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ENZN > SEC Filings for ENZN > Form 10-K on 18-Mar-2013All Recent SEC Filings

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Form 10-K for ENZON PHARMACEUTICALS INC


18-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read together with our consolidated financial statements and notes to those statements included elsewhere in this Annual Report on Form 10-K.

Forward-Looking Information and Factors That May Affect Future Results

The following discussion contains forward-looking statements within the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. All statements contained in the following discussion, other than statements that are purely historical, are forward-looking statements. Forward-looking statements can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "will," "should," "potential," "anticipates," "plans," or "intends" or the negative thereof, or other variations thereof, or comparable terminology, or by discussions of strategy. Forward-looking statements are based upon management's present expectations, objectives, anticipations, plans, hopes, beliefs, intentions or strategies regarding the future and are subject to known and unknown risks and uncertainties that could cause actual results, events or developments to be materially different from those indicated in such forward-looking statements, including the risks and uncertainties set forth in Item 1A. Risk Factors. These risks and uncertainties should be considered carefully and readers are cautioned not to place undue reliance on such forward-looking statements. As such, no assurance can be given that the future results covered by the forward-looking statements will be achieved.

The percentage changes throughout the following discussion are based on amounts stated in thousands of dollars and not the rounded millions of dollars reflected in this section.

Overview

We are a biotechnology company that had been dedicated to the research and development of innovative therapeutics for patients with high unmet medical needs. We receive royalty revenues from licensing arrangements with other companies related to sales of products developed using our proprietary Customized PEGylation Linker Technology (Customized Linker Technology®). We receive royalties on seven marketed products that utilize our proprietary PEGylation platform, namely PegIntron®, Sylatron®, Macugen®, CIMZIA®, OMONTYS®, Oncaspar and Adagen. The primary source of our royalty revenue is PegIntron, which is marketed by Merck.

In December 2012, we announced that our Board of Directors retained Lazard Frères & Co. LLC ("Lazard") to act as financial advisor in a review of the possible sale or disposition of one or more corporate assets or a sale of our company and that our Board of Directors established a special committee to oversee our sale review process. In connection with our sale review process, we have substantially suspended all clinical development activities with a goal of conserving capital and maximizing value returned to our stockholders. Our sale review process entails numerous significant risks and uncertainties, including the risks and uncertainties set forth in Item 1A. Risk Factors of this Annual Report on Form 10-K. There can be no assurance that our sale review process will result in any transaction.

Prior to the substantial suspension of our clinical development activities, we
(i) maintained drug development programs utilizing two platforms - Customized PEGylation Linker Technology (Customized Linker Technology®) and third-generation messenger ribonucleic acid (mRNA) antagonists utilizing the Locked Nucleic Acid (LNA) technology, (ii) had three compounds in human clinical development, a PEGylated version of the active metabolite of the cancer drug irinotecan, PEG-SN38, and mRNA antagonists targeting Hypoxia-Inducible Factor-1? (HIF-1?) and the Androgen Receptor (AR), and (iii) had novel mRNA antagonist targets in various stages of preclinical research.

Prior to January 29, 2010, we were a biopharmaceutical company involved in the development, manufacture, and commercialization of medicines for patients with cancer and other life-threatening conditions and had operated in three business segments comprised of a products segment, royalties segment, and a contract manufacturing segment. On January 29, 2010, we consummated the sale of our former specialty pharmaceutical business comprised principally of our former products and the contract manufacturing segments. For financial reporting purposes, beginning in 2010, the operations and cash flows of our former products and contract manufacturing segments were eliminated from our continuing operations and classified as discontinued operations.

The sale of our former specialty pharmaceutical business also involved the sale of certain in-process research and development associated with the divested products, which resulted in the potential receipt of certain contingent milestone payments, the potential receipt of certain royalties, and our provision of various transitional services to the purchaser.

