##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934FOR QUARTERLY PERIOD ENDED MARCH 31, 2005ORo
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 Commission File Number: 0-20117 ENCYSIVE PHARMACEUTICALS INC. 
  Delaware
    
    13-3532643(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)
 4848 Loop Central Drive, Suite 700, Houston, Texas
    
    
    77081(Address of principal executive office)
    
    (Zip code)
 (713) 796-8822 
  Not Applicable 
  Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes
þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). Yes
þ No o Indicate the number of shares outstanding of each of the issuers classes of Common Stock,
exclusive of treasury shares, as of the latest practicable date. Class
    
    Outstanding at April 25, 2005Common stock, $0.005 par value
    
    58,081,067




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ENCYSIVE PHARMACEUTICALS INC. TABLE OF CONTENTS PAGE NO.Part I.
    
    Financial InformationItem 1:
    
    Financial Statements (Unaudited)Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004
    
    
    1Consolidated Statements of Operations and Comprehensive Loss for the three nine months ended March 31, 2005 and 2004
    
    
    2Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004
    
    
    3Notes to Consolidated Financial Statements
    
    
    4Item 2:
    
    Managements Discussion And Analysis Of Financial Condition And Results Of Operations
    
    
    11Item 3:
    
    Quantitative And Qualitative Disclosures About Market Risk
    
    
    21Item 4:
    
    Controls And Procedures
    
    
    21Part II.
    
    Other InformationItem 1:
    
    Legal Proceedings
    
    
    21Item 2:
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    21Item 3:
    
    Defaults Upon Senior Securities
    
    
    21Item 4:
    
    Submission Of Matters To A Vote Of Security Holders
    
    
    22Item 5:
    
    Other Information
    
    
    22Item 6:
    
    Exhibits
    
    
    22SIGNATURES
    
    
    
    
    23Certification of CEO Pursuant to Rule 13a-14(a)Certification of CFO Pursuant to Rule 13a-14(a)Certification of CEO Pursuant to Section 1350Certification of CFO Pursuant to Section 1350




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ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
 ($ in thousands, except per share data)
 (Unaudited)
 March 31,
    
    
    December 31,2005
    
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    123,690
    
    
    $
    46,130Short-term investments
    
    
    58,441
    
    
    
    22,971Accounts receivable
    
    
    2,313
    
    
    
    4,816Other current receivables
    
    
    163
    
    
    
    348Prepaids
    
    
    1,926
    
    
    
    849Total current assets
    
    
    186,533
    
    
    
    75,114Equipment and leasehold improvements, net
    
    
    5,856
    
    
    
    5,107Deferred debt origination costs, net of accumulated amortization of $37
    
    
    4,604
    
    
    
    Intangible and other assets, net of accumulated amortization of $500 and $474
    
    
    525
    
    
    
    551Total assets
    
    $
    197,518
    
    
    $
    80,772LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    3,167
    
    
    $
    2,897Accrued expenses
    
    
    13,862
    
    
    
    12,300Deferred revenue
    
    
    1,288
    
    
    
    561Total current liabilities
    
    
    18,317
    
    
    
    15,758Deferred revenue
    
    
    2,252
    
    
    
    1,119Long-term debt
    
    
    131,658
    
    
    
    1,730Minority interest in Revotar
    
    
    363
    
    
    
    628Commitments and contingenciesStockholders equity:Preferred stock, par value $.005 per share. 5,000,000 shares
authorized, none issued or outstanding
    
    
    
    
    
    
    Common stock, par value $.005 per share. At March 31, 2005
75,000,000 shares authorized; 58,237,582 shares issued,
58,024,582 shares
outstanding. At December 31, 2004, 75,000,000 shares authorized;
58,131,254 shares issued, 57,918,254 shares outstanding
    
    
    291
    
    
    
    291Additional paid-in capital
    
    
    301,659
    
    
    
    300,906Deferred compensation expense
    
    
    (81
    )
    
    
    (129
    )Treasury stock, 213,000 shares
    
    
    (1,602
    )
    
    
    (1,602
    )Accumulated other comprehensive income
    
    
    222
    
    
    
    189Accumulated deficit
    
    
    (255,561
    )
    
    
    (238,118
    )Total stockholders equity
    
    
    44,928
    
    
    
    61,537Total liabilities and stockholders equity
    
    $
    197,518
    
    
    $
    80,772
 See accompanying notes to consolidated financial statements 1




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ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
 ($ in thousands, except per share data)
 (Unaudited)
 Three Months Ended March 31,2005
    
    
    2004Revenues:Research agreements
    
    $
    
    
    
    $
    761Royalty income, net
    
    
    2,346
    
    
    
    1,792License fees, milestones and grants
    
    
    194
    
    
    
    282Total revenues
    
    
    2,540
    
    
    
    2,835Expenses:Research and development
    
    
    16,784
    
    
    
    12,015General and administrative
    
    
    3,812
    
    
    
    2,485Total expenses
    
    
    20,596
    
    
    
    14,500Operating loss
    
    
    (18,056
    )
    
    
    (11,665
    )Investment income, net
    
    
    519
    
    
    
    390Interest expense
    
    
    (171
    )
    
    
    (40
    )Loss before minority interest
    
    
    (17,708
    )
    
    
    (11,315
    )Minority interest in loss of Revotar
    
    
    265
    
    
    
    194Net loss
    
    
    (17,443
    )
    
    
    (11,121
    )Other comprehensive income:Unrealized gain on foreign currency translation
    
    
    33
    
    
    
    79Comprehensive loss
    
    $
    (17,410
    )
    
    $
    (11,042
    )Net loss per common share-basic and diluted
    
    $
    (0.30
    )
    
    $
    (0.21
    )Weighted average common shares used to compute
basic and diluted net loss per share
    
    
    57,655,886
    
    
    
    52,178,130
 See accompanying notes to consolidated financial statements 2




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ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS ($ in thousands) (Unaudited)
 Three Months Ended March 31,2005
    
    
    2004Cash flows from operating activities:Net loss
    
    $
    (17,443
    )
    
    $
    (11,121
    )Adjustments to reconcile net loss to net cash
used in operating activities:Depreciation and amortization
    
    
    327
    
    
    
    243Minority interest in loss of Revotar
    
    
    (265
    )
    
    
    (194
    )Expenses paid with stock
    
    
    480
    
    
    
    201Stock-based compensation expense
    
    
    61
    
    
    
    67Loss on disposition of fixed assets
    
    
    7
    
    
    
    3Amortization of debt issue costs
    
    
    37
    
    
    
    Amortization of discount/premium on investments
    
    
    (7
    )
    
    
    Change in interest receivable included in short-term investments
    
    
    (14
    )
    
    
    119Change in operating assets and liabilities:Accounts receivable
    
    
    2,503
    
    
    
    (11
    )Prepaids
    
    
    (1,078
    )
    
    
    (761
    )Other current receivables
    
    
    179
    
    
    
    498Accounts payable and accrued expenses
    
    
    1,861
    
    
    
    1,147Deferred revenue
    
    
    1,860
    
    
    
    (140
    )Net cash used in operating activities
    
    
    (11,492
    )
    
    
    (9,949
    )Cash flows from investing activities:Purchases of equipment and leasehold improvements
    
    
    (1,100
    )
    
    
    (275
    )Purchases of investments
    
    
    (63,362
    )
    
