UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(MARK ONE)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended July 31, 2006
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to ___________________
Commission File Number 001-09974
ENZO BIOCHEM, INC.
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(Exact name of registrant as specified in its charter)
New York 13-2866202
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
527 Madison Avenue
New York, New York 10022
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(Address of principal executive offices) (Zip Code)
(212) 583-0100
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(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
(TITLE OF EACH CLASS) (NAME OF EACH EXCHANGE ON WHICH REGISTERED)
--------------------- -------------------------------------------
Common Stock, $.01 par value The New York Stock Exchange
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes |_| No |X|
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
Yes |_| No |X|
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 |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes |_| No |X|
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer |_| Accelerated filer |X| Non-accelerated filer |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Securities Exchange Act of 1934).
Yes |_| No |X|
The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant was approximately $355,971,000 as of January
31, 2006.
The number of shares of the Company's common stock, $.01 par value, outstanding
at September 30, 2006 was approximately 32,274,500.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement to be delivered to
shareholders in connection with the Annual Meeting of Shareholders to be held on
or about January 22, 2007 are incorporated by reference into Part III of this
annual report.
TABLE OF CONTENTS
PART I DESCRIPTION PAGE
Item 1. Business 2
Item 1A. Risk Factors 24
Item 1B. Unresolved Staff Comments 32
Item 2. Properties 32
Item 3. Legal Proceedings 33
Item 4. Submission of Matters to a Vote of Security Holders 34
PART II
Item 5. Market for Registrant's Common Stock, Related Stockholder Matters and Issuer 34
Purchases of Equity Securities
Item 6. Selected Financial Data 35
Item 7. Management's Discussion and Analysis of Financial Condition and Results of 36
Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 46
Item 8. Financial Statements and Supplementary Data 46
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial 46
Disclosure
Item 9A. Controls and Procedures 47
Item 9B. Other Information 49
PART III
Item 10. Directors and Executive Officers 49
Item 11. Executive Compensation 49
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related 49
Stockholders' Matters
Item 13. Certain Relationships and Related Transactions 49
Item 14. Principal Accountant Fees and Services 49
PART IV
Item 15. Exhibits and Financial Statement Schedules 49
Financial Statements Index F-1
Report of Independent Registered Public Accounting Firm F-2
Consolidated Financial Statements and Related Notes F-3
Schedule II - Valuation Accounts and Qualifying Accounts S-1
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PART I
Item 1. BUSINESS
OVERVIEW
Enzo Biochem, Inc. (the "Company" or "Enzo") is a life sciences and
biotechnology company focused on harnessing genetic processes to develop
research tools, diagnostics and therapeutics and a provider of diagnostic
services to the medical community. Since its founding in 1976, Enzo's strategic
focus has been on the development, for commercial purposes, of enabling
technologies in the life sciences field. Enzo's pioneering work in genomic
analysis coupled with its extensive patent estate and enabling platforms have
strategically positioned Enzo to play an important role in the rapidly growing
life sciences and molecular medicine marketplaces.
In the course of the Company's research and development activities,
Enzo has built a substantial portfolio of intellectual property assets, with 211
issued patents worldwide, and more than 185 pending patent applications, along
with extensive enabling technologies and platforms.
Enzo is comprised of three interconnected operating companies that have
evolved out of Enzo's core competence: the use of nucleic acids as informational
molecules and the use of compounds for immune modulation. These wholly owned
operating companies conduct their operations through three segments (see Note
13 in the notes to consolidated financial statements).
Below are brief descriptions of each of the three operating segments:
ENZO LIFE SCIENCES is a company that manufacturers, develops and
markets biomedical research products and tools to research and pharmaceutical
customers around the world and has amassed a large patent and technology
portfolio. The pioneering platforms developed by Enzo Life Sciences enable the
development of a wide range of products in the research products marketplace.
ENZO THERAPEUTICS is a biopharmaceutical company that has developed
multiple novel approaches in the areas of gastrointestinal, infectious,
ophthalmic and metabolic diseases, many of which are derived from the pioneering
work of Enzo Life Sciences. The Company has focused its efforts on developing
treatment regimens for diseases and conditions in which current treatment
options are ineffective, costly, and/or cause unwanted side effects. This focus
has generated a clinical and preclinical pipeline, as well as more than 40
patents and patent applications.
ENZO CLINICAL LABS is a regional clinical laboratory to the greater New
York and New Jersey medical community. The Company believes having this
capability allows us to capitalize firsthand on our extensive advanced molecular
and cytogenetic capabilities and the broader trends in predictive diagnostics.
We offer a menu of routine and esoteric clinical laboratory tests or procedures
used in general patient care by physicians to establish or support a diagnosis,
monitor treatment or medication, or search for an otherwise undiagnosed
condition. We operate a full-service clinical laboratory in Farmingdale, New
York, a network of 19 patient service centers, a stand alone "stat" or rapid
response laboratory in New York City, and a full-service phlebotomy department.
The Company's primary sources of revenue have historically been from
sales and royalties of Life Sciences' products utilized in life science research
and from the clinical laboratory services provided to the healthcare community.
For the fiscal years ended July 31, 2006, 2005 and 2004, respectively,
approximately 20%, 24% and 31% of the Company's operating revenues were derived
from product sales and royalties and approximately 80%, 76% and 69% were derived
from clinical laboratory services.
MARKETS
BACKGROUND
Deoxyribonucleic Acid ("DNA") is the source of biological information
that governs the molecular mechanisms underlying life. This information is
stored in the linear sequences of nucleotides that comprise DNA. The sequence of
the human genome, comprising well over 30,000 genes, has been identified by
genome research, including the Human Genome Project. The challenge for the next
decade will be the determination of the function and relevance of each gene.
This information will facilitate the understanding of biological mechanisms and
how variations and mutations in such mechanisms result in disease, enabling more
rapid and accurate detection of specific diseases and the development of new
therapeutics to treat them.
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TOOLS FOR BIOMEDICAL AND PHARMACEUTICAL RESEARCH
There is an increasing demand by biomedical and pharmaceutical
researchers for diagnostics tools that both facilitate and accelerate the
generation of biological information. This demand can be met by gene-based
diagnostics and a variety of formats, or tools, have been developed that allow
researchers to study biological pathways and to identify mutations in gene
sequences and variations in gene expression levels that can lead to disease.
These tools include DNA sequencing instruments and systems, microarrays,
biochips, microspheres, and microfluidic chips. Common among these formats is
the need for reagents that allow the identification, quantification and
characterization of specific genes or nucleic acid sequences.
We believe this market will grow as a result of:
o research spending by academic, government and private
organizations to determine the function and clinical relevance of
the gene sequences that have been identified by genome research;
o development of commercial applications based on information
derived from this research; and
o ongoing advancements in tools that accelerate these research and
development activities.
CLINICAL DIAGNOSTICS
The clinical diagnostics market has currently been reported by industry
sources to be greater than $20 billion annually. It is comprised of a broad
range of tests such as clinical chemistry, microbiology, immunoassay, blood
banking and cancer screening. Many of these tests employ traditional
technologies, such as immunoassays and cell culture technologies, for the
detection of diseases. Immunoassays are based on the use of antibodies directed
against a specific target, or antigen, to detect that antigen in a patient
sample. Cell culturing techniques involve the growth, isolation and visual
detection of the presence of microorganisms.
There are several drawbacks to these technologies. Immunoassays do not
allow for early detection of diseases because they require minimum levels of
antigens to be produced by the microorganism for detection. These levels vary by
microorganism, and the delay involved could be several days or several months,
as seen in HIV/AIDS. Cell cultures are slow, labor intensive and not amenable to
all microorganisms. For example, gonorrhea and chlamydia are difficult to
culture.
Gene-based diagnostics have many advantages over the traditional
technologies. Since gene-based diagnostics focus on the identification of
diseases at the gene level, they can identify the presence of the disease at its
earliest stage of manifestation in the body. These tests provide results more
rapidly, are applicable to a broad spectrum of microorganisms and can easily be
automated in a multiplex platform.
Several advances in technology are accelerating the adoption of
gene-based diagnostics in clinical laboratories. These advances include high
throughput automated formats that minimize labor costs, non-radioactive probes
and reagents that are safe to handle, and amplification technologies that
improve the sensitivity of such diagnostics.
According to recognized industry sources, the market for molecular
diagnostic tools, assays and other products is now more than $3 billion per year
as a result of:
o rising number of diagnostic tests being developed from discoveries
in genome research;
o advances in formats and other technologies that automate and
accelerate gene-based diagnostic testing;
o growing emphasis by the health care industry on early diagnosis
and treatment of disease; and
o application of gene-based diagnostics as tools to match therapies
to specific patient genetics commonly referred to as
pharmacogenomics.
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THERAPEUTICS
Many diseases result from either the expression of foreign genes, such
as those residing in viruses and pathogenic organisms, or from the abnormal or
unregulated expression of the body's own genes. In other cases, it is the
failure to express a gene that causes the disease. In addition, a number of
diseases result from the body's failure to adequately regulate its immune
system.
Recent advancements in gene analysis have provided the information and
tools necessary to develop drugs that intervene in the disease process at the
genetic level. For a broad spectrum of diseases, this approach can be more
precise and effective than intervening in the downstream molecular processes of
the disease. Therapies targeting genetic processes are called gene medicines.
There are two fundamental approaches to gene medicines, synthetic and genetic.
Synthetic gene medicine involves the administration of synthetic
nucleic acid sequences called "oligos" that are designed to bind to, and thus
deactivate, ribonucleic acid ("RNA") produced by a specific gene. To date, this
approach has demonstrated limited success. Since a single cell may contain
thousands of strands of RNA, large amounts of oligos are necessary to shut down
the production of unwanted proteins. Also, since oligos are synthetic, they are
quickly metabolized or eliminated by the body. As a result, large quantities of
oligos must be delivered in multiple treatments, which can be both toxic to the
body as well as costly.
Genetic medicine or gene therapy involves the insertion of a gene into
a cell. The inserted gene biologically manufactures the therapeutic product
within the cell on an ongoing basis. This gene may be inserted to enable a
beneficial effect or to disable a pathological mechanism within the cell. For
example, the gene may be inserted to replace a missing or malfunctioning gene
responsible for synthesizing an essential protein. On the other hand, the
inserted gene may code for a molecule that would deactivate either an overactive
gene or a gene producing an unwanted protein. As a permanent addition to the
cellular DNA, the inserted gene produces RNA and/or proteins where needed.
A major challenge in designing gene therapy medicines has been to
enable the efficient and safe delivery of the gene to the appropriate target
cell. Gene delivery is often accomplished using a delivery vehicle known as a
vector. A critical quality of the vector is its ability to bind to the target
cell and effectively deliver, or transduce, the gene into the cell. It is also
critical that the nucleic acid of the vector not produce proteins or antigens
that can trigger an adverse immune response.
Other diseases may be the consequence of an inappropriate reaction of
the body's immune system, either to a foreign antigen, such as a bacterium or
virus, or, in the case of an autoimmune condition, to the body's own components.
In recent years, several new strategies of medication for the treatment of
immune-based diseases such as Crohn's disease, uveitis, and rheumatoid
arthritis, have been developed. These treatments are all based on a systemic
suppression of certain aspects of the immune system and can lead to significant
side effects. Thus, there continues to be a need for a therapeutic strategy that
is more specific and less global in its effect on the immune system.
STRATEGY
Our objective is to be a leading developer and provider of the tools
and diagnostics used to study and detect disease at the molecular level and
provider of therapeutic approaches to various diseases. There can be no
assurance that our objective will be met. Key elements of our strategy include:
APPLY OUR INNOVATIVE TECHNOLOGY TO THE INFECTIOUS AND IMMUNE MEDIATED
DISEASE MARKETS
We believe our core technologies have broad diagnostic and therapeutic
applications. We have initially focused our efforts on the infectious and immune
mediated disease markets. Infectious diseases are among the largest contributors
to healthcare costs worldwide. Generally, there are no long-term effective
treatments for viral pathogens as there are for bacterial pathogens. Many viral
diseases such as hepatitis have an immune component. It is known that the
cytopathic effect on the liver in patients infected with hepatitis is caused,
not by the virus itself, but by a reaction of the immune system against the
virus. Although the cause of disorders such as Crohn's disease, certain forms of
uveitis and non-alcoholic steatohepatitis (NASH) remains unknown, various
features suggest immune system involvement in their pathogenesis.
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We continue to develop novel technologies we believe can serve as
enabling platforms for developing medicines that genetically target and inhibit
viral functions, as well as medicines that regulate the immune response. In
addition to such therapeutic products, we continue to capitalize on our nucleic
acid labeling, amplification and detection technologies to develop diagnostic
and monitoring tests for infectious agents.
MAXIMIZE OUR RESOURCES BY COLLABORATING WITH OTHERS IN RESEARCH AND
COMMERCIALIZATION ACTIVITIES
We enter into research collaborations with leading academic and other
research centers to augment our core expertise on specific programs. We have
research collaborations with, among others, Hadassah University Hospital in
Jerusalem, Israel relating to our immune regulation technology and the
University of California at San Francisco for the application of our genetic
antisense technology against HIV.
During fiscal 2005 the Company acquired the rights and intellectual
property to a candidate drug and technology intended for use in the treatment of
autoimmune uveitis. We also entered into a collaboration agreement with
scientists at Ludwig-Maximilians University in Munich, Germany to evaluate
certain of Enzo's proprietary technology for treating uveitis in an animal model
system. In fiscal 2004, Enzo, through Enzo Therapeutics, entered into two
agreements with the University of Connecticut Health Center at Farmington, CT,
to license and cooperatively develop novel therapeutics for the stimulation and
enhancement of bone formation. The products if any, emanating from this
technology could provide potential therapy for bone disorders, including bone
loss, fractures, abnormalities, diseases, and other applications. In fiscal
2004, we also entered into a licensing agreement with Thomas Jefferson
University, Philadelphia, PA for certain patents relating to the development of
products within our therapeutic program. There can be no assurance that any of
these collaborative projects will be successful.
Similarly, we seek to fully exploit the commercial value of our
technology by partnering with for-profit enterprises in areas in order to act on
opportunities that can be accretive to our efforts in accelerating our
development program. In line with this strategy, during fiscal 2004 Enzo
acquired the assets of OraGen Corporation, Moorestown, New Jersey a privately
owned biotechnology company specializing in immune regulation technologies. This
acquisition is expected to broaden our capabilities in the area of immune
regulation, particularly as it relates to the treatment of infectious diseases.
APPLY OUR BIOMEDICAL RESEARCH PRODUCTS TO THE CLINICAL DIAGNOSTICS
MARKET
We intend to apply our gene-based tests to the clinical diagnostics
market. We currently offer over 25 gene-based tests for the research market, for
the identification of such viruses as human papillomavirus, cytomegalovirus, and
Epstein-Barr virus. We also have an extensive library of probes for the
detection of various diseases. We have developed a standardized testing format
that permits multiple diagnoses to be performed on the same specimen and are in
discussions with third parties to develop instrumentation for this purpose.
LEVERAGE MARKETING AND DISTRIBUTION INFRASTRUCTURE OF LEADING LIFE
SCIENCES COMPANIES
During fiscal 2006, Enzo Life Sciences continued to develop the sales
and marketing infrastructure to more directly service its end users, while
simultaneously positioning the Company for product line expansion. The program
has evolved into strategic initiatives to develop direct key relationships and
collaborations with end users, sustaining a marketing campaign, increased
attendance at top industry trade meetings, as well as the continued updating and
enhancement of the interactive web site. In addition to our direct sales, we
distribute our research products through other life sciences companies in
foreign markets.
EXPAND AND PROTECT OUR INTELLECTUAL PROPERTY ESTATE
Since our inception, we have followed a strategy to create a broad
encompassing patent position in the life sciences and therapeutics areas. We
have made obtaining patent protection a central strategic policy, both with
respect to our proprietary platform technologies and products, as well as
broadly in the areas of our research activities. During fiscal 2006 we increased
our intellectual property estate with several new patents including two patents
covering nucleic acid labeling and another patent covering processes for
producing large quantities of therapeutic proteins of RNAs within living target
cells as follows:
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U.S. Patent No. 6,992,180, "Oligo-or polynucleotides comprising
phosphate-moiety labeled nucleotides," among other aspects, covers, nucleic acid
labeling molecules that are attached through the phosphate portion of the
nucleic acid, either directly or indirectly. Among the labeling elements covered
by this patent are fluorescent, chemiluminescent, and chemical molecules,
including biotin. These are the labeling components most commonly used in
medical research and diagnostic products.
U.S. Patent No. 7,074,197, "System, array and non-porous solid support
comprising fixed or immobilized nucleic acids," covers nucleic acids that are
fixed or immobilized to non-porous solid supports and includes systems
containing such supports and arrays with fixed or immobilized nucleic acids.
These compositions are useful for nucleic acid analyses and a host of
applications, including, for example, detection, mutational analysis and
quantification.
U.S. Patent No. 6,986,985, "Process for producing multiple nucleic acid
copies in vivo using a protein nucleic acid construct," covers processes for
producing large quantities of therapeutic proteins or RNAs within living target
cells. An important application of this technology may be to deliver therapeutic
proteins to particular target cells in animals and humans. It may also
facilitate delivery of regulatory RNA molecules, including antisense RNA
molecules for the management of medically important diseases. As such it could
represent a potentially safer and a more efficient strategy for gene expression
and protein production in mammals, including humans.
CORE TECHNOLOGIES
We have developed a portfolio of proprietary technologies with a
variety of research, diagnostic and therapeutic applications.