Results of Continuing Operations (in millions of dollars):

                                                           Year Ended December 31,
                                                     2012             2011           2010
Revenues:
Royalties                                         $      41.5      $     40.9     $     44.9
Sale of in-process research and development                 -             5.0           40.9
Contract research and development                          .1             1.5            9.3
Miscellaneous income                                      1.0             0.7            2.8
Total revenues                                           42.6            48.1           97.9
Operating expenses:
Research and development - pipeline                      20.9            40.2           49.9
Research and development - specialty and
contracted services                                        .1             1.0            7.2
General and administrative                               14.5            17.3           25.4
General and administrative - contracted
services                                                    -             0.1            2.0
Impairment of property and equipment                     11.3               -              -
Restructuring charges                                     (.2 )           6.0           14.0
Operating loss                                           (4.0 )         (16.5 )         (0.6 )
Other expense, net                                       (2.9 )          (4.1 )         (2.5 )
Income tax (expense) benefit                              4.1            (0.2 )          0.3
Loss from continuing operations                   $      (2.8 )    $    (20.8 )   $     (2.8 )

Overview

The sale of our former specialty pharmaceutical business in January 2010 had numerous effects on our financial results and makes year-to-year comparisons and inferences regarding future trends difficult. Even after reclassifying the majority of revenues and expenses of the divested business as discontinued operations, several large and unique items remain that are reported as part of continuing operations but that are not expected to be recurring events:

· The sale of in-process research and development for $40.9 million in 2010 and the related $5.0 million milestone payment received in 2011 were part of the total sale of our former specialty pharmaceutical business but are reported as part of continuing operations because we had operated as a research and development organization.

· Revenues from a transition services agreement entered into with the purchaser of our former specialty pharmaceutical business totaling $11.8 million in 2010
(contract research and development and the majority of miscellaneous income) diminished significantly in 2011 and 2012.

· Operating expenses for research and development contracted services in 2010 largely represented the expenses incurred ($5.5 million) in support of the transition services revenues mentioned above and also diminished significantly in 2011 and 2012 to approximately $1.0 million and $0.1 million, respectively. Also in this caption are the expenses incurred by us prior to the sale of our former specialty pharmaceutical business in support of the products we owned at that time ($1.7 million in 2010).

In 2012, there was a reduction in our restructuring charge of $0.2 million. After taking the aforementioned items and the restructuring charges of $6.0 million and $14.0 million in 2011 and 2010, respectively, into account, visibility of the underlying trends we have experienced in royalty revenues, research and development spending and general and administrative expenses is enhanced. These and other elements of our statements of operations are discussed more fully in the below sections.

Royalty Revenues (in millions of dollars):



                                Year Ended December 31,
                                %                      %
                   2012      Change       2011      Change       2010

Royalty revenue   $ 41.5           1     $ 40.9          (9 )   $ 44.9

The majority of royalty revenue relates to sales of PegIntron, a PEG-enhanced version of the alpha-interferon product, INTRON A, marketed by Merck, for the treatment of chronic hepatitis C. The following table summarizes our PegIntron royalties earned:

PegIntron royalties from (in millions of dollars):

                                        Year Ended December 31,
                                       %                       %
                          2012       Change       2011       Change       2010

U.S. sales               $  7.1           34     $  5.3            8     $  4.9
Foreign sales - Europe   $ 10.9           (2 )   $ 11.1          (14 )   $ 12.9
Foreign sales - Japan    $  8.4          (24 )   $ 11.0           (9 )   $ 12.1
Foreign sales - Other    $ 12.1            9     $ 11.1          (10 )   $ 12.4
 Total                   $ 38.5                  $ 38.5                  $ 42.3

Other royalty revenues and certain licensing revenues relate to the application of our technology to third-party products including those under a cross-license agreement with Nektar Therapeutics, Inc. (Nektar) under which we receive a share of the royalties and licensing income received by Nektar. There are currently three third-party products for which Nektar has granted sublicenses to our PEGylation technology and for which we are participating in royalty and licensing income revenues: UCB's CIMZIA for the treatment of Crohn's disease and rheumatoid arthritis in the European Union, OSI and Pfizer's Macugen for the treatment of neovascular (wet) age-related macular degeneration, and Takeda and Affymax's OMONTYS for the treatment of anemia due to chronic kidney disease (CKD) in adult patients on dialysis. We are also entitled to royalties from the purchaser of our former specialty pharmaceutical business of 5 to 10 percent on incremental net sales above a 2009 baseline amount through 2014 from the four marketed products we sold to them.