    
    (13,000
    )Maturity of investments
    
    
    27,913
    
    
    
    4,000Net cash used in investing activities
    
    
    (36,549
    )
    
    
    (9,275
    )Cash flows from financing activities:Proceeds from sale of common stock and option and
warrant exercises, net
    
    
    261
    
    
    
    2,526Debt issue costs
    
    
    (4,641
    )
    
    
    Borrowing (repayment) of long-term debt
    
    
    130,000
    
    
    
    (6,000
    )Net cash provided by (used in) financing activities
    
    
    125,620
    
    
    
    (3,474
    )Effect of exchange rate changes on cash
    
    
    (19
    )
    
    
    (23
    )Net (decrease) increase in cash and cash equivalents
    
    
    77,560
    
    
    
    (22,721
    )Cash and cash equivalents at beginning of period
    
    
    46,130
    
    
    
    65,302Cash and cash equivalents at end of period
    
    $
    123,690
    
    
    $
    42,581Supplemental schedule of noncash financing activities:Stock-based compensation expense
    
    $
    61
    
    
    $
    67Issuance of Common Stock for expenses
    
    
    480
    
    
    
    201Interest paid
    
    
    3
    
    
    
    39
 See accompanying notes to consolidated financial statements 3




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ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 March 31, 2005 (unaudited) (1) Basis of Presentation The accompanying unaudited consolidated financial statements of Encysive Pharmaceuticals Inc.,
a Delaware corporation, and its subsidiaries (collectively referred to as the Company or
Encysive) have been prepared in accordance with accounting principles generally accepted in the
United States of America (USA) for interim financial information and with the instructions to
Form 10-Q and Rule 10-01 of Regulation S-X. They do not include all information and notes required
by accounting principles generally accepted in the USA for complete financial statements. It is
recommended that these interim condensed consolidated financial statements be read in conjunction
with the consolidated financial statements and notes thereto included in the Companys Annual
Report on Form 10-K for the year ended December 31, 2004. Except as disclosed herein, there has
been no material change in the information disclosed in the notes to the consolidated financial
statements included in the Companys Annual Report on Form 10-K for the year ended December 31,
2004. In the opinion of management, all adjustments (consisting only of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating results for the
three-month period ended March 31, 2005, are not necessarily indicative of the results that may be
expected for any other interim period or for the year ending December 31, 2005. (2) Organization and Significant Accounting Policies (a) Organization Encysive is a biopharmaceutical company focused on the discovery, development and
commercialization of novel synthetic small molecule compounds to address unmet medical needs.
The Companys research and development programs are predominantly focused on the treatment
and prevention of interrelated diseases of the vascular endothelium and exploit its expertise
in the area of the intravascular inflammatory process, referred to as the inflammatory
cascade, and vascular diseases. Since its formation in 1989, the Company has been engaged
principally in research and drug discovery programs and clinical development of certain drug
compounds. The Company is presently working on a number of long-term development projects that
involve experimental and unproven technology, which may require many years and substantial
expenditures to complete, and which may or may not be successful. Sales of the Companys
first FDA-approved product, Argatroban, for which it receives royalty income, began during
November 2000. (b) Basis of Consolidation The Companys consolidated financial statements include the accounts of the Company, its
wholly owned subsidiaries, ImmunoPharmaceutics, Inc. (IPI), a California corporation,
Encysive, L.P. (ELP), a Delaware limited partnership, EP-ET, LLP, a Delaware limited
partnership, Encysive (UK) Limited, a private company located in the United Kingdom (UK), and
its majority controlled subsidiary, Revotar Biopharmaceuticals AG (Revotar), a German
corporation. All material intercompany balances and transactions have been eliminated. (c) Stock-Based Compensation At March 31, 2005, the Company had five stock-based compensation plans for employees and
non-employee directors. The Company accounts for those plans under the recognition and
measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations. The Companys results of operations for
the three-month periods ended March 31, 2005 and 2004, included stock-based compensation
expense arising from the grant of shares of restricted common stock to employees and the
recognition of deferred 4




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compensation expense arising from the grant of stock options in March 2003 to certain
employees, which were subject to the approval of stockholders of an amendment to increase the
authorized shares in the 1999 plan. No other stock-based employee compensation expense is
reflected in net loss, however, as all options granted under those plans had an exercise
price equal to the market price of the underlying Common Stock on the date of grant. The
following table illustrates the effect on net loss and loss per share if the Company had
applied the fair value recognition provisions of FASB Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation, to stock-based employee
compensation (dollars in thousands, except for per share data). In December 2004, the FASB issued Statement No. 123R, Share-Based Payment (FAS
123R), which requires the measurement of all employee share-based payments to employees,
including grants of employee stock options, using a fair-value based method and the recording
of such expense in our consolidated statements of operations and comprehensive loss. The
implementation of accounting provisions of FAS 123R has been delayed and will now be
effective for annual reporting periods beginning after June 15, 2005. The Company is
required to adopt FAS 123R in the first quarter of 2006. The pro forma disclosures
previously permitted under FAS 123 no longer will be an alternative to financial statement
recognition. Although we have not yet determined whether the adoption of FAS 123R will
result in amounts that are similar to the current pro forma disclosures under FAS 123, we are
evaluating the requirements of FAS 123R and expect the adoption may have a significant
adverse impact on our future consolidated statements of operations and comprehensive loss. Three Months EndedMarch 31,2005
    
    
    2004Net loss, as reported
    
    $
    (17,443
    )
    
    $
    (11,121
    )Add: Stock-based employee
compensation expense
included in reported
net loss
    
    
    13
    
    
    
    28Deduct: Total stock-based
employee compensation
expense determined
under fair value method
for all awards
    
    
    (1,018
    )
    
    
    (604
    )Pro forma net loss
    
    $
    (18,448
    )
    
    $
    (11,697
    )Loss per share:As reported, basic and diluted
    
    $
    (0.30
    )
    
    $
    (0.21
    )Pro forma, basic and diluted
    
    $
    (0.32
    )
    
    $
    (0.22
    )
 The per-share weighted average fair value of stock options granted during the
three-month periods ended March 31, 2005 and 2004, was $6.62 and $5.99, respectively, on the
grant date using the Black-Scholes option pricing model with the following assumptions: Three Months EndedMarch 31,2005
    
    
    2004Expected dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Risk-free interest rate
    
    
    4.2
    %
    
    
    2.6
    %Expected volatility
    
    
    69.3
    %
    
    
    74.5
    %Expected life in years
    
    
    4.92
    
    
    
    4.79
 5




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(d) Debt Issue Costs The Company incurred costs, principally comprised of underwriting fees and various legal and
professional fees, of approximately $4,641,000 related to the issue of its 2.50% Convertible Senior
Notes due 2012 (the Notes) in March 2005. Recognition of the debt issue costs is deferred, and
recognized from the issuance of the Notes through the maturity date of the Notes, March 15, 2012. Interest expense in the three-months ended March 31, 2005, includes
approximately $37,000 in amortized debt issue costs. Remaining unamortized debt issue costs were
approximately $4,604,000 at March 31, 2005. For additional information about the Notes, see Note
9. (3) Capital Stock In March 2005, the Company issued the Notes in the principal amount of $130,000,000. As the
Notes are convertible into the Companys common stock, the Company has reserved 9,322,001 shares
for issuance upon conversion, including 213,000 treasury shares. For additional information about
the Notes, see Note 9. The Company has reserved Common Stock for issuance as of March 31, 2005, as
follows: Stock option plans
    
    
    7,444,7502.50% Convertible Senior Notes due 2012
    
    
    9,322,001Total shares reserved
    
    
    16,766,751
 The Company has proposed to its stockholders for consideration at its 2005 annual meeting
scheduled for May 11, 2005, that the number of authorized shares be increased from 75,000,000 to
150,000,000. (4) Cash, Cash Equivalents, and Short-Term Investments Cash equivalents are considered to be those securities or instruments with original
maturities, when purchased, of three months or less and are recorded at cost. Short-term
investments consist of debt securities with remaining maturities of less than one year and original
maturities greater than three months at the purchase date. The Company classifies all short-term
investments as held-to-maturity. Held-to-maturity securities are those securities in which the
Company has the ability and intent to hold the security until maturity. Short-term investments are
stated at amortized cost plus accrued interest. Interest income is accrued as earned. The Company
evaluates the carrying value of its securities by comparing the carrying values of the securities
to their market values. In the event that the fair value of a security were to decline below its
carrying cost, and in the opinion of management such decline was other than temporary, the Company
would record a loss and reduce the carrying value of such security to its fair value. Composition
of cash and investments was as follows (dollars in thousands): March 31, 2005
    
    
    December 31, 2004Cash and cash equivalents:Demand and money market accounts
    
    $
    334
    
    
    $
    881Corporate commercial paper
    
    
    123,356
    
    
    
    45,249Total cash and cash equivalents
    
    $
    123,690
    
    
    $
    46,130
 6




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Investments at March 31, 2005, and December 31, 2004, were as follows (dollars in thousands): As of March 31, 2005Gross
    
    
    GrossShort-term investments
    
    Amortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedHeld-to-maturity
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueCorporate commercial paper
and loan participations
    
    $
    56,425
    
    
    $
    5
    
    
    $
    (29
    )
    
    $
    56,401US Government agency
securities
    
    
    2,016
    
    
    
    
    
    
    
    (33
    )
    
    
    1,983Total short-term
held-to-maturity investments
    
    $
    58,441
    
    
    $
    5
    
    
    $
    (62
    )
    
    $
    58,384
 As of December 31, 2004Gross
    
    
    GrossShort-term investments
    
    Amortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedHeld-to-maturity
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueU.S. Government agency
securities
    
    $
    2,006
    
    
    $
    
    
    
    $
    (21
    )
    
    $
    1,985Corporate commercial paper
    
    
    19,964
    
    
    
    14
    
    
    
    (46
    )
    
    
    19,932Corporate debt securities
    
    
    1,001
    
    
    
    
    
    
    
    (1
    )
    
    
    1,000Total short-term
held-to-maturity investments
    
    $
    22,971
    
    
    $
    14
    
    
    $
    (68
    )
    
    $
    22,917
 (5) Net Loss per Common Share Basic net loss per common share is calculated by dividing the net loss by the weighted average
number of common and common equivalent shares outstanding during the period. For the three-month
periods ended March 31, 2005 and 2004, the weighted average common shares used to compute basic and
diluted net loss per common share totaled 57,655,886 and 52,178,130, respectively. Securities
convertible into Common Stock comprised of stock options, warrants, shares of common stock reserved for
issuance upon conversion of the Notes and unvested shares of restricted common stock totaling
15,033,552 and 5,423,117 shares at March 31, 2005 and 2004, respectively, were not used in the
calculation of diluted net loss per common share because the effect would have been antidilutive. (6) Income Taxes The Company did not incur tax expense (benefit) during the three-month periods ended March 31,
2005 and 2004, due to operating losses and the related increase in the valuation allowance. (7) Entity-Wide Geographic Data The Company operates in a single business segment that includes research and development of
pharmaceutical products. The following table summarizes the Companys long-lived assets in
different geographic locations (dollars in thousands): 7




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March 31, 2005
    
    
    December 31, 2004Long-lived assets:United States
    
    $
    10,053
    
    
    $
    4,591Germany
    
    
    932
    
    
    
    1,067Total
    
    $
    10,985
    
    
    $
    5,658
 The following table summarizes the Companys revenues in different geographic locations
(dollars in thousands): Three Months EndedMarch 31, 2005
    
    
    March 31, 2004Revenues:United States
    
    $
    2,486
    
    
    $
    2,693Germany
    
    
    54
    
    
    
    142Total
    
    $
    2,540
    
    
    $
    2,835
 The Companys revenues are primarily derived from several entities, each of whom represents a
significant percentage of total revenues. The following table summarizes the Companys sources of
revenues from its principal customers (dollars in thousands): Three Months EndedMarch 31, 2005
    
    
    March 31, 2004Customers:GSK
    
    $
    2,346
    
    
    $
    1,792Schering-Plough
    
    
    140
    
    
    
    901Other
    
    
    54
    
    
    
    142Total
    
    $
    2,540
    
    
    $
    2,835
 (8) Foreign Subsidiary In April 2005, the stockholders of Revotar agreed to restructure Revotars capitalization (the
Restructuring). Under the terms of the Restructuring, Revotars stockholders other than the
Company have agreed to contribute additional funds to Revotar, and the Companys ownership will be
reduced to approximately 14% of the outstanding common stock of Revotar. Revotars other
stockholders may also subsequently purchase the shares of Revotar common stock owned by the Company
for nominal consideration. Upon the funding of Revotar by the other stockholders, the Company has
agreed to license its worldwide rights to bimosiamose and certain follow-on compounds to Revotar
for which it could receive substantial future royalty payments from Revotar in the event that these
compounds are subsequently approved and commercialized, or licensed to a third party. Further,
the Company has agreed to cancel its outstanding loan, and accrued interest thereon, of
approximately $3.7 million. The transaction will become effective upon contribution of the
additional capital by Revotars other stockholders. For additional discussion of Revotars
indebtedness, see Note 9. Following the completion of the Restructuring, the Companys
consolidated financial statements will no longer include the results of Revotar. The Companys
management believes that the Restructuring will not have a material adverse effect on the Companys
results of operations or financial position. Encysive formed Revotar in 2000 to conduct research and development of novel small molecule
compounds and to develop and commercialize selectin antagonists. The Company initially retained
ownership of approximately 55% of the outstanding common stock of Revotar and has consolidated the
financial results of Revotar into Encysives consolidated financial statements. Since the
development and commercialization rights contributed by the Company to Revotar had no basis for
financial reporting purposes, the Company assigned no value to its contribution of intellectual
property rights. The Companys equity in the originally contributed assets by the minority
stockholders is included with the minority interest in Revotar on the consolidated balance sheets
at March 31, 2005, and December 31, 2004. 8




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The minority interest in Revotar at March 31, 2005, and December 31, 2004, was $363,000 and
$628,000, respectively. The Companys consolidated net loss for the three-month periods ended
March 31, 2005 and 2004 was reduced $265,000 and $194,000, respectively, by the Revotar minority
stockholders approximately 45% interest in Revotars losses. (9) Long-Term Debt In March 2005, the Company issued $130,000,000 in Notes, due 2012. The Company will pay 2.50%
interest per annum on the Notes on March 15 and September 15 of each year, beginning September 15,
2005. Holders of the Notes may convert the Notes into shares of common stock at any time prior to
the maturity date of the Notes at a conversion rate of 71.7077 shares of common stock per $1,000
principal amount of Notes, which is equal to an initial conversion price of approximately $13.95
per share, subject to adjustment as set forth in the indenture governing the Notes. In the event
of certain types of fundamental changes, the Company will increase the number of shares issuable
upon conversion or, in lieu thereof, the Company may in certain circumstances elect to adjust the
conversion rate and related conversion obligation so that the Notes are convertible into shares of
the acquiring or surviving company, or at the option of the Company, the Company may elect to pay
the additional value represented by an increase in the conversion rate in cash to holders electing
to convert their Notes. On or after March 20, 2010, the Company may redeem some or all of the
Notes for cash at 100% of the principal amount plus accrued interest, if the trading price of the
Companys common stock exceeds 140% of the conversion price of the Notes then in effect for at
least 20 trading days within a period of 30 consecutive trading days ending on the trading day
prior to the date on which the redemption notice is mailed. Upon the occurrence of a fundamental
change meeting certain conditions, holders of the Notes may require the Company to repurchase for
cash all or part of their Notes. The Notes are senior unsecured obligations and rank equally in right of payment with any
senior unsecured indebtedness that the Company may incur in the future. The Notes will be
effectively subordinated to all future secured indebtedness and all existing and future liabilities
of the Companys subsidiaries, including trade payables and senior in right of payment to any
future subordinated indebtedness that the Company may incur. The Company was a party to a note arising from its acquisition of the partnership interest of
ICOS Corporation in ELP in April 2003. The note required a payment of $4,000,000 on April 22, 2004,
and a payment of $2,000,000 on October 22, 2004. The outstanding principal balance of the note
accrued interest at a rate which approximated the three-month London interbank offering rate for
U.S. dollars (LIBOR) plus 1.5 percent. The Companys obligations under the note were secured with
an irrevocable standby letter of credit for which the Company pledged marketable securities with an
amortized cost of $7,011,000. On March 31, 2004, the Company prepaid its remaining $6,000,000
obligation under the note plus accrued interest of $38,000, and the pledged marketable securities
were returned to the Company. The stockholders of Revotar provided approximately $4.5 million in unsecured loans to Revotar,
of which the Companys commitment was approximately $3.4 million. The terms of the loans required
quarterly interest payments, however the stockholders of Revotar have waived such payments, and
repayment of all principal on or before April 1, 2007. Pursuant to such agreement, the Company has
advanced its entire commitment of approximately $3.4 million to Revotar and the minority
shareholders of Revotar have advanced their entire commitment of approximately 1.3 million euros to
Revotar as of March 31, 2005. The loan from the Company is denominated in U.S. dollars. The
Companys loan to Revotar has been eliminated in consolidation, however the amount borrowed from
Revotars minority shareholders, valued at approximately $1.7 million at March 31, 2005, is
included in long-term debt on our consolidated balance sheet. As discussed in Note 8, the Company
has agreed to cancel its loan, including accrued interest thereon totaling approximately $3.7
million, upon completion of the Restructuring. 9




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(10) Commitments and Contingencies (a) Foreign Currency Exchange Risk The Company is exposed to market risk primarily from changes in foreign currency
exchange rates. Although not material to our operations, we were exposed to an increased
risk of fluctuating foreign exchange rates during the three months ended March 31, 2005 as a
result of the increasing weakness of the U.S. dollar and our increased clinical trial
activity in areas outside the U.S. Historically, we have not hedged any of these foreign
currency exchange risks except at Revotar. The following describes the nature of this risk
that we believe is not material to us. We have a majority-owned affiliate in Berlin,
Germany, and consolidate the results of operations into our consolidated financial results.
Although not material to date, our reported expenses and cash flows from this affiliate are
exposed to changing exchange rates. We also have contracts with entities in other areas
outside the U.S. that are denominated in a foreign currency. To date, these currencies have
not fluctuated materially. (b) Other contingencies Like other biopharmaceutical companies, the Company is subject to other contingencies,
including legal proceedings and claims arising out of its business that cover a wide range of
matters, including, among others, environmental matters, contract and employment claims, and
product liability. The Company may be involved in legal actions from time to time. The
Company has used various substances in its research and development that have been or may be
deemed to be hazardous or dangerous, and the extent of its potential liability, if any, under
environmental, product liability and workers compensation statutes, rules, regulations and
case law is unclear. 10




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Item 2. ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Three Months Ended March 31, 2005 and March 31, 2004 OVERVIEW The following discussion of our financial condition and results of operations should be read
in conjunction with our consolidated financial statements and the related notes to the financial
statements included in our Annual Report on Form 10-K for the year ended December 31, 2004, and
with the consolidated financial statements and related notes to the financial statements included
elsewhere in this Form 10-Q. This discussion contains forward-looking statements based on current
expectations that are subject to risks and uncertainties, such as statements of our plans,
objectives, expectations and intentions. When used in this discussion, the words expect,
anticipate, intend, plan, believe, seek, estimate and similar expressions are intended
to identify forward-looking statements, although not all forward-looking statements contain these
identifying words. Our actual results and the timing of events could differ materially from those
anticipated or implied by the forward-looking statements discussed here as a result of various
factors, including, among others, those set forth under the Cautionary Note Regarding
Forward-Looking Statements in our Annual Report on Form 10-K for the year ended December 31, 2004.
You should not place undue reliance on these forward-looking statements, which speak only as of the
date of this report. Except as required by law, we undertake no obligation to update any of the
forward-looking statements in this discussion after the date of this report. Encysive is a biopharmaceutical company engaged in the discovery, development and
commercialization of novel, synthetic, small molecule compounds to address unmet medical needs. Our
research and development programs are predominantly focused on the treatment and prevention of
interrelated diseases of the vascular endothelium and exploit our expertise in the area of the
intravascular inflammatory process, referred to as the inflammatory cascade, and vascular diseases.
We have successfully developed one FDA-approved drug, Argatroban, for the treatment of
heparin-induced thrombocytopenia, or HIT, which is marketed by GlaxoSmithKline plc, or GSK. Our
lead drug candidate, Thelin (sitaxsentan sodium) is an endothelin receptor antagonist that has
successfully completed final Phase III clinical trials for the treatment of pulmonary arterial
hypertension, or PAH. In addition, we have earlier stage clinical product candidates in development
including TBC3711, a next generation endothelin receptor antagonist. Bimosiamose is being
developed by our majority-owned German affiliate, Revotar Biopharmaceuticals AG, or Revotar. In
April 2005, we agreed to substantially revise our licensing agreement with Revotar and to a capital
restructuring of Revotar. For more information, see Note 8 to the financial statements included
herein. In March 2005, we issued $130 million of 2.50 percent Convertible Senior Notes, or the Notes,
due 2012. For additional information about the Notes, see Note 9 to the consolidated financial
statements included herein. Thelin  for the treatment of Pulmonary Arterial Hypertension We recently completed the pivotal Phase III clinical trials of Thelin, an oral small molecule
for the treatment of PAH and we believe a New Drug Application, or NDA, may be submitted in May
2005. We also expect to file in the European Union in the third quarter of 2005. Additionally,
during 2004, we obtained orphan drug designation for Thelin from both the FDA and the European
Commission. We have worldwide commercialization rights to Thelin. We
intend to build a new specialty sales force, which we currently plan to consist of approximately 50
to 60 representatives, for the commercialization of Thelin in North America, and we have reserved
all marketing rights to Thelin in the rest of the world. We believe it is advantageous to allow
the market to continue to grow globally before making a final decision on any marketing plans
outside North America. While we are considering the 11