GENE ANALYSIS TECHNOLOGY
All gene-based testing is premised on the knowledge that DNA forms a
double helix comprised of two complementary strands that match and bind to each
other. If a complementary piece of DNA (a probe) is introduced into a sample
containing its matching DNA, it will bind to, or hybridize, to form a double
helix with that DNA. Gene-based testing is carried out by:
o amplification of the target DNA sequence (a process that is
essential for the detection of very small amounts of nucleic
acid);
o labeling the probe with a marker that generates a detectable
signal upon hybridization;
o addition of the probe to the sample containing the DNA; and
o binding or hybridization of the probe to the target DNA sequence,
if present, to generate a detectable signal.
We have developed a broad technology base for the labeling, detection,
amplification and formatting of nucleic acids for gene analysis which is
supported by our significant proprietary position in these fields.
AMPLIFICATION. In the early stages of infection, a pathogen may be
present in very small amounts and consequently may be difficult to detect. Using
DNA amplification, samples can be treated to cause a pathogen's DNA to be
replicated, or amplified, to detectable levels. We have developed a proprietary
amplification process for multicopy production of nucleic acid, as well as
proprietary techniques for amplifying the signals of our probes to further
improve sensitivity. Our amplification technologies are particularly useful for
the early detection of very small amounts of target DNA and, unlike PCR
(currently the most commonly used method of amplification), we have developed
isothermal amplification procedures that can be performed at constant
temperatures and thus do not require expensive heating and cooling systems or
specialized heat-resistant enzymes.
NON-RADIOACTIVE LABELING AND DETECTION. Traditionally, nucleic acid
probes were labeled with radioactive isotopes. However, radioactively labeled
probes have a number of shortcomings. They are unstable and consequently have a
limited shelf life. They are potentially hazardous, resulting in restrictive
licensing requirements and safety precautions for preparation, use and disposal.
Finally, radioactive components are expensive. Our technologies permit gene
analysis without the problems associated with radioactively labeled probes and
are adaptable to a wide variety of formats.
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FORMATS. There are various processes, or formats, for performing
probe-based tests. In certain formats, the probe is introduced to a target
sample affixed to a solid matrix; in others the probe is combined with the
sample in solution (homogeneous assay). Solid matrix assays include: IN SITU
assays in which the probe reaction takes place directly on a microscope slide;
dot blot assays in which the target DNA is fixed to a membrane; and microplate
and microarray assays in which the DNA is fixed on a solid surface, and the
reaction can be quantified by instrumentation.
THERAPEUTIC TECHNOLOGY PLATFORMS
We have developed proprietary technologies in the areas of gene
regulation (genetic antisense or antisense RNA) and immune regulation that we
are using as platforms for a portfolio of novel therapeutics.
GENE REGULATION. We are pursuing a novel approach to gene regulation
known as genetic antisense or antisense RNA. Our technology involves the
introduction into cellular DNA of a gene that codes for an RNA molecule that
binds to, and thus deactivates, RNA produced by a specific gene. To deliver our
antisense gene to the target cell, IN a process called transduction, we have
developed proprietary vector technology. Our vector technology has the following
strengths:
o EFFICIENT TRANSDUCTION. A principal problem of many gene therapy
programs has been inefficient transduction, or an unacceptably low rate
of delivery of operating genes to the target cells. We have achieved
transduction rates significantly higher than those reported by other
researchers.
o IMMUNOLOGICALLY "QUIET." Transduced or engineered cells (cells
containing the gene that was delivered by the vector) often produce
non-essential proteins that may trigger an immune response, causing
such cells to be cleared from the body before they can produce a
therapeutic effect. Cells transduced with our Stealth Vectors(TM) have
not expressed extraneous proteins.
o "SMART" VECTORS. We incorporate into the surface of our vectors
proteins are designed to have an affinity for the surface of the cell
types intended to be transduced. By including this targeting mechanism,
we create in essence "smart" vectors that preferentially transduces the
intended cell type. This may ultimately permit us to develop a genetic
antisense product that is administered directly to the patient.
o SAFETY COMPONENTS. Certain retroviral vectors have been shown to insert
within the cell in regions of the cellular DNA that could activate
genes that cause cells to grow or multiply. This insertional gene
activation may cause uncontrolled cell division resulting in a cancer.
Enzo's vector has been designed to prevent insertional gene activation
by inactivation of the viral promoters.
We believe, though there can be no assurance, that our vector
technology has broad applicability in the field of gene medicine. This can be
attributed to the following properties of our construct:
o the viral promoters are inactivated;
o insertional gene activation is prevented - a major safety factor;
o chromosomal integration; and
o nuclear localization.
IMMUNE REGULATION.
o ORAL IMMUNE REGULATION. We are exploring a potentially novel
therapeutic approach based on immune regulation. Our immune regulation
technology seeks to control an individual's immune response to a
specific antigen in the body. An antigen is a substance that the body
perceives as foreign and, consequently, against which the body mounts
an immune response. We are developing our technology to treat
immune-mediated diseases, infectious diseases and complications arising
from transplantation. Our technology utilizes oral administration of
known proteins to regulate the subject's immune response against the
antigen. Specific formulations of the protein are administered orally
to the patient according to precise dosing protocols.
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We have filed patent applications relating to this technology, as well
as to our therapeutics platforms and protocols under development, relating to
areas of infectious diseases and immunological adjustments and enhancements
characteristic of this reaction. There can be no assurance that we will be able
to secure patents or that these programs will be successful. We are applying our
expertise in immune regulation to develop proprietary therapies for the
treatment of a variety of diseases, including chronic active hepatitis
autoimmune uveitis, and inflammatory bowel disease, including Crohn's Disease
and ulcerative colitis. During fiscal 2005, the Company acquired the rights and
intellectual property to a candidate drug and technology intended for use in the
treatment of autoimmune uveitis, a chronic inflammation of the eye that can lead
to blindness.
SMALL MOLECULE DEVELOPMENT
o EGS21. We have developed a new immunomodulator agent, EGS21, a
beta-D-glucosylceramide (GC) compound, as a potential therapeutic for
treating immune mediated disorders. GC is a glycolipid that has been
shown by Enzo scientists and collaborators to act as an
anti-inflammatory agent in animal model systems, and therefore is being
evaluated as an important candidate drug in the treatment of various
immune mediated diseases, such as Crohn's disease, hepatitis,
non-alcoholic steatohepatitis (NASH) or fatty liver and HIV. We believe
that GC might be utilized either as a separate therapeutic or as an
adjunct or combination treatment with our other platforms for the
management of immune mediated disorders.
o PROTEIN-PROTEIN INTERACTIONS. Enzo's newest therapeutic platform
involves the development as pharmaceutical agents, of protein factors
or associated peptides, as well as small molecules that interfere with
protein-protein interactions. It has been shown recently that bone
density is dependent on a homeostatic mechanism requiring the
interaction of several protein factors. The interference of
factor-factor interactions by small molecules can lead to significant
increases in bone mass. Enzo is developing these observations to yield
new pharmaceutical products for the management of osteoporosis and
certain periodontal disorders.
PRODUCTS AND SERVICES
We are applying our core technologies to develop novel therapeutics as
well as research tools for the life sciences and clinical diagnostics markets.
In addition, we provide clinical laboratory services to physicians and other
health care providers in the greater New York area.
RESEARCH PRODUCTS
We are a developer and marketer of novel research tools for gene
analysis. We manufacture over 300 products that may be sold individually or
combined in a kit to meet the specific needs of the researcher. We market these
products to biomedical and pharmaceutical firms worldwide. We have summarized
our products into the following major categories:
PRE-FORMATTED IN SITU KITS. Our pre-formatted IN SITU kits include all
of the components necessary to identify or detect a gene in a cell or tissue on
a glass slide. These components include specific labeled non-radioactive nucleic
acid probes on a glass slide, signaling reagents and buffers. We offer probes
that will detect a variety of infectious agents, such as human papillomavirus
(HPV), HBV, cytomegalovirus (CMV) and chlamydia. We market these kits under the
PATHOGENE(R) brand name. These kits target the pathology market.
LABELED PROBES. We have developed a line of non-radioactive nucleic
acid probes that have been chemically-labeled to allow detection of infectious
agents. We offer labeled probes that can detect such infectious agents as
adenovirus, HBV, cytomegalovirus (CMV), herpes simplex virus (HSV) and
chlamydia, as well as certain oncogenes. These probes can be used in
hybridization and detection assays in the format chosen by the researcher. These
probes are broadly sold into the life sciences research market under the
BIOPROBE(R) brand name.
LABELING AND SIGNALING REAGENTS. We have developed an extensive line of
nucleic acid labeling and detections reagent and kits that are designed for the
life sciences research market. The products are used by scientists to detect and
identify genes in certain specific formats. Our line of kits for the labeling of
nucleic acids for the study of specific gene expression is marketed under the
BIOARRAY(R) brand name. This product line also includes a new kit, BIOSCORE(TM),
for amplifying small quantities of genetic material from pathological samples,
as well as providing a quality score for that sample, thus saving the researcher
precious time and money that would have otherwise been wasted on continuing to
process that sample.
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THERAPEUTIC DEVELOPMENT PROGRAMS
We have a number of therapeutic products in various stages of
development that are based on our proprietary genetic antisense and immune
regulation technologies. Our therapeutic programs are described below.
HUMAN IMMUNODEFICIENCY VIRUS (HIV-1)
HIV-1 is a human pathogenic virus. After infection it runs a slow
course in which certain of the cells in the immune system (CD4+ cells)
progressively disappear from the body. This results in a state in which the
infected person can no longer mount an immune response. This loss of immune
responsiveness is the cause of the complex of diseases known as AIDS and
ultimately of death.
According to the World Health Organization, there were more than 60
million individuals worldwide living with HIV infection during 2005. There were
over 5 million new infections and 3 million deaths from HIV during that same
year. Over 20 million have died since the first cases of AIDS were identified in
1981. At present, two classes of products have received FDA marketing approval
for HIV-1 infection: reverse transcriptase inhibitors and protease inhibitors.
HIV's rapid rate of mutation results in the development of viral strains that no
longer respond to these medications. This problem is often exacerbated by
interruptions in dosing, as non-compliance is common in patients on combination
therapies. Moreover, currently approved drugs produce toxic side-effects in many
patients, affecting a variety of organs and tissues, including the peripheral
nervous system and gastrointestinal tract, which side-effects also often result
in patients interrupting or discontinuing therapy.
HGTV43(TM) GENE MEDICINE. Enzo's proprietary Stealth Vector(TM)
HGTV43(TM) gene construct is a vehicle designed to carry and deliver anti-HIV-1
antisense RNA genes. These genes produce antisense RNA directed against the
genes responsible for viral replication. HGTV43 is designed to deliver the
antisense genes to targeted blood cells of subjects infected with HIV-1. These
genes are incorporated into the DNA of the blood cells, and subsequent
production of the antisense RNA prevents replication of the virus, providing
resistance to the virus.
Preclinical in vitro studies, performed in conjunction with our
academic collaborators, demonstrated resistance to HIV-1 in human immune cells
into which the antisense genes had been inserted. Our Phase I clinical trial of
the HIV-1 gene medicine is in the long-term safety follow up phase. In this
study, white blood cell precursors, known as stem cells, were collected from the
subjects. These stem cells were then treated EX VIVO with our Stealth Vector(R)
HGTV43(TM) transducing vector and infused into the subject. Results of the trial
showed that all subjects tolerated the procedure and that anti-HIV-1 antisense
RNA continued to be expressed in the subjects' circulating white blood cells,
the longest running subject at 72 months to date.
o all subjects tolerated the procedure - there were no
treatment-related adverse events during the study and no evidence
for expansion of the inserted transgenes in any subjects tested,
nor was any evidence of leukemia seen by standard hematology.
o anti HIV-1 antisense RNA was detected in the circulation of
subjects, the longest at 72 months
o purified CD4+ cells from evaluable subjects were tested for the
presence of anti HIV-1 antisense RNA and these cells contained the
antisense RNA;
o CD34+ cells from the bone marrow of all subjects were tested for
the presence of anti HIV-1 antisense RNA between 6 months and 20
months after infusion and these cells contained the antisense RNA.
Based on these Phase I trial results demonstrating long-term survival
and functioning of antisense RNA in white blood cells, including CD4+ cells, we
have commenced the next phase of the study in which we will test strategies to
increase the percentage of CD4+ cells that contain the anti-HIV-1 antisense
genes.
9
The Phase I/II study is being conducted at University of California San
Francisco (UCSF) the site of the Phase I study. This study will focus on a
strategy designed to increase the percentage of engineered CD4+ cells. Enzo's
protocol for this phase of the study successfully passed review by the National
Institutes of Health Recombinant DNA Advisory Committee (RAC), the UCSF
Committee on Human Research (CHR) and the U.S. FDA. We have begun the process of
enrolling subjects. A similar study initiated at New York Presbyterian
Hospital-Cornell Medical Center has not enrolled subjects pending completion of
manufacturing protocols.
HEPATITIS B VIRUS (HBV). We are developing HBV therapeutics utilizing
our proprietary immune regulation technology.
HBV is a viral pathogen that can lead to a condition in which the body
destroys its own liver cells through an immune response. This condition is
commonly referred to as chronic active hepatitis. According to the latest
figures published by the World Health Organization, approximately 2 billion
people are infected by HBV, of whom an estimated 350 million are chronically
infected and therefore at risk of death from liver disease.
EHT899 IMMUNE REGULATION PRODUCT. EHT899 is a proprietary formulation
of an HBV viral protein designed to eliminate the undesirable immune response
elicited by the HBV infection. It also apparently enhances a secondary immune
response to clear the viral infection, resulting in reduction in liver damage
and decrease in viral load.
In a clinical trial, conducted at the Liver Unit of Hadassah-Hebrew
University Medical Center, in Jerusalem, Israel, a formulation of EHT899 was
administered orally to a total of 42 subjects with chronic active hepatitis.
Subjects received the medication three times a week for 20 - 30 weeks and were
followed for an additional 20 weeks. Results of the trial have shown that:
o the drug was well tolerated in all subjects;
o 46% of subjects showed a decrease in HBV viral load and
improvement in liver function tests; and
o 33% of subjects showed a decrease in inflammation seen on liver
biopsy.
Based on these results, the Company is exploring improved manufacturing
processes and pharmaceutical partnerships are being explored. A master cell bank
for manufacture of the HBV specific protein (EHT899) is under construction.
Preclinical animal studies with EHT899 showed that this medication was
able to achieve complete suppression of HBV-associated human liver cancer and
significantly reduced mortality in laboratory mice. These studies may have
significant potential application for treatment of liver and other cancers in
humans.
UVEITIS. Posterior uveitis, which results from inflammation of a part
of the eye known as the uvea, is believed to result from an immune reaction
against some of the antigens in the eye, specifically the S antigen protein
(Sag) and the interphotoreceptor retinoid-binding protein (IRBP). There is no
known cure for uveitis, which in the United States, according to the American
Uveitis Society, is diagnosed in approximately 38,000 people every year. While
there are steps that can be taken to preserve sight and slow the progress of
vision loss, individuals with uveitis are also at increased risk of developing
cataracts, glaucoma or retinal detachment.
In fiscal 2005, we acquired rights and intellectual property to a
candidate drug and technology intended for use in the treatment of uveitis. The
drug is the result of a discovery by scientists at the eye clinic of the Ludwig
Maximilians University in Munich, Germany, who found a small peptide that when
fed to rats with experimental allergic uveitis promoted their recovery. Based on
favorable preclinical studies, the developers conducted a small Phase I clinical
trial in Germany with encouraging results.
Using its immune regulation platform and the recently acquired rights
to the candidate drug, B27PD, Enzo is currently developing a protocol for a
multi-center Phase I/II clinical trial to be carried out in the United States
and in Germany. The study drug has been granted orphan status in Europe and we
will apply for the same in the U.S. Orphan status designation can confer both
financial and marketing benefits. B27PD has been manufactured and animal
toxicology studies were successfully carried out. The protocol will be submitted
for approval to both the U.S. FDA and the central regulatory agencies in
Germany.
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INFLAMMATORY BOWEL DISEASES. We believe our immune regulation
technology may be used to treat inflammatory bowel disease (IBD), including
ulcerative colitis and Crohn's Disease. According to the Inflammatory Bowel
Disease Foundation, approximately one million persons in the United States
suffer from IBD. Although the cause of these disorders remains unknown, various
features suggest immune system involvement in their pathogenesis.
Patients are managed during short-term episodes through the use of
anti-inflammatory medications, or immunosuppressants, which provide symptomatic
relief over short periods of time, but do not provide a cure. These drugs are
all based on a generalized suppression of the immune response and are
non-specific. As such, they have considerable side effects and cannot be used
for long periods of time because of their inherent toxicity.
Enzo has completed a Phase II randomized double-blind clinical trial of
ALEQUEL(TM) our innovative immune regulation medicine for treatment of Crohn's
Disease. In this study, subjects were evaluated using the Crohn's Disease
Activity Index (CDAI), a standard measure of the severity of the disease, with
higher scores indicating more severe disease activity. An expanded study to
broaden the diversity of the patient population is ongoing at Hadassah Hospital.
Enzo plans to continue the study at additional sites in the United States and is
currently conducting a selection review process to determine the appropriate
site at which to expand the study.
This latest trial followed a successful open label Phase I study and
was based on successful preclinical results achieved in an animal model system.
The preclinical study results showed that when laboratory animals with
experimentally induced colitis were given specific proteins by oral
administration, a remission of the condition was seen. The experimental animals
exhibited a marked amelioration of the symptoms, including significant reduction
in tissue inflammation, as well as a decrease in the levels of gamma interferon
in the serum, both indicative of remission.