Royalty revenue increased approximately 1 percent in 2012 compared to 2011. This was driven almost entirely by a 65% increase in royalties on CIMZIA compared to 2011. Royalties on PegIntron in 2012 were flat versus 2011. MACUGEN royalties in 2012 declined 28.7% compared to 2011. Royalty revenue for OMONTYS in the amount of $0.3 million was recorded for the first time in 2012. On February 23, 2013, Affymax and Takeda announced a nationwide-voluntary recall of all lots of OMONTYS (peginesatide) injection as a result of new postmarketing reports regarding serious hypersensitivity reactions, including anaphylaxis, which can be life-threatening or fatal. This recall will negatively affect our future royalty revenues from OMONTYS.

Royalty revenue declined approximately 9 percent in 2011 compared to 2010. This was driven almost entirely by lower sales of PegIntron, which also declined approximately 9 percent during the same period. Royalties on net sales of CIMZIA and Macugen were relatively flat for 2011 versus 2010, while royalties on the on net sales of the four divested marketed products declined by approximately 17% year-over-year.

Our future revenues are heavily weighted towards royalties and revenues to be received from the use of our technology and are dependent upon numerous factors outside of our control. We derive almost all of our royalties from

sales of PegIntron, which have been in decline since 2008. Merck's obligation to pay us royalties on sales of PegIntron terminates, on a country-by-country basis, upon the later of the date on which the last patent to contain a claim covering PegIntron expires in the country or 15 years after the date on which PegIntron is first approved for commercial marketing in such country. Currently, expirations of our right to receive royalties are expected to occur in 2016 in the U.S., 2018 in Europe and 2019 in Japan.

Other factors potentially affecting our royalty revenues include new or increased competition from products that may compete with the products for which we receive royalties, the effectiveness of marketing by our licensees, and new uses and geographies for PegIntron, CIMZIA, Macugen, and OMONTYS. Our rights to receive royalties on CIMZIA, Macugen, and OMONTYS will terminate in 2014. After the expiration of the patents and royalties, we are entitled to immunity fees on a country-by-country and product-by-product basis for up to twelve years from the date of first sale of these drugs.

Sale of In-Process Research and Development

When we sold our former specialty pharmaceutical business, we had retained our research and development organization. We had been engaged in studies oriented towards the next-generation formulations of Oncaspar and Adagen, two products that were among those sold as part of our former specialty pharmaceutical business. No revenue was recognized in 2012. The in-process research and development related to Oncaspar and Adagen was sold to the purchaser of our former specialty pharmaceutical business and, in connection with the sale, $40.9 million was recognized as revenue in the first quarter of 2010. During the first quarter of 2011, we earned and recognized an additional $5.0 million milestone payment related to divested in-process research and development. The selling price of the in-process research and development represented management's best estimate of its standalone fair value based on the stage of development and future milestone payment consideration. All necessary technology and know-how were transferred to the purchaser at the time of the sale and the purchaser could resell the in-process research and development asset. At the time of the sale, the activities necessary to complete the work on the Oncaspar and Adagen next-generation formulations could have been performed by the purchaser or others.

Contract Research and Development Revenue

Pursuant to a transition services agreement entered into at the time of the sale of our former specialty pharmaceutical business, we began performing product-support research and development, consulting and technology transfer functions for the purchaser effective with the close of the sale transaction on January 29, 2010. The transition services associated with product-support research and development are being reported in continuing operations due to our ongoing involvement in the research and development related to the divested products. We are being compensated for this work at actual cost plus a mark-up per the terms of the transition services agreement. Revenue was generated from these services in the amount of $0.1 million, $1.5 million, and $9.3 million for the years ended December 31, 2012, 2011, and 2010, respectively. Our contractual obligation is to assist with these transition services for a period of up to three years subsequent to the date of the sale, although the level of such activity declined significantly during 2011 and 2012. The transition services agreement was terminated by the purchaser on September 30, 2012.

Miscellaneous Income

Miscellaneous income includes rental receipts totaling approximately $0.6 million and $0.6 million in 2012 and 2011, respectively, in connection with the sublease of unused manufacturing and excess office facilities for which we have ongoing lease commitments. The underlying rental expense is reflected in general and administrative expense. In addition, during the second quarter of 2012, we received a non-refundable, non-creditable upfront payment of $0.2 million related to the licensing of PEG-SN38 as part of the Collaboration Agreement with Hisun. Also, as part of the transition services agreement referred to above, we were compensated for various general and administrative services provided to the purchaser of our former specialty pharmaceutical business. The compensation for this work includes reimbursement of costs incurred plus a mark-up defined in the agreement. Approximately $0.1 million and $0.1 million have been earned for the services in each of the years ended December 31, 2012 and 2011, respectively. The expenses

incurred in relation to these services are reported as general and administrative - contracted services. Our involvement in the transitioning of general and administrative activities was essentially concluded during 2011.

