** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

## **Washington, D.C. 20549**

 

### **FORM 10-Q**

**(Mark One)**

 

**ý****  QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**        For the quarterly period ended September30, 2001**

** **

**OR**

 

**o****  TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**        For the transition period from ________to ___________**

** **

**Commissionfile number: 0-21130**

 

 

### **EnchiraBiotechnology Corporation**

(Exact name of registrantas specified in its charter)

 
| **Delaware**                             |   | **04-3078857**      |
|------------------------------------------|--------|---------------------|
| (State or other jurisdiction of          |   | (IRS Employer       |
| incorporation or organization)           |   | Identification No.) |
|                                     |   |                |
| **4200 Research Forest Drive**           |   |                |
| **The Woodlands, Texas**                 |   | **77381**           |
| (address of principal executive offices) |   | (zip code)          |

 

**281-419-7000**

(Registrant’s telephonenumber, including area code)

 

                Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes  ý  No  o

 

 

                As of November 1,2001, there were outstanding 9,127,890 shares of Common Stock, par value $.01per share, of the registrant.

 

 

#### **ENCHIRA BIOTECHNOLOGY CORPORATION**

** **

** **

**Form 10-Q for the Quarter Ended September 30, 2001**

 

**INDEX**

 

 
|                                          |                                                                                                  |   |
|-----------------------------------------------|-------------------------------------------------------------------------------------------------------|--------|
| Factors  Affecting Forward-Looking Statements |                                                                                                  |
|                                          |                                                                                                  |   |
| PART I.                                       | FINANCIAL INFORMATION                                                                                 |   |
|                                          |                                                                                                  |   |
| Item 1.                                       | Financial Statements                                                                                  |   |
|                                          |                                                                                                  |   |
|                                          | Balance Sheets as of September 30, 2001  (Unaudited) and December 31, 2000                            |   |
|                                          |                                                                                                  |   |
|                                          | Statements of Operations for  the Three and Nine Months Ended September 30, 2001 and 2000 (Unaudited) |   |
|                                          |                                                                                                  |   |
|                                          | Statements of Cash Flows for  the Nine Months Ended September 30, 2001 and 2000 (Unaudited)           |   |
|                                          |                                                                                                  |   |
|                                          | Notes to Financial  Statements                                                                        |   |
|                                          |                                                                                                  |   |
| Item  2.                                      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations           |   |
|                                          |                                                                                                  |   |
| Item  3.                                      | Quantitative  and Qualitative Disclosures About Market Risk                                           |   |
|                                          |                                                                                                  |   |
| PART II.                                      | OTHER  INFORMATION                                                                                    |   |
|                                          |                                                                                                  |   |
| Item 1.                                       | Legal Proceedings                                                                                     |   |
|                                          |                                                                                                  |   |
| Item 5.                                       | Other Information                                                                                     |   |
|                                          |                                                                                                  |   |
| Item 6.                                       | Exhibits and  Reports on Form 8-K                                                                     |   |
|                                          |                                                                                                  |   |
| SIGNATURES                                    |                                                                                                  |

 

 

 

**FACTORS AFFECTING FORWARD-LOOKING STATEMENTS**

 

                This Quarterly Report on Form 10-Q includes“forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities ExchangeAct of 1934, as amended.  The words“anticipate”, “believe”, “expect”, “estimate”, “project” and similarexpressions are intended to identify forward-looking statements.  Such statements are subject to certainrisks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, orshould underlying assumptions prove incorrect, actual results may varymaterially from those anticipated, believed, expected, estimated orprojected.  These risks anduncertainties include technological uncertainty and risks associated with thecommercialization of the Company’s technology, the Company’s history ofoperating losses and uncertainty of future profitability, manufacturing risksand uncertainties, uncertainty of market acceptance of the Company’stechnology, uncertainties as to the protection offered by the Company’s patentsand proprietary technology, the Company’s dependence on collaborations, theCompany’s need for additional funds, limited marketing experience anddependence on key personnel, government regulations, competition and otherrisks and uncertainties described in the Company’s filings with the Securitiesand Exchange Commission.  For additionaldiscussion of such risks, uncertainties and assumptions (“CautionaryStatements”), see “Item 2.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations -Liquidity and Capital Resources” included elsewhere in this report and “Item1.  Business - Risk Factors” in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2000(“2000 Form 10-K”).  All subsequentwritten and oral forward-looking statements attributable to the Company orpersons acting on its behalf are expressly qualified in their entirety by theCautionary Statements.

 

 

**Part I.  FINANCIALINFORMATION**

 

**Item1.  *Financial Statements***

 

                The followingunaudited financial statements have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission.  Certain information and note disclosuresnormally included in annual financial statements prepared in accordance withgenerally accepted accounting principles have been condensed or omittedpursuant to those rules and regulations, although the Company believes that thedisclosures made herein are adequate to make the information presented notmisleading.  These financial statementsshould be read in conjunction with the 2000 Form 10-K.