Enzo is also investigating the use of EGS21 in managing Crohn's
disease. The compound has been shown by Enzo scientists and collaborators to act
as an anti-inflammatory agent in animal model systems. EGS21 was tested for
safety in healthy human volunteers at the Hadassah-Hebrew University Medical
Center. All subjects were followed by complete blood analysis and standard blood
chemistries. All laboratory results were within normal limits and no treatment
related adverse events were observed during the treatment period or during the
follow-up period. A Phase II randomized double blind study is currently being
carried out at Hadassah.
NON-ALCOHOLIC STEATOHEPATITIS (NASH)
Enzo is evaluating the use of EGS21 as a potential product for
treatment of fatty liver or non alcoholic steatohepatitis (NASH). Fatty liver,
often associated with a metabolic syndrome defined by hyperlipidemia, insulin
resistance and obesity, can be demonstrated by imaging studies in 25% of the
general population. Recent studies have suggested an immunologic basis for NASH.
This condition is presently considered to be a risk factor for the development
of non-alcoholic steatohepatitis (NASH), one of the top three causes of liver
disease in the USA and a form of chronic hepatitis that is increasingly
recognized as a predisposing condition for the development of liver cirrhosis.
NASH is present in 20% of obese individuals and in 2.5% of the general
population. Using experimental animal model systems, we showed that EGS21 had a
beneficial effect on NASH and its associated metabolic syndrome in these
experimental animals.
Following the successful safety study of EGS21, an open label pilot
study was recently conducted at Hadassah-Hebrew University Medical Center. The
results suggested that EGS21 may be efficacious in treating NASH and its
associated metabolic syndrome in human subjects. A Phase II double blind study
was approved by the regulatory authorities in Israel and is currently being
conducted. This study is being partially funded by a $1.0 million grant from the
Israel-U.S. Binational Industrial Research and Development Foundation (BIRD).
OSTEOPOROSIS AND CERTAIN BONE DISORDERS.
Enzo has a number of new compounds in preclinical development that
could provide therapy for treating bone disorders including osteoporosis, bone
loss, fractures, abnormalities, diseases, and other applications.
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CLINICAL LABORATORY SERVICES
We operate a regional clinical laboratory that offers full diagnostic
services to the greater New York and New Jersey medical community. The Company's
clinical laboratory testing is utilized by physicians as an essential element in
the delivery of healthcare services. Physicians use laboratory tests to assist
in the detection, diagnoses, evaluation, monitoring and treatment of diseases
and other medical conditions. Clinical laboratory testing is generally
categorized as clinical testing and anatomic pathology testing. Clinical testing
is performed on body fluids, such as blood and urine. Anatomic pathology testing
is performed on tissues and other samples, such as human cells. Most clinical
laboratory tests are considered routine and can be performed by most commercial
clinical laboratories. Tests that are not routine and that require more
sophisticated equipment and highly skilled personnel are considered esoteric
tests and may be performed less frequently than routine tests. The Company does
not perform certain low-volume esoteric tests in-house; generally many of these
tests are referred to an esoteric clinical testing laboratory that specializes
in performing these more complex tests.
The Company offers a comprehensive menu of routine and esoteric
clinical laboratory tests or procedures. These tests are frequently used in
general patient care by physicians to establish or support a diagnosis, to
monitor treatment or medication, or search for an otherwise undiagnosed
condition.
Our full service clinical laboratory in Farmingdale, NY contains
infrastructure that includes a comprehensive information technology, logistics,
client service and billing departments. Also, we have a network of nineteen
patient service centers and a full service phlebotomy department. Patient
service centers collect the specimens as requested by physicians. We also
operate a STAT laboratory in New York City. A "STAT" lab is a laboratory that
has the ability to perform certain routine tests quickly and report results to
the physician immediately.
Patient specimens are delivered to our laboratory facilities by our
logistics department accompanied by a test requisition form. These forms, which
are completed by the ordering physician, indicate the tests to be performed and
demographic patient information. Once this information is entered into the
laboratory computer system the tests are performed and the results are entered
primarily through an interface from the laboratory testing equipment or in some
instances, manually into the laboratory computer system. Most routine testing is
completed by early the next morning, and test results are reported to the
ordering physician. These test results are either delivered electronically via
our EnzoDirect(TM) system or delivered by the logistic department directly to
the ordering physicians' offices. Physicians who request that they be called
with a result are so notified.
For fiscal years ended July 31, 2006, 2005, and 2004 respectively, 80%,
76%, and 69% of the Company's revenues were derived from the clinical
laboratory. At July 31, 2006 and 2005, respectively, approximately 88% and 94%
of the Company's net accounts receivable were derived from its clinical
laboratory business. The Company believes that the concentration of credit risk
with respect to clinical laboratory's accounts receivable is limited due to the
diversity of the various numbers of third party insurance carriers, the Federal
Medicare Program and the numerous individual patient accounts. Revenue, net of
contractual adjustments, from direct billings under the Federal Medicare program
during the years ended July 31, 2006, 2005 and 2004 were approximately 23%, 21%,
and 26%, respectively, of the clinical laboratory segment's total revenue. The
clinical laboratory industry is characterized by a significant amount of
uncollectible accounts receivable related to the inability to receive accurate
and timely billing information in order to forward it on to the third party
payers for reimbursement, and the inaccurate information received from the
covered individual patients for unreimbursed unpaid amounts. The Company's
provision for uncollectible accounts receivable is within historical
expectations.
Billing for laboratory services is complicated. Depending on the
billing arrangement and applicable law, we must bill various payers, such as
patients, insurance companies and the Federal Medicare Program, all of which
have different requirements. In New York State, the law prohibits the Company
from billing the ordering physician. Compliance with applicable laws and
regulations as well as, internal compliance policies and procedures adds further
complexity to the billing process. We depend on the ordering physician to
provide timely, accurate billing demographic and diagnostic coding information
to us. Additional factors complicating the billing process include:
o pricing differences between our fee schedules and the
reimbursement rates of the payers;
o disputes with payers as to which party is responsible for payment;
and
o disparity in coverage and information requirements among various
payers.
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We believe that most of our bad debt expense is primarily the result of
missing or incorrect billing information on requisitions received from the
ordering physician rather than credit related issues. We perform the requested
tests and report test results regardless of whether the billing or diagnostic
coding information is incorrect or missing. We subsequently attempt to contact
the ordering physician to obtain any missing information and rectify incorrect
billing information. Missing or incorrect information on requisition adds
complexity to and slows the billing process, creates backlogs of unbilled
requisitions, and generally increases the aging of accounts receivable. When all
issues relating to the missing or incorrect information are not resolved in a
timely manner, the related receivables are fully reserved to the allowance for
doubtful accounts or written off.
We incur significant additional costs as a result of our participation
in Medicare, as billing and reimbursement for clinical laboratory testing is
subject to considerable and complex federal and state regulations. These
additional costs include those related to: (1) complexity added to our billing
processes; (2) training and education of our employees and customers; (3)
compliance and legal costs; and (4) costs related to, among other factors,
medical necessity denials and advance beneficiary notices. The Centers for
Medicare & Medicaid Services, or CMS (formerly the Health Care Financing
Administration), establishes procedures and continuously evaluates and
implements changes in the reimbursement process.
The permitted Medicare reimbursement rate for clinical laboratory
services has been reduced by the Federal government in a number of instances
over the past several years to a present level equal to 74% of the national
median of laboratory charges. Clinical Labs have been subjected to a five-year
freeze (ending in 2008) on Laboratory fee updates, as required by the Medicare
Modernization Act of 2003. A number of proposals for legislation or regulation,
such as competitive bidding on laboratory services are under discussion which
could have the effect of substantially reducing Medicare reimbursements to
clinical laboratories through reduction of the present allowable percentage or
through other means. In addition, the structure and nature of Medicare
reimbursement for laboratory services is also under discussion and we are unable
to predict the outcome of these discussions. Depending upon the nature of
congressional and/or regulatory action, if any, which is taken and the content
of legislation, if any, which is adopted, we could experience a significant
decrease in revenue from Medicare, which could have a material adverse effect on
us.
RESEARCH & DEVELOPMENT
Our principal research and development efforts are directed toward
expanding our research product lines, as well as developing innovative new
therapeutic products to meet unmet market needs. We have developed our core
research expertise in the life science field as a result of 30 years of
dedicated focus in this area. We conduct our research and other product
development efforts through internal research and collaborative relationships.
In the fiscal years ended July 31, 2006, 2005 and 2004, the Company incurred
costs of approximately $7,896,000, $8,452,000, and $8,078,000, respectively, for
research and development activities.
INTERNAL RESEARCH PROGRAMS
Our professional staff of 31 scientists, including 28 with post
doctorate degrees, performs our internal research and development activities.
Our product development programs incorporate various scientific areas of
expertise, including recombinant DNA, monoclonal antibody development,
enzymology, microbiology, biochemistry, molecular biology, organic chemistry,
and fermentation. In addition, we continuously review in-licensing opportunities
in connection with new technology.
EXTERNAL RESEARCH COLLABORATIONS
We have and continue to explore collaborative relationships with
prominent companies and leading-edge research institutions in order to maximize
the application of our technology in areas where we believe such relationship
will benefit the development of our technology.
SALES AND MARKETING
Our sales and marketing strategy is to sell our life science products
through three distinct channels: (i) direct sales to end-users; and (ii) supply
agreements with manufacturers and (iii) through distributors in major geographic
markets. We market the clinical laboratory services to ordering physicians in
the metro New York and New Jersey region through our direct sales force,
customer service and patient service representatives.
We focus our sales efforts on obtaining and retaining profitable
accounts. We also have an active account management process to evaluate the
profitability of all of our accounts. Where appropriate, we change the service
levels and terminate accounts that are not profitable.
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DIRECT SALES AND MARKETING EFFORT
We market our life science products through a direct field sales group
and professional sales management team; as well as through our interactive
e-commerce web site. Our domestic and worldwide marketing efforts also consist
of advertisements in major scientific journals, direct mailings to researchers,
presentations at scientific seminars and exhibitions at scientific meetings.
DISTRIBUTION ARRANGEMENTS
We also distribute our life science products internationally through a
network of distributors. Through these arrangements, we are able to leverage the
established marketing and distribution infrastructure of these companies. Enzo
Life Sciences is focused on a strategic initiative to expand its international
network of distributors. Prior to fiscal 2005, the Company distributed through
leading life science companies and is currently evaluating new relationships.
See Item 3. Legal Proceedings.
COMPETITION
We compete with other life science and biotechnology companies, as well
as pharmaceutical, chemical and other companies. Competition in our industry is
intense. Many of these companies are performing research targeting the same
technology, applications and markets. Some of these competitors are
significantly larger than we are and have more resources than we do. The primary
competitive factors in our industry are the ability to create scientifically
advanced technology, successfully develop and commercialize products on a timely
basis, establish and maintain intellectual property rights and attract and
retain a breadth and depth of human resources
Our clinical laboratory services business competes with numerous
national, regional, local entities, some of which are larger than we are and
have greater financial resources than we do. Our laboratory competes primarily
on the basis of the quality and specialized nature of its testing, reporting and
information services, its reputation in the medical community, its reliability
and speed in performing diagnostic tests, and its ability to employ qualified
laboratory personnel.
INTELLECTUAL PROPERTY
We consider our intellectual property program to be a key asset and a
major strategic component to the execution of our business strategy. A broad
portfolio of issued patents and pending patent applications supports our core
technology platforms. Our policy is to seek patent protection for our core
technology platforms, as well as for ancillary technologies that support these
platforms and provide a competitive advantage.
At the end of fiscal 2006 we owned or licensed 44 U.S. and 167 foreign
patents relating to products, methods and procedures resulting from our internal
or sponsored research projects. During fiscal 2006, the following key enabling
patents were issued to Enzo:
U.S. Patent No. 6,992,180, "Oligo-or polynucleotides comprising
phosphate-moiety labeled nucleotides," among other aspects, covers nucleic acid
labeling molecules that are attached through the phosphate portion of the
nucleic acid, either directly or indirectly. Among the labeling elements covered
by this patent are fluorescent, chemiluminescent, and chemical molecules,
including biotin. These are the labeling components most commonly used in
medical research and diagnostic products.
U.S. Patent No. 7,074,197, "System, array and non-porous solid support
comprising fixed or immobilized nucleic acids," covers nucleic acids that are
fixed or immobilized to non-porous solid supports and includes systems
containing such supports and arrays with fixed or immobilized nucleic acids.
These compositions are useful for nucleic acid analyses and a host of
applications, including, for example, detection, mutational analysis and
quantification.
U.S. Patent No. 6,986,985 "Process for producing multiple nucleic acid
copies in vivo using a protein nucleic acid construct," covers processes for
producing large quantities of therapeutic proteins or RNAs within living target
cells. An important application of this technology may be to deliver therapeutic
proteins to particular target cells in animals and humans. It may also
facilitate delivery of regulatory RNA molecules, including antisense RNA
molecules for the management of medically important diseases. As such it could
represent a potentially safer and a more efficient strategy for gene expression
and protein production in mammals, including humans.
There can be no assurance that patents will be issued on pending
applications or that any issued patents will have commercial benefit. We do not
intend to rely on patent protection as the sole basis for protecting our
proprietary technology. We also rely on our trade secrets and continuing
technological innovation.
14
We require each of our employees to sign a confidentiality agreement
that prohibits the employee from disclosing any confidential information about
us, including our technology or trade secrets.
In August of 2006, Enzo was granted interference against patents held
by Princeton University (now licensed to Abbott Labs) and Chiron Diagnostics
(now Bayer Diagnostics). In this action, Enzo has been designated as the senior
party because the Company's filing of its patent application preceded the
others. In addition, the relevant claims for this patent were published in
Europe before the Princeton and Chiron applications were even filed. Based on
this management believes that that Enzo will prevail, and as such, would have
the rights to the technology.
During fiscal 2005, several patents relating to the BioProbe(R) nucleic
acid probe system expired, while additional patents were issued in the U.S. and
Europe. During fiscal 2006 we increased our intellectual property estate with
several new patents including two patents covering nucleic acid labeling and
another patent covering processes for producing large quantities of therapeutic
proteins of RNAs within living target cells.
Enzo's intellectual property portfolio can be divided into patents that
provide claims in three primary categories, as described below:
NUCLEIC ACID CHEMISTRY
We currently have broad patent coverage in the area of nucleic acid
chemistry. The Company has done extensive work on the labeling of nucleic acids
for the purpose of generating a signal that dates back over twenty years. Enzo
has multiple issued patents covering the modification of nucleic acids at all
three potential modification sites (sugar, base and phosphate).
The claims contained in these patents cover any product that
incorporates a signaling moiety into a nucleic acid for the purpose of nucleic
acid sequence detection or quantification
SIGNAL DELIVERY
We also have a long history of innovation in the area of analyte
detection using non-radioactive signaling entities. At the signaling entity
itself, there are several Enzo patents that cover the formation of this
structure. A patent which was allowed in 2006, covers the attachment of
signaling molecules through the phosphate moiety of a nucleic acid, which is how
the signal-generating enzyme is bound. Additionally, the allowed claims
contained in Enzo's signal delivery patents cover any product that incorporates
either of the following:
o A first part which comprises a molecular bridging entity
comprising of a first portion that hybridizes to an analyte and a
second portion comprising of nucleic acid sequences or segments.
o A second part which comprises one or more non-radioactive
signaling entities incapable of binding to the aforementioned
bridging entity second portion, and or more signaling portions.
NUCLEIC ACID ANALYSIS FORMAT
We also have patents with issued claims covering the use of arrays of
single-stranded nucleic acids fixed or immobilized in hybridizable form to a
non-porous solid support. These patents cover any product that uses arrays of
nucleic acids for molecular analysis.
In some instances, we may enter into royalty agreements with
collaborating research parties in consideration for the commercial use by us of
the developments of their joint research. In other instances the collaborating
party might obtain a patent, but we receive the license to use the patented
subject matter. In such cases, we will seek to secure exclusive licenses. In
other instances, we might have an obligation to pay royalties to, or reach a
royalty arrangement with, a third party in consideration of our use of
developments of such third party. The Research Foundation of the State
University of New York has granted us the exclusive rights to a genetic
engineering technology using antisense nucleic acid control methodologies. In
fiscal 2006, the Enzo Life Sciences entered into an agreement with the
Children's Mercy Hospital and Clinics ("Mercy") in Kansas City, MO whereby Enzo
licensed from Mercy two patents in the area of single copy genomic hybridization
probes. The Company plans to utilize this technology in its plans to develop a
line of products and services designed specifically for the cytogenetics market.
REGULATION OF PHARMACEUTICAL PRODUCTS
New drugs and biological drug products are subject to regulation under
the Federal Food, Drug and Cosmetic Act, and biological products are also
regulated under the Public Health Service Act. We believe that products
developed
15
by us or our collaborators will be regulated either as biological products or as
new drugs. Both statutes and the regulations promulgated thereunder govern,
among other things, the testing, licensing, manufacturing, marketing,
distributing, safety, and efficacy requirements, labeling, storage, exporting,
record keeping, advertising and other promotional practices involving biologics
or new drugs, as the case may be. FDA review or approval or other clearances
must be obtained before clinical testing, and before manufacturing and
marketing, of biologics and drugs. At the FDA, the Center for Biological
Evaluation and Research ("CBER") is responsible for the regulation of biological
drugs and the Center for Drug Evaluation and Research ("CDER") is responsible
for the regulation of non-biological drugs. Biological drugs are licensed and
other drugs are approved before commercialization.