Research and Development Expenses - Pipeline (in millions of dollars):



                                                   Year Ended December 31,
                                                  %                       %
                                     2012       Change       2011       Change       2010

Research and development expenses   $ 20.9          (48 )   $ 40.2          (19 )   $ 49.9

The following table summarizes our major pipeline research and development projects, the costs incurred for the years ended December 31, 2012, 2011 and 2010 and the latest phases of development (millions of dollars):

                                   For the Years Ended
                                       December 31,
Category                        2012       2011       2010      Latest Phase of Development
PEG-SN38                       $  4.4     $ 15.0     $ 18.7     Phase I and Phase II
HIF - 1a antagonist               0.6        2.6        3.4     Phase I
Survivin antagonist               0.3        1.0        1.7     Phase I, Returned to Santaris
Androgen Receptor antagonist      4.8        4.8       11.4     Phase I
Depreciation (1)                  3.1        3.4          -
Additional LNA targets            0.2        0.9       12.1     Pre-clinical
PEGylation technology (2)         1.9          -        2.3     Pre-clinical
Other R&D costs - pipeline        5.6       12.5        0.3
Total R&D - pipeline           $ 20.9     $ 40.2     $ 49.9

(1) In 2010, depreciation was allocated by project , but thereafter it was not.

(2) In 2012 and 2010, expenses for PEGylation technology were allocated separately, while 2011 they were included in other R&D costs.

Research and development expenses consist primarily of contractor fees principally related to clinical projects; costs related to research and development collaborations or licenses; drug supplies for preclinical and clinical activities; salaries, stock-based compensation and benefits; other research supplies and facilities charges. Program costs are those research and development costs which are directly related to specific programs that are tracked and managed at the individual program level. Other research and development costs are those costs incurred related to the Company's on-going research and development activities, such as some personnel and facilities-related expenses, which are not allocated to specific programs given their general nature.

For the year ended December 31, 2012, research and development expenses decreased 48 percent to $20.9 million. We invested in the following programs during 2012:

· PEG-SN38 - Spending on PEG-SN38 decreased in 2012 as clinical activity decreased. Spending on PEG-SN38 increased in 2011 as clinical activity increased in the Phase II metastatic colorectal cancer study, the Phase II metastatic breast cancer study, and the Phase I pediatric study. Enrollment stopped in 2012 in the Phase I pediatric study, and stopped in the two Phase II studies in 2011.

Additionally, a Phase I study of PEG-SN38 and bevacizumab at the National Cancer Institute, Bethesda, MD, in patients who failed multiple prior chemotherapy regimens continued to enroll patients in 2012 under an IND held by the National Cancer Institute.

· HIF-1? antagonist - Spending on the HIF-1? antagonist program decreased in 2012 versus 2011. Spending for 2012 was substantially lower than 2011 due to having completed enrollment in the two Phase I studies. A pilot study in patients with cancer in the liver remains open at the National Cancer Institute under an IND held by the National Cancer Institute.

· Survivin antagonist - Spending on the Survivin mRNA antagonist program decreased in 2012 versus 2011due to having completed enrollment in the Phase I study. In late 2012, Enzon returned this project to Santaris.

· Androgen Receptor (AR) antagonist - Spending on the AR mRNA antagonist program remained stable in 2012 versus 2011 as the Phase I study in patients with castrate resistant prostate cancer continued to accrue patients. In December 2012, Enzon decided to suspend clinical development of this program.

· Additional LNA targets - Under our agreement with Santaris, we have the right to develop and commercialize RNA antagonists directed against additional novel oncology gene targets selected by us which were HER3 and ß-catenin. This agreement provides that any one of the compounds licensed by us could be returned to Santaris if the findings of our preclinical or clinical work do not support our continued investment we returned three of the targets to Santaris during 2011 and one target to Santaris during 2012. In 2010, we incurred milestone payments totaling $5.0 million for the commencement of preclinical studies for three of our targets (in addition to the $2.0 million milestone payment for the AR antagonist IND referred to above). In 2012 and 2011, there were no milestone payments made to Santaris on our remaining targets.

Research and Development Expenses - Specialty and Contracted Services

Expenses associated with generating contract research and development revenue amounted to $0.1 million and $1.0 million in 2012 and 2011, respectively. Also included in the 2010 line caption are the $1.6 million of costs for the period from January 1 through January 29, 2010 incurred in our research and development activities related to the marketed products we previously owned. This work was directed largely towards development of new formulations of Oncaspar and Adagen.

General and Administrative Expenses (in millions of dollars):



                                                     Year Ended December 31,
                                                    %                       %
                                       2012       Change       2011       Change       2010

General and administrative expenses   $ 14.5          (17 )   $ 17.3          (32 )   $ 25.4

General and administrative expenses consist primarily of salaries and benefits for support functions; outside professional services for accounting, audit, tax, legal, and financing activities; depreciation; patent filing fees and facilities costs.

For the year ended December 31, 2012, general and administrative expenses were $14.5 million, down 17 percent from the prior year. The decline in 2012 from 2011 was largely the result of a continued restructuring program. Others factors included a reduction in force and lower contractor services, insurance, rent, stock compensation expense, depreciation, and auditing/accounting fees. In addition, during the second quarter of 2012, we recognized $0.8 million for severance payments and benefits related to the departure of our former Principal Executive Officer, Chief Operating Officer, Executive Vice President and Chief Financial Officer that were payable under the terms of her Severance and Release Agreement.

For the year ended December 31, 2011, general and administrative expenses were $17.3 million, down 32 percent from the prior year. The decline from the preceding year was largely the result of a restructuring program implemented in the fourth quarter of 2010, which reduced the number of employees and therefore the associated payroll costs, as well as the effects of our on-going cost containment efforts, including consolidation of facilities into the Piscataway, New Jersey location from our former Bridgewater, New Jersey headquarters facility.

General and Administrative Expenses - Contracted Services

As part of the transition services agreement with the purchaser of our former specialty pharmaceutical business, we provided certain general, administrative, financial, legal, human resource and information technology services for a period of up to one year. We were compensated for these services based upon costs incurred plus a mark-up defined in the transition services agreement. During the years ended December 31, 2012, 2011, and 2010 expenses associated with generating this revenue were approximately $0.0 million, $0.1 million, and $2.0 million, respectively. This administrative support activity effectively concluded during 2011.

Impairment of Property and Equipment

We continually evaluate property and equipment, including leasehold improvements, to determine whether events or changes in circumstances have occurred that may warrant revision of the estimated useful life or whether the remaining balance should be evaluated for possible impairment. We use an estimate of the related undiscounted cash flows over the remaining life of the property and equipment in assessing whether an asset has been impaired. We measure impairment losses based upon the amount by which the carrying amount of the asset exceeds the fair value. See Note 2 of the Notes to Consolidated Financial Statements for information about our fair value of property and equipment. For the year ended December 31, 2012, we recorded $11.3 million of non-cash impairment charges related to our property and equipment to reduce the carrying value of these assets to fair market value. These charges mostly relate to leasehold improvements representing the Company's process development laboratory and related equipment and were considered necessary in view of the Company's announcement of plans to suspend all clinical development activities.

Restructuring

In December 2012, we made an announcement that contemplated a reduction in our workforce of approximately 15-20 employees. We expect that we will incur approximately $1.4 million in charges in 2013 related to this reduction in force, all of which would result in cash expenditures for one-time employee termination benefits and associated costs. These changes are not reflected in our consolidated financial statements for the fiscal year ended December 31,2012, included in this Annual Report on Form 10-K .

As a result of our transition from a fully integrated biopharmaceutical company with research, manufacturing and marketing operations to a biotechnology company dedicated to oncology research and development, we undertook reductions in our workforce during 2011, 2010 and 2009. In connection with our decision to exit our former headquarters facility in Bridgewater, New Jersey, we also incurred lease-related charges and wrote-off certain furnishings and leasehold improvements in 2011 and 2010.

We incurred the following costs in connection with our restructuring programs during the years ended December 31, 2012, 2011 and 2010 (in thousands of dollars):

                                    Year Ended December 31,
                                 2012        2011         2010
Employee separation benefits:
. . .
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