 

                The informationpresented in the accompanying financial statements is unaudited, but in theopinion of management, reflects all adjustments (which include only normalrecurring adjustments) necessary to present fairly such information.

 

 

#### **ENCHIRA BIOTECHNOLOGY CORPORATION**

** **

** **

**BALANCESHEETS**

** **
|                                                                                                                                                                              |   | **September 30,** |       | **December 31,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|------------|------------------|--------|
|                                                                                                                                                                              |   | **2001**          |       | **2000**         |   |
|                                                                                                                                                                              |   | **(Unaudited)**   |       |             |   |
| ASSETS                                                                                                                                                                            |   |              |       |             |   |
| Current assets:                                                                                                                                                                   |   |              |       |             |   |
| Cash and cash equivalents                                                                                                                                                         |   | $                 | 7,885,833  |             | $      | 7,524,191 |   |
| Short-term investments                                                                                                                                                            |   | 1,282,347         |       | 4,475,679        |   |
| Prepaid expenses and other current assets                                                                                                                                         |   | 244,162           |       | 900,266          |   |
| Total current assets                                                                                                                                                              |   | 9,412,342         |       | 12,900,136       |   |
|                                                                                                                                                                              |   |              |       |             |   |
| Long-term investments                                                                                                                                                             |   | —            |       | 1,280,937        |   |
| Furniture, equipment and leasehold improvements, net                                                                                                                              |   | 439,460           |       | 638,865          |   |
| Intangible and other assets, net                                                                                                                                                  |   | 950,201           |       | 1,038,175        |   |
| Total assets                                                                                                                                                                      |   | $                 | 10,802,003 |             | $      | 15,858,113 |   |
|                                                                                                                                                                              |   |              |       |             |   |
| LIABILITIES & STOCKHOLDERS' EQUITY                                                                                                                                            |   |              |       |             |   |
|                                                                                                                                                                              |   |              |       |             |   |
| Current liabilities:                                                                                                                                                              |   |              |       |             |   |
| Accounts payable and accrued liabilities                                                                                                                                          |   | $                 | 1,826,608  |             | $      | 544,836 |   |
| Capital lease, short-term                                                                                                                                                         |   | 13,296            |       | 12,304           |   |
| Deferred revenue                                                                                                                                                                  |   | 263,333           |       | 730,000          |   |
| Note payable                                                                                                                                                                      |   | —            |       | 255,867          |   |
| Total current liabilities                                                                                                                                                         |   | 2,103,237         |       | 1,543,007        |   |
|                                                                                                                                                                              |   |              |       |             |   |
| Capital lease, long-term                                                                                                                                                          |   | 47,020            |       | 57,991           |   |
|                                                                                                                                                                              |   |              |       |             |   |
| Stockholders' equity:                                                                                                                                                             |   |              |       |             |   |
| Series B Convertible Preferred Stock, $0.01 par value(liquidation value $19,850,397;  760,000 shares authorized, 307,700 and 387,700 shares,respectively, issued and outstanding) |   | 19,642,508        |       | 23,512,474       |   |
| Common Stock, $0.01 par value (30,000,000 shares authorized,  10,170,739 shares, and 9,067,700 shares,respectively, issued and outstanding)                                       |   | 101,707           |       | 90,677           |   |
| Additional paid-in capital                                                                                                                                                        |   | 78,672,589        |       | 73,626,674       |   |
| Accumulated deficit                                                                                                                                                               |   | (89,765,058       | )          | (82,972,710      | )      |
| Total stockholders' equity                                                                                                                                                        |   | 8,651,746         |       | 14,257,115       |   |
| Total liabilities and stockholders’ equity                                                                                                                                   |   | $                 | 10,802,003 |             | $      | 15,858,113 |   |

 

The accompanying notesare an integral part of these financial statements.

 

 

#### **ENCHIRA BIOTECHNOLOGY CORPORATION**

** **

** **

**STATEMENTSOF OPERATIONS**

**(Unaudited)**

 

