing research and development projects. See also
"Additional Risk Factors" in Item 1 "Business" in our Annual Report on Form 10-K
for the year ended December 31, 2003, and "Longer-Term Outlook," below.
These expectations are based upon various assumptions, which are subject
to certain risks, trends and uncertainties that could cause actual results to
differ materially from those projected. Among these risks, trends and
uncertainties are timing and cost of our clinical trials, attainment of research
and clinical goals and milestones of product candidates, and sales levels of
Argatroban. Argatroban sales trends during the first nine months of 2004 have
been higher than we originally projected, accordingly we have assumed that
recent sales trends of Argatroban over the previous year will continue. While we
do not sell
18
Argatroban, our revenues include a royalty from GSK, which is based on sales and
will, accordingly, vary with sales. Our actual royalty revenues could vary from
our assumptions to the extent that the actual sales of Argatroban differ from
assumed levels.
Projected revenues contain continued amortization of deferred license fees
and milestones previously received from Schering-Plough, which are being
deferred over the estimated development period of the respective compound or
program. We periodically review our estimates of development periods and actual
recognized revenues could increase or decrease to the extent that we increase or
decrease our estimated development periods. Our original outlook assumed that
funding under the Schering-Plough research agreement would end on June 30, 2004,
and such funding has ended.
Projected operating expenses are based upon our current expectations for
the year. We have assumed additional staff necessary to prepare for regulatory
filing in the U.S. as well as in the rest of the world. Increased projected
operating expenses also reflect higher overall patient enrollment in some of the
clinical and other supporting trials and additional human pharmacology studies
of Thelin(TM) than was assumed in our original outlook. Our projected 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 two percent on an average of approximately $50 million in
funds available for investment throughout the year.
Cash and investments at year-end are 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 included the proceeds of our sale of 4,600,000
shares of our common stock in September 2004, and 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.
Longer-Term Outlook
We expect to incur substantial research and development expenditures as we
design and develop biopharmaceutical products for the prevention and treatment
of cardiovascular and other interrelated diseases of the vascular endothelium.
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 Thelin(TM) and research and
clinical trial costs for development of bimosiamose compounds and
expect to begin to incur costs for pre-clinical activities and 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 a contract research organization; and
- purchasing and formulating large quantities of the compound to
be used in such trials.
- As regulatory standards continue to evolve on a global basis, we
recognize that new hurdles may be put in place that may raise costs
or increase the uncertainty of timing, approvability or use of drugs
in development on a local or regional basis.
- There may be additional costs in future periods related to
Argatroban in complying with ongoing FDA requirements.
19
- Our administrative costs and costs to commercialize our products
will increase as our products are further developed and marketed.
- If Thelin(TM) receives regulatory approval, we will incur
significant commercialization expenses. In addition, if the FDA
grants a priority review to Thelin(TM), the timing of
commercialization activities will be accelerated.
We have been unprofitable to date and expect to incur operating losses for
the next several years as we invest in 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, 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
indications for Thelin(TM);
- continued scientific progress in our drug discovery programs;
- the magnitude of these programs;
- progress with preclinical testing and clinical trials;
- the time and costs involved in obtaining regulatory approvals;
- the costs involved in filing, prosecuting and enforcing patent
claims;
- competing technological and market developments and changes in our
existing research relationships;
- our ability to maintain and establish additional collaborative
arrangements; and
- effective commercialization activities and arrangements.
We are in the process of developing our operating plan, or budget, for
year 2005. Subject to the outcome of the budgeting process and the above
factors, we anticipate that our existing capital resources and other revenue
sources should be sufficient to fund our cash requirements through the end of
2005. Notwithstanding revenues, which may be produced through sales of potential
future products, if approved, we anticipate that we will need to secure
additional funds to continue the required levels of research and development to
reach our long-term goals. We intend to seek such additional funding through
collaborative arrangements and/or through public or private financings. Upon
regulatory approval, we intend to commercialize Thelin(TM) in North America
through our own specialty sales force. Although we had previously announced our
intention to seek a marketing partner for the rest of the world, in June 2004 we
announced our intention to reserve all marketing rights to Thelin(TM). We
believe it is advantageous to allow the market to continue to grow globally
before making a final decision on any marketing plans outside North America.