Any therapeutics products that we develop will require regulatory
review before clinical trials, and additional regulatory clearances before
commercialization. New human gene medicine products as well as immune regulation
products, as therapeutics, are subject to regulation by the FDA and comparable
agencies in other countries. The FDA on a case-by-case basis currently reviews
each protocol. The FDA has published "Points to Consider" guidance documents
with respect to the development of therapeutics protocols. In addition, the
National Institutes of Health ("NIH") is also involved in the oversight of gene
therapies and the FDA has required compliance with certain NIH requirements.
Obtaining FDA approval has historically been a costly and
time-consuming process. Generally, to gain FDA approval, a developer first must
conduct pre-clinical studies in the laboratory evaluating product chemistry,
formulation and stability and, if appropriate, in animal model systems, to gain
preliminary information on safety and efficacy. Pre-clinical safety tests must
be conducted by laboratories that comply with FDA regulations governing Good
Laboratory Practices (GLP). The results of those studies are submitted with
information characterizing the product and its manufacturing process and
controls as a part of an investigational new drug ("IND") application, which the
FDA must review and declare effective before human clinical trials of an
investigational drug can start. The IND application includes a detailed
description of the clinical investigations to be undertaken in addition to other
pertinent information about the product, including descriptions of any previous
human experience and the company's future plans for studying the drug.
In order to commercialize any products, we (as the sponsor) file an IND
and will be responsible for initiating and overseeing the clinical studies to
demonstrate the safety and efficacy necessary to obtain FDA marketing approval
of any such products. For INDs that we sponsor, we will be required to select
qualified clinical sites (usually physicians affiliated with medical
institutions) to supervise the administration of the products, and ensure that
the investigations are conducted and monitored in accordance with FDA
regulations, Good Clinical Practices (GCP) and the general investigational plan
and protocols contained in the IND. Each clinical study is reviewed and approved
by an Institutional Review Board (IRB). The IRB will consider, among other
things, ethical factors and the safety of human subjects. Clinical trials are
normally conducted in three phases, although the phases might overlap. Phase I
trials, concerned primarily with the safety and tolerance of the drug, and its
pharmacokinetics (or how it behaves in the body including its absorption and
distribution) involve fewer than 100 subjects. Phase II trials normally involve
a few hundred patients and are designed primarily to demonstrate preliminary
effectiveness and the most suitable dose or exposure level for treating or
diagnosing the disease or condition for which the drug is intended, although
short-term side effects and risks in people whose health is impaired may also be
examined. Phase III trials are expanded, adequate and well-controlled clinical
trials with larger numbers of patients and are intended to gather the additional
information for proper dosage and labeling of the drug. Clinical trials
generally take two to five years, but the period may vary. Certain regulations
promulgated by the FDA may shorten the time periods and reduce the number of
patients required to be tested in the case of certain life-threatening diseases,
which lack available alternative treatments.
The FDA receives reports on the progress of each phase of clinical
testing, and it may require the modification, suspension or termination of
clinical trials if an unwarranted risk is presented to patients. Human gene
medicine products are a new category of therapeutics. There can be no assurance
regarding the length of the clinical trial period, the number of patients that
the FDA will require to be enrolled in the clinical trials in order to establish
the safety, purity and potency of human gene medicine products, or that the
clinical and other data generated will be acceptable to the FDA to support
marketing approval.
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After completion of clinical trials of a new product, FDA marketing
approval must be obtained before the product can be sold in the United States.
If the product is regulated as a new biologic, CBER requires the submission and
approval of a Biologics License Application (BLA) before commercial marketing of
the biologic product. If the product is classified as a new drug, we must file a
New Drug Application ("NDA") with CDER and receive approval before commercial
marketing of the drug. The NDA or BLA must include results of product
development, pre-clinical studies and clinical trials. The testing and approval
processes require substantial time and effort and there can be no assurance that
any approval will be granted on a timely basis, if at all. The median time to
obtain new product approvals after submission to the FDA is approximately 12
months. If questions arise during the FDA review process, approval can take
longer. Before completing its review, the FDA may seek guidance from an Advisory
Committee of outside experts at a public or closed meeting. While the advice of
these committees is not binding on the FDA, it is often followed.
Notwithstanding the submission of relevant data, the FDA might ultimately decide
that the NDA or BLA does not satisfy its regulatory criteria for approval and,
thus, reject the application, refuse to approve it, or require additional
clinical, preclinical or chemistry studies. Even after FDA regulatory approval
or licensure, a marketed drug product is subject to continual review by the FDA.
In addition, if previously unknown problems are discovered or we fail to comply
with the applicable regulatory requirements, we might be restricted from
marketing a product, we might be required to withdraw the product from the
market, and we might possibly become subject to seizures, injunctions, voluntary
recalls, or civil, monetary or criminal sanctions. In addition, the FDA may
condition marketing approval on the conduct of specific post-marketing studies
to further evaluate safety and effectiveness.
For commercialization of our biological or other drug products, the
manufacturing processes described in our NDA or BLA must receive FDA approval
and the manufacturing facility must successfully pass an inspection prior to
approval or licensure of the product for sale within the United States. The
pre-approval inspection assesses whether, for example, the facility complies
with the FDA's current good manufacturing practices (cGMP) regulations. These
regulations elaborate testing, control, documentation, personnel, record keeping
and other quality assurance procedure requirements that must be met. Once the
FDA approves our biological or other drug products for marketing, we must
continue to comply with the cGMP regulations. The FDA periodically inspects
biological and other drug manufacturing facilities to ensure compliance with
applicable cGMP requirements. Failure to comply with the statutory and
regulatory requirements subjects the manufacturer to possible legal or
regulatory action, such as suspension of manufacturing, seizure of product or
voluntary recall of a product.
If a developer obtains designations by the FDA of a biologic or other
drug as an "orphan" for a particular use, the developer may request grants from
the federal government to defray the costs of qualified testing expenses in
connection with the development of such drug. Orphan drug designation is
possible for drugs for rare diseases, including many genetic diseases, which
means the drug is for a disease that has a prevalence of less than 200,000
patients in the United States. The first applicant who receives an orphan drug
designation and who obtains approval of a marketing application for such drug
acquires the exclusive marketing rights to that drug for that use for a period
of seven years unless the subsequent drug can be shown to be clinically
superior. Accordingly, no other company would be allowed to market an identical
orphan drug with the same active ingredient for the use approved by the FDA for
seven years after the approval.
REGULATION OF DIAGNOSTICS
The diagnostic products that are developed by our collaborators or us
are likely to be regulated by the FDA as medical devices. Unless an exemption
applies, medical devices must receive either "510(k) clearance" or pre-market
approval ("PMA") from the FDA before marketing them in the United States. The
FDA's 510(k) clearance process usually takes from four to 12 months, but it can
last longer. The process of obtaining PMA approval is much more costly, lengthy
and uncertain. It generally takes from one to three years or even longer. We
cannot be sure that 510(k) clearance or PMA approval will ever be obtained for
any product we propose to market.
The FDA decides whether a device must undergo either the 510(k)
clearance or PMA approval process based upon statutory criteria. These criteria
include the level of risk that the agency perceives is associated with the
device and a determination whether the product is a type of device that is
similar to devices that are already legally marketed. Devices deemed to pose
relatively less risk are placed in either class I or II, which requires the
manufacturer to submit a premarket notification requesting 510(k) clearance,
unless an exemption applies. The pre-market notification must demonstrate that
the proposed device is "substantially equivalent" in intended use and in safety
and effectiveness to a legally marketed "predicate device" that is either in
class I, class II, or is a "pre-amendment" class III device (i.e., one that was
in commercial distribution before May 28, 1976) for which the FDA has not yet
called for submission of a PMA application.
After a device receives 510(k) clearance, any modification that could
significantly affect its safety or effectiveness, or that would constitute a
major change in its intended use, requires a new 510(k) clearance or could
require a PMA approval. The FDA requires each manufacturer to make this
determination in the first instance, but the
17
FDA can review any such decision. If the FDA disagrees with a manufacturer's
decision not to seek a new 510(k) clearance, the agency may retroactively
require the manufacturer to seek 510(k) clearance or PMA approval. The FDA also
can require the manufacturer to cease marketing and/or recall the modified
device until 510(k) clearance or PMA approval is obtained.
Devices deemed by the FDA to pose the greatest risk, such as
life-sustaining, life-supporting or implantable devices, or deemed not
substantially equivalent to a legally marketed class I or class II predicate
device, or to a preamendment class III device for which PMAs have not been
called, are placed in class III. Such devices are required to undergo the PMA
approval process in which the manufacturer must prove the safety and
effectiveness of the device to the FDA's satisfaction. A PMA application must
provide extensive preclinical and clinical trial data and also information about
the device and its components regarding, among other things, device design,
manufacturing and labeling. After approval of a PMA, a new PMA or PMA supplement
is required in the event of a modification to the device, it's labeling or its
manufacturing process.
Although clinical investigations of most devices are subject to the
investigational device exemption ("IDE") requirements, clinical investigations
of in vitro diagnostic ("IVDs") tests are exempt from the IDE requirements,
including the need to obtain the FDA's prior approval, provided the testing is
noninvasive, does not require an invasive sampling procedure that presents a
significant risk, does not introduce energy into the subject, and is not used as
a diagnostic procedure without confirmation by another medically established
test or procedure. In addition, the IVD must be labeled for Research Use Only
(RUO) or Investigational Use Only (IUO), and distribution controls must be
established to assure that IVDs distributed for research or investigation are
used only for those purposes. The FDA expressed its intent to exercise
heightened enforcement with respect to IUO and RUO devices improperly
commercialized prior to receipt of FDA clearance or approval.
We have developed products that we currently distribute in the United
States on a RUO basis. There can be no assurance that the FDA would agree that
our distribution of these products meets the requirements for RUO distribution.
Furthermore, failure by us or recipients of our RUO products to comply with the
regulatory limitations on the distribution and use of such devices could result
in enforcement action by the FDA, including the imposition of restrictions on
our distribution of these products.
Any devices that we manufacture or distribute will be subject to a host
of regulatory requirements, including the Quality System Regulation (which
requires manufacturers to follow elaborate design, testing, control,
documentation and other quality assurance procedures), the Medical Device
Reporting regulation (which requires that manufacturers report to the FDA
certain types of adverse events involving their products), labeling regulations,
and the FDA's general prohibition against promoting products for unapproved or
"off label" uses. Class II devices also can have special controls such as
performance standards, post market surveillance, patient registries, and FDA
guidelines that do not apply to class I devices. Unanticipated changes in
existing regulatory requirements or adoption of new requirements could hurt our
business, financial condition and results of operations.
We are subject to inspection and market surveillance by the FDA to
determine compliance with regulatory requirements. If the FDA finds that we have
failed to comply, the agency can institute a wide variety of enforcement
actions, ranging from a public warning letter to more severe sanctions such as
fines, injunction, civil penalties, recall or seizure of our products, the
issuance of public notices or warnings, operating restrictions, partial
suspension or total shutdown of production, refusal of our requests for 510(k)
clearance or PMA approval of new products, withdrawal of 510(k) clearance or PMA
approvals already granted, and criminal prosecution.
The FDA also has the authority to request repair, replacement or refund
of the cost of any medical device manufactured or distributed by us. Our failure
to comply with applicable requirements could lead to an enforcement action that
may have an adverse effect on our financial condition and results of operations.
Unanticipated changes in existing regulatory requirements, our failure
to comply with such requirements or adoption of new requirements could have a
material adverse effect on us.
We have employees to expedite the preparation and filing of
documentation necessary for FDA clearances and approvals, patent issuances and
licensing agreements.
We cannot assure you that future clinical diagnostic products developed
by us or our collaborators will not be required to be reviewed by FDA under the
more expensive and time consuming pre-market approval process.
18
CLINICAL LABORATORY REGULATIONS
The clinical laboratory industry is subject to significant federal and
state regulation, including inspections and audits by governmental agencies.
Governmental authorities may impose fines or criminal penalties or take other
actions to enforce laws and regulations, including revoking a clinical
laboratory's federal certification to operate a clinical laboratory operation.
Changes in regulation may increase the costs of performing clinical laboratory
tests, increase the administrative requirements of claims or decrease the amount
of reimbursement. Our clinical laboratory and (where applicable) patient service
centers are licensed and accredited by the appropriate federal and state
agencies. CLIA (The Clinical Laboratory Improvement Act of 1967, and the
Clinical Laboratory Improvement Amendments of 1988) regulates virtually all
clinical laboratories by requiring that they be certified by the federal
government and comply with various operational, personnel and quality
requirements intended to ensure that their clinical laboratory testing services
are accurate, reliable and timely. CLIA does not preempt state laws that are
more stringent than federal laws. Many clinical laboratories must meet other
governmental standards, undergo proficiency testing, and are subject to
inspection. Clinical laboratory certificates or licenses are also required by
various state and local laws.
CLIA places all tests into one of three categories of complexity
(waived, moderate complexity and high complexity) and establishes varying
requirements depending upon the complexity category of the test performed. A
laboratory that performs high complexity tests must meet more stringent
requirements than a laboratory that performs only moderate complexity tests,
while those that perform only waived tests may apply for a certificate of waiver
from most of the requirements of CLIA. Our facility is certified to perform
highly complex tests. In general, the Secretary of Health and Human Services
("HHS") regulations require laboratories that perform high or moderate
complexity tests to implement systems that ensure the accurate performance and
reporting of test results, establish quality control and quality assurance
systems ensure hiring of personnel that meet specified standards, engage in
proficiency testing by approved agencies and undergo biennial inspections.
Clinical laboratories also are subject to state regulation. CLIA
provides that a state may adopt different or more stringent regulations than
Federal law, and permits states to apply for exemption from CLIA if HHS
determines that the state's laboratory laws are equivalent to, or more stringent
than, CLIA. The State of New York's clinical laboratory regulations contain
provisions that are more stringent than Federal law, and New York has received
exemption from CLIA. Therefore, as long as New York maintains its CLIA-exempt
status, laboratories in New York, including our laboratory, are regulated under
New York law rather than CLIA. Our laboratory is licensed in New York and has
continuing programs to ensure that its operations meet all applicable regulatory
requirements.
The sanction for failure to comply with these regulations may be
suspension, revocation, or limitation of a laboratory's CLIA certificate
necessary to conduct business, significant fines and criminal penalties. The
loss of, or adverse action against, a license, the imposition of a fine, or
future changes in Federal, state and local laboratory laws and regulations (or
in the interpretation of current laws and regulations) could have a material
adverse effect on our business.
CLINICAL LABORATORY REIMBURSEMENT
Billing and reimbursement for clinical laboratory testing is subject to
significant and complex federal and state regulation. Penalties for violations
of laws relating to billing federal healthcare programs and for violations of
federal fraud and abuse laws include: (1) exclusion from participation in
Medicare/Medicaid programs; (2) asset forfeitures; (3) civil and criminal fines
and penalties; and (4) the loss of various licenses, certificates and
authorizations necessary to operate some or all of a clinical laboratory's
business. The Company is not aware of any material violations.
The health care industry has been undergoing significant change because
third-party payers, such as Medicare (serving primarily patients 65 and older),
Medicaid serving primarily indigent patients, health maintenance organizations
and commercial insurers, have increased their efforts to control the cost,
utilization and delivery of health care services. To address the problem of
increasing health care costs, legislation has been proposed or enacted at both
the Federal and state levels to regulate health care delivery in general and
clinical laboratories in particular. Additional health care reform efforts are
likely to be proposed in the future. In particular, we believe that reductions
in reimbursement for Medicare services will continue to be implemented from time
to time. Reductions in the reimbursement rates of other third-party payers,
commercial insurer and health maintenance organizations are likely to occur as
well. We cannot predict the effect that health care reform, if enacted, would
have on our business, and there can be no assurance that such reforms, if
enacted, would not have a material adverse effect on our business and
operations.
Containment of health care costs, including reimbursement for clinical
laboratory services, has been a focus of ongoing governmental activity. In 1984,
Congress established the Medicare fee schedule for clinical laboratory services,
which is applicable to patients covered under Part B of the Medicare program as
well as patients receiving Medicaid. Clinical laboratories must bill Medicare
directly for the services provided to Medicare beneficiaries and may only
collect the amounts permitted under this fee schedule. Reimbursement to clinical
laboratories under the Medicare Fee Schedule has been steadily declining since
its inception.
19
Furthermore, Medicare has mandated use of the Physicians Current
Procedural Terminology ("CPT") for coding of laboratory services which has
altered the way we bill these programs for some of our services, thereby
reducing the reimbursement that we receive.
In March 1996, HCFA (now, the Center for Medicare and Medicaid Services
or CMS) implemented changes in the policies used to administer Medicare payments
to clinical laboratories for the most frequently performed automated blood
chemistry profiles. Among other things, the changes established a consistent
standard nationwide for the content of the automated chemistry profiles. Another
change requires laboratories performing certain automated blood chemistry
profiles to obtain and provide documentation of the medical necessity of tests
included in the profiles for each Medicare beneficiary. Reimbursements have been
reduced as a result of this change. Because a significant portion of our costs
is fixed, these Medicare reimbursement reductions and changes have a direct
adverse effect on our net earnings and cash flows.
Future changes in federal, state and local regulations (or in the
interpretation of current regulations) affecting governmental reimbursement for
clinical laboratory testing could have a material adverse effect on our
business. We cannot predict, however, whether and what type of legislation will
be enacted into law. In addition, reimbursement disapprovals by the third party
payers, commercial insures and health maintenance organizations, reductions or
delays in the establishment of reimbursement rates, and carrier limitations on
the insurance coverage of the Company's services or the use of the Company as a
service provider could have a negative effect on the Company's future revenues.