** **
|                                                                         |   | **Three Months Ended** |       | **Nine Months Ended** |   |
|------------------------------------------------------------------------------|--------|------------------------|------------|-----------------------|--------|
|                                                                         |   | **September 30,**      |       | **September 30,**     |   |
|                                                                         |   | **2001**               |       | **2000**              |   | **2001** |   | **2000** |   |
|                                                                         |   |                   |       |                  |   |   |   |   |   |
| Sponsored research and licensing revenues                                    |   | $                      | 125,000    |                  | $      | 135,157 |   | $ | 655,601 |   | $ | 493,322 |   |
|                                                                         |   |                   |       |                  |   |   |   |   |   |
| Cost and expense:                                                            |   |                   |       |                  |   |   |   |   |   |
| Research and development                                                     |   | 1,110,283              |       | 964,327               |   | 3,025,519 |   | 2,949,998 |   |
| General and administrative                                                   |   | 1,467,668              |       | 816,334               |   | 3,452,278 |   | 1,831,455 |   |
|                                                                         |   |                   |       |                  |   |   |   |   |   |
| Total costs and expenses                                                     |   | 2,577,951              |       | 1,780,661             |   | 6,477,797 |   | 4,781,453 |   |
|                                                                         |   |                   |       |                  |   |   |   |   |   |
| Interest and investment income (loss)                                        |   | (13,182                | )          | 68,440                |   | 162,753 |   | 193,879 |   |
| Net loss                                                                     |   | $                      | (2,466,133 | )                     | $      | (1,577,064 | ) | $ | (5,659,443 | ) | $ | (4,094,252 | ) |
|                                                                         |   |                   |       |                  |   |   |   |   |   |
| Net loss per common share - basic and diluted                                |   | $                      | (0.31      | )                     | $      | (0.28 | ) | $ | (0.77 | ) | $ | (0.83 | ) |
|                                                                         |   |                   |       |                  |   |   |   |   |   |
| Shares used in computing net loss per common share – basic and  diluted |   | 9,444,391              |       | 7,551,257             |   | 9,265,289 |   | 7,077,747 |   |

 

 

The accompanying notesare an integral part of these financial statements.

 

 

#### **ENCHIRA BIOTECHNOLOGY CORPORATION**

** **

** **

**STATEMENTSOF CASH FLOWS**

**(Unaudited)**

** **

** **
|                                                                         |   | **Nine Months Ended** |       |
|------------------------------------------------------------------------------|--------|-----------------------|------------|
|                                                                         |   | **September 30,**     |       |
|                                                                         |   | **2001**              |       | **2000** |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                        |   |                  |       |   |   |
| Net loss                                                                     |   | $                     | (5,659,443 | ) | $ | (4,094,252 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities: |   |                  |       |   |   |
| Depreciation and amortization                                                |   | 247,726               |       | 350,361 |   |
| Write-off of RACHITTTM patent costs                                      |   | 167,921               |       | — |   |
| Issuance of common stock for services                                        |   | 50,000                |       | 25,000 |   |
| Changes in assets and liabilities:                                           |   |                  |       |   |   |
| Decrease (increase) in prepaid expenses and other current assets             |   | 656,104               |       | (240,733 | ) |
| Increase (decrease) in deferred revenue                                      |   | (466,667              | )          | 675,000 |   |
| Increase in accounts payable and accrued liabilities                         |   | 1,281,772             |       | 245,800 |   |
| Net cash used in operating activities                                        |   | (3,722,587            | )          | (3,038,824 | ) |
|                                                                         |   |                  |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                        |   |                  |       |   |   |
| Capital expenditures                                                         |   | (21,319               | )          | (97,109 | ) |
| Patent expenditures                                                          |   | (106,947              | )          | (187,894 | ) |
| Net sale (purchase) of investments held to maturity                          |   | 4,474,269             |       | (1,352,195 | ) |
| Net cash provided by (used in) investing activities                          |   | 4,346,003             |       | (1,637,198 | ) |
|                                                                         |   |                  |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                        |   |                  |       |   |   |
| Payments on notes payable                                                    |   | (255,867              | )          | (61,594 | ) |
| Payments on capital lease obligations                                        |   | (9,979                | )          | (9,957 | ) |
| Dividends paid                                                               |   | —                |       | (115,522 | ) |
| Proceeds from exercise of common stock and warrants                          |   | 4,072                 |       | 304,168 |   |
| Issuance of common stock                                                     |   | —                |       | 12,457,087 |   |
| Net cash provided by (used in) financing activities                          |   | (261,774              | )          | 12,574,182 |   |
|                                                                         |   |                  |       |   |   |
| NET INCREASE IN CASH AND CASH EQUIVALENTS                                    |   | 361,642               |       | 7,898,160 |   |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                             |   | 7,524,191             |       | 2,510,274 |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                   |   | $                     | 7,885,833  |   | $ | 10,408,434 |   |

 

The accompanying notesare an integral part of these financial statements.

 

 

**ENCHIRA BIOTECHNOLOGY CORPORATIONNOTES TO FINANCIAL STATEMENTSSeptember 30, 2001**

 

 

 

**Note1.  Basis of Presentation andSignificant Accounting Policies**

 

Enchira Biotechnology Corporation (“Enchira” or the“Company”), formerly Energy BioSystems Corporation, was incorporated in theState of Delaware on December 20, 1989, and commenced operations in January 1990.Enchira is a biotechnology company incorporating genetic recombination and highthroughput screening (“HTS”) in an integrated technology platform. It isapplying its new proprietary Drug Candidate Optimization Platformä tocreate new therapeutic proteins.  TheDrug Candidate Optimization Platformä incorporates the next generation ofdirected evolution technology developed by the Company.  The Company is focusing its efforts onprotein kinases, which are involved in various cellular processes.  Irregularities of these proteins have beenimplicated in many human diseases, including cancer and other proliferativedisorders.  Of particular interest arecertain protein tyrosine kinases (PTKs) and related receptor tyrosine kinases(RTKs) that regulate cell growth and proliferation and that have beenimplicated in the most malignant forms of cancer.