While we are considering the option of marketing the product on our own
worldwide, we intend to leave our options open and continually re-assess the
situation as we move closer to commercialization.
In 2002, the stockholders of Revotar executed an agreement to provide
approximately $4.5 million in unsecured loans, of which our commitment was
approximately $3.4 million. Under the loan agreement, we have advanced our full
commitment of approximately $3.4 million to Revotar as of September 30, 2004.
Revotar's current shareholders have no obligation to advance additional funds to
Revotar. We believe that Revotar's existing funds, and the remaining commitment
under the loan agreement and proceeds under German government scientific grants,
will be sufficient to fund Revotar into the first quarter of 2005. In order to
continue to operate beyond that time, Revotar will need to seek additional
funding through collaborative arrangements and/or through public or private
financings in the future. We
20
cannot assure you that such funding will be available on acceptable terms.
Revotar is actively seeking a partner, or partners, to develop the inhaled
indications of bimosiamose. If Revotar is unable to obtain additional funding,
Revotar will no longer be able to continue its operations, and may have to
consider various methods of maximizing shareholder value, including the sale or
liquidation of its assets to its stockholders or third parties.
Off-Balance Sheet Arrangements
We do not engage in off-balance sheet financing arrangements.
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,
2003, 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.
21
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 affiliate in Berlin, Germany, and consolidate the
results of operations into our consolidated financial results. Although not
material to date, our reported expenses and cash flows from this affiliate are
exposed to changing exchange rates. We also have contracts with entities in
other areas outside the U.S. that are denominated in a foreign currency. To
date, these currencies have not fluctuated materially.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, our management carried
out an evaluation, with the participation of our principal executive officer
(the "CEO") and our principal financial officer (the "CFO"), of the
effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15
of the Securities Exchange Act of 1934. Based on those evaluations, the CEO and
CFO believe:
(i) that our disclosure controls and procedures are designed to ensure
that information required to be disclosed by us in the reports that we file or
submit under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and that such information is accumulated and communicated to our
management, including the CEO and CFO, as appropriate to allow timely decisions
regarding required disclosure; and
(ii) that our disclosure controls and procedures are effective.
Changes in Internal Controls Over Financial Reporting
There have been no significant changes in our internal controls over
financial reporting during the period covered by this report that has materially
affected, or are reasonably likely to materially affect, our control over
financial reporting.
22
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
EXHIBIT NO. DESCRIPTION
3.1 Restated Certificate of Incorporation of Encysive
Pharmaceuticals Inc.
10.1 Form of Option Agreement for Incentive Stock Options Awarded
to Directors and Executive Officers
10.2 Form of Option Agreement for Non-Qualified Stock Options
Awarded to Directors and Executive Officers
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) / Rule 15d-14(a), promulgated under the Securities
Exchange Act of 1934, as amended.
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) / Rule 15d-14(a), promulgated under the Securities
Exchange Act of 1934, as amended.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
23
ENCYSIVE PHARMACEUTICALS INC.
NOVEMBER 4, 2004
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 4th day of November, 2004.
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)
24
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
3.1 Restated Certificate of Incorporation of Encysive
Pharmaceuticals Inc.
10.1 Form of Option Agreement for Incentive Stock Options Awarded
to Directors and Executive Officers
10.2 Form of Option Agreement for Non-Qualified Stock Options
Awarded to Directors and Executive Officers
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) / Rule 15d-14(a), promulgated under the Securities
Exchange Act of 1934, as amended.
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) / Rule 15d-14(a), promulgated under the Securities
Exchange Act of 1934, as amended.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.