##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934FOR QUARTERLY PERIOD ENDED SEPTEMBER 30, 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)
  
   
   þ o
  þ o
 o þ
  Class
    
    Outstanding at October 31, 2005Common stock, $0.005 par value
    
    58,424,489




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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 September 30, 2005 and December 31, 2004
    
    
    1Consolidated Statements of Operations and Comprehensive Loss for the
three and nine months ended September 30, 2005 and 2004
    
    
    2Consolidated Statements of Cash Flows for the nine months ended
September 30, 2005 and 2004
    
    
    3Notes to Consolidated Financial Statements
    
    
    4Item 2: Managements Discussion And Analysis Of
Financial Condition And Results Of Operations
    
    
    10Item 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)/Rule 15d-14(a)Certification of CFO pursuant to Rule 13a-14(a)/Rule 15d-14(a)Certification pursuant to 18 U.S.C. Section 1350Certification pursuant to 18 U.S.C. Section 1350




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ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES
 
 CONSOLIDATED BALANCE SHEETS
 ($ in thousands, except share and per share data)
(Unaudited)
 September 30,
    
    
    December 31,2005
    
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    122,798
    
    
    $
    46,130Short-term investments
    
    
    23,961
    
    
    
    22,971Accounts receivable
    
    
    2,740
    
    
    
    4,816Other current receivables
    
    
    449
    
    
    
    348Prepaids
    
    
    944
    
    
    
    849Total current assets
    
    
    150,892
    
    
    
    75,114Equipment and leasehold improvements, net
    
    
    4,955
    
    
    
    5,107Deferred debt origination costs, net of accumulated amortization of $370 and $
    
    
    4,293
    
    
    
    Intangible and other assets, net of accumulated amortization of $553 and $474
    
    
    472
    
    
    
    551Total assets
    
    $
    160,612
    
    
    $
    80,772LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    2,801
    
    
    $
    2,897Accrued expenses
    
    
    16,671
    
    
    
    12,300Deferred revenue
    
    
    1,288
    
    
    
    561Total current liabilities
    
    
    20,760
    
    
    
    15,758Deferred revenue
    
    
    1,608
    
    
    
    1,119Long-term debt
    
    
    130,000
    
    
    
    1,730Minority interest
    
    
    
    
    
    
    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 September 30, 2005
150,000,000 shares authorized; 58,604,819 shares issued, 58,391,819 shares
outstanding. At December 31, 2004, 75,000,000 shares authorized;
58,131,254 shares issued, 57,918,254 shares outstanding
    
    
    293
    
    
    
    291Additional paid-in capital
    
    
    303,588
    
    
    
    300,906Deferred compensation expense
    
    
    (411
    )
    
    
    (129
    )Treasury stock, 213,000 shares
    
    
    (1,602
    )
    
    
    (1,602
    )Accumulated other comprehensive income
    
    
    
    
    
    
    189Accumulated deficit
    
    
    (293,624
    )
    
    
    (238,118
    )Total stockholders equity
    
    
    8,244
    
    
    
    61,537Total liabilities and stockholders equity
    
    $
    160,612
    
    
    $
    80,772
  1




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ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
 ($ in thousands, except share and per share data)
(Unaudited)
 Three
Months EndedSeptember 30,
    
    

Nine
Months EndedSeptember 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Revenues:Research agreements
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    1,521Royalty income, net
    
    
    2,643
    
    
    
    2,307
    
    
    
    7,643
    
    
    
    6,059License fees, milestones and grants
    
    
    322
    
    
    
    141
    
    
    
    784
    
    
    
    421Total revenues
    
    
    2,965
    
    
    
    2,448
    
    
    
    8,427
    
    
    
    8,001Expenses:Research and development
    
    
    16,248
    
    
    
    16,540
    
    
    
    49,929
    
    
    
    40,682General and administrative
    
    
    5,922
    
    
    
    2,573
    
    
    
    16,501
    
    
    
    7,723Total expenses
    
    
    22,170
    
    
    
    19,113
    
    
    
    66,430
    
    
    
    48,405Operating loss
    
    
    (19,205
    )
    
    
    (16,665
    )
    
    
    (58,003
    )
    
    
    (40,404
    )Investment income, net
    
    
    1,351
    
    
    
    320
    
    
    
    3,284
    
    
    
    1,041Interest expense
    
    
    (975
    )
    
    
    (1
    )
    
    
    (2,122
    )
    
    
    (42
    )Loss from continuing operations
    
    
    (18,829
    )
    
    
    (16,346
    )
    
    
    (56,841
    )
    
    
    (39,405
    )Gain (loss) on discontinued operations
    
    
    
    
    
    
    (233
    )
    
    
    1,335
    
    
    
    (601
    )Net loss
    
    
    (18,829
    )
    
    
    (16,579
    )
    
    
    (55,506
    )
    
    
    (40,006
    )Other comprehensive income:Foreign currency translation:Unrealized (loss) gain
    
    
    
    
    
    
    (182
    )
    
    
    
    
    
    
    82Less: reclassification
adjustment for gains
included in net loss
    
    
    
    
    
    
    
    
    
    
    (189
    )
    
    
    Comprehensive loss
    
    $
    (18,829
    )
    
    $
    (16,761
    )
    
    $
    (55,695
    )
    
    $
    (39,924
    )Net loss per common share-basic and diluted
    
    $
    (0.32
    )
    
    $
    (0.31
    )
    
    $
    (0.96
    )
    
    $
    (0.76
    )Weighted average common shares used to compute
basic and diluted net loss per share
    
    
    58,077,323
    
    
    
    53,606,539
    
    
    
    57,877,713
    
    
    
    52,781,749
  2




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ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 ($ in thousands)
(Unaudited)
 Nine Months Ended September 30,2005
    
    
    2004Cash flows from operating activities:Net loss from continuing operations
    
    $
    (56,841
    )
    
    $
    (39,405
    )Adjustments to reconcile net loss from continuing operations to net cash
used in operating activities:Depreciation and amortization
    
    
    813
    
    
    
    546Expenses paid with stock
    
    
    666
    
    
    
    586Stock-based compensation expense
    
    
    179
    
    
    
    216Loss on disposition of fixed assets
    
    
    14
    
    
    
    3Amortization of debt issue costs
    
    
    370
    
    
    
    Amortization of discount/premium on investments
    
    
    (15
    )
    
    
    89Change in interest receivable included in short-term investments
    
    
    (235
    )
    
    
    131Change in operating assets and liabilities:Accounts receivable
    
    
    2,076
    
    
    
    (528
    )Prepaids
    
    
    (108
    )
    
    
    (568
    )Other current receivables
    
    
    (265
    )
    
    
    460Accounts payable and accrued expenses
    
    
    4,962
    
    
    
    5,438Deferred revenue
    
    
    1,216
    
    
    
    (421
    )Net cash used in continuing operations
    
    
    (47,168
    )
    
    
    (33,453
    )Net cash used in discontinued operations
    
    
    (603
    )
    
    
    (1,006
    )Net cash used in operating activities
    
    
    (47,771
    )
    
    
    (34,459
    )Cash flows from investing activities:Purchases of equipment and leasehold improvements
    
    
    (1,663
    )
    
    
    (567
    )Purchases of investments
    
    
    (83,187
    )
    
    
    (43,860
    )Maturity of investments
    
    
    82,447
    
    
    
    29,898Investing activities of discontinued operations
    
    
    
    
    
    
    (15
    )Net cash used in investing activities
    
    
    (2,403
    )
    
    
    (14,544
    )Cash flows from financing activities:Proceeds from sale of common stock and option exercises
    
    
    1,557
    
    
    
    38,958Debt issue costs
    
    
    (4,663
    )
    
    
    Borrowing (repayment) of long-term debt
    
    
    130,000
    
    
    
    (6,000
    )Net cash provided by financing activities
    
    
    126,894
    
    
    
    32,958Effect of exchange rate changes on cash
    
    
    (52
    )
    
    
    (12
    )Net increase (decrease) in cash and cash equivalents
    
    
    76,668
    
    
    
    (16,057
    )Cash and cash equivalents at beginning of period
    
    
    46,130
    
    
    
    65,302Cash and cash equivalents at end of period
    
    $
    122,798
    
    
    $
    49,245Supplemental disclosure of cash flow information:Cash paid during the period for interest
    
    $
    1,624
    
    
    $
    39Non-cash transactions during the period:Issuance of Common Stock for expenses
    
    $
    666
    
    
    $
    586Stock-based compensation expense
    
    $
    179
    
    
    $
    216
  3




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ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 September 30, 2005 (unaudited)
 (1)
    
    Basis of Presentation
  (2)
    
    Organization and Significant Accounting Policies
 (a)
    
    Organization
   (b)
    
    Basis of Consolidation
  4




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(c)
    
    Stock-Based Compensation
 Accounting for Stock
Issued to Employees
 Share-Based Payment Accounting for Stock-Based Compensation
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Net loss, as reported
    
    $
    (18,829
    )
    
    $
    (16,579
    )
    
    $
    (55,506
    )
    
    $
    (40,006
    )Add: Stock-based employee
compensation expense
Included in reported
net loss
    
    
    5
    
    
    
    56
    
    
    
    43
    
    
    
    216Deduct: Total stock-based
Employee compensation
expense determined
under fair value method
for all awards
    
    
    (1,241
    )
    
    
    (1,037
    )
    
    
    (3,657
    )
    
    
    (2,625
    )Pro forma net loss
    
    $
    (20,065
    )
    
    $
    (17,560
    )
    
    $
    (59,120
    )
    
    $
    (42,415
    )Loss per share:As reported, basic and
diluted
    
    $
    (0.32
    )
    
    $
    (0.31
    )
    
    $
    (0.96
    )
    
    $
    (0.76
    )Pro forma, basic and diluted
    
    $
    (0.35
    )
    
    $
    (0.33
    )
    
    $
    (1.02
    )
    
    $
    (0.80
    )
  5




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Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2005
    
    2004
    
    2005
    
    2004Expected dividend yield
    
    
    0.0%
    
    
    
    0.0%
    
    
    
    0.0%
    
    
    
    0.0%Risk-free interest rate
    
    
    4.0%
    
    
    
    3.1%
    
    
    
    4.1%
    
    
    
    2.9%Expected volatility
    
    
    55.2%
    
    
    
    69.6%
    
    
    
    67.2%
    
    
    
    73.6%Expected life in years
    
    
    4.52
    
    
    
    4.47
    
    
    
    4.91
    
    
    
    4.82
 (d) Debt
Issue Costs
  (e) Use of Estimates
  (f) Reclassifications
  (3)
    
    Capital Stock
  Stock option plans
    
    
    8,849,8322.50% Convertible Senior Notes due 2012
    
    
    9,322,001Total shares reserved
    
    
    18,171,833
 (4)
    
    Cash, Cash Equivalents, and Short-Term Investments
  6




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September 30, 2005Gross
    
    
    GrossShort-term investments
    
    Amortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedHeld-to-maturity
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueCorporate commercial paper
and loan participations
    
    $
    21,945
    
    
    $
    
    
    
    $
    (9
    )
    
    $
    21,936US Government agency
securities
    
    
    2,016
    
    
    
    
    
    
    
    (20
    )
    
    
    1,996Total short-term
held-to-maturity investments
    
    $
    23,961
    
    
    $
    
    
    
    $
    (29
    )
    
    $
    23,932
 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
  (6)
    
    Income Taxes
  7




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(7)
    
    Entity-Wide Geographic Data
   Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Entities:GSK
    
    $
    2,643
    
    
    $
    2,307
    
    
    $
    7,643
    
    
    $
    6,059Schering-Plough
    
    
    322
    
    
    
    141
    
    
    
    784
    
    
    
    1,942Total
    
    $
    2,965
    
    
    $
    2,448
    
    
    $
    8,427
    
    
    $
    8,001
 (8)
    
    Foreign Subsidiary
   (9)
    
    Long-Term Debt
   8




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(10)
    
    Commitments and Contingencies
 (a)
    
    Foreign Currency Exchange Risk
  (b)
    
    Other contingencies
  9




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Item 2.
 ENCYSIVE PHARMACEUTICALS INC. AND SUBSIDIARIES
 MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 Three and Nine Months Ended September 30, 2005, and September 30, 2004
 OVERVIEW
      10




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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.
  Stock Options
 Accounting for Stock Issued to
Employees Accounting for Stock-Based Compensation
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Share-Based Payment
 Drug Manufacturing and Packaging
  Costs Related to Issue of Long-Term Debt
  13




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Results of Operations
  Three and nine month periods ended September 30, 2005 and 2004
 Revenues
   Research and Development Expense
   14




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General and Administrative Expense
    Total Operating Expenses
   15




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Operating Loss
   Interest Expense
  Investment Income
  Gain (loss) on discontinued operations
  Liquidity and Capital Resources
    16




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Material Commitments
   Less than
    
    
    1-3
    
    
    3-5
    
    
    After 5Contractual Obligations
    
    Total
    
    
    1 year
    
    
    years
    
    
    years
    
    
    yearsLong-term debt
    
    $
    130,000
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    130,000Operating leases
    
    
    4,002
    
    
    
    1,715
    
    
    
    1,828
    
    
    
    459
    
    
    
    Purchase
obligations
    
    
    246
    
    
    
    246
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    134,248
    
    
    $
    1,961
    
    
    $
    1,828
    
    
    $
    459
    
    
    $
    130,000
 Outlook for 2005
 Royalties
    
    $
    10.6 to $11.4 millionRevenues (including royalties)
    
    $
    11.2 to $12.5 millionExpenses
    
    $
    89.0 to $95.0 millionNet loss
    
    $(75) to $(84) millionCash and investments at year-end
    
    $
    110 to $115 million
   17




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Longer-Term Outlook
  
    
    We have begun to incur significant commercialization expenses for Thelin. These costs
include:
 
    
    market research;
    
    hiring a general counsel, vice president of sales and
other key staff personnel;
    
    hiring a qualified marketing and field sales force in the U.S., Canada and Europe;
    
    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 payers; 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:
 18




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
    
    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.
  
    
    expenses and risks associated with clinical trials to expand the indications for Thelin;
    
    continued scientific progress in our drug discovery programs;
    
    the magnitude of these programs;
    
    progress with preclinical testing and clinical trials;
    
    the time and costs involved in obtaining regulatory approvals;
    
    the costs involved in filing, prosecuting and enforcing patent claims;
    
    competing technological and market developments and changes in our existing research
relationships;
    
    our ability to maintain and establish additional collaborative arrangements; and
    
    effective commercialization activities and arrangements.
  Off-Balance Sheet Arrangements
  19




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Impact of Inflation and Changing Prices
  Cautionary Note Regarding Forward-Looking Statements
  
    
    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.
   20




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Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Foreign Currency Exchange Risk
  
 Item 4. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures
    Changes in Internal Controls Over Financial Reporting
  
 PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  21




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##### Table of Contents



Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  
 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.
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##### Table of Contents



ENCYSIVE PHARMACEUTICALS INC.
 November 8, 2005
 
 SIGNATURES
  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 Administration
Secretary and Treasurer(Acting Principal Financial and Accounting Officer)
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##### Table of Contents



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.
 24