 

On April 27, 2000 the Company received notice fromMaxygen Inc. (“Maxygen”) that Maxygen had elected to seek arbitration under theLicense and Development Agreement dated May 19, 1997 (the “DevelopmentAgreement”) between Enchira and Maxygen. Maxygen claimed that Enchira used their confidential information todevelop the RACHITTÔ technology, which they allege wasprovided to Enchira under the Development Agreement.

 

On November 3, 2001, the arbitrator issued a ruling inthe arbitration between Maxygen and the Company.  The ruling states that Enchira is enjoined until May 19, 2017from using, licensing or selling the RACHITTTM technology.  This injunction does not prohibit theCompany from independently developing and commercializing other technologiesthat are not described and claimed in any RACHITTTM applications.  Additionally, the Company is enjoined for aperiod of three years from using, licensing or selling Maxygen High ThroughputScreening technology, but this injunction does not prohibit the Company fromindependently developing and commercializing different (as defined in thearbitration award) HTS  technology.  The arbitrator’s ruling further declaredMaxygen the exclusive owner of RACHITTTM between Maxygen and the Company.  The Company is required to pay Maxygen’sattorneys’ fees in the amount of $556,826 and arbitration costs in the amountof $100,000 as well as any unbilled fees of the arbitrator.  These costs have been accrued and expensedas general and administrative costs as of September 30, 2001.  The Company wrote-off $167,921 inRACHITTTM-related capitalized patent costs as of September 30, 2001.  As a result of the ruling, the Companyreturned $550,000 to Genencor International Inc. (“Genencor”) for license feespreviously received under the license agreement. Mangament expects the licenseagreement with Genencor to be terminated. As of September 30, 2001, the $550,000 has been reclassified fromdeferred revenue to accounts payable in the accompanying balance sheet.  The Company also has a research anddevelopment collaboration agreement with Genencor.  Genencor has notified the Company that the research anddevelopment collaboration will terminate on December 31, 2001.

 

Immediately following theexecution of the award, the company filed an application to vacate or modifythe arbitration award in the 151st District Court of Harris County,Texas.  The petition requests that theCourt enter judgement vacating the arbitration award in its entirety or modifythe arbitration award in certain respects due to its vague and ambiguousnature.

 

Since inception Enchirahas devoted substantially all of its efforts to research and development.  There have been no revenues from operationsother than sponsored research revenues and one site license fee of itsbiodesulfurization technology in 1998 and there is no assurance of futurerevenues.  Enchira has an accumulated deficitof approximately $89.8 million and expects that its existing financialresources will fund operations through mid-2002. Enchira may seek additionalfinancing through various alternatives, including an equity financing,government research funding and alliances with corporate partners. Adequatefunds for these purposes, whether obtained through financial markets orcollaborative or other arrangements with corporate partners or from otherresources, may not be available when needed or on terms acceptable toEnchira.  Enchira’s inability to raisefunds when needed may require Enchira to delay, scale back or eliminate some orall of its research and product development programs.  The Company has been advised by its independent publicaccountants that if its available financial resources at the time of its annualaudit of the consolidated financial statements for the year ended December 31,2001 have not improved from the current levels and are not adequate to fund itsanticipated operations through December 31, 2002, their report on thosefinancial statements will include an explanatory fourth paragraph expressingsubstantial doubt about its ability to continue as a going concern.

 

The accompanyingunaudited interim financial statements reflect all adjustments, which, in theopinion of management, are necessary for a fair presentation of the results forthe interim periods presented.  Thesefinancial statements should be read in conjunction with the 2000 Form 10-K.

 

Net Loss Per Common Share

 

Net loss per sharehas been computed by dividing the net loss, which has been increased forperiodic accretion and accrued dividends on the Series B Convertible PreferredStock issued in February and March 1997, by the weighted average number ofshares of common stock outstanding during the period.

 

**Note2.  Series B Convertible Preferred Stock**

 

Shares of Series BPreferred Stock are convertible into shares of common stock at an adjustedconversion price currently equal to $16.76 per share, subject to certainadjustments.  The Series B PreferredStock may be redeemed by the Company under certain circumstances after February26, 1999 and is required to be redeemed, subject to certain limitations, onFebruary 26, 2002 at a redemption price of $50.00 per share, plus accrued andunpaid dividends. The redemption price is payable in cash or common stock or acombination thereof at the option of the Company.  It is the Company’s present intent to redeem the Series BPreferred Stock for common stock, and accordingly, the Series B Preferred Stockis included in stockholders’ equity. Should the ability of the Company to redeem its Series B Preferred Stockusing its shares of common stock become outside of its control, the carryingvalue of the Series B Preferred Stock will be classified as a liability in itsbalance sheet.  Such redemption withshares of common stock is subject to several requirements, including arequirement that the shares of common stock issued in payment of suchredemption price be listed on a national exchange, including The NasdaqNational Market.  Additionally, theCompany shall use its reasonable best efforts to subject such shares of commonstock to a firm commitment underwritten offering by an investment-banking firm mutuallyagreeable to the Company and the holders of shares of Series B PreferredStock.  There can be no assurance thatthe Company will be able to meet such requirements at such time.  In the event the Company is able and electsto redeem the Series B Preferred Stock with shares of its common stock, suchredemption will result in a dilution of the Company’s current commonstockholders.  As of September 30, 2001,394,400 aggregate shares of Series B Preferred Stock have been converted to741,348 shares of common stock.   Theremaining 307,700 shares of Series B Preferred Stock are convertible into917,959 shares of common stock.

