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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-Q





|x |  | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2002.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------




| ̈ |  | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from
             to             .
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------




Commission File Number


0-27410





INCARA PHARMACEUTICALS CORPORATION


(Exact Name
of Registrant as Specified in its Charter)





Delaware

56-1924222(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification
Number)





P.O. Box 14287


79 T.W. Alexander Drive


4401 Research Commons, Suite 200


Research Triangle Park, NC   27709


(Address of Principal Executive Office)
    (Zip Code)





919-558-8688


(Registrants Telephone Number, Including Area Code)





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 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 the number of shares outstanding of each of the
issuers classes of common stock, as of the latest practicable date.





Class

Outstanding as of August 1, 2002Common Stock, par value $.001

14,057,908 Shares





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INCARA PHARMACEUTICALS CORPORATION





INDEX TO FORM 10-Q





PAGEPART I.

FINANCIAL INFORMATIONItem 1.

Financial StatementsConsolidated Balance Sheets as of June 30, 2002 (unaudited) and September 30, 2001

3Consolidated Statements of Operations for the Three Months and Nine Months ended June 30, 2002 and 2001 (unaudited)

4Consolidated Statements of Cash Flows for the Nine Months ended June 30, 2002 and 2001 (unaudited)

5Notes to Consolidated Financial Statements

6Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

13PART II.

OTHER INFORMATIONItem 2.

Changes in Securities and Use of Proceeds

18Item 6.

Exhibits and Reports on Form 8-K

18SIGNATURES

19




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INCARA PHARMACEUTICALS CORPORATION





CONSOLIDATED BALANCE SHEETS


(Dollars in thousands, except per share data)





June 30, 2002


September 30, 2001(Unaudited)


(Restated)ASSETSCurrent assets:Cash and cash equivalents

$
1,343


$
5,453Accounts receivable from Incara Development


764



1,147Prepaids and other current assets


224



321Total current assets


2,331



6,921Property and equipment, net


1,313



1,341Other assets


356



356$
4,000


$
8,618LIABILITIES, EXCHANGEABLE PREFERRED STOCK AND STOCKHOLDERS DEFICITCurrent liabilities:Accounts payable

$
829


$
1,437Accrued expenses


509



523Accumulated losses of Incara Development in excess of investment


638



969Current portion of capital lease obligations


23



25Current portion of notes payable


141



Total current liabilities


2,140



2,954Long-term portion of capital lease obligations






17Long-term portion of notes payable


324



Series C redeemable convertible exchangeable preferred stock, 20,000 shares authorized; 12,015 issued and outstanding
(liquidation value of $13,327 at June 30, 2002)


13,327



12,667Stockholders deficit:Preferred stock, $.01 par value per share, 3,000,000 shares authorized:Series B nonredeemable convertible preferred stock, 600,000 shares authorized; 503,544 and 28,457 shares issued and
outstanding at June 30, 2002 and September 30, 2001, respectively


5



1Common stock, $.001 par value per share, 80,000,000 and 40,000,000 shares authorized at June 30, 2002 and September 30,
2001, respectively; 14,057,908 and 12,717,093 shares issued and outstanding at June 30, 2002 and September 30, 2001, respectively


14



13Additional paid-in capital


104,677



99,850Restricted stock


(266
)


(112
)Accumulated deficit


(116,221
)


(106,772
)Total stockholders deficit


(11,791
)


(7,020
)$
4,000


$
8,618





The accompanying notes are an integral part of these unaudited consolidated
financial statements.




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INCARA PHARMACEUTICALS CORPORATION





CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)


(In thousands, except per share data)





Three Months Ended June
30,


Nine Months Ended June
30,2002


2001


2002


2001Revenue:Cell processing revenue

$
3


$
15


$
40


$
18Costs and expenses:Research and development


2,158



1,931



5,872



5,306General and administrative


742



843



2,213



2,289Total costs and expenses


2,900



2,774



8,085



7,595Loss from operations


(2,897
)


(2,759
)


(8,045
)


(7,577
)Equity in loss of Incara Development


(246
)


(283
)


(865
)


(12,471
)Investment income (expense), net


(16
)


40



(29
)


196Other income










150



767Net loss


(3,159
)


(3,002
)


(8,789
)


(19,085
)Preferred stock dividend accreted


(224
)


(235
)


(660
)


(414
)Net loss attributable to common stockholders

$
(3,383
)

$
(3,237
)

$
(9,449
)

$
(19,499
)Net loss per weighted share attributable to common stockholders:Basic and diluted

$
(0.26
)

$
(0.40
)

$
(0.74
)

$
(2.59
)Weighted average common shares outstanding:Basic and diluted


13,200



8,046



12,834



7,514





The accompanying notes are an integral part of these consolidated financial
statements.