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option of marketing the product on our own worldwide, we intend to leave our options open and
will re-assess the situation as we move closer to commercialization. Argatroban Argatroban, licensed from Mitsubishi Pharma Corporation (Mitsubishi) and developed in North
America by Encysive, is a synthetic direct thrombin inhibitor approved by the FDA in 2000. It is
indicated for prophylaxis or treatment of thrombosis for patients with HIT, a profound allergic
reaction to anticoagulation therapy with heparin, and for use in HIT patients undergoing
precutaneous coronary intervention. Argatroban was approved in Canada in 2002 for use as an
anticoagulant therapy in patients with HIT syndrome. GSK markets Argatroban in the U.S. and Canada,
and has Hatch-Waxman market exclusivity in the U.S. until June 2005. A pediatric study is underway,
which could prolong exclusivity in the U.S. to the end of 2005. In the three months ended March 31,
2005, Encysive earned royalties from the sales of Argatroban totaling $2.3 million. See Outlook
for 2005, below, for additional information about our plans and expectations for the remainder of
2005. Other Development Programs In addition to Thelinand Argatroban, we have a number of projects in clinical and
preclinical development. TBC3711, a next generation ET(A) receptor antagonist, has completed Phase
I clinical development for the treatment of PAH. TBC3711 is more selective and more potent than
Thelin. Revotar is developing bimosiamose, a selectin antagonist discovered in Encysives
laboratories, which is designed to block inflammatory cells from leaving the vascular space to
travel to tissue sites of inflammation. Revotar completed Phase IIa clinical trials evaluating the
use of topical bimosiamose for the treatment of psoriasis and atopic dermatitis. The results of
the Phase IIa clinical trial showed a decline in thickness of the psoriatic plaque. Revotar is
evaluating the conduct of additional clinical trials of bimosiamose. An inhaled version of
bimosiamose has completed a 12-patient proof-of-concept study in asthma that demonstrated a
statistically significant improvement in the late asthmatic response, the same target addressed by
inhaled steroid use in asthma. In April 2005, the stockholders of Revotar agreed to restructure Revotars capitalization in
an arrangement referred to as the Restructuring. Under the terms of the Restructuring, Revotars
stockholders other than Encysive have agreed to contribute additional funds to Revotar, and our
ownership will be reduced to approximately 14% of the outstanding common stock of Revotar.
Revotars other stockholders may also subsequently purchase the shares of Revotar common stock
owned by us for nominal consideration. Upon the funding of Revotar by the other stockholders,
Encysive has agreed to license its worldwide rights to bimosiamose and certain follow-on compounds
to Revotar for which we could receive substantial future royalty payments from Revotar in the event
that these compounds are subsequently approved and commercialized, or licensed to a third party.
Further, we have agreed to cancel our outstanding loan, and accrued interest thereon, of
approximately $3.7 million. The transaction will become effective upon contribution of the
additional capital by Revotars other stockholders. Following the completion of the Restructuring,
our consolidated financial statements will no longer include the results of Revotar. We believe
that the Restructuring will not have a material adverse effect on our results of operations or
financial position. We have entered into a worldwide research collaboration and license agreement with
Schering-Plough Corporation and Schering-Plough LTD (collectively Schering-Plough), to discover,
develop and commercialize VLA-4 antagonists. Schering-Plough has informed us that they have
completed pre-clinical development with TBC4746, an oral VLA-4 antagonist. In March 2005, the
initiation of clinical studies by Schering-Plough triggered a milestone payment to us. VLA-4 is a
potential target in the inflammatory cascade taking place within the vasculature. TBC4746 has the
potential to address a number of diseases, including asthma and multiple sclerosis. Additionally,
on June 30, 2004 Schering-Plough ended their funding of our research on a follow-on compound
pursuant to the research agreement. 12




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Encysives Research Programs Our research efforts are concentrated on targets within the vasculature, and the potential
indications of our drug candidates include cardiovascular diseases and a potentially wide variety
of inflammatory diseases involving two complementary sets of targets. The first set of targets
relate to vascular G-protein coupled receptors (GPCRs). Historically, GPCRs have been some of the
most amenable targets for developing commercially successful pharmaceuticals, such as
beta-blockers, antihistamines, and most anti-psychotics and anti-depressants. Endothelin receptors,
targeted by Thelin and TBC3711, are examples of GPCRs. Encysive also has developed expertise in pharmacologically intervening in the intravascular
inflammatory cascade, representing a second set of intravascular targets. Bimosiamose and TBC4746
are examples of drug candidates that we designed to target two distinct steps in this cascade, the
selectins and VLA-4, respectively. Some of the targets in this cascade are GPCRs. Thus, our focus
on endothelial cell and related vascular biology has opened up a broad range of disease targets
with high, unmet medical need. Critical Accounting Policies Revenue Recognition  
    We recognize revenue from service contracts as services are performed.
    Royalty revenue is recognized as products are sold by a licensee and we have received
sufficient information to record a receivable. Our royalty revenue is based on net sales
of product, that is, sales net of discounts, returns and allowances. We have estimated a
percentage of gross sales, based on recent experience, as an allowance for future
returns, however there can be no assurance that our estimate will be accurate. We
believe, however, that differences between estimated and actual future returns will not
have a material effect upon our results of operations or financial condition.
    Revenue from collaborative research and development activities is recognized as
services are performed.
    We defer the recognition of milestone payments related to contractual agreements that
are still in the development stage. Such deferred revenues are amortized into income
over the estimated remaining development period. Milestone payments received under
contractual agreements that have completed the development stage are evaluated and
either recognized into income when earned or amortized over a future period depending
upon whether or not the Company continues to have obligations under the terms of the
arrangement.
    License fees received under the terms of licensing agreements for our intellectual
property are similarly deferred and amortized into income over the estimated
developmental period of the licensed item or items.
    Revenue from grants is recognized as earned under the terms of the related grant
agreements, typically as expenses are incurred. Amounts received in advance of services being performed under contracts are recorded as
deferred revenue and recognized as services are performed. We periodically evaluate our estimates
of remaining development periods and adjust the recognition of remaining deferred revenues over the
adjusted development period remaining. At March 31, 2005, remaining deferred revenue was
approximately $3.5 million, of which we expect to recognize approximately $1.3 million over the
next twelve months. A future change in our estimate of development periods could accelerate or
decelerate the timing of future recognition of deferred revenue. Stock Options We apply Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations (APB 25) in accounting for our stock option plans and
apply FASB Statement No. 123, Accounting for Stock-Based Compensation, and related
interpretations (FAS 13