 

Dividends on theSeries B Preferred Stock are cumulative from the date of the initial closing,February 27, 1997, and are payable, at the Company’s election, in cash or commonstock of the Company, or a combination thereof, at an annual rate equal to (i)$4.00 per share to the extent the dividend is paid in cash and (ii) $4.50 pershare to the extent the dividend is paid in common stock.  The Company has not declared a dividendpayment since November 1998, and since that date, has not paid dividends onSeries B Preferred Stock except on certain conversions of Series B PreferredStock to common stock.  As of September30, 2001, Enchira has paid common stock dividends of 1,399,369 shares of commonstock and cash dividends of $115,522 on Series B Preferred Stock.

 

In September 2001,the Company made an offer to shareholders of the Series B Preferred Stock toconvert their shares to common stock. The Company believed this offer would remove potential impediments tofuture financings and was in the best interest of the Company’sshareholders.  Of the 307,700 shares ofSeries B Preferred Stock outstanding at September 30, 2001, 215,000 shares ofSeries B Preferred Stock were converted into 641,394 shares of common stock inOctober 2001.  In connection with theconversion, the Company agreed to pay $2,510,732 in cash for accrued dividendson shares of Series B Preferred Stock. The remaining 92,700 shares of Series B Preferred Stock are convertibleinto 276,551 shares of common stock.

 

##### **Note 3. Subsequent Events**

 

On October 19,2001 the Company purchased, at a significant discount from the publicly tradedmarket price, 1,080,000 shares of its issued and outstanding common stock fromseveral stockholders whose shares were under common management.  In connection with this repurchase, theCompany acquired and cancelled for no additional consideration warrants topurchase an aggregate of 376,500 shares of its common stock that were held bythe sellers.  The repurchased commonstock will be recorded at its aggregate cost of $21,600 as Treasury Stock inthe Company’s stockholders’ equity.  Asa result of this transaction, the number of outstanding shares of common stockhas been reduced to approximately 9.0 million

 

**Item2.  *Management's Discussion and Analysis of FinancialCondition and Results of Operations***

 

**Overview**

 

 To date, Enchira has devoted substantiallyall of its efforts to research and development.  There have been no revenues from operations other than sponsoredresearch revenues and one site license fee of its biodesulfurization technologyin 1998 and there is no assurance of future revenues.  The Company has incurred cumulative net losses since inceptionand expects to incur substantial losses for at least the next several years,due primarily to its research and development activities and the development ofits new proprietary Drug Candidate Optimization PlatformTM.  The Drug Candidate Optimization Platformäincorporates the next generation of directed evolution developed by theCompany.  The Company expects thatlosses will fluctuate from quarter to quarter and that such fluctuations may besubstantial.  Enchira has an accumulateddeficit since inception of approximately $89.8 million and believes that it canconserve its existing financial resources to fund operations through mid-2002.

 

On April 27, 2000the Company received notice from Maxygen Inc. (“Maxygen”) that Maxygen hadelected to seek arbitration under the License and Development Agreement datedMay 19, 1997 (the “Development Agreement”) between Enchira and Maxygen.  Maxygen claimed that Enchira used theirconfidential information to develop the RACHITTÔtechnology, which they allege was provided to Enchira under the DevelopmentAgreement.

 

On November 3, 2001, the arbitrator issued a ruling inthe arbitration between Maxygen and the Company.  The ruling states that Enchira is enjoined until May 19, 2017from using, licensing or selling the RACHITTTM technology.  This injunction does not prohibit theCompany from independently developing and commercializing other technologiesthat are not described and claimed in any RACHITTTM applications.  Additionally, the Company is enjoined for aperiod of three years from using, licensing or selling Maxygen High ThroughputScreening (as defined in the arbitration award) technology, but this injunctiondoes not prohibit the Company from independently developing and commercializingdifferent High Throughput Screening technology.  The arbitrator’s ruling further declared Maxygen the exclusiveowner of RACHITTTM between Maxygen and the Company.  The Company is required to pay Maxygen’s attorneys’ fees in theamount of $556,826 and arbitration costs in the amount of $100,000 as well asany unbilled fees of the arbitrator. These costs have been accrued and expensed as general and administrativecosts as of September 30, 2001.  TheCompany wrote-off $167.921 in RACHITTTM-related capitalized patent costs atSeptember 30, 2001.  As a result of theruling, the Company returned $550,000 to Genencor International Inc.(“Genencor”) for license fees previously received under the licenseagreement.  Management expects thelicense agreement with Genencor to be terminated.  As of September 30, 2001, the $550,000 has been reclassified fromdeferred revenue to accounts payable in the accompanying balance sheet.  The Company also has a research anddevelopment collaboration agreement with Genencor.  Genencor has notified the Company that the research anddevelopment collaboration agreement will be terminated on December 31, 2001.

 

Immediately following the execution of the award, theCompany filed an application to vacate or modify the arbitration award in the151st District Court of Harris County, Texas.  The petition requests that the Court enterjudgement vacating the arbitration award in its entirety or modify thearbitration award in certain respects due to its vague and ambiguous nature.

 

**Resultsof Operations**

 

The Company hadsponsored research revenues for the three months ended September 30, 2001 and2000 of  $125,000 and $135,157,respectively.  The decrease in sponsoredresearch revenues of $10,157 resulted primarily from the completion of theDepartment of Energy (“DOE”) grant in the second quarter of 2001 offset in partfrom payments received under the research and collaboration agreement withGenencor entered into in August 2000.

 

TheCompany had sponsored research revenues of $655,601 during the first ninemonths of 2001 as compared to  $493,322during the first nine months of 2000. The increase of $162,279 in sponsored research revenues resulted from$375,000 recognized from the collaboration with Genencor offset in part by thedecrease in 2001 from the completion of the DOE grant in the second quarter of2001.

 

The Company hadresearch and development expenses for the three months ended September 30, 2001and 2000 of $1,110,283 and $964,327, respectively, and for the nine monthsended September 30, 2001 and 2000 of $3,025,519 and $2,949,998, respectively.  The increase in research and development expenses of $145,956 and$75,521, respectively, for the three and nine months ended September 30, 2001as compared to the corresponding prior year periods resulted primarily frompayments made under a joint collaboration agreement with The University ofTexas M. D. Anderson Cancer Center and the write-off of patent costs associatedwith the RACHITTTM technology as a result of the arbitration ruling of November3, 2001, offset in part by a reduction in research and development personneldue to attrition.  The Company expectsits fourth quarter 2001 research and development expenses to be below fourthquarter 2000 levels, reflecting the impact of a decrease in the number ofresearch and development personnel.

 

 The Company had general and administrativeexpenses for the three months ended September 30, 2001 and 2000 of $1,467,668and $816,334, respectively, and for the nine months ended September 30, 2001and 2000 of $3,452,278 and $1,831,455, respectively. The increase of $651,334 forthe three months ended September 30, 2001 reflects an increase in legalexpenses paid to Maxygen resulting from the settlement of the arbitration.  The increase of $1,620,823 for the ninemonths ended September 30, 2001 as compared to the corresponding period of 2000resulted from increases in legal expenses paid to Maxygen resulting from thesettlement of  the arbitration and theaddition of a Vice President for Business Development in September 2000.  The Company expects its fourth quarter 2001general and administrative expenses to be comparable with fourth quarter 2000levels.

 

The Company had aninterest and investment loss of $13,182 in the third quarter of 2001 ascompared to income of $68,440 in the third quarter of 2000.  The decrease of $81,622 in interest andinvestment income resulted primarily from realized and unrealized capitallosses on cash equivalents and short-term investments during the third quarterof 2001 reflecting a general decline in market value of its investments.  The Company had interest and investmentincome of $162,753 for the first nine months of 2001 compared to $193,879 forthe first nine months of 2000.  Thedecrease of $31,126 in interest and investment income resulted primarily fromrealized and unrealized capital losses on cash equivalents and short-terminvestments during the first nine months of 2001.

 

**Liquidityand Capital Resources**

 

As of September30, 2001, 394,400 shares of Series B Preferred Stock had been converted to741,348 shares of common stock. Dividends on the Series B Preferred Stock are cumulative from the dateof the initial closing, February 27, 1997, and are payable, at the Company’selection, in cash or common stock of the Company, or a combination thereof, atan annual rate equal to (i) $4.00 per share to the extent the dividend is paidin cash and (ii) $4.50 per share to the extent the dividend is paid in commonstock.  The Company has not declared adividend payment since November 1998, and has not paid dividends on Series BPreferred Stock except on certain conversions of Series B Preferred Stock tocommon stock.  As of September 30, 2001,Enchira has paid common stock dividends of 1,399,369 shares of common stock andcash dividends of $115,522 on Series B Preferred Stock.  However, in connection with the conversionof certain shares of Series B Preferred Stock following the end of the quarter,the Company paid accrued dividends in cash. See Part II. Item 5.  Other Information.

 

For the nine months endedSeptember 30, 2001, the Company used $3,722,587 in operating activities,incurred $128,266 in capital and patent expenditures and used $261,774 infinancing activities.  At September 30,2001, the Company had cash, cash equivalents and short-term investments totaling$9,168,180 and working capital of $7,309,105. See Part II.  Item 5.  Other Information.

 

Enchira expects toincur substantial additional research and development expenses, includingexpenses associated with its proprietary Drug Candidate Optimization PlatformTMand analytical and high throughput screening capabilities. Enchira is subjectto cost sharing arrangements under various collaborative agreements, asdiscussed below.  Enchira also expectsits general and administrative expenses to increase as it increases itsbusiness development efforts.

 

In October 2000,the Company established a joint collaboration with The University of Texas M.D. Anderson Cancer Center (“M. D. Anderson”) to apply its Drug CandidateOptimization ProgramTM to the development of more effective cancer therapiestargeted toward epidermal growth factor receptors.  In this collaboration, Enchira will provide its recombinationtechnologies and robotic screening research and has retained certain ownershipand licensing rights to developments made by the Company that come out of therelationship.  As of September 30, 2001,the Company has paid $150,000 to M. D. Anderson.

 

In August 2000, theCompany entered into a collaboration agreement with Genencor for research anddevelopment work on improved industrial proteins.  Under the agreement Genencor will provide $1 million of fundingto the Company over a two-year period. Through September 30, 2001, the Company has received $625,000 forresearch and development under the Genencor agreement, $83,333 of which isdeferred for recognition in the fourth quarter of 2001.  Genencor has notified the Company that thecollaboration agreement will be terminated on December 31, 2001.

 

In May 2000, the Companyentered into a licensing agreement with Genencor involving EBC’s proprietarygene shuffling technology for directed evolution.  Under the agreement, Genencor would use the Company’s proprietarytechnologies, which includes the RACHITTTM technology to develop gene-basedproducts for the cleaning, textiles, grain processing, animal-feed and foodingredients industries.  Genencor paidan initial licensing fee and an additional fee for an option to expand thelicensing field in June 2000.  Revenuesof $550,000 received during the second quarter of 2000 have been refunded as aresult of the November 3, 2001 arbitrator’s ruling that Maxygen is the exclusiveowner of the RACHITTTM technology between Maxygen and the Company and that theCompany is enjoined from licensing the RACHITTTM technology.  The $550,000 is reflected in accountspayable as of September 30, 2001.

 

In August 1997, Enchirawas awarded funding by the DOE for a $2.9 million program, as amended andextended to May 2001, dedicated to the development of a biodesulfurizationapplication for gasoline.  ThroughSeptember 30, 2001 the Company has recognized all the sponsored researchrevenue from the grant.

 

The Company hasexperienced negative cash flow from operations since its inception and hasfunded its activities to date primarily from equity financings and sponsoredresearch revenues.  The Company willcontinue to require substantial funds to continue its research and developmentactivities and to market, sell and commercialize its technology.  The Company believes that its availablecash, investments and interest income will be adequate to fund its operationsthrough mid-2002.

 

The Company's capital requirements will depend on manyfactors, including the problems, delays, expenses and complications frequentlyencountered by companies developing and commercializing new technologies; theprogress of the Company's research and development activities; the rate oftechnological advances; determinations as to the commercial potential of theCompany's technology under development; the status of competitive technology;the establishment of collaborative relationships; the success of the Company’ssales and marketing programs; the decision of the holders of the Series BPreferred Stock regarding redemption; the cost of filing, prosecuting anddefending and enforcing patents and intellectual property rights and otherchanges in economic, regulatory or competitive conditions in the Company’splanned business.  Estimates about theadequacy of funding for the Company’s activities are based upon certainassumptions, including assumptions that the research and development programsrelating to the Company’s technology can be conducted at projected costs andthat progress towards the commercialization of its technology will be timelyand successful.  There can be noassurance that changes in the Company’s research and development plans,acquisitions or other events will not result in accelerated or unexpectedexpenditures.

 

To satisfy its capital requirements, the Company mayseek additional funding through various alternatives, including:  an equity financing, government funding andalliances with corporate partners. There can be no assurance that any such funding will be available to theCompany on favorable terms or at all. If adequate funds are not available when needed, the Company may berequired to delay, scale back or eliminate some or all of its research andproduct development programs.  TheCompany has been advised by its independent public accounts that if itsavailable financial resources at the time of its annual audit of theconsolidated financial statements for the year ended December 31, 2001 have notimproved from the current levels and are not adequate to fund its anticipatedoperations through December 31, 2002, their report on those financialstatements will include an explanatory fourth paragraph expressing substantialdoubt about its ability to continue as a going concern.  If the Company is successful in obtainingadditional financing, the terms of such financing may have the effect ofdiluting or adversely affecting the holdings or the rights of the holders ofthe Company's Common Stock.

 

**Item3.  *Quantitative and Qualitative Disclosure About MarketRisk***

 

Not Applicable

 

**PartII.  Other Information**

 

**Item 1.  Legal Proceedings**

 

                On November 3,2001, the arbitrator issued his final ruling in the arbitration between Maxygenand the Company.  The ruling states thatEnchira is enjoined until May 19, 2017 from using, licensing or selling theRACHITTTM technology.  This injunctiondoes not prohibit the Company from independently developing and commercializingother technologies that are not described and claimed in any RACHITTTMapplications.  Additionally, the Companyis enjoined for a period of three years from using, licensing or sellingMaxygen High Throughput Screening (as defined in the arbitration award)technology, but this injunction does not prohibit the Company fromindependently developing and commercializing different HTS technology.  The arbitrator’s ruling further declaredMaxygen the exclusive owner of RACHITTTM between Maxygen and Enchira.  The Company is required to pay Maxygen’s attorneys’ feesin the amount of $556,826 and arbitration costs in the amount of $100,000 aswell as any unbilled fees of the arbitrator. These costs have been accrued and expensed as general and administrativecosts as of September 30, 2001.  TheCompany wrote-off $167,921 in RACHITTä- related capitalized patent costs at September 30, 2001.  As a result of the ruling, the Companyreturned $550,000 to Genencor for license fees previously received under thelicense agreement.  Management expectsthe license agreement with Genencor to be terminated.  As of September 30, 2001, the $550,000 has been reclassified fromdeferred revenue to accounts payable in the accompanying balance sheet.  The Company also has a research anddevelopment collaboration agreement with Genencor.  Genencor has notified the Company that the research anddevelopment collaboration agreement will be terminated on December 31, 2001.

 

Immediatelyfollowing the execution of the award, the Company filed an application tovacate or modify the arbitration award in the 151st District Courtof Harris County, Texas.  The petitionrequests that the Court enter judgement vacating the arbitration award in itsentirety or modify the arbitration award in certain respects due to its vagueand ambiguous nature.

 

**Item 5.  OtherInformation**

 

OnAugust 21, 2001, the Company received a delisting notice from The Nasdaq StockMarket because the Company had not met the minimum market value of public floatand minimum bid price requirements of The Nasdaq National Market MarketplaceRules for a period of 30 days.  TheCompany immediately appealed, and a hearing was scheduled for October 4,2001.  On September 27, 2001, The NasdaqStock Market implemented a moratorium on the above-referenced requirements forcontinued listing on The Nasdaq National Market.  Under the moratorium, those requirements will be suspended untilJanuary 2, 2002, at which time the 30 and 90-day periods provided by theMarketplace Rules would start anew.  Asa result of the moratorium, Enchira will only be considered noncompliant if itfails to satisfy the applicable standards for 30 consecutive trading daysfollowing January 1, 2002, and thereafter would have a 90-calendar day periodin which to regain compliance.

 

                In September 2001, the Companymade an offer to shareholders of the Series B Preferred Stock to convert theirshares to common stock.  The Companybelieved this offer would remove potential impediments to future financings andwas in the best interest of the Company’s shareholders.  Of the 307,700 shares of Series B PreferredStock outstanding at September 30, 2001, 215,000 shares of Series B PreferredStock were converted into 641,394 shares of common stock in October 2001.  In connection with the conversion, theCompany agreed to pay $2,510,732 in cash for accrued dividends on shares ofSeries B Preferred Stock.  The remaining92,700 shares of Series B Preferred Stock are convertible into 276,551 sharesof common stock.

 

OnOctober 19, 2001 the Company purchased, at a significant discount from thepublicly traded market price, 1,080,000 shares of its issued and outstandingcommon stock from several stockholders whose shares were under commonmanagement.  In connection with thisrepurchase, the Company acquired and cancelled for no additional considerationwarrants to purchase an aggregate of 376,500 shares of its common stock thatwere held by the sellers.  Therepurchased common stock will be recorded at its aggregate cost of $21,600 asTreasury Stock in the Company’s stockholders’ equity.  As a result of this transaction, the number of outstanding sharesof common stock has been reduced to approximately 9.0 million.

 

**Item6.  Exhibits and Reports on Form 8-K**

 

                    a.     Exhibits

 

                            11.1 Statement regarding Computation ofPer Share Earnings.

 

b.     Reports on Form 8-K

 

        On August 22, September 6, October 10and November 6, 2001, the Company filed current reports on Forms 8-K, eachreporting an event under Item 5.

 

 

 

**SIGNATURES**

 

                    Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 

Enchira Biotechnology Corporation

 
| By:    | /s/ Peter P. Policastro               |   |
|--------|---------------------------------------|--------|
|   | Peter P. Policastro                   |
|   | Chief Executive Officer and President |

 

Date: November 12, 2001

 
| By:    | /s/ Paul G. Brown III                                                   |   |
|--------|-------------------------------------------------------------------------|--------|
|   | Paul G. Brown III                                                       |
|   | Chief Financial Officer and Vice President, Finance  and Administration |

 

Date: November 12, 2001