ANTI FRAUD AND ABUSE LAWS
Existing Federal laws governing Medicare, as well as state laws, also
regulate certain aspects of the relationship between healthcare providers,
including clinical laboratories and their referral sources such as physicians,
hospitals and other laboratories. One provision of these laws, known as the
"Anti-Kickback Law," contains extremely broad proscriptions. Violation of this
provision may result in criminal penalties, exclusion from Medicare, and
significant civil monetary penalties. Under another Federal law, known as the
"Stark" law or "self-referral prohibition," physicians who have an investment or
compensation relationship with an entity furnishing clinical laboratory services
(including anatomic pathology and clinical chemistry services) may not, subject
to certain exceptions, refer clinical laboratory testing for Medicare patients
to that entity. Similarly, laboratories may not bill Medicare or Medicaid or any
other party for services furnished pursuant to a prohibited referral. Violation
of these provisions may result in disallowance of Medicare for the affected
testing services, as well as the imposition of civil monetary penalties. New
York State also has laws similar to the Federal Stark and Anti-Kickback laws.
The Federal Stark laws, and New York State law, have also placed
restrictions on the supplies and other items that laboratories may provide to
their clients. These laws specify that laboratories may only provide clients
with items or devices that are used solely to collect, transport or store
specimens for the laboratory or to communicate results or tests. Items such as
biopsy needles, snares and reusable needles are specifically prohibited from
being supplied by laboratories to their clients. These laws represent a
significant deviation from practices that previously occurred throughout the
industry. The Company has put in place procedures to ensure compliance with
these laws and restrictions and believes that it is in compliance with these
laws.
In February 1997, the OIG released a model compliance plan for
laboratories. One key aspect of the model compliance plan is an emphasis on the
responsibilities of laboratories to notify physicians that Medicare covers only
medically necessary services. These requirements, and their likely effect on
physician test ordering habits, focus on chemistry tests, especially routine
tests, rather than on anatomic pathology services or the non-automated tests,
which make up the majority of the Company's business measured in terms of net
revenues. Nevertheless, they potentially could affect physicians' test ordering
habits more broadly. The Company is unable to predict whether, or to what
extent, these developments have had an impact or the utilization of the
Company's services.
20
The Company seeks to structure its arrangements with physicians and
other customers to be in compliance with the Anti-Kickback, Stark and state
laws, and to keep up-to-date on developments concerning their application by
various means, including consultation with legal counsel. In addition, in order
to address these various Federal and state laws, the Company has developed its
own Corporate Compliance Program based upon the OIG model program. The Company's
Program focuses on establishing clear standards, training and monitoring of the
Company's billing and coding practices. Furthermore, as part of this Program,
the Company's Corporate Compliance Committee meets on a regular basis to review
various operations and relationships as well as to adopt policies addressing
these issues.
However, the Company is unable to predict how the laws described above
will be applied in the future, and no assurances can be given that its
arrangements or processes will not become subject to scrutiny under these laws.
The Company is unaware of any material violations.
CONFIDENTIALITY OF HEALTH INFORMATION
The Health Insurance Portability and Accountability Act of 1996
("HIPAA") was signed into law on August 21, 1996, and it includes
"administrative simplification" provisions designed to standardize common
electronic transactions in health care and to protect the security and privacy
of health information. Congress' purpose in promulgating HIPAA was to increase
the efficiency of health care transactions while, at the same time, protecting
the confidentiality of patient information. Final regulations have been adopted
for electronic transaction, privacy and security standards. Further, final
regulations adopting a National Employer Identifier to be used in electronic
health care transactions have been finalized. These provisions have very broad
applicability and they specifically apply to health care providers, which
include physicians and clinical laboratories. The deadline for providers to
obtain and implement use of the National Provider Identifier is May 23, 2007.
The National Provider Identifier is an identifier that will replace all other
identifiers that are currently used for healthcare transactions (e.g., UPIN,
Medicaid provider numbers; identifiers assigned by commercial insurers). Those
providers who do not have their National Provider Number by May 23, 2007 will
not be able to conduct common healthcare transactions, such as claims submission
and eligibility verification. Even though there is no cost associated with
obtaining a National Provider Identifier, there could be a significant financial
impact for failure to obtain the National Provider Identifier in a timely
fashion. Enzo has submitted the application for its National Provider Identifier
and is waiting for it to be assigned. It is anticipated that Enzo will receive
its National Provider Identifier well in advance of the deadline.
The electronic transaction standards regulations create guidelines for
certain common health care transactions. With certain exceptions, these
standards require that when we conduct certain transactions electronically with
another provider, clearinghouse or health plan we must comply with the standards
set forth in the regulations. The regulations establish standard data content
and format for submitting electronic claims and other administrative health
transactions. All health care providers will be able to use the electronic
format to bill for their services and all health plans and providers will be
required to accept standard electronic claims, referrals, authorizations, and
other transactions. The Company believes it is in compliance with these
standards. Despite the initial costs, the use of uniform standards for all
electronic transactions could lead to greater efficiency in processing claims
and in handling health care information.
The privacy regulations, which went into effect in April 2003, create
specific requirements for the use and disclosure of protected health information
("PHI"). We are required to maintain numerous policies and procedures in order
to comply with these requirements. Furthermore, we need to continuously ensure
that there mechanisms to safeguard the PHI, which is used or maintained in any
format (e.g., oral, written, or electronic). Failure to comply with these
requirements can result in criminal and civil penalties.
The security regulations, which were finalized in February 2003 and
went into effect April 2005, require us to ensure the confidentiality, integrity
and availability of all electronic protected health information ("EPHI") that we
create, receive, maintain, or transmit. We have some flexibility to fashion our
own security measures to accomplish these goals, but, in general, the starting
point is to determine what security measures we need to take. The security
regulations strongly emphasize that we must conduct an accurate and thorough
assessment of the potential risks and vulnerabilities of the confidentiality,
integrity and availability of our EPHI and then document our response to the
various security regulations on the basis of that assessment.
Complying with the electronic transaction, privacy and security rules
will require significant effort and expense for virtually all entities that
conduct health care transactions electronically and handle patient health
information.
21
The implementation of the Health Insurance Portability and
Accountability Act of 1996 (HIPAA) regulations impacts electronic billing and
the security and privacy of patient identifiable health information by all
health providers, including Enzo Clinical Labs. In response to this challenge,
we have implemented an approach to identify, assess and plan for changes
required by the HIPAA regulations. A HIPAA Oversight Committee ("Oversight
Committee), was formed to coordinate this task. The Oversight Committee consists
of members from management and a designated HIPAA Compliance Officer. We have in
place a framework for activities in this area.
As the HIPAA rules are released and their impact upon our operations
are analyzed, our response to HIPAA is reviewed and revised as necessary.
MEDICAL REGULATED WASTE
We are subject to licensing and regulation under federal, state and
local laws relating to the handling and disposal of medical specimens,
infectious and hazardous waste, as well as to the safety and health of
laboratory employees. All our laboratories are required to operate in accordance
with applicable federal and state laws and regulations relating to biohazard
disposal of all facilities specimens and we use outside vendors to dispose such
specimens. Although we believe that we comply in all respects with such federal,
state and local laws, our failure to comply with those laws could subject us to
denial of the right to conduct business, fines, criminal penalties and/or other
enforcement actions.
OCCUPATIONAL SAFETY
In addition to its comprehensive regulation of safety in the workplace,
the Federal Occupational Safety and Health Administration ("OSHA") has
established extensive requirements relating to workplace safety for health care
employers, including clinical laboratories, whose workers may be exposed to
blood-borne pathogens such as HIV and the hepatitis B virus. These regulations,
among other things, require work practice controls, protective clothing and
equipment, training, medical follow-up, vaccinations and other measures designed
to minimize exposure to, and transmission of, blood-borne pathogens. The Federal
Drug Enforcement Administration regulates the use of controlled substances in
testing for drugs of abuse. We are also subject to OSHA's requirement that
employers using hazardous chemicals communicate the properties and hazards
presented by those chemicals to their employees. We believe that we are in
compliance with these OSHA requirements. Our failure to comply with those
regulations and requirements could subject us to tort liability, civil fines,
criminal penalties and/or other enforcement actions.
OTHER REGULATION
Our business is and will continue to be subject to regulation under
various state and federal environmental, safety and health laws, including the
Occupational Safety and Health Act, the Resource Conservation and Recovery Act,
and the Atomic Energy Act or their state law analogs. These and other laws
govern our use, handling and disposal of various biological, chemical and
radioactive substances used in our operations and wastes generated by our
operations. We are required to possess licenses under, or are otherwise subject
to federal and state regulations pertaining to, the handling and disposal of
medical specimens, infectious and hazardous waste and radioactive materials.
We believe that we are in compliance with applicable environmental,
safety and health laws and that our continual compliance with these laws will
not have a material adverse effect on our business. All of our laboratories are
operated in accordance with applicable federal and state laws and regulations
relating to hazardous substances and wastes, and we use qualified third-party
vendors to dispose of biological specimens and other hazardous wastes. Although
we believe that we comply in all respects with such federal, state and local
laws, our failure to comply with those laws could subject us to denial of the
right to conduct business, civil fines, criminal penalties and/or other
enforcement actions. Environmental contamination resulting from spills or
disposal of hazardous substances generated by our operations, even if caused by
a third-party contractor or occurring at a remote location could result in
material liability.
MANUFACTURING AND FACILITIES
Most of the manufacturing and scientific efforts for our three segments
take place at our leased 43,000 square feet facility in Farmingdale, New York.
We have a completely integrated laboratory and manufacturing facility, with
special handling capabilities and clean rooms suitable for our operations.
We also contract with qualified third-party contractors to manufacture
our products in cases where we deem it appropriate, for example, when it is not
cost-effective to produce a product ourselves or where we seek to leverage the
expertise of another manufacturer in a certain area.
22
In June 2006, we acquired a 22,000 square foot facility adjacent to our
Farmingdale, New York facility that will be utilized, upon completion of
renovations for the Life Science and Therapeutics research and manufacturing
operations.
EMPLOYEES
As of July 31, 2006, we employed 285 full-time and 55 part-time
employees. Of the full-time employees, 35 were engaged in research, development,
manufacturing, and marketing of research products, 10 in therapeutics research,
225 in the clinical laboratories and 15 in finance, legal and administrative
functions. Our scientific staff, including 28 individuals with post doctoral
degrees, possesses a wide range of experience and expertise in the areas of
recombinant DNA, nucleic acid chemistry, molecular biology and immunology. We
believe that the relationships we have established with our employees are good.
INFORMATION SYSTEMS
Information systems are used extensively in virtually all aspects of
our clinical laboratory business, including laboratory testing, billing,
customer service, logistics, and management of medical data. Our success
depends, in part, on the continued and uninterrupted performance of our
information technology systems. Computer systems are vulnerable to damage from a
variety of sources, including telecommunications or network failures, malicious
human acts and natural disasters. Moreover, despite network security measures,
some of our servers are potentially vulnerable to physical or electronic
break-ins, computer viruses and similar disruptive problems. Over the past two
fiscal years, we have invested heavily in the upgrade of our information and
telecommunications systems to improve the quality, efficiency and security of
our businesses. In addition, we have developed and currently maintain, a
proprietary physician connectivity solution, Enzo Direct TM, which provides the
clinical laboratory clients with the ability to electronically laboratory teats
and receive patient results.
Despite the precautionary measures that we have taken to prevent
unanticipated problems that could affect our information technology systems,
sustained or repeated system failures that interrupt our ability to process test
orders, deliver test results or perform tests in a timely manner could adversely
affect our reputation and result in a loss of customers and net revenues
QUALITY ASSURANCE
We consider the quality of our clinical laboratory tests to be of
critical importance, and, therefore, we maintain a comprehensive quality
assurance program designed to help assure accurate and timely test results. In
addition to the compulsory external inspections and proficiency programs
demanded by the Medicare program and other regulatory agencies, our clinical
laboratory has in place systems to emphasize and monitor quality assurance.
In addition to our own internal quality control programs, our
laboratory participates in numerous externally administered, blind quality
surveillance programs, including on-site evaluation by the College of American
Pathologies ("CAP") proficiency testing program and the New York State survey
program. The blind programs supplement all other quality assurance procedures
and give our management the opportunity to review our technical and service
performance from the client's perspective.
The CAP accreditation program involves both on-site inspections of our
laboratory and participation in the CAP's proficiency testing program for all
categories in which our laboratory is accredited by the CAP. The CAP is an
independent nongovernmental organization of board certified pathologists, which
offers an accreditation program to which laboratories can voluntarily subscribe.
A laboratory's receipt of accreditation by the CAP satisfies the Medicare
requirement for participation in proficiency testing programs administered by an
external source. Our clinical laboratory facilities are accredited with
distinction, by the CAP.
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FORWARD-LOOKING AND CAUTIONARY STATEMENTS
This Annual Report contains "forward-looking statements" as defined in
the Private Securities Litigation Reform Act of 1995. All statements other than
statements of historical fact, including, without limitation, the statements
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations" are "forward-looking statements." Forward-looking statements may
include the words "believes," "expects," "plans," "intends," "anticipates,"
"continues" or other similar expressions. These statements are based on the
Company's current expectations of future events and are subject to a number of
risks and uncertainties that may cause the Company's actual results to differ
materially from those described in the forward-looking statements. Should one or
more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those
anticipated, estimated or projected.
The Company files annual, quarterly and current reports, proxy
statements and other information with the Securities and Exchange Commission
(the "SEC"). These filings are available to the public via the Internet at the
SEC's website located at http://www.sec.gov. You may also read and copy any
document the Company files with the SEC at the SEC's public reference room
located at 100 F Street, N.E., Washington, D.C. 20549. For more information,
please call the SEC at 1-800-SEC-0330.
The Company's website is located at www.enzo.com. You may request a
copy of the Company's filings with the SEC (excluding exhibits) at no cost by
writing or telephoning us at the following address or telephone number:
Enzo Biochem, Inc.
527 Madison Avenue
New York, New York 10022
Tel: (212) 583-0100
Attn: Investor Relations
Item 1A - RISK FACTORS
Risks Relating to our Company and our industries
WE HAVE EXPERIENCED SIGNIFICANT LOSSES IN OUR LAST FISCAL
YEAR. IF SUCH LOSSES CONTINUE, THE VALUE OF YOUR ENTIRE INVESTMENT
COULD DECLINE SIGNIFICANTLY.
We incurred a net loss of $15,667,000 for the fiscal year ended July
31, 2006. We cannot assure you that we will be able to achieve net
income on a quarterly or annual basis. If our revenues do not increase,
or if our operating expenses exceed expectations or cannot be reduced,
we will continue to suffer substantial losses which could have an
adverse effect on our business and adversely affect your investment in
our Company
WE FACE INTENSE COMPETITION, WHICH COULD CAUSE US TO DECREASE
THE PRICES FOR OUR PRODUCTS OR SERVICES OR RENDER OUR PRODUCTS
UNECONOMICAL OR OBSOLETE, ANY OF WHICH COULD REDUCE OUR REVENUES AND
LIMIT OUR GROWTH.
Our competitors in the biotechnology industry in the United
States and abroad are numerous and include major pharmaceutical,
energy, food and chemical companies, as well as specialized genetic
engineering firms. Many of our large competitors in genetic engineering
have substantially greater resources than us and have the capability of
developing products which compete directly with our products. Many of
these companies are performing research in the same areas as we are.
Our clinical laboratory business is highly fragmented and
intensely competitive, and we compete with numerous national and local
companies. Some of these entities are larger than we are and have
greater resources than we do. We compete primarily on the basis of the
quality of our testing, reporting and information services, our
reputation in the medical community, the pricing of our services and
our ability to employ qualified laboratory personnel.
24
These competitive conditions could, among other things:
o Require us to reduce our prices to retain market share;
o Require us to increase our marketing efforts which could
reduce our profit margins;
o Increase our cost of labor to attract qualified
laboratory personnel;
o Render our biotechnology products uneconomical or
obsolete; or
o Reduce our revenue.
WE ARE REQUIRED TO EXPEND SIGNIFICANT RESOURCES FOR RESEARCH
AND DEVELOPMENT FOR OUR PRODUCTS IN DEVELOPMENT AND THESE PRODUCTS MAY
NOT BE DEVELOPED SUCCESSFULLY. FAILURE TO SUCCESSFULLY DEVELOP THESE
PRODUCTS MAY PREVENT US FROM EARNING A RETURN ON OUR RESEARCH AND
DEVELOPMENT EXPENDITURES.
The products we are developing are at various stages of
development and clinical evaluations and may require further technical
development and investment to determine whether commercial application
is practicable. There can be no assurance that our efforts will result
in products with valuable commercial applications. Our cash
requirements may vary materially from current estimates because of
results of our research and development programs, competitive and
technological advances and other factors. In any event, we will require
substantial funds to conduct development activities and pre-clinical
and clinical trials, apply for regulatory approvals and commercialize
products, if any, that are developed. We do not have any commitments or
arrangements to obtain any additional financing and there is no
assurance that required financing will be available to us on acceptable
terms, if at all. Even if we spend substantial amounts on research and
development, our potential products may not be developed successfully.
If our product candidates on which we have expended significant amounts
for research and development are not commercialized, we will not earn a
return on our research and development expenditures, which may harm our
business.
PROTECTING OUR PROPRIETARY RIGHTS IS DIFFICULT AND COSTLY. IF
WE FAIL TO ADEQUATELY PROTECT OR ENFORCE OUR PROPRIETARY RIGHTS, WE
COULD LOSE REVENUE.
Our success depends in large part on our ability to obtain
maintain and enforce our patents. Our ability to commercialize any
product successfully will largely depend on our ability to obtain and
maintain patents of sufficient scope to prevent third parties from
developing similar or competitive products. In the absence of patent
protection, competitors may impact our business by developing and
marketing substantially equivalent products and technology.