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INCARA PHARMACEUTICALS CORPORATION





CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)


(In thousands)





Nine Months Ended June
30,2002


2001Cash flows from operating activities:Net loss

$
(8,789
)

$
(19,085
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


289



89Equity in loss of Incara Development


1,044



12,739Gain on settlement of accrued liability






(767
)Noncash consulting, license fee and financing costs


164



Noncash compensation


98



89Noncash interest expense


25



Change in assets and liabilities:Accounts receivable from Incara Development


383



(877
)Prepaids and other assets


97



(565
)Accounts payable and accrued expenses


(622
)


451Net cash used in operating activities


(7,311
)


(7,926
)Cash flows from investing activities:Investment in Incara Development


(1,375
)


Proceeds from sales and maturities of marketable securities






4,678Purchases of property and equipment


(261
)


(703
)Net cash provided by (used in) investing activities


(1,636
)


3,975Cash flows from financing activities:Proceeds from Elan note payable


1,375



Proceeds from other notes payable


565



Proceeds from issuance of common stock


36



2,636Proceeds from issuance of Series B preferred stock and warrants


2,980



1,430Principal payments on notes payable


(100
)


(27
)Principal payments on capital lease obligations


(19
)


(17
)Net cash provided by financing activities


4,837



4,022Net increase (decrease) in cash and cash equivalents


(4,110
)


71Cash and cash equivalents at beginning of period


5,453



1,877Cash and cash equivalents at end of period

$
1,343


$
1,948Supplemental disclosure of financing activities:Equity issued in exchange for note payable and accrued interest

$
1,400Series C preferred stock dividend accreted

$
660


$
414Series C preferred stock issued for investment in Incara Development





$
12,015Issuance of restricted common stock

$
252Common stock issued in settlement of accrued liability





$
416Retirement of common stock in conjunction with settlement of accrued liability





$
83





The accompanying notes are an integral part of these unaudited consolidated
financial statements.




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INCARA PHARMACEUTICALS CORPORATION





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





A.Basis of Presentation





The Company is developing therapies focused on tissue protection, repair and regeneration. The Company is developing liver cell therapy for the treatment of liver
failure. The Company is also conducting research and development of a series of catalytic antioxidants as a treatment for protection of cells from damage occurring in cancer radiation therapy, stroke and for protection of cells from transplant
rejection. The Company, in collaboration with Elan Corporation, plc, an Irish company, and its subsidiaries (Elan), also is conducting a Phase 2/3 clinical trial of deligoparin, an ultra-low molecular weight heparin for the treatment of
ulcerative colitis. Deligoparin was previously known as OP2000.





The Company refers collectively to
Incara Pharmaceuticals Corporation, a Delaware corporation (Incara Pharmaceuticals), its two wholly owned subsidiaries, Aeolus Pharmaceuticals, Inc., a Delaware corporation (Aeolus), and Incara Cell Technologies, Inc., a
Delaware corporation (Cell Technologies), as well as its equity investee, Incara Development, Ltd., a Bermuda corporation (Incara Development). As of June 30, 2002, Incara Pharmaceuticals owned 80.1% of Incara Development and
35.0% of CPEC LLC. Incara Pharmaceuticals uses the equity method to account for CPEC LLC.





All significant
intercompany activity has been eliminated in the preparation of the consolidated financial statements. The unaudited consolidated financial statements have been prepared in accordance with the requirements of Form 10-Q and Rule 10-01 of Regulation
S-X. Some information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations. In the opinion of
management, the accompanying unaudited consolidated financial statements include all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the consolidated financial position, results of operations and cash flows
of the Company. The consolidated balance sheet at September 30, 2001 was derived from the Companys restated audited financial statements included in the Companys Amended Annual Report on Form 10-K/A, filed by the Company on August 13,
2002. The unaudited consolidated financial statements included herein should be read in conjunction with the restated audited consolidated financial statements and the notes thereto included in the Companys Amended Annual Report on Form 10-K/A
for the fiscal year ended September 30, 2001 and in the Companys other SEC filings. Results for the interim period are not necessarily indicative of the results for any other period.





B.Liquidity





The accompanying unaudited financial statements have been prepared on a basis which assumes that the Company will continue as a going concern and which contemplates the realization of assets and the satisfaction of liabilities and
commitments in the normal course of business. The Company had an accumulated deficit of $116,221,000 at June 30, 2002, incurred a




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net loss of $8,789,000 for the nine months then ended, and expects to incur additional losses during the remainder of fiscal 2002 and for several more years.





The Company has an immediate need to raise additional cash, as without additional financing or other funding, the Company will run out of
cash around the end of fiscal 2002. Management has attempted to raise additional capital, but has been unsuccessful to date. The Company is considering various alternatives to satisfy its need for capital. However, the Company might not be
successful in completing any transaction.





The development of deligoparin depends on the Companys
collaboration with Elan, which is outside of its control. As described in Note F to these unaudited financial statements, the collaboration involves various arrangements that involve additional funding of this program. Should the interim results not
be as expected, such funding might not be forthcoming. If that would occur, the Company could reduce its expenditures for this program significantly.





The Cell Technologies and Aeolus programs are expected to require significant expenditures during the remainder of fiscal 2002 and later years. The Company has the intent and ability to quickly and
sharply reduce such expenditures during 2002 or later years if sufficient resources are not available to fund these programs.





The Company intends to enter into additional collaborative arrangements for research and development, for which it will need to obtain additional arrangements for the manufacturing and marketing of its potential products. Otherwise,
the Company will have to develop the expertise, obtain the additional capital and spend the resources to perform those functions.





The continued funding of the Companys operations is affected by its ability to sell additional equity in the form of common or preferred stock. The Companys common stock is currently listed on the Nasdaq National Market.
Nasdaq has requirements that a company must meet in order to remain listed on Nasdaq. The Company might not be able to maintain the standards for continued quotation on the Nasdaq National Market, including a minimum bid price requirement of $1.00
per share, a minimum market value of public float of $5,000,000 and a minimum net tangible assets value of $4,000,000. The Companys net tangible assets at June 30, 2002 were a negative $11,791,000, market value of public float at July 31, 2002
was $3,096,000 and the common stock has not closed above $1.00 since March 11, 2002. On July 24, 2002, the Company received a Nasdaq Staff Determination stating that the Company failed to comply with the $1.00 minimum bid price requirement for
continued listing set forth in Marketplace Rule 4450(a)(5) and that its common stock is subject to delisting from Nasdaq. The Company also does not currently meet the Nasdaq National Markets requirement of $5,000,000 minimum market value for
publicly held shares as set forth in Marketplace Rule 4450(a)(2), or the $4,000,000 minimum net tangible assets requirement set forth in Marketplace Rule 4450(a)(3). A hearing is scheduled for August 29, 2002 before a Nasdaq Listing Qualifications
Panel to review the Staff Determination. The Companys delisting has been stayed pending the Panels decision. At the hearing, the Company intends to present its recapitalization plans for meeting the requirements for continued Nasdaq
listing in order for its common stock to remain listed on the




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Nasdaq National Market or be allowed to move to the Nasdaq SmallCap Market. There can be no assurance the Panel will grant the Companys request for continued listing or allow its common
stock to move to the Nasdaq SmallCap Market. Nasdaq has adopted amendments to replace its minimum net tangible assets requirement with a stockholders equity requirement that would require companies to have a minimum of $10,000,000 of
stockholders equity in order to remain listed on the Nasdaq National Market after October 31, 2002. At June 30, 2002, the Companys stockholders deficit was $11,791,000, which was below the new requirement. If the Companys
common stock is delisted, its stock will become more illiquid, which would make the sale of additional equity more difficult.





The ability of the Company to continue in its present form is largely dependent on its ability to obtain additional debt or equity financing, generate additional revenues primarily through collaborations, and control overall
expenses. The Company raised an aggregate of approximately $11,000,000 between August 2001 and May 2002 and intends to continue to try to raise additional funds through the sale of stock or by establishing collaborations.





Although management continues to pursue these plans, the Company might not be successful in raising capital or establishing collaboration
agreements on terms acceptable to the Company. If the Company is not successful in raising sufficient cash for its operations, then it will need to scale back, delay or discontinue one or more of its programs, which would have a material adverse
affect on the Companys business, or cease operations altogether. Management is evaluating the current situation and will consider the various alternatives that are available to the Company.





C.    Recent Accounting Pronouncements





In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS 141
supersedes Accounting Principles Board Opinion No. 16, Business Combinations, and is applicable for all business combinations initiated after June 30, 2001. The most significant provisions of SFAS 141 require (a) the application of the
purchase method of accounting for all business combinations; (b) the establishment of specific criteria for the recognition of intangible assets separately from goodwill; and (c) unallocated negative goodwill to be written off immediately as an
extraordinary gain. SFAS 142 supersedes APB No. 17, Intangible Assets, and first became effective for the Companys quarter ended December 31, 2001. The most significant provisions of SFAS 142 provide (a) goodwill and indefinite
lived intangible assets can no longer be amortized; (b) goodwill and intangible assets deemed to have an indefinite life must be tested at least annually for impairment; and (c) the amortization period of intangible assets with finite lives is no
longer limited to forty years. The Company adopted SFAS 142 effective October 1, 2001 and the adoption did not have a material effect on the Companys financial position or results of operations as the Company did not have then and currently
has no goodwill and no intangible assets.




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D.    Net Loss Per Common Share





The Company computes basic net loss per weighted share attributable to common stockholders using the weighted average number of shares of
common stock outstanding during the period. The Company computes diluted net loss per weighted share attributable to common stockholders using the weighted average number of shares of common and dilutive potential common shares outstanding during
the period. Potential common shares consist of stock options, restricted common stock, warrants and convertible preferred stock, which are excluded if their effect is antidilutive. At June 30, 2002, diluted weighted average common shares excluded
approximately 12,455,000 incremental shares related to stock options, unvested shares of restricted common stock, convertible preferred stock and warrants to purchase common and preferred stock. These shares are excluded due to their antidilutive
effect as a result of the Companys net loss from operations.





E.    Restatement





The Company has restated its 2001 financial statements to reclassify the Series C redeemable convertible exchangeable non-voting preferred
stock (Series C Stock) from stockholders equity to the mezzanine section of the balance sheet because the exchange feature allows the Series C Stock to be redeemed for certain assets. This restatement did not affect the net loss or
cash flows for the year ended September 30, 2001 or the nine months ended June 30, 2001, nor did it affect total assets. The effect of the restatement on the September 30, 2001 balance sheet is summarized below (in thousands):





As originally reported

As restatedSeries C redeemable convertible exchangeable preferred stock

$


$
12,667Stockholders equity (deficit)

$
5,647

$
(7,020
)





F.    Incara Development, Ltd.





In January 2001, Incara Pharmaceuticals closed on a collaborative transaction with Elan. As part of the transaction, Elan and Incara
Pharmaceuticals formed a Bermuda corporation, Incara Development, Ltd., to develop deligoparin, a compound being investigated as a drug treatment for inflammatory bowel disease. Incara Pharmaceuticals owns all of the common stock and 60.2% of the
non-voting preferred shares of Incara Development and Elan owns 39.8% of the non-voting preferred shares of Incara Development. Of the outstanding combined common and non-voting preferred shares of Incara Development, Incara Pharmaceuticals owns
80.1% and Elan owns 19.9%. As part of the transaction, Elan and Incara Pharmaceuticals entered into license agreements under which Incara Pharmaceuticals licensed to Incara Development rights to deligoparin and Elan licensed to Incara Development
proprietary drug delivery technology.





As part of the transaction, Elan purchased 12,015 shares of Incara
Pharmaceuticals Series C Stock with a face value of $1,000 per share, or a total of $12,015,000. Incara Pharmaceuticals contributed to Incara Development the proceeds from the issuance of the Series C Stock to Elan in exchange for




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securities of Incara Development. Elan also contributed $2,985,000 to Incara Development for its shares of preferred stock of Incara Development. In addition, Elan granted Incara Development a
license to Elans proprietary drug delivery technology for a license fee of $15,000,000. The Series C Stock bears a mandatory stock dividend of 7%, compounded annually. The Series C Stock is exchangeable at the option of Elan at any time for
all of the preferred stock of Incara Development held by Incara Pharmaceuticals which, if exchanged, would give Elan ownership of 50% of the initial amount of combined common and preferred stock of Incara Development. Because the exchange feature
allows the Series C Stock to be redeemed for certain assets, the Series C Stock is presented outside of stockholders equity (deficit) and is reported at its current redemption value. Future adjustments to the Series C Stock carrying value may
be necessary to adjust the carrying value to the current fair value of the assets required to be delivered under the exchange provision, reduced by any amounts owed to Incara Pharmaceuticals by Elan upon an exchange under the terms of the Series C
preferred stock. These terms require Elan to reimburse Incara Pharmaceuticals for the portion of Incara Developments cumulative losses that Incara Pharmaceuticals funded in excess of its then remaining 50% ownership. After December 20, 2002,
the Series C Stock is convertible by Elan into shares of Incara Pharmaceuticals Series B convertible preferred stock (Series B Stock) at the rate of $64.90 per share. Each share of Series B Stock is convertible into ten shares of
common stock. If the Series C Stock is outstanding as of December 21, 2006, Incara Pharmaceuticals will exchange the Series C Stock and accrued dividends, at its option, for either cash or shares of stock and warrants of Incara Pharmaceuticals
having a then fair market value of the amount due.





For financial reporting purposes, the value recorded as Incara
Pharmaceuticals initial investment in Incara Development was the same as the fair value of the Series C Stock issued, which was $12,015,000. The technology obtained by Incara Development from Elan was expensed at inception because the
feasibility of using the contributed technology in conjunction with deligoparin had not been established and Incara Development had no alternative future use for the contributed technology. Incara Pharmaceuticals immediately expensed as Equity
in loss of Incara Development its investment in Incara Development, reflective of Incara Pharmaceuticals pro rata interest in Incara Development. From the date of issue up to December 21, 2006, Incara Pharmaceuticals will accrete the
Series C Stock for the 7% dividend from its recorded value up to its redemption value. Upon a liquidation of the Company, holders of Series C Stock will be entitled to liquidation payments equal to the face value per share at issuance plus accrued
dividends.





While Incara Pharmaceuticals owns 80.1% of the outstanding stock of Incara Development, Elan has
retained significant minority investor rights, including 50% control of the management committee which oversees the deligoparin program, that are considered participating rights as defined in the Emerging Issues Task Force Consensus No.
96-16. Accordingly, Incara Pharmaceuticals does not consolidate the financial statements of Incara Development, but instead accounts for its investment in Incara Development under the equity method of accounting. The Company recognized 100% of the
losses of Incara Development to the extent of its original investment, plus all subsequent losses of Incara Development to the extent that it has committed to provide further financial support to fund those losses. Further, because Elan can exchange
its investment in Incara Pharmaceuticals Series C Stock for Incara Pharmaceuticals 30.1% preferred interest in Incara Development, Incara Pharmaceuticals will only recognize 50% of any accumulated net earnings of Incara Development.





Elan and Incara Pharmaceuticals intend to fund Incara Development pro rata, based on their respective percentage
ownership of the combined outstanding common and preferred stock of Incara Development. Subject to mutual agreement, Elan agreed to lend Incara Pharmaceuticals up to $4,806,000 to fund Incara Pharmaceuticals pro rata share of development
funding for Incara Development. In return, Incara Pharmaceuticals issued a convertible promissory note that bears interest at 10% compounded semi-annually on the amount outstanding




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thereunder. After December 20, 2002, the note balance is convertible at the option of Elan into shares of Series B Stock at $43.27 per share. The note will mature on December 21, 2006, when the
outstanding principal plus accrued interest will be due and payable. Incara Pharmaceuticals has the option to repay the note either in cash or in shares of Series B Stock and warrants having a then fair market value of the amount due. In October
2001 and February 2002, Incara Pharmaceuticals borrowed from Elan $857,000 and $518,000, respectively, pursuant to the terms of the note arrangement. In February 2002, Incara Pharmaceuticals, with Elans consent, converted the outstanding
principal and accrued interest of $1,400,000 into 480,000 shares of common stock and 58,883 shares of Series B Stock. Incara Pharmaceuticals can borrow up to an additional $3,431,000 through December 21, 2003 under the note arrangement with Elan to
fund its 80.1% pro rata interest in the operating costs of Incara Development. At June 30, 2002, no amounts were due to Elan under the note payable.





During the fiscal year ended September 30, 2001, Incara Pharmaceuticals equity in loss of Incara Development was $12,650,000, including $12,015,000 for Incara Pharmaceuticals interest in
the immediate write-off at inception of the technology acquired from Elan by Incara Development. Incara Development is a development stage company with no revenue. Excluding the initial license fee for the technology contributed by Elan, Incara
Development had operating expenses of approximately $1,235,000 for the fiscal year ended September 30, 2001. Incara Development had net operating expenses and a net loss of approximately $386,000 and $1,287,000 for the three months and nine months
ended June 30, 2002, respectively.





The following summary information is provided for Incara Development.





Three Months Ended June 30,

Nine Months Ended June
30,2002

2001

2002

2001(in thousands)Operating expenses:Purchased in-process research and development

$


$


$


$
15,000Research and development


386


519


1,272


888General and administrative








15


15Net loss

$
386

$
519

$
1,287

$
15,903





Incara Pharmaceuticals invoices Incara Development for research and
development expenses that Incara Pharmaceuticals incurs on behalf of Incara Development. These expenses are recognized as a reduction of Incara Pharmaceuticals research and development expenses, net of intercompany profits. The following table
is a reconciliation of the net loss of Incara Development to the Equity in loss of Incara Development included in the Companys statements of operations.





Three Months Ended June 30,


Nine Months Ended June
30,2002


2001


2002


2001(in thousands)Incara Development net loss

$
386


$
519


$
1,287


$
15,903Incara Pharmaceuticals portion (80.1%)

$
309


$
416


$
1,031


$
12,738Profit on services provided to Incara Development


(63
)


(133
)


(187
)


(267
)Other










21



Equity in loss of Incara Development

$
246


$
283


$
865


$
12,471




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G.    Elan Investment Related to Catalytic Antioxidant Program





In May 2002, Elan purchased 416,204 shares of Series B Stock for $3,000,000. Elan agreed that it will make additional equity
investments in the future based upon the completion of various financial and clinical milestones related to Aeolus program for catalytic antioxidant compounds as adjunctive agents to cancer treatment. Elan received an exclusive option to
negotiate commercialization or collaboration terms at a later phase relating to catalytic antioxidants being developed by Aeolus in the prevention and treatment of radiation-induced and chemotherapy-induced tissue damage. Aeolus is also exploring
the use of its antioxidants to protect against the toxicity from total body irradiation such as might occur in accidental or terrorist-related exposure to nuclear material. In addition to its other rights, Elan may cancel this agreement for any
reason upon 30 days notice.





H.    Commitments and Contingencies





In October 2001, the Company executed a Master Loan and Security Agreement with Transamerica Technology Finance Corporation to finance
equipment purchases. In October 2001, the Company borrowed $565,000 from Transamerica and pledged equipment with a cost of $686,000 as collateral.





In December 1999, Incara Pharmaceuticals sold IRL, its anti-infectives division, to a private pharmaceutical company. Incara Pharmaceuticals remains contingently liable through May 2007 on debt and
lease obligations of approximately $6,000,000 assumed by the purchaser, including the IRL facility lease in Cranbury, New Jersey.




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Item 2.Managements Discussion and Analysis of Financial Condition and Results of Operations.





Introduction





Unless otherwise noted, the phrase
we or our refers collectively to Incara Pharmaceuticals Corporation and our two wholly owned subsidiaries, Aeolus Pharmaceuticals, Inc. and Incara Cell Technologies, Inc., as well as our equity investee, Incara Development,
Ltd. At June 30, 2002, Incara Pharmaceuticals owned 80.1% of Incara Development.





This Report contains, in
addition to historical information, statements by us with respect to expectations about our business and future results, which are forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements
and other statements made elsewhere by us or our representatives, which are identified or qualified by words such as likely, will, suggests, expects, might, believe,
could, should, may, estimates, potential, predict, continue, would, anticipates, plans, or similar expressions, are based on a
number of assumptions that are subject to risks and uncertainties. Actual results could differ materially from those currently anticipated or suggested due to a number of factors, including those set forth herein, those set forth in our Annual
Report on Form 10-K and in our other SEC filings, and including risks relating to the need to obtain funds for operations, the failure to satisfy the listing requirements of the Nasdaq Stock Market, dependence on collaborative partners, the early
stage of products under development, uncertainties relating to clinical trials and regulatory reviews, and competition. All forward-looking statements are based on information available as of the date hereof, and we do not assume any obligation to
update such forward-looking statements.





We are focused on the development of potential therapies for protection,
repair and regeneration of tissue damaged by injury and disease. We currently have programs in three areas: liver cell therapy and progenitor cell therapy as treatments for liver failure; catalytic antioxidants as treatments for protection of cells
from damage caused by stroke and cancer radiation therapy and for protection of cells from transplant rejection; and deligoparin, an ultra-low molecular weight heparin being developed with Elan Corporation through Incara Development for treatment of
ulcerative colitis.





Immediate Need For Additional Funds





We have an immediate need to raise additional cash, as without additional financing or other funding we will run out of cash around the end of fiscal 2002. Our need for
additional financing is discussed under Liquidity and Capital Resources.





Results of Operations





We had a net loss attributable to common stockholders of $3,383,000 and $9,449,000 for the three months and nine months ended
June 30, 2002, respectively, versus a net loss attributable to common stockholders of $3,237,000 and $19,499,000 for the three months and nine months ended June 30, 2001, respectively. The net loss for the nine months ended June 30,




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2002 was reduced by a $150,000 gain recognized on the sale of trademarks for a discontinued program. The net loss for the nine months ended June 30, 2001 included a $12,015,000 charge for Incara
Pharmaceuticals interest in the immediate write-off at inception of the technology contributed by Elan to Incara Development. Also, the net loss for the nine months ended June 30, 2001 was reduced by a $767,000 gain recognized on the
settlement of a disputed accrued liability for a discontinued program.





We had cell processing revenue of $3,000
and $40,000 for the three months and nine months ended June 30, 2002, respectively. This revenue resulted from fees we earned for processing liver cells that are used for research purposes by other pharmaceutical companies.





Our research and development, or R&D, expenses increased $227,000, or 12%, to $2,158,000 for the three months ended June 30, 2002 from
$1,931,000 for the three months ended June 30, 2001. R&D expenses increased $566,000, or 11%, to $5,872,000 for the nine months ended June 30, 2002 from $5,306,000 for the nine months ended June 30, 2001. R&D expenses were higher in the
first three quarters of this fiscal year primarily due to significant increases in spending on our liver cell therapy program, offset by a reduction in R&D expenses due to how expenses are classified for our deligoparin program.





Deligoparin expenses incurred during the first quarter of fiscal 2001 were $335,000, which were charged to R&D expenses. In
January 2001, Incara Pharmaceuticals transferred the rights to deligoparin to Incara Development. Also, in January 2001, Incara Development began a Phase 2/3 clinical trial, which is on-going. As of July 31, 2002, we had enrolled 138 patients in the
trial. We expect to complete enrollment around the end of 2002. Costs for deligoparin incurred after the transfer are incurred on behalf of Incara Development. Amounts billable to Incara Development for expenses incurred and work performed by Incara
Pharmaceuticals for deligoparin are recorded as a reduction of R&D expenses. Subsequent to our investment in Incara Development, our expenses associated with development of deligoparin flow through Equity in loss of Incara
Development. For the three months and nine months ended June 30, 2002, our equity in loss of Incara Development was $246,000 and $865,000, respectively. The equity in loss of Incara Development was $283,000 and $12,471,000 for the three months
and nine months ended June 30, 2001, respectively, which included $12,015,000 for Incara Pharmaceuticals interest in the immediate write-off at inception of the technology acquired from Elan by Incara Development.





R&D expenses for Cell Technologies increased $484,000, or 63%, to $1,253,000 for the three months ended June 30, 2002 from $769,000
for the three months ended June 30, 2001. R&D expenses for Cell Technologies increased $1,835,000, or 103%, to $3,608,000 for the nine months ended June 30, 2002 from $1,773,000 for the nine months ended June 30, 2001. Our research and
development for the treatment of liver disorders, using liver cell therapy, is in the preclinical stages and is conducted through Incara Cell Technologies. In June 2002, we filed an Investigational New Drug Application with the Food and Drug
Administration to begin Phase 1 clinical trials of human liver cells for the treatment of patients with cirrhosis and end-stage liver disease. Expenses were higher in the first three quarters of this fiscal year due to increased activity in the
program and the establishment of our own laboratory facility in August 2001. We




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incurred increases in spending on laboratory supplies, contract and sponsored research, occupancy costs and personnel.





R&D expenses for Aeolus decreased $205,000, or 23%, to $683,000 for the three months ended June 30, 2002 from $888,000 for the three months ended June 30, 2001. R&D
expenses for Aeolus decreased $374,000, or 17%, to $1,828,000 for the nine months ended June 30, 2002 from $2,202,000 for the nine months ended June 30, 2001. Our research and development of small molecule antioxidants for disorders such as stroke
and other tissue damage is in the preclinical stage and is conducted through Aeolus. Expenses were less this fiscal year due to lower levels of preclinical contract services and sponsored research.





R&D expenses also include other general expenses that have not specifically been allocated to the above program costs.





General and administrative, or G&A, expenses decreased $101,000, or 12%, to $742,000 for the three months ended June 30,
2002 from $843,000 for the three months ended June 30, 2001. G&A expenses decreased $76,000, or 3%, to $2,213,000 for the nine months ended June 30, 2002 from $2,289,000 for the nine months ended June 30, 2001.





We accreted $224,000 and $660,000 of dividends on our Series C preferred stock during the three months and nine months ended June 30,
2002, respectively. From the date of issue until the earlier of December 21, 2006 or the date the Series C preferred stock is exchanged or converted, we will accrete the Series C preferred stock for the 7% dividend, compounded annually from its
recorded value up to its redemption value. Future adjustments to the Series C preferred stock carrying value might be necessary to adjust the carrying value to the then current fair value of the assets required to be delivered under the exchange
provision reduced by amounts owed to us by Elan upon an exchange under the terms of the Series C preferred stock.





Liquidity and
Capital Resources





At June 30, 2002, we had cash and cash equivalents of $1,343,000, a decrease of $4,110,000
from September 30, 2001. Cash decreased primarily due to the net loss of $8,789,000 for the nine months ended June 30, 2002, offset by the purchase of $3,000,000 of our Series B preferred stock by Elan in May 2002 and by $1,965,000 of proceeds from
notes payable.





We have an immediate need to raise additional cash, as without additional financing or other
funding, we will run out of cash around the end of fiscal 2002. We have attempted to raise additional capital, but have been unsuccessful to date. We are considering various alternatives to satisfy our need for capital. We are evaluating the current
situation and will consider the various alternatives that are available to us. However, we might not be successful in completing any transaction.





During the past two years, we have incurred average operational expenses of approximately $11,000,000 per year, on an annualized basis, including expenses of our R&D programs, but excluding
non-cash charges for the purchase of in-process research and development. We anticipate our annual net operational costs to remain at approximately this level, or slightly higher, during fiscal 2002 and for the foreseeable future, although our
ongoing cash requirements will depend on numerous factors, particularly the progress of our R&D programs and our ability to negotiate and complete collaborative agreements. In order to fund




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our on-going operating cash requirements, we need to raise significant additional funds in fiscal 2002 and beyond. We intend to try to:





| |  |  | establish new collaborations for our current research programs that include initial cash payments and on-going research support;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------




| |  |  | sell additional shares of our stock to Elan and other investors; and
| | - |  | --------------------------------------------------------------------




| |  |  | borrow additional cash from Elan under the terms of an existing note arrangement that we have with Elan to meet our obligations for Incara Development.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------




There are uncertainties as to all of these potential sources of capital. Due to market and
economic conditions and other limitations on the stock offerings, we might not be able to sell securities under these arrangements, or raise other funds on terms acceptable or favorable to us. At times it is difficult for biotechnology companies to
raise funds in the equity markets. In addition, any potential investor or collaborator, including Elan, must have the economic ability to invest in us. Any additional equity financing, if available, would likely result in substantial dilution to our
stockholders. At our Annual Meeting held in March 2002, our stockholders approved the sale of up to $25,000,000 of our securities; however, we might not be able to sell any securities.





The continued funding of our operations is affected by our ability to sell additional equity in the form of common or preferred stock. Our common stock is currently listed
on the Nasdaq National Market. Nasdaq has requirements that a company must meet in order to remain listed on Nasdaq. We might not be able to maintain the standards for continued quotation on the Nasdaq National Market, including a minimum bid price
requirement of $1.00 per share, a minimum market value of public float of $5,000,000 and a minimum net tangible assets value of $4,000,000. Our net tangible assets at June 30, 2002 were a negative $11,791,000, our market value of public float at
July 31, 2002 was $3,096,000 and our common stock has not closed above $1.00 since March 11, 2002. On July 24, 2002, we received a Nasdaq Staff Determination stating that we fail to comply with the $1.00 minimum bid price requirement for continued
listing set forth in Marketplace Rule 4450(a)(5) and that our common stock is subject to delisting from Nasdaq. We also do not currently meet the Nasdaq National Markets requirement of $5,000,000 minimum market value for our publicly held
shares as set forth in Marketplace Rule 4450(a)(2), or the $4,000,000 minimum net tangible assets requirement set forth in Marketplace Rule 4450(a)(3). We have a hearing scheduled for August 29, 2002 before a Nasdaq Listing Qualifications Panel to
review the Staff Determination. Our delisting has been stayed pending the Panels decision. At the hearing, we intend to present our recapitalization plans for meeting the requirements for continued Nasdaq listing in order for our common stock
to remain listed on the Nasdaq National Market or be allowed to move to the Nasdaq SmallCap Market. There can be no assurance the Panel will grant our request for continued listing or allow our common stock to move to the Nasdaq SmallCap Market.
Nasdaq has adopted amendments to replace its minimum net tangible assets requirement with a stockholders equity requirement that would require companies to have a minimum of $10,000,000 of stockholders equity in order to remain listed on
the Nasdaq National Market after October 31, 2002. At June 30, 2002, our stockholders deficit was $11,791,000, which was below the new requirement. If our common stock is delisted it would become more illiquid, which would make the sale of
additional equity more difficult.




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Similarly, our access to capital might be restricted because we might not be able
to enter into collaborations for any of our programs or to enter into any collaborations on terms acceptable or favorable to us due to conditions in the pharmaceutical industry or in the economy in general or based on the prospects of any of our
programs. Even if we are successful in obtaining collaborations for any of our programs, we might have to relinquish rights to technologies, product candidates or markets that we might otherwise develop ourselves.





We may borrow up to an additional $3,431,000 through December 21, 2003 under the note arrangement with Elan to fund our 80.1% pro rata
interest in the operating costs of Incara Development. Advances under the note are subject to the mutual consent of Elan and Incara Pharmaceuticals; consequently, we can only borrow under the note if Elan approves the borrowing. The note matures on
December 21, 2006.





The Series C preferred stock we sold to Elan is exchangeable at the option of Elan at any time
for all of the preferred stock of Incara Development held by Incara Pharmaceuticals which, if exchanged, would give Elan ownership of 100% of Incara Developments preferred stock or 50% of the initial amount of combined common and preferred
stock of Incara Development. After December 20, 2002, the Series C preferred stock is convertible by Elan into shares of Incara Pharmaceuticals Series B preferred stock at the rate of $64.90 per share. If the Series C preferred stock is
outstanding as of December 21, 2006, it must be redeemed for an amount equal to $1,000 per share plus any accrued unpaid dividends. At such date, we will exchange the Series C preferred stock and accrued dividends, at our option, for either cash or
shares of stock and warrants of Incara Pharmaceuticals having a then fair market value of the amount due.





If we
are unable to enter into new collaborations or raise additional capital to continue to support our operations, we will be required to scale back, delay or discontinue one or more of our programs, which would have a material adverse affect on our
business, or cease operations altogether. Reduction or discontinuation of any of our programs could result in additional charges, which would be reflected in the period of the reduction or discontinuation.





If we are unable to raise additional capital, borrow additional funds or enter into new collaborations, we will also consider:





| |  |  | investments by third parties in our subsidiaries;
| | - |  | -------------------------------------------------




| |  |  | the sale of all or some of our assets or programs; and
| | - |  | ------------------------------------------------------




| |  |  | a merger of our company with a third party.
| | - |  | -------------------------------------------




In December 1999, Incara Pharmaceuticals sold IRL, its anti-infectives division, to a private pharmaceutical company. We remain contingently liable through May 2007 on debt and lease obligations of
approximately $6,000,000 assumed by the purchaser, including the IRL facility lease in Cranbury, New Jersey.




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Part II.    OTHER INFORMATION





Item 2.Changes in Securities and Use of Proceeds





On May 7, 2002, Incara Pharmaceuticals issued shares of common stock to Duke University as a royalty payment pursuant to a license agreement dated May 7, 2002 between Aeolus Pharmaceuticals, Inc. and Duke University. This transaction
was exempt from registration under Section 4(2) of the Securities Act of 1933.





On May 15, 2002, Elan Corporation,
plc purchased 416,204 shares of Series B convertible preferred stock. Each share of Series B preferred stock is convertible into ten shares of common stock, subject to adjustment for subdivision and combination of Incara Pharmaceuticals common
stock. The issuance of the Series B preferred stock was effected pursuant to Rule 506 of Regulation D under the Securities Exchange Act of 1934.





Item 6.Exhibits and Reports on Form 8-K.





(a) Exhibits





Exhibit Number

Description of Document10.90

Amendment No. 7, effective June 30, 2002 to Sponsored Research Agreement between the University of North Carolina at
Chapel Hill and Incara Cell Technologies, Inc.





(b) The following reports on Form 8-K were filed by Incara
Pharmaceuticals during the three months ended June 30, 2002:





Date filed

EventMay 24, 2002

Equity investment by Elan Corporation, plc (as amended by Forms 8-K/A filed on May 24 and July 3, 2002)




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SIGNATURES





Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, who certify that to their knowledge this report fully complies with the requirements of Section 13(a) or 15(d) of that Act and the
information contained in this report fairly presents, in all material respects, the financial condition and results of operations of the registrant as of and for the period ended June 30, 2002.





INCARA PHARMACEUTICALS CORPORATIONDate: August 13, 2002



By:

/s/    CLAYTON I.
DUNCANClayton I. Duncan, President and Chief Executive Officer (Principal Executive Officer)





Date: August 13, 2002



By:

/s/    RICHARD W.
REICHOWRichard W. Reichow, Executive Vice President,Chief Financial Officer and Treasurer(Principal Financial and
Accounting Officer)




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