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123) in reporting for our stock option plans. APB 25 utilizes the intrinsic value of stock
options, defined as the difference between the exercise price of an option and the market price of
the underlying share of common stock on the measurement date, which is generally the date of
grant. Since the exercise price of employee stock options issued under our plans is set to match
the market price of our Common Stock, there is generally no compensation expense recognized upon
grant of employee stock options. Options granted to non-employees, if any, are valued at the fair
value of the option, as defined by FAS 123, utilizing the Black-Scholes option pricing model. We
record compensation expense for the fair value of options granted to non-employees. The pro forma
effect of recognizing the fair value of stock option grants to employees on our consolidated
results of operations is discussed in Note 2(c), Stock-Based Compensation. In December 2004, the FASB issued Statement No. 123R, Share-Based Payment (FAS 123R),
which requires the measurement of all employee share-based payments to employees, including grants
of employee stock options, using a fair-value based method and the recording of such expense in our
consolidated statements of operations and comprehensive loss. The implementation of accounting
provisions of FAS 123R has been delayed and will now be effective for annual reporting periods
beginning after June 15, 2005. We are required to adopt FAS 123R in the first quarter of 2006.
The pro forma disclosures previously permitted under FAS 123 no longer will be an alternative to
financial statement recognition. See Note 2(c) to the notes to the consolidated financial
statements for the pro forma net loss and net loss per share amounts, for the three months ended
March 31, 2005 and 2004, as if we had used a fair-value based method similar to the methods
required under FAS 123R to measure compensation expense for employee stock option awards. Although
we have not yet determined whether the adoption of FAS 123R will result in amounts that are similar
to the current pro forma disclosures under FAS 123, we are evaluating the requirements of FAS 123R
and expect the adoption may have a significant adverse impact on our future consolidated statements
of operations and comprehensive loss. Drug Manufacturing and Packaging Costs arising from the manufacturing and packaging of drug product, which is intended for use
in clinical trials, are recognized as incurred and included in research and development expenses. Costs Related to Issue of Long-Term Debt Costs incurred in the issuance of long-term debt, primarily comprised of underwriter
discounts, legal and other professional fees have been deferred, and will be amortized and reported
as a component of interest expense during the periods beginning with the issuance date to
the maturity date of the debt. Results of Operations The preparation of financial statements in conformity with accounting principles generally
accepted in the United States requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and expenses during the
reporting period. Our operating results have fluctuated significantly during each quarter and year
and we anticipate that such fluctuations, which are largely attributable to varying research and
development commitments and expenditures, will continue for the next several years. We have been
unprofitable to date and expect to incur substantial operating losses for the next several years as
we invest in product research and development, preclinical and clinical testing and regulatory
compliance. We have sustained net losses of approximately $255.6 million from the date of our
inception to March 31, 2005. We have primarily financed our operations to date through a series of
private placements and public offerings of our common stock, the sale of notes and several
collaborative agreements with third parties to jointly pursue product research and development.
See Liquidity and Capital Resources below. See also Additional Risk Factors in Item 1
Business in our Annual Report on Form 10-K for the year ended December 31, 2004. 14




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Three month periods ended March 31, 2005 and 2004 Revenues Total revenues decreased $0.3 million in the three months ended March 31, 2005, compared with
the three months ended March 31, 2004. As discussed above, funding from Schering-Plough under the
research agreement ended June 30, 2004, and the quarter ended March 31, 2004 included approximately
$0.8 million in such funding. Royalties earned on sales of Argatroban by GSK increased $0.6
million in the quarter ended March 31, 2005, compared with the quarter ended March 31, 2004.
Grants received by Revotar from the German government declined approximately $0.1 million in the
quarter ended March 31, 2005, compared with the quarter ended March 31, 2004. Research and Development Expense Research and development expense in the three-month period ended March 31, 2005, increased
$4.8 million, compared with the three months ended March 31, 2004, primarily due to the costs
associated with the ongoing Thelin development program. Thelin development costs increased $4.1
million in the current quarter, compared to the quarter ended March 31, 2004. STRIDE-2 completed enrollment in September 2004, and in February 2005, we released top-line
results. We believe the NDA may be submitted in May 2005. We also expect to file in the European
Union in the third quarter of 2005. Additionally, during 2004, we obtained orphan drug designation
for Thelin from both the FDA and the European Commission. We are continuing to enroll patients in
STRIDE 3, a long-term safety study and also expect to incur significant expenses for activities
such as data management and analysis as we review the results of the STRIDE clinical trials. We
also expect to incur significant expenses necessary to prepare our NDA submission in the U.S. and
submissions seeking regulatory approval for marketing in Europe. Accordingly, we expect research
and development expenses for 2005 to significantly exceed expenses incurred in the comparable
prior-year periods. See Outlook for 2005, below, for additional information about our plans and
expectations for 2005. General and Administrative Expense General and administrative expense in the three months ended March 31, 2005 increased $1.3
million compared with the three months ended March 31, 2004. In anticipation of submitting an NDA,
we have begun to build the corporate infrastructure necessary to support commercialization of
Thelin, assuming regulatory approval. We anticipate that general and administrative expenses in
2005 will significantly exceed expenses incurred in the comparable prior-year periods. See
Outlook for 2005, below, for additional information about our plans and expectations for 2005. Total Operating Expenses Total operating expenses in the three months ended March 31, 2005, increased $6.1 million
compared to the three months ended March 31, 2004, primarily due to higher research and development
expenses, discussed above. Operating Loss Operating loss in the three months ended March 31, 2005, increased $6.4 million compared with
the three months ended March 31, 2004 due to lower revenues and increased operating expenses in the
three months ended March 31, 2005. As discussed in Outlook for 2005, below, we expect operating losses in the remainder of 2005
to exceed comparable periods in 2004. 15




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Interest Expense Interest expense of $0.2 million in the three months ended March 31, 2005 is primarily due to
the issuance of the Notes. Interest expense in the three months ended March 31, 2004 was primarily
due to the $6 million note payable resulting from the acquisition of ELP. Investment Income Investment income in the three month period ended March 31, 2005 increased approximately $0.1
million compared with the three months ended March 31, 2004, as we invested proceeds received upon
issuance of the Notes in March 2005. Liquidity and Capital Resources We have financed our research and development activities and other operations primarily
through public and private offerings of our Common Stock and the Notes and from funds received
through our collaborations, research agreements and partnerships. We also have received royalty
revenue from sales of Argatroban. Cash, cash equivalents and investments in marketable securities, including accrued interest
thereon, was $123.7 million at March 31, 2005, compared with $46.1 million at December 31, 2004.
We used $11.5 million in cash in operating activities during the three months ended March 31, 2005,
compared to $9.9 million during the three months ended March 31, 2004. In March 2005, we received a
$2 million milestone payment from Schering Plough, which is included in deferred revenue at March
31, 2005. The primary operating uses of cash in the 2005 and 2004 periods were to fund our general
operating expenses and the ongoing research and development programs, reduced by cash received from
investment income, milestones, and research payments from our collaborative partners. Investing activities are primarily comprised of our investments in debt securities. Cash is
generated from investing activities when marketable securities mature, and the resulting cash is
utilized primarily to fund operating activities. Cash used in investing activities during the three
months ended March 31, 2005, was primarily comprised of the investment of funds received from our
sale of Notes in March 2005, build out of our new office facility and purchases of equipment. Cash
used in investing activities during the three months ended March 31, 2004, was primarily comprised
of the investment of excess funds and the purchase of equipment. Cash provided by financing activities of $125.6 million during the three months ended March
31, 2005, included net proceeds of $125.4 million from the sale of the Notes in March 2005 and
approximately $0.3 million in proceeds from the exercise of employee stock options. Cash used in
financing activities during the three months ended March 31, 2004 included repayment of a $6.0
million note arising from our acquisition of ELP, partially offset by $2.5 million in proceeds from
the exercise of employee stock options. Material Commitments Our material contractual obligations are comprised of (i) amounts borrowed through the issue
of the Notes, (ii) amounts borrowed by Revotar from its minority shareholders (see Note 8), (iii)
obligations under our operating lease agreements and (iv) a contingent obligation to pay the other
party of a research agreement a termination fee in the event that we elect to terminate the project
prior to completion. In addition, we have signed a long-term purchase agreement for the
manufacturing and supply of Thelin, however our obligations under the agreement are contingent
upon receiving regulatory approval for the marketing of Thelin in the U.S. 16




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As of March 31, 2005, the Company had contractual obligations as follows ($ in thousands): Less than
    
    
    1-3
    
    
    3-5
    
    
    After 5Total
    
    
    1 year
    
    
    years
    
    
    years
    
    
    yearsContractual ObligationsLong-term debt
    
    $
    131,658
    
    
    
    
    
    
    $
    1,658
    
    
    
    
    
    
    $
    130,000Operating leases
    
    
    5,242
    
    
    $
    1,932
    
    
    
    1,934
    
    
    $
    1,376
    
    
    
    Purchase obligations
    
    
    343
    
    
    
    343
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    137,243
    
    
    $
    2,275
    
    
    $
    3,592
    
    
    $
    1,376
    
    
    $
    130,000
 Outlook for 2005 Royalties
    
    $
    10.6 to $11.4 millionRevenues (including royalties)
    
    $
    11.2 to $12.5 millionExpenses (net of Revotar minority interest)
    
    $
    89.0 to $95.0 millionNet loss
    
    $(75) to $(84) millionCash and investments at year-end
    
    $
    110 to $115 million
 For a number of reasons discussed elsewhere in this Form 10-Q, we cannot estimate, with a
reasonable degree of certainty, total completion costs or dates of completion of our ongoing
research and development projects. See also Additional Risk Factors in Item 1 Business in our
Annual Report on Form 10-K for the year ended December 31, 2004, and Longer-Term Outlook, below. These expectations are based upon various assumptions, which are subject to certain risks,
trends and uncertainties that could cause actual results to differ materially from those projected.
Among these risks, trends and uncertainties are timing and cost of our clinical trials, attainment
of research and clinical goals and milestones of product candidates, and sales levels of
Argatroban. While we do not sell Argatroban, our revenues include a royalty from GSK, which is
based on sales and will, accordingly, vary with sales. Our actual royalty revenues could vary from
our assumptions to the extent that the actual sales of Argatroban differ from assumed levels. Projected revenues contain continued amortization of deferred license fees and milestones
previously received from Schering-Plough, which are being deferred over the estimated development
period of the respective compound or program. We periodically review our estimates of development
periods and actual recognized revenues could increase or decrease to the extent that we increase or
decrease our estimated development periods. Projected operating expenses are based upon our current expectations for the year. We have
assumed additional staff and other costs necessary to prepare for regulatory filing in the U.S. as
well as in the rest of the world. Increased projected operating expenses also reflect higher
overall patient enrollment in some of the clinical and other supporting trials. We have assumed
additional clinical trial work for Thelin in additional indications. Our projected expenses also
include basic research efforts on our other programs and levels of administrative support we
believe to be necessary. General and administrative expenses are assumed to be significantly
greater than in previous years, as we intend to build the infrastructure necessary to support
eventual commercialization of Thelin in North America, assuming that we receive regulatory
approval. Projected investment income assumes that the rate of return on invested funds of approximately
2.75% on an average of approximately $150 million in funds available for investment throughout the
remainder of the year. Projected interest expense is comprised of interest on the Notes, plus a portion of deferred
debt issue costs. 17




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The range of estimated net loss is based upon our projected revenues and expenses, as
discussed above. Longer-Term Outlook We expect to incur substantial research and development expenditures as we design and develop
biopharmaceutical products for the prevention and treatment of cardiovascular and other diseases.
We anticipate that our operating expenses will significantly increase in subsequent years because:  
    If Thelin receives regulatory approval, we will incur significant commercialization
expenses. These costs include:  - market research;- hiring a qualified marketing and field sales force;- establishing appropriate infrastructure to support field sales force;- preparation and production of educational and promotional materials;- hiring personnel to administer reimbursement from government and private
third-party payors; and- establishing manufacturing, warehousing and distribution processes for our
products.  
    We expect to incur significant expenses in conjunction with additional clinical trial
costs for Thelin and expect to begin to incur costs for clinical trials related to
additional compounds. These costs include:  - hiring personnel to direct and carry out all operations related to clinical trials;
- hospital and procedural costs;- services of a contract research organization; and- purchasing and formulating large quantities of the compound to be used in such trials.  
    There may be additional costs in future periods related to Argatroban in complying with
ongoing FDA requirements.
    Our administrative costs and costs to commercialize our products will increase as our
products are further developed and marketed. We have been unprofitable to date and expect to incur operating losses for the next several
years as we invest in research and development, preclinical and clinical testing and regulatory
compliance. We may require additional funding to complete the research and development of our
product candidates, to establish commercial scale manufacturing facilities, if necessary, and to
market our products. Estimates of our future capital requirements will depend on many factors,
including:  
    market acceptance and commercial success of Argatroban;
    expenses and risks associated with clinical trials to expand the indications for Thelin;
    continued scientific progress in our drug discovery programs; 18




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
    the magnitude of these programs;
    progress with preclinical testing and clinical trials;
    the time and costs involved in obtaining regulatory approvals;
    the costs involved in filing, prosecuting and enforcing patent claims;
    competing technological and market developments and changes in our existing research
relationships;
    our ability to maintain and establish additional collaborative arrangements; and
    effective commercialization activities and arrangements. Subject to these factors, we anticipate that our existing capital resources and other revenue
sources should be sufficient to fund our cash requirements for the foreseeable future. We believe
we will submit an NDA to the FDA for Thelin in May 2005. If the FDA grants priority
review status to our NDA, our expenses and cash expenditures related to the commercialization of
Thelin in the U.S. could be accelerated in 2005 from future periods. We believe the effect of such accelerated
expenditures could be offset, however, by earlier marketing of Thelin with resulting revenues in
2006 if we receive approval from the FDA. Notwithstanding revenues, which may be produced through sales of potential future products, if
approved, we may need to secure additional funds to continue the required levels of research and
development to reach our long-term goals. We could seek such additional funding through
collaborative arrangements and/or through public or private equity or debt financings or bank debt.
Upon regulatory approval, we intend to commercialize Thelin in North America through our own
specialty sales force. While we are considering the option of marketing the product on our own
worldwide, we intend to leave our options open and continually re-assess the situation as we move
closer to commercialization. In 2002, the stockholders of Revotar executed an agreement to provide approximately $4.5
million in unsecured loans, of which our commitment was approximately $3.4 million. Under the loan
agreement, we have advanced our full commitment of approximately $3.4 million to Revotar as of
March 31, 2005. Revotars current shareholders have no obligation to advance additional funds to
Revotar, and Revotars other shareholders have advanced their commitment of 1.3 million euros. In
April 2005, the stockholders of Revotar agreed to restructure Revotars capitalization in an
arrangement referred to as the Restructuring. Because of this, we will cancel our loan
to Revotar and have no further financial commitment to fund Revotars operations. For additional information about the Restructuring,
see Note 8 to the financial statements included herein. Off-Balance Sheet Arrangements We have not engaged in off-balance sheet financing arrangements. Impact of Inflation and Changing Prices The pharmaceutical research industry is labor intensive and wages and related expenses
increase in inflationary periods. The lease of space and related building services for the Houston
facility contains a clause that escalates rent and related services each year based on the increase
in building operating costs and the increase in the Houston Consumer Price Index, respectively. To
date, inflation has not had a significant impact on our operations. 19




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Cautionary Note Regarding Forward-Looking Statements This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking
statements represent our managements judgment regarding future events. In many cases, you can
identify forward-looking statements by terminology such as may, will, should,
could, plan, expect, anticipate, estimate, believe, predict,
intend, potential, or continue or the negative of these terms or other words of similar
import, although some forward-looking statements are expressed differently. All statements, other
than statements of historical fact, included in and incorporated by reference into this Form 10-Q
regarding our financial position, business strategy and plans or objectives for future operations
are forward-looking statements. Without limiting the broader description of forward-looking
statements above, we specifically note that statements regarding our estimate of the sufficiency of
our existing capital resources, our ability to raise additional capital to fund cash requirements
for future operations, timelines for initiating new clinical trials, planned announcements of
clinical data, the possibility of obtaining regulatory approval, our ability to manufacture and
sell any products, potential drug candidates, their potential therapeutic effect, market acceptance
or our ability to earn a profit from sales or licenses of any drug candidate, our ability to
discover new drugs in the future, and our ability to establish future collaborative arrangements
are all forward-looking in nature. Although we believe that the expectations reflected in these
forward-looking statements are reasonable, we cannot give any assurance that such expectations
reflected in these forward-looking statements will prove to have been correct, and you should be
aware that results and events could differ materially and adversely from those contained in the
forward-looking statements due to a number of factors, including:  
    our failure to achieve positive results in clinical trials or receive required regulatory approvals;
    competitive factors;
    our failure to successfully commercialize our products;
    our inability to manufacture our products;
    variability of our revenue;
    our ability to enter into future collaborative agreements;
    uncertainty regarding our patents and patent rights;
    compliance with current or prospective governmental regulation;
    technological change; and
    general economic conditions. You should read these forward-looking statements carefully because they discuss our
expectations about our future performance, contain projections of our future operating results or
our future financial condition, or state other forward-looking information. You should be aware
that the occurrence of any of the events described in Business, Additional Risk Factors,
Managements Discussion and Analysis of Financial Condition and Results of Operations and
elsewhere in our Annual Report on Form 10-K for the fiscal year ended December 31, 2004, could
substantially harm our business, results of operations and financial condition and that upon the
occurrence of any of these events, the trading price of our common stock could decline, and you
could lose all or part of your investment. All subsequent written and oral forward-looking statements attributable to us or to persons
acting on our behalf are expressly qualified in their entirety by the applicable cautionary
statements. We cannot guarantee any future results, levels of activity, performance or
achievements. Except as required by law, we undertake no obligation to update any of the
forward-looking statements in this Form 10-Q after the date of this Form 10-Q. As used in this Form 10-Q, the words we, our, us, Encysive, and the Company refer to
Encysive Pharmaceuticals Inc., its predecessors and subsidiaries, except as otherwise specified.
This Form 10-Q may contain trademarks and service marks of other companies. 20




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Item 3. Quantitative and Qualitative Disclosures About Market Risk Foreign Currency Exchange Risk The Company is exposed to market risk primarily from changes in foreign currency exchange
rates. Although not material to our operations, we were exposed to an increased risk of
fluctuating foreign exchange rates during the three months ended March 31, 2005 as a result of the
increasing weakness of the U.S. dollar and our increased clinical trial activity in areas outside
the U.S. Historically, we have not hedged any of these foreign currency exchange risks except at
Revotar. The following describes the nature of this risk that is not believed to be material to
us. We have a majority-owned affiliate in Berlin, Germany, and consolidate the results of
operations into our consolidated financial results. Although not material to date, our reported
expenses and cash flows from this affiliate are exposed to changing exchange rates. We also have
contracts with entities in other areas outside the U.S. that are denominated in a foreign currency.
To date, these currencies have not fluctuated materially. 
 Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures As of the end of the period covered by this report, our management carried out an evaluation,
with the participation of our principal executive officer (the CEO) and our principal financial
officer (the CFO), of the effectiveness of our disclosure controls and procedures pursuant to
Rule 13a-15 of the Securities Exchange Act of 1934. Based on those evaluations, the CEO and CFO
concluded: (i) that our disclosure controls and procedures are designed to ensure that information
required to be disclosed by us in the reports that we file or submit under the Securities Exchange
Act of 1934 is recorded, processed, summarized and reported within the time periods specified in
the SECs rules and forms, and that such information is accumulated and communicated to our
management, including the CEO and CFO, as appropriate to allow timely decisions regarding required
disclosure; and (ii) that our disclosure controls and procedures are effective. Changes in Internal Controls Over Financial Reporting There have been no changes in our internal controls over financial reporting during the period
covered by this report that have materially affected, or that are reasonably likely to materially
affect, our internal control over financial reporting. 
 PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings None 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None. 
 Item 3. Defaults Upon Senior Securities None 21




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Item 4. Submission of Matters to a Vote of Security Holders None. 
 Item 5. Other Information In April 2005, the stockholders of Revotar agreed to restructure Revotars capitalization
(the Restructuring. Under the terms of the Restructuring, Revotars stockholders other
than the Company have agreed to contribute additional funds to Revotar, and the Companys
ownership will be reduced to approximately 14% of the outstanding common stock of Revotar.
Revotars other stockholders may also subsequently purchase the shares of Revotar common
stock owned by the Company for nominal consideration. Upon the funding of Revotar by the
other stockholders, the Company has agreed to license its worldwide rights to bimosiamose
and certain follow-on compounds to Revotar for which it could receive substantial future
royalty payments from Revotar in the event that these compounds are subsequently approved
and commercialized, or licensed to a third party. Further, the Company has agreed to
cancel its outstanding loan, and accrued interest thereon, of approximately $3.7 million.
The transaction will become effective upon contribution of the additional capital by
Revotars other stockholders. For additional discussion of Revotars indebtedness, see
Note 9. Following the completion of the Restructuring, the Companys consolidated
financial statements will no longer include the results of Revotar. The Companys
management believes that the Restructuring will not have a material adverse effect on the
Companys results of operations or financial position. 
 Item 6.Exhibits Exhibit No.
    
    Description31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) / Rule
15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.31.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) / Rule
15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.32.1
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
 22




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ENCYSIVE PHARMACEUTICALS INC. April 29, 2005 
 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized, on the 29th
day of April 2005. ENCYSIVE
    
    PHARMACEUTICALS INC.By:
    
    /s/ Bruce D. Given, M.D.Bruce D. Given, M.D.President and Chief Executive OfficerBy:
    
    /s/ Stephen L. MuellerStephen L. MuellerVice President, Finance and AdministrationSecretary and Treasurer(Principal Financial and Accounting Officer)
 23




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INDEX TO EXHIBITS Exhibit No.
    
    Description31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) / Rule
15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.31.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) / Rule
15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.32.1
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.