Patent disputes are frequent and can preclude the
commercialization of products. We have in the past been, are currently,
and may in the future be, involved in material patent litigation, such
as the matters discussed under "Part I--Item 3. Legal Proceedings" in
this report. Patent litigation is time-consuming and costly in its own
right and could subject us to significant liabilities to third parties.
In addition, an adverse decision could force us to either obtain
third-party licenses at a material cost or cease using the technology
or product in dispute.
We have filed applications for United States and foreign
patents covering certain aspects of our technology, but there is no
assurance that pending patents will issue or as to the degree of
protection which any issued patent might afford. We also utilize
certain unpatented proprietary technology.
LAWSUITS IN THE BIOTECHNOLOGY INDUSTRY ARE NOT UNCOMMON. IF WE
BECOME INVOLVED IN ANY SIGNIFICANT LITIGATION, WE WOULD SUFFER AS A
RESULT OF THE DIVERSION OF OUR MANAGEMENT'S ATTENTION, THE EXPENSE OF
LITIGATION AND ANY JUDGMENTS AGAINST US.
In addition to intellectual property litigation, other
substantial, complex or extended litigation could result in large
expenditures by us and distraction of our management. For example,
lawsuits by employees, stockholders, collaborators or distributors
could be very costly and substantially disrupt our business. Disputes
from time to time with companies or individuals are not uncommon in the
biotechnology industry, and we cannot assure you that we will always be
able to resolve them out of court.
25
WE MAY BE UNABLE TO OBTAIN OR MAINTAIN REGULATORY APPROVALS
FOR OUR PRODUCTS, WHICH COULD REDUCE OUR REVENUE OR PREVENT US FROM
EARNING A RETURN ON OUR RESEARCH AND DEVELOPMENT EXPENDITURES.
Our research, preclinical development, clinical trials,
product manufacturing and marketing are subject to regulation by the
FDA and similar health authorities in foreign countries. FDA approval
is required for our products, as well as the manufacturing processes
and facilities, if any, used to produce our products that may be sold
in the United States. The process of obtaining approvals from the FDA
is costly, time consuming and often subject to unanticipated delays.
Even if regulatory approval is granted, such approval may include
significant limitations on indicated uses for which any products could
be marketed. Further, even if such regulatory approvals are obtained, a
marketed product and its manufacturer are subject to continued review,
and later discovery of previously unknown problems may result in
restrictions on such product or manufacturer, including withdrawal of
the product from the market.
New government regulations in the United States or foreign
countries also may be established that could delay or prevent
regulatory approval of our products under development. Further, because
gene therapy is a relatively new technology and has not been
extensively tested in humans, the regulatory requirements governing
gene therapy products are uncertain and may be subject to substantial
further review by various regulatory authorities in the United States
and abroad. This uncertainty may result in extensive delays in
initiating clinical trials and in the regulatory approval process. Our
failure to obtain regulatory approval of their proposed products,
processes or facilities could have a material adverse effect on our
business, financial condition and results of operations. The proposed
products under development may also be subject to certain other
federal, state and local government regulations, including, but not
limited to, the Federal Food, Drug and Cosmetic Act, the Environmental
Protection Act, and Occupational Safety and Health Act, and state,
local and foreign counterparts to certain of such acts.
We cannot be sure that we can obtain necessary regulatory
approvals on a timely basis, if at all, for any of the products we are
developing or manufacturing or that we can maintain necessary
regulatory approvals for our existing products, and all of the
following could have a material adverse effect on our business:
o Significant delays in obtaining or failing to obtain
required approvals;
o Loss of, or changes to, previously obtained approvals;
o Failure to comply with existing or future regulatory
requirements; and
o Changes to manufacturing processes, manufacturing process
standards or Good Manufacturing Practices following
approval or changing interpretations of these factors.
OUR CLINICAL LABORATORY BUSINESS IS SUBJECT TO EXTENSIVE
GOVERNMENT REGULATION AND OUR LOSS OF ANY REQUIRED CERTIFICATIONS OR
LICENSES COULD REQUIRE US TO CEASE OPERATING THIS PART OF OUR BUSINESS,
WHICH WOULD REDUCE OUR REVENUE AND INJURE OUR REPUTATION.
The clinical laboratory industry is subject to significant
governmental regulation at the Federal, state and local levels. Under
the Clinical Laboratory Improvement Act of 1967 and the Clinical
Laboratory Improvement Amendments of 1988 (collectively, as amended,
"CLIA") virtually all clinical laboratories, including ours, must be
certified by the Federal government. Many clinical laboratories also
must meet governmental standards, undergo proficiency testing and are
subject to inspection. Certifications or licenses are also required by
various state and local laws. The failure of our clinical laboratory to
obtain or maintain such certifications or licenses under these laws
could interrupt our ability to operate our clinical laboratory business
and injure our reputation.
REGULATIONS REQUIRING THE USE OF "STANDARD TRANSACTIONS" FOR
HEALTHCARE SERVICES ISSUED UNDER THE HEALTH INSURANCE PORTABILITY AND
ACCOUNTABILITY ACT OF 1996, OR HIPAA, MAY NEGATIVELY IMPACT OUR
PROFITABILITY AND CASH FLOWS.
Pursuant to the Health Insurance Portability and
Accountability Act of 1996, or HIPAA, the Secretary of the Department
of Health and Human Services, or HHS, has issued final regulations
designed to improve the efficiency and effectiveness of the healthcare
system by facilitating the electronic exchange of information in
certain financial and administrative transactions while protecting the
privacy and security of the information
26
exchanged. Three principal regulations have been issued in final form:
standards for electronic transactions, security regulations and privacy
regulations.
The HIPAA transaction standards are complex, and subject to
differences in interpretation by payers. For instance, some payers may
interpret the standards to require us to provide certain types of
information, including demographic information not usually provided to
us by physicians. While most of our transactions are submitted and / or
received in ANSI standard format, inconsistent application of
transaction standards by some remaining payers or our inability to
obtain certain billing information not usually provided to us by
physicians could increase our costs and the complexity of billing. In
addition, new requirements for additional standard transactions, such
as claims attachments, could prove technically difficult,
time-consuming or expensive to implement. We are working closely with
our payers to establish acceptable protocols for claims submissions and
with our industry trade association and an industry coalition to
present issues and problems as they arise to the appropriate regulators
and standards setting organizations.
COMPLIANCE WITH THE HIPAA SECURITY REGULATIONS AND PRIVACY
REGULATIONS MAY INCREASE OUR COSTS.
The HIPAA privacy and security regulations, which became fully
effective in April 2003 and April 2005, respectively, establish
comprehensive federal standards with respect to the uses and
disclosures of protected health information by health plans, healthcare
providers and healthcare clearinghouses, in addition to setting
standards to protect the confidentiality, integrity and availability of
protected health information. The regulations establish a complex
regulatory framework on a variety of subjects, including:
o the circumstances under which uses and disclosures of
protected health information are permitted or required
without a specific authorization by the patient,
including but not limited to treatment purposes,
activities to obtain payments for our services, and our
healthcare operations activities;
o a patient's rights to access, amend and receive an
accounting of certain disclosures of protected health
information;
o the content of notices of privacy practices for protected
health information; and
o administrative, technical and physical safeguards
required of entities that use or receive protected health
information.
We have implemented practices to meet the requirements of the
HIPAA privacy and security regulations, as required by law. The privacy
regulations establish a "floor" and do not supersede state laws that
are more stringent. Therefore, we are required to comply with both
federal privacy regulations and varying state privacy laws. In
addition, for healthcare data transfers from other countries relating
to citizens of those countries, we must comply with the laws of those
other countries. The federal privacy regulations restrict our ability
to use or disclose patient-identifiable laboratory data, without
patient authorization, for purposes other than payment, treatment or
healthcare operations (as defined by HIPAA), except for disclosures for
various public policy purposes and other permitted purposes outlined in
the privacy regulations. The privacy and security regulations provide
for significant fines and other penalties for wrongful use or
disclosure of protected health information, including potential civil
and criminal fines and penalties. Although the HIPAA statute and
regulations do not expressly provide for a private right of damages, we
also could incur damages under state laws to private parties for the
wrongful use or disclosure of confidential health information or other
private personal information.
Compliance with all of the HIPAA regulations, including new
standard transactions, requires ongoing resources from all healthcare
organizations, not just clinical laboratories. While we believe our
total costs to comply with HIPAA will not be material to our operations
or cash flows, new standard transactions and additional customer
requirements resulting from different interpretations of the current
regulations could impose additional costs on us.
REIMBURSEMENTS FROM THIRD-PARTY PAYERS, UPON WHICH OUR
CLINICAL LABORATORY BUSINESS IS DEPENDENT, ARE SUBJECT TO INCONSISTENT
RATES AND COVERAGE AND LEGISLATIVE REFORM THAT ARE BEYOND OUR CONTROL.
THIS INCONSISTENCY AND ANY REFORM THAT DECREASES COVERAGE AND RATES
COULD REDUCE OUR EARNINGS AND HARM OUR BUSINESS.
27
Our clinical laboratory business is primarily dependent upon
reimbursement from third-party payers, such as Medicare (which
principally serves patients 65 and older) and insurers. We are subject
to variances in reimbursement rates among different third-party payers,
as well as constant renegotiation of reimbursement rates. We also are
subject to audit by Medicare which can result in the return of payments
made to us under these programs. These variances, rates and audit
results could reduce our margins and thus our earnings.
The health care industry continues to undergo significant
change as third-party payers' increase their efforts to control the
cost, utilization and delivery of health care services. In an effort to
address the problem of increasing health care costs, legislation has
been proposed or enacted at both the Federal and state levels to
regulate health care delivery in general and clinical laboratories in
particular. Some of the proposals include managed competition, global
budgeting and price controls. Changes that decrease reimbursement rates
or coverage, or increase administrative burdens on billing third-party
payers could reduce our revenues and increase our expenses.
FDA REGULATION OF LABORATORY-DEVELOPED TESTS, ANALYTE SPECIFIC
REAGENTS, OR GENETIC TESTING COULD LEAD TO INCREASED COSTS AND DELAYS
IN INTRODUCING NEW GENETIC TESTS.
The FDA has regulatory responsibility over instruments, test
kits, reagents and other devices used to perform diagnostic testing by
clinical laboratories. In the past, the FDA has claimed regulatory
authority over laboratory-developed tests, but has exercised
enforcement discretion in not regulating tests performed by high
complexity CLIA-certified laboratories. In December 2000, the HHS
Secretary's Advisory Committee on Genetic Testing recommended that the
FDA be the lead federal agency to regulate genetic testing. In late
2002, a new HHS Secretary's Advisory Committee on Genetics, Health and
Society, or SACGHS, was appointed to replace the prior Advisory
Committee. Ultimately, SACGHS decided that it would continue to monitor
the progress of the federal agencies in the oversight of genetic
technologies, but it did not believe that further action was warranted.
In the meantime, the FDA is considering revising its regulations on
analyte specific reagents, which are used in laboratory-developed
tests, including laboratory-developed genetic testing. FDA interest in
or actual regulation of laboratory-developed tests or increased
regulation of the various medical devices used in laboratory-developed
testing could lead to periodic inquiry letters from the FDA and
increased costs and delays in introducing new tests, including genetic
tests.
THE CONTINUED GROWTH OF MANAGED CARE MAY REDUCE OUR REVENUES
AND INCREASE OUR LOSS OR REDUCE OUR NET EARNINGS.
The number of individuals covered under managed care contracts
or other similar arrangements has grown over the past several years and
may continue to grow in the future. In addition, Medicare and other
government healthcare programs may continue to shift to managed care.
Entities providing managed care coverage have reduced payments for
medical services, including clinical laboratory services, in numerous
ways such as entering into arrangements under which payments to a
service provider are capitated, limiting testing to specified
procedures, denying payment for services performed without prior
authorization and refusing to increase fees for specified services.
These trends reduce our revenues and limit our ability to pass cost
increases to our customers. Also, if these or other managed care
organizations do not select us as a participating provider, we may lose
some or all of that business, which could have an adverse effect on our
business, financial condition and results of operations.
COMPLIANCE WITH MEDICARE ADMINISTRATIVE POLICIES, INCLUDING
THOSE PERTAINING TO CERTAIN AUTOMATED BLOOD CHEMISTRY PROFILES, MAY
REDUCE THE REIMBURSEMENTS WE RECEIVE.
Containment of health care costs, including reimbursement for
clinical laboratory services, has been a focus of ongoing governmental
activity. In 1984, Congress established the Medicare fee schedule for
clinical laboratory services, which is applicable to patients covered
under Part B of the Medicare program. Clinical laboratories must bill
Medicare directly for the services provided to Medicare beneficiaries
and may only collect the amounts permitted under this fee schedule.
Reimbursement to clinical laboratories under the Medicare Fee Schedule
has been steadily declining since its inception. Furthermore, Medicare
has mandated use of the Physicians Current Procedural Terminology, or
CPT, for coding of laboratory services which has altered the way we
bill these programs for some of our services, thereby reducing the
reimbursement that we receive.
In March 1996, HCFA (now, the Center for Medicare and Medicaid
Services or CMS) implemented changes in the policies used to administer
Medicare payments to clinical laboratories for the most frequently
28
performed automated blood chemistry profiles. Among other things, the
changes established a consistent standard nationwide for the content of
the automated chemistry profiles. Another change requires laboratories
performing certain automated blood chemistry profiles to obtain and
provide documentation of the medical necessity of tests included in the
profiles for each Medicare beneficiary. Reimbursements have been
reduced as a result of this change. Because a significant portion of
our costs is fixed, these Medicare reimbursement reductions and changes
have a direct adverse effect on our net earnings and cash flows.
WE DEPEND ON KEY EMPLOYEES IN A COMPETITIVE MARKET FOR SKILLED
PERSONNEL, AND THE LOSS OF THE SERVICES OF ANY OF OUR KEY EMPLOYEES,
INCLUDING OUR SENIOR MANAGEMENT, COULD DELAY OUR RESEARCH AND
DEVELOPMENT PROGRAMS AND WOULD ADVERSELY AFFECT OUR ABILITY TO DEVELOP
OUR BUSINESS.
The specialized scientific nature of our business requires us
to attract and retain personnel with a wide variety of scientific
capabilities. There is intense competition in the biotechnology
industry for qualified scientific and technical personnel. To a large
extent, our success in developing proprietary technological products
has been the result of the effective efforts of our internal scientific
staff and our experience and talent. Since our inception an
insignificant number of key employees have left us. We have key man
life insurance on Dr. Elazar Rabbani, our Chief Executive Officer, in
the amount of $3,000,000. There can be no assurance that we will
continue to attract and retain personnel of high scientific caliber. If
we lose the services of our management and scientific personnel and
fail to recruit other scientific and technical personnel, our research
and development programs could be materially and adversely delayed.
NEGATIVE PUBLICITY AND NEWS COVERAGE ABOUT US OR THE CLINICAL
LABORATORY INDUSTRY MAY HARM OUR BUSINESS AND OPERATING RESULTS.
In the past, the clinical laboratory industry has received
negative publicity. This publicity has led to increased legislation,
regulation, and review of industry practices. These factors may
adversely affect our ability to market our services, require us to
change our services and increase the regulatory burdens under which we
operate, further increasing the costs of doing business and adversely
affecting our operating results.
ADVERSE PERCEPTION AND INCREASED REGULATORY SCRUTINY OF GENE
MEDICINE AND GENETIC RESEARCH MIGHT LIMIT OUR ABILITY TO CONDUCT OUR
BUSINESS.
Ethical, social and legal concerns about gene medicine,
genetic testing and genetic research could result in additional
regulations restricting or prohibiting the technologies we or our
collaborators may use. Recently, gene medicine studies have come under
increasing scrutiny, which has delayed ongoing and could delay future
clinical trials and regulatory approvals. Federal and state agencies,
congressional committees and foreign governments have expressed
interest in further regulating biotechnology. More restrictive
regulations or claims that our products are unsafe or pose a hazard
could prevent us from commercializing any products.
OUR FUTURE SUCCESS WILL DEPEND IN PART UPON OUR ABILITY TO
ENHANCE EXISTING PRODUCTS AND TO DEVELOP AND INTRODUCE NEW PRODUCTS.
The market for our products is characterized by rapidly
changing technology, evolving industry standards and new product
introductions, which may make our existing products obsolete. Our
future success will depend in part upon our ability to enhance existing
products and to develop and introduce new products.
The development of new or enhanced products is a complex and
uncertain process requiring the accurate anticipation of technological
and market trends as well as precise technological execution. In
addition, the successful development of new products will depend on the
development of new technologies. We will be required to undertake
time-consuming and costly development activities and to seek regulatory
approval for these new products. We may experience difficulties that
could delay or prevent the successful development, introduction and
marketing of these new products. Regulatory clearance or approval of
any new products may not be granted by the FDA or foreign regulatory
authorities on a timely basis, or at all, and the new products may not
be successfully commercialized.
OUR INABILITY TO CARRY OUT OUR CERTAIN OF OUR MARKETING AND
SALES PLANS MAY MAKE IT DIFFICULT FOR US TO GROW OR MAINTAIN OUR
BUSINESS.
29
During fiscal 2006, Enzo Life Sciences continued to implement
an aggressive marketing program designed to more directly service its
end users, while simultaneously positioning us for product line
expansion. The program involves continuing to expand the reach of
companies by the direct field sales force, develop a focused
advertising campaign, continued attendance at top industry trade
meetings, and publications in leading scientific journals, as well as
the on-going enhancement of our interactive web site. In addition to
our direct sales, we distribute our products through our international
distribution network. If we are unable to successfully implement these
programs, we may be unable to grow and our business could suffer.
BECAUSE OF COMPETITIVE PRESSURES AND THE COMPLEXITY AND
EXPENSE OF THE BILLING PROCESS IN OUR CLINICAL LABORATORY BUSINESS, WE
MUST OBTAIN NEW CUSTOMERS WHILE MAINTAINING EXISTING CUSTOMERS TO GROW
OUR BUSINESS.
Intense competition in the clinical laboratory business,
increasing administrative burdens upon the reimbursement process and
reduced coverage and payments by insurers make it necessary for us to
increase our volume of laboratory services. To do so, we must obtain
new customers while retaining existing customers. Our failure to
attract new customers or the loss of existing customers or a reduction
in business from those customers could significantly reduce our
revenues and impede our ability to grow.
WE DEPEND ON SUPPLIERS FOR MATERIALS THAT COULD IMPAIR OUR
ABILITY TO MANUFACTURE OUR PRODUCTS.
Outside vendors provide key components and raw materials used
in the manufacture of our products. Although we believe that
alternative sources for these components and raw materials are
available, any supply interruption in a limited or sole source
component or raw material would harm our ability to manufacture our
products until a new source of supply is identified and qualified. In
addition, an uncorrected defect or supplier's variation in a component
or raw material, either unknown to us or incompatible with our
manufacturing process, could harm our ability to manufacture products.
We might not be able to find a sufficient alternative supplier in a
reasonable time period, or on commercially reasonable terms, if at all.
If we fail to obtain a supplier for the components of our products, our
operations could be disrupted.
WE USE HAZARDOUS MATERIALS IN OUR BUSINESS. ANY CLAIMS
RELATING TO IMPROPER HANDLING, STORAGE OR DISPOSAL OF THESE MATERIALS
COULD BE COSTLY AND TIME-CONSUMING.
Our manufacturing, clinical laboratory and research and
development processes involve the storage, use and disposal of
hazardous substances, including hazardous chemicals, biological
hazardous materials and radioactive compounds. We are subject to
federal, state and local regulations governing the use, manufacture,
storage, handling and disposal of materials and waste products.
Although we believe that our safety and environmental management
practices and procedures for handling and disposing of these hazardous
materials are in accordance with good industry practice and comply with
applicable laws, permits, licenses and regulations, the risk of
accidental environmental or human contamination or injury from the
release or exposure of hazardous materials cannot be completely
eliminated. In the event of an accident, we could be held liable for
any damages that result, including environmental clean-up or
decontamination costs, and any such liability could exceed the limits
of, or fall outside the coverage of, our insurance. We may not be able
to maintain insurance on acceptable terms, or at all. We could be
required to incur significant costs to comply with current or future
environmental and public and workplace safety and health laws and
regulations.
WE PURCHASE INSURANCE TO COVER OUR POTENTIAL BUSINESS RISK.
Although we believe that our present insurance coverage is
sufficient to cover our current estimated exposures, we cannot assure
that we will not incur liabilities in excess of our policy limits. In
addition, although we believe that will be able to continue to obtain
adequate coverage, we cannot assure that we will be able to do so at
acceptable costs.
RISKS RELATING TO OUR COMMON STOCK
OUR STOCK PRICE HAS BEEN VOLATILE, WHICH COULD RESULT IN
SUBSTANTIAL LOSSES FOR INVESTORS.
Our common stock is quoted on the New York Stock Exchange, and
there has been historical volatility in the market price of our common
stock. The trading price of our common stock has been, and is likely to
continue to be, subject to significant fluctuations due to a variety of
factors, including:
30
o fluctuations in our quarterly operating and earnings per
share results;
o the gain or loss of significant contracts;
o loss of key personnel;
o announcements of technological innovations or new
products by us or our competitors;
o delays in the development and introduction of new
products;
o legislative or regulatory changes;
o general trends in the industry;
o recommendations and/or changes in estimates by equity and
market research analysts;
o biological or medical discoveries;
o disputes and/or developments concerning intellectual
property, including patents and litigation matters;
o public concern as to the safety of new technologies;
o sales of common stock of existing holders;
o securities class action or other litigation;
o developments in our relationships with current or future
customers and suppliers; and
o general economic conditions, both in the United States
and abroad.
In addition, the stock market in general has experienced
extreme price and volume fluctuations that have affected the market
price of our common stock, as well as the stock of many companies in
our industries. Often, price fluctuations are unrelated to operating
performance of the specific companies whose stock is affected.
In the past, following periods of volatility in the market
price of a company's stock, securities class action litigation has
occurred against the issuing company. If we were subject to this type
of litigation in the future, we could incur substantial costs and a
diversion of our management's attention and resources, each of which
could have a material adverse effect on our revenue and earnings. Any
adverse determination in this type of litigation could also subject us
to significant liabilities.
BECAUSE WE DO NOT INTEND TO PAY CASH DIVIDENDS ON OUR COMMON
STOCK, AN INVESTOR IN OUR COMMON STOCK WILL BENEFIT ONLY IF IT
APPRECIATES IN VALUE.
We currently intend to retain our retained earnings and future
earnings, if any, to finance the expansion of our business and do not
expect to pay any cash dividends on our common stock in the foreseeable
future. As a result, the success of an investment in our common stock
will depend entirely upon any future appreciation. There is no
guarantee that our common stock will appreciate in value or even
maintain the price at which an investor purchased her shares.
IT MAY BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US, WHICH
COULD INHIBIT STOCKHOLDERS FROM REALIZING A PREMIUM ON THEIR STOCK
PRICE.
We are subject to the New York anti-takeover laws regulating
corporate takeovers. These anti-takeover laws prohibit certain business
combinations between a New York corporation and any "interested
shareholder" (generally, the beneficial owner of 20% or more of the
corporation's voting shares) for five years following the time that the
shareholder became an interested shareholder, unless the corporation's
board of directors approved the transaction prior to the interested
shareholder becoming interested.
31
Our certificate of incorporation, as amended, and by-laws
contain provisions that could have the effect of delaying, deferring or
preventing a change in control of us that stockholders may consider
favorable or beneficial. These provisions could discourage proxy
contests and make it more difficult for stockholders to elect directors
and take other corporate actions. These provisions could also limit the
price that investors might be willing to pay in the future for shares
of our common stock. These provisions include:
o a staggered board of directors, so that it would take
three successive annual meetings to replace all
directors; and
o advance notice requirements for the submission by
stockholders of nominations for election to the board of
directors and for proposing matters that can be acted
upon by stockholders at a meeting.
FUTURE SALES OF SHARES OF OUR COMMON STOCK OR THE ISSUANCE OF
SECURITIES SENIOR TO OUR COMMON STOCK COULD ADVERSELY AFFECT THE
TRADING PRICE OF OUR COMMON STOCK AND OUR ABILITY TO RAISE FUNDS IN NEW
EQUITY OFFERINGS.
We are not restricted from issuing additional common stock,
preferred stock or securities convertible into or exchangeable for
common stock. Future sales of a substantial number of our shares of
common stock or equity-related securities in the public market or
privately, or the perception that such sales could occur, could
adversely affect prevailing trading prices of our common stock, and
could impair our ability to raise capital through future offerings of
equity or equity-related securities. No prediction can be made as to
the effect, if any, that future sales of shares of common stock or the
availability of shares of common stock for future sale, will have on
the trading price of our common stock.
THERE IS NO ASSURANCE THAT WE WILL REMAIN LISTED ON AN ACTIVE
TRADING MARKET.
Although our common stock is quoted on the New York Stock Exchange,
there can be no assurance that we will, in the future, be able to meet all the
requirements for continued quotation on that exchange. In the absence of an
active trading market or if our common stock cannot be traded on the New York
Stock Exchange, our common stock could instead be traded on the OTC Bulletin
Board or in the Pink Sheets. In such event, the liquidity and stock price in the
secondary market may be adversely affected. In addition, in the event our common
stock was de-listed; broker-dealers have certain regulatory burdens imposed upon
them which may discourage them from effecting transactions in our common stock
and hence, could further limit the liquidity of our common stock.
These and other risks and uncertainties are disclosed from time to time
in the Company's filings with the Securities and Exchange Commission, in the
Company's press releases and in oral statements made by or with the approval of
authorized personnel. The Company assumes no obligation to update any
forward-looking statements as a result of new information or future events or
developments.
Item 1B - UNRESOLVED STAFF COMMENTS
None.
Item 2. PROPERTIES
The following are the principal facilities of the Company:
Approximate Lease expiration
Location Principal Operations Area (Sq. Ft.) Base Rent Date
-------- -------------------- -------------- --------- ----
60 Executive Blvd Clinical laboratory, research 43,000 $1,193,000 March 31, 2017
Farmingdale, N.Y. and manufacturing facilities
(See Note 11 of Notes to
Consolidated Financial Statements)
10 Executive Blvd Note 1 below 22,000 Owned N/A
Farmingdale, NY
527 Madison Ave Corporate headquarters 6,400 $367,000 December 31, 2013
New York, NY
In March 2005, the Company amended and extended the lease for its
Farmingdale laboratory and headquarters for a period of 12 years. We believe the
current facilities are suitable and adequate for the Company's current operating
needs for its clinical laboratories, life science and therapeutics segments, and
that the production capacity in the Farmingdale facility is being substantially
utilized.
Note 1 - In June 2006, we acquired a 22,000 square foot facility
adjacent to our Farmingdale, New York facility that will be utilized, upon
completion of renovations, for the Life Science and Therapeutics research and
manufacturing operations. The new facility will be used to manage the additional
space required for the anticipated growth.
32
Item 3. LEGAL PROCEEDINGS
In October 2002, the Company filed suit in the United States District
Court of the Southern District of New York against Amersham plc, Amersham
Biosciences, Perkin Elmer, Inc., Perkin Elmer Life Sciences, Inc., Sigma-Aldrich
Corporation, Sigma Chemical Company, Inc., Molecular Probes, Inc. and Orchid
Biosciences, Inc. In January 2003, the Company amended its Complaint to include
defendants Sigma Aldrich Co. and Sigma Aldrich, Inc. The counts set forth in the
suit are for breach of contract; patent infringement; unfair competition under
state law; unfair competition under federal law; tortious interference with
business relations; and fraud in the inducement of contract. The Complaint
alleges that these counts arise out of the defendants' breach of distributorship
agreements with the Company concerning labeled nucleotide products and
technology, and the defendants' infringement of patents covering the same. In
April, 2003, the Court directed that individual Complaints be filed separately
against each defendant. The defendants have answered the individual Complaints
and asserted a variety of affirmative defenses and counterclaims. Fact discovery
is ongoing. The Court issued a claim construction opinion on July 10, 2006. The
Company and Sigma Aldrich ("Sigma") entered into a Settlement Agreement and
Release effective September 15, 2006 (the "Agreement"). Pursuant to the
Agreement, the Company's litigation with Sigma was dismissed and the Company
will recognize $2 million on settlement in the first quarter ending October 31,
2006. There can be no assurance that the Company will be successful with the
remaining outstanding litigation. However, even if the Company is not
successful, management does not believe that there will be a significant adverse
monetary impact to the Company. The Company has not recorded revenue under these
agreements in fiscal 2006. The Company recorded revenue from only Perkin Elmer
in fiscal 2005.
On October 28, 2003, the Company and Enzo Life Sciences, Inc., a
subsidiary of the Company, filed suit in the United States District Court of the
Eastern District of New York against Affymetrix, Inc. The Complaint alleges that
Affymetrix improperly transferred or distributed substantial business assets of
the Company to third parties, including portions of the Company's proprietary
technology, reagent systems, detection reagents and other intellectual property.
The Complaint also charges that Affymetrix failed to account for certain
shortfalls in sales of the Company's products, and that Affymetrix improperly
induced collaborators and customers to use the Company's products in
unauthorized fields or otherwise in violation of the agreement. The Complaint
seeks full compensation from Affymetrix to the Company for its substantial
damages, in addition to injunctive and declaratory relief to prohibit, among
other things, Affymetrix's unauthorized use, development, manufacture, sale,
distribution and transfer of the Company's products, technology, and/or
intellectual property, as well as to prohibit Affymetrix from inducing
collaborators, joint venture partners, customers and other third parties to use
the Company's products in violation of the terms of the agreement and the
Company's rights. Subsequent to the filing of the Complaint against Affymetrix,
Inc. referenced above, on or about November 10, 2003, Affymetrix, Inc. filed its
own Complaint against the Company and its subsidiary, Enzo Life Sciences, Inc.,
in the United States District Court for the Southern District of New York,
seeking among other things, declaratory relief that Affymetrix, Inc., has not
breached the parties' agreement, that it has not infringed certain of Enzo's
Patents, and that certain of Enzo's patents are invalid. The Affymetrix
Complaint also seeks damages for alleged breach of the parties' agreement,
unfair competition, and tortuous interference, as well as certain injunction
relief to prevent alleged unfair competition and tortuous interference. The
Company does not believe that the Affymetrix Complaint has any merit and intends
to defend vigorously. Affymetrix also moved to transfer venue of Enzo's action
to the Southern District of New York, where other actions commenced by Enzo were
pending as well as Affymetrix's subsequently filed action. On January 30, 2004,
Affymetrix's motion to transfer was granted. Accordingly, the Enzo and
Affymetrix actions are now both pending in the Southern District of New York.
Initial pleadings have been completed and discovery has commenced. The Court
issued a Marksman (claim construction) opinion on July 10, 2006. The Company did
not record any revenue from Affymetrix during the fiscal years ended July 31,
2006, 2005 and 2004.
On June 2, 2004 Roche Diagnostic GmbH and Roche Molecular Systems, Inc.
(collectively "Roche") filed suit in the U.S. District Court of the Southern
District of New York against Enzo Biochem, Inc. and Enzo Life Sciences, Inc.
(collectively "Enzo"). The Complaint was filed after Enzo rejected Roche's
latest cash offer to settle Enzo's claims for, INTER ALIA, alleged breach of
contract and misappropriation of Enzo's assets. The Complaint seeks declaratory
judgment (i) of patent invalidity with respect to Enzo's 4,994,373 patent (the
"'373 patent"), (ii) of no breach by Roche of its 1994 Distribution and Supply
Agreement with Enzo (the "1994 Agreement"), (iii) that non-payment by Roche to
Enzo for certain sales of Roche products does not constitute a breach of the
1994 Agreement, and (iv) that Enzo's claims of ownership to proprietary
inventions, technology and products developed by Roche are without basis. In
addition, the suit claims tortious interference and unfair competition. The
Company does not believe that the Complaint has merit and intends to vigorously
respond to such action with appropriate affirmative defenses and counterclaims.
Enzo filed an Answer and Counterclaims on November 3, 2004 alleging multiple
breaches of the 1994 Agreement and related infringement of Enzo's `373 patent.
Discovery has commenced. The Court issued a Markman opinion on July 10, 2006.
The Company did not record any revenue from Roche during the fiscal year ended
July 31, 2006.
On March 6, 2002, the Company was named, along with certain of its
officers and directors among others, in a complaint entitled Lawrence F. Glaser
and Maureen Glaser, individually and on behalf of Kimberly, Erin, Hannah, and
Benjamin Glaser v. Hyman Gross, Barry Weiner, Enzo Biochemical Inc., Elazar
Rabbani, Shahram Rabbani, John
33
Delucca, Dean Engelhardt, Richard Keating, Doug Yates, and Does I-50, Case No.
CA-02-1242-A (the "Glasser Action"), in the U.S. District Court for the Eastern
District of Virginia. This complaint was filed by an investor in the Company who
had filed for bankruptcy protection and his family. The complaint alleged
securities fraud, breach of fiduciary duty, conspiracy, and common law fraud and
sought in excess of $150 million in damages. On August 22, 2002, the complaint
was voluntarily dismissed; however a new substantially similar complaint was
filed at the same time. On October 21, 2002, the Company and the other
defendants filed a motion to dismiss the complaint, and the plaintiffs responded
by amending the complaint and dropping their claims against defendants Keating
and Yates. On November 18, 2002, the Company and the other defendants again
moved to dismiss the Amended Complaint. On July 16, 2003, the Court issued a
Memorandum Opinion dismissing the Amended Complaint in its entirety with
prejudice. Plaintiffs thereafter moved for reconsideration but the Court denied
the motion on September 8, 2003. Plaintiffs thereafter appealed the decision to
the United States Court of Appeals for the Fourth Circuit. On March 21, 2005,
the Fourth Circuit affirmed the lower Court's prior dismissal of all claims
asserted in the action, with the sole exception of a portion of the claim for
common law fraud and remanded that remaining portion of the action to the U.S.
District Court for the Eastern District of Virginia. On May 20, 2005, defendants
again moved the District Court to dismiss the sole remaining claim before it. On
July 14, 2005, the District Court granted defendants' renewed motion to dismiss.
On July 29, 2005, Plaintiffs moved to amend their Complaint for reconsideration.
On August 19, 2005, the Court denied Plaintiffs' motion to amend and entered
final judgment dismissing the complaint. Thereafter, Plaintiffs appealed the
order and judgment to the Fourth Circuit. On September 16, 2006, the United
States Court of Appeals for the Fourth Circuit affirmed the dismissal of the
Complaint relating to the Glasser Action. Although the Glasser plaintiffs still
have the option of requesting a rehearing before the Fourth Circuit or
petitioning for a writ of certiorari from the United States Supreme Court,
absent such further relief, the Glasser Action will be closed. The Company
continues to believe that the Glasser Action and the remaining complaint has no
merit whatsoever and intends to continue to defend the actions vigorously.
On June 7, 2004, the Company and its wholly-owned subsidiary, Enzo Life
Sciences, Inc., filed suit in the United States District Court for the District
of Connecticut against Applera Corporation and its wholly-owned subsidiary
Tropix, Inc. The complaint alleges infringement of six patents (relating to DNA
sequencing systems, labelled nucleotide products, and other technology). Yale
University is the owner of four of the patents and the Company is the exclusive
licensee. Accordingly, Yale is also a plaintiff in the lawsuit. Yale and Enzo
are aligned in protecting the validity and enforceability of the patents. Enzo
Life Sciences is the owner of the remaining two patents. The complaint seeks
permanent injunction and damages (including treble damages for wilful
infringement). Defendants answered the complaint on July 29, 2004. The answer
pleads affirmative defences of invalidity, estoppels and laches and asserts
counterclaims of non-infringement and invalidity. Fact discovery is ongoing. A
one-day Markman hearing was held on May 25, 2006 and the parties are currently
waiting for a Markman ruling. Dispositive motions due dates are based on the
Markman ruling date. The trial date is currently scheduled for December 1, 2006.
There can be no assurance that the Company will be successful in this
litigation. Even if the Company is not successful, management does not believe
that there will be a significant adverse monetary impact on the Company.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were brought to a vote of the Company's stockholders in the
fourth fiscal quarter ended July 31, 2006.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The common stock of the Company is traded on the New York Stock
Exchange (Symbol:ENZ). The following table sets forth the high and low price of
the Company's Common Stock for the periods indicated as reported on the New York
Stock Exchange.
2005 Fiscal Year (August 1, 2004 to July 31, 2005):
HIGH LOW
1st Quarter $17.69 $11.15
2nd Quarter $20.40 $17.27
3rd Quarter $19.27 $13.62
4th Quarter $18.24 $14.08
2006 Fiscal Year (August 1, 2005 to July 31, 2006):
1st Quarter $17.30 $12.92
2nd Quarter $14.10 $12.40
3rd Quarter $13.55 $11.67
4th Quarter $15.08 $9.30
34
As of September 30, 2006, the Company had approximately 1,070
stockholders of record of its Common Stock.
The Company has not paid a cash dividend on its Common Stock and
intends to continue a policy of retaining earnings to finance and build its
operations. Accordingly, the Company does not anticipate the payment of cash
dividends to holders of Common Stock in the foreseeable future. During fiscal
2005, the Company's board of directors declared a 5% stock dividend on October
5, 2004 payable November 15, 2004 to shareholders of record as of October 25,
2004. The fiscal 2004 per share data was adjusted retroactively to reflect the
stock dividend declared on October 5, 2004. The Company recorded a charge to
accumulated deficit and offsetting credits to both common stock and additional
paid-in capital of approximately $23,433,400 in fiscal 2005 which reflects the
fair value of the stock dividends on the dates of declaration
Item 6. SELECTED FINANCIAL DATA
The following table, which is derived from the audited consolidated
financial statements of the Company for the fiscal years 2002 through 2006
should be read together with the discussion in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Company's
consolidated financial statements and notes to those statements included
elsewhere in this Annual Report on Form 10-K.
For the fiscal year ended July 31,
(In thousands, except per share amounts)
---------------------------------------------------------
OPERATING RESULTS 2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
Operating revenues $ 39,826 $ 43,403 $ 41,644 $ 52,767 $ 54,015
Gain on patent litigation settlement -- 14,000 -- -- --
Interest income 3,144 1,523 1,152 1,355 1,350
(Loss) Income before income taxes (17,009) 5,217 (11,080) 5,725 10,340
Benefit (provision) for income taxes 1,342 (2,213) 4,848 (1,881) (3,417)
-------- -------- -------- -------- --------
Net (loss) income (15,667) 3,004 (6,232) 3,844 6,923
======== ======== ======== ======== ========
Basic net (loss) income per common share: $ (0.49) $ 0.09 $ (0.20) $ 0.12 $ 0.22
======== ======== ======== ======== ========
Diluted net (loss) income per common share: $ (0.49) $ 0.09 $ (0.20) $ 0.12 $ 0.21
======== ======== ======== ======== ========
Weighted average common shares
Basic 32,215 32,097 31,700 31,399 31,359
Diluted 32,215 32,763 31,700 32,175 32,327
July 31,
---------------------------------------------------------
FINANCIAL POSITION (IN 000'S): 2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
Working capital $ 80,161 $ 96,280 $ 92,259 $ 97,723 $ 92,772
Total assets 101,524 116,466 110,334 115,878 109,291
Long term obligations -- 150 300 -- --
Stockholders' equity 95,587 108,267 104,166 109,380 104,733
35
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 in conjunction with our financial statements and
related notes. This discussion contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ materially from those
anticipated in these forward-looking statements. See "Forward-Looking and
Cautionary Statements." Because of the foregoing factors, you should not rely on
past financial results as an indication of future performance. We believe that
period-to-period comparisons of our financial results to date are not
necessarily meaningful and expect that our results of operations might fluctuate
from period to period in the future.
The Company is a life sciences and biotechnology company focused on
harnessing genetic processes to develop research tools and therapeutics and the
provision of diagnostic services to the medical community. Since its founding in
1976, Enzo's strategic focus has been on the development, for commercial
purposes, of enabling technologies in the life sciences field. Enzo's pioneering
work in genomic analysis coupled with its extensive patent estate and enabling
platforms have strategically positioned Enzo to play a crucially important role
in the rapidly growing life sciences and molecular medicine marketplaces
The Company is comprised of three interconnected operating companies
that have evolved out of Enzo's core competence: the use of nucleic acids as
informational molecules and the use of compounds for immune modulation. These
wholly owned operating companies conduct their operations through three
segments. Below are brief descriptions of each of the three operating segments
(see Note 13 in the notes to consolidated financial statements):
ENZO LIFE SCIENCES is a company that manufacturers, develops and
markets biomedical research products and tools to research and pharmaceutical
customers around the world and has amassed a large patent and technology
portfolio. The pioneering platforms developed by Enzo Life Sciences enable the
development of a wide range of products in the research products marketplace.
ENZO THERAPEUTICS is a biopharmaceutical company that has developed
multiple novel approaches in the areas of gastrointestinal, infectious,
ophthalmic and metabolic diseases, many of which are derived from the pioneering
work of Enzo Life Sciences. The Company has focused its efforts on developing
treatment regimens for diseases and conditions in which current treatment
options are ineffective, costly, and/or cause unwanted side effects. This focus
has generated a clinical and preclinical pipeline, as well as more than 40
patents and patent applications.
ENZO CLINICAL LABS is a regional clinical laboratory to the greater New
York and New Jersey medical community. The Company believes having this
capability allows us to capitalize firsthand on our extensive advanced molecular
and cytogenetic capabilities and the broader trends in predictive diagnostics.
We offer a menu of routine and esoteric clinical laboratory tests or procedures
used in general patient care by physicians to establish or support a diagnosis,
monitor treatment or medication, or search for an otherwise undiagnosed
condition. We operate a full-service clinical laboratory in Farmingdale, New
York, a network of 19 patient service centers, a stand alone "stat" or rapid
response laboratory in New York City, and a full-service phlebotomy department.
The Company's sources of revenue from the Life Sciences segment have
been from the direct sales of products consisting of labeling and detection
reagents for the genomics and sequencing markets, as well as through
non-exclusive distribution agreements with other companies and royalty income.
Another source of revenue has been from the clinical laboratory service market.
Payments for clinical laboratory testing services are made by the Medicare
program, healthcare insurers and patients. Fees billed to patients, Medicare,
and third party payers are billed on the laboratory's standard gross fee
schedule, subject to any limitations on fees negotiated with the third party
payers or with the ordering physicians on behalf of their patients.
36
The Company incurs additional costs as a result of our participation in
the Medicare programs, as billing and reimbursement for clinical laboratory
testing is subject to considerable and complex federal regulations. Compliance
with applicable laws and regulations, as well as internal compliance policies
and procedures, adds further complexity and costs to our operations. Government
payers such as Medicare, as well as healthcare insurers have taken steps and may
continue to take steps to control the costs, utilizations and delivery of
healthcare services, including clinical laboratory services. Principally as a
result of reimbursement reductions and measures adopted by the Centers for
Medicare & Medicaid Services, or CMS, which establishes procedures and
continuously evaluates and implements changes in the reimbursement process to
control utilization. Despite the added cost and complexity of participating in
the Medicare program, we continue to participate because we believe that our
other business may depend, in part, on continued participation in Medicare since
certain ordering physicians may want a single laboratory capable of performing
all of their clinical laboratory testing services, regardless of who pays for
such services.
Information systems are used extensively in virtually all aspects of
the clinical laboratory operations, including testing, billing, customer
service, logistics, and management of medical data. Our success depends, in
part, on the continued and uninterrupted performance of our information
technology systems. Through maintenance, staffing, and investments in our
information technology system, we expect to limit the risk associated with our
heavy reliance on these systems.
The clinical laboratory is subject to seasonal fluctuations in
operating results and cash flows. Typically, testing volume declines during the
summer months, year end holiday periods and other major holidays, reducing net
revenues and operating cash flows. Testing volume is also subject to declines in
winter months due to inclement weather, which varies in severity from year to
year.
For the fiscal years ended July 31, 2006, 2005, and 2004 respectively,
approximately 20%, 24%, and 31% of the Company's operating revenues were derived
from product sales and royalty income and approximately 80%, 76%, and 69% were
derived from clinical laboratory services.
37
RESULTS OF OPERATIONS
COMPARATIVE FINANCIAL DATA FOR THE FISCAL YEARS ENDED JULY 31,
(in 000's)
Increase Increase
2006 (Decrease) % Change 2005 (Decrease) % Change 2004
----- ---------- -------- ----- ---------- -------- ----
Revenues:
Product sales and royalties $ 7,900 (2,646) (25) $ 10,546 $ (2,426) (19) $ 12,972
Clinical laboratory services 31,926 (931) (3) 32,857 4,185 15 28,672
-------- ------- -------- -------- --------
Total revenue 39,826 (3,577) (8) 43,403 1,759 (4) 41,644
Costs and expenses and other (income):
Cost of products 2,174 (23) (1) 2,197 (321) (13) 2,518
Cost of laboratory services 13,917 1,369 11 12,548 1,962 19 10,586
Research & development 7,896 (556) (7) 8,452 374 5 8,078
Selling, general and administrative 24,971 4,902 24 20,069 5,702 40 14,367
Provision for uncollectible A/R 3,633 (1,334) (27) 4,967 (7,020) (59) 11,987
Legal expenses 7,388 1,912 35 5,476 (864) (14) 6,340
Interest income (3,144) (1,621) 106 (1,523) (371) 32 (1,152)
Gain on patent litigation settlement -- 14,000 (100) (14,000) (14,000) -- --
-------- ------- -------- -------- --------
Costs and expenses 56,835 18,649 38,186 (14,538) 52,724
-------- ------- -------- -------- --------
Operating (loss) income $(17,009) (22,226) $ 5,217 $ 16,297 $(11,080)
======== ======= ======== ======== ========
FISCAL 2006 COMPARED TO FISCAL 2005
CONSOLIDATED RESULTS
Fiscal 2006 product revenues and royalty income was $7.9 million
compared to $10.5 million in fiscal 2005, a decrease of $2.6 million or 25%. The
decrease in product revenue and royalty income was primarily due to the decrease
in the volume of shipments of research products of $2.6 million and a decrease
in revenue from a former distributor of $1.5 million (see Item 3. Legal
Proceedings). This decrease was partially offset by an increase in royalty
income of $1.5 million.
Fiscal 2006 clinical laboratory revenues were $31.9 million compared to
$32.9 million in fiscal 2005, a decrease of approximately $0.9 million or 3%.
The contractual adjustment expense, which reduces gross billings, increased to
75.2% of gross billing as compared to 72.5% in the prior period, due to
competitive pricing throughout the industry. In addition, the Company
experienced a decrease in gross billing due to decreased reimbursement rates on
certain tests.
The cost of products during both fiscal 2006 and fiscal 2005 was $2.2
million. The cost of product revenues was negatively impacted in fiscal 2006 by
the write-off or reserve of approximately $0.4 million for excess or obsolete
inventory due to an evaluation made of the current and estimated demand for such
product offerings.
38
The cost of clinical laboratory services during fiscal 2006 was $13.9
million compared to $12.5 million in fiscal 2005, an increase of $1.4 million or
11%. The increase is primarily due to an increase in the overall cost of
performing testing services, including increased reagent costs of $0.8 million
and outside testing costs for certain esoteric tests of $0.1 million, and an
increase of hiring additional phlebotomists for the New Jersey market of
approximately $0.3 million.
Research and development expenses were $7.9 million in fiscal 2006
compared to $8.5 million in fiscal 2005, a decrease of $0.6 million or 7%. The
decrease was primarily due to a reduction of $1.4 million in patent expense and
the amortization of patent costs and a decrease in compensation expense for
executive officers due to the realignment of responsibilities to other expense
categories of $0.6 million. The decrease was partially offset by an increase in
clinical trial study activities of $1.0 million and the recognition of
share-based compensation charges required by the adoption of SFAS 123(R) of $0.2
million during the 2006 period. Research and development expenses include costs
of scientific personnel, supplies, consultants, allocated facility costs, costs
related to pre-clinical and clinical trials, amortization of patent expense, and
other patent related costs.
Selling, general and administrative expenses were $25.0 million during
fiscal 2006, compared to $20.1 million in fiscal 2005, an increase of $4.9
million or 24%. The increase in the 2006 period was primarily due to the
recognition of share-based compensation charges required by the adoption of SFAS
123(R) of $1.5 million, increases in expenditures for corporate governance,
consulting, accounting and other professional fees of $1.2 million, an increase
in compensation expense of executive officers previously included in research
and development due to the realignment of responsibilities, of $0.7 million,
increases in compensation of $0.5 million and other increased costs.
The provision for uncollectible accounts receivable relating to the
clinical laboratory segment during fiscal 2006 was $3.6 million, compared to
$5.0 million during fiscal 2005, a decrease of $1.3 million or 27%. The
provision declined due to improved billing and collection procedures and an
overall increase in collections.
Legal expense was $7.4 million during fiscal 2006 compared to $5.5
million in fiscal 2005, an increase of $1.9 million or 35%, due to an increase
in ongoing patent litigation activities.
Interest income increased $1.6 million or 106% to $3.2 million during
fiscal 2006 compared to $1.5 million during fiscal 2005, due to higher interest
rates earned offset by lower investments. The Company earns interest by
investing primarily in short term (30 - 90 days) commercial paper and money
market funds with high credit ratings.
For the year ended July 31, 2006, the Company's net benefit for income
taxes was $1.3 million or an effective rate of 8%, comprised of a federal tax
carryback benefit of $2.0 million for taxes paid in the fiscal year ended July
31, 2005 and other adjustments, offset by a valuation allowance charge of $0.6
million equal to net deferred tax assets as of July 31, 2005, and by state and
local taxes of $0.1 million, based on capital. Pursuant to SFAS 109 "Accounting
for Income Taxes", the Company recorded a valuation allowance charge during the
year ended July 31, 2006 equal to its net deferred tax assets at July 31, 2005
and has applied a full valuation allowance against increases in its net deferred
tax assets generated during the 2006 period. The benefit for income taxes, at an
effective rate of 8% was different from the U.S. statutory rate of 34% due to
state and local taxes, net of federal tax benefit, of 5%, expenses not
deductible for income taxes of 4%, and the effect of the valuation allowance of
28%. The Company believes that the valuation allowance is necessary as it is not
more likely than not that net deferred tax assets will be realized in the
foreseeable future based on positive and negative evidence available at this
time. This conclusion was reached because of uncertainties relating to future
taxable income, in terms of both its timing and its sufficiency, which would
enable the Company to realize the net deferred tax assets. For the year ended
July 31, 2005, the Company's (provision) for income taxes was $2.2 million which
was based on the effective federal, state and local income tax rates applied to
2005 period's taxable income, which was primarily comprised of the $14 million
gain from the Digene agreement. The provision for income taxes, at an effective
rate of 42%, was different from the U.S. federal statutory rate of 34% due to
state income taxes net of federal tax deduction, of approximately 6%, expenses
not deductible for income tax return purposes of 2%, a benefit for foreign sales
of (1%) and other of 1%.
Fiscal 2006 net loss was $15.7 million as compared to net income of
$3.0 million in fiscal 2005. Fiscal 2005 results included the gain from the
patent litigation settlement from Digene Corp. of $14 million. Fiscal 2006's net
loss was impacted by decreased revenues and increased expenses as discussed
above.
39
SEGMENT RESULTS
The life sciences segment's loss before income taxes was approximately
$0.2 million for the year ended July 31, 2006, compared to income before income
taxes of approximately $14.6 million in the fiscal 2005 period. Fiscal 2006
product revenues and royalty income was $7.9 million compared to $10.5 million
in fiscal 2005, a decrease of $2.6 million or 25%. The decrease in product
revenue and royalty income was primarily due to the decrease in the volume of
shipments of research products of $2.6 million and a decrease in revenue from a
former distributor of $1.5 million (see Item 3. Legal Proceedings). This
decrease was partially offset by an increase in royalty income of $1.5 million.
The 2005 period's income included the $14 million gain from a settlement and
license agreement with Digene Corp. The decline in the gross profit margin on
product sales and royalties in fiscal 2006 compared to fiscal 2006 was partially
due to the write-off or reserve of approximately $0.4 million of excess or
obsolete inventory due to an evaluation made of the current and estimated demand
for such product offerings, decline in sales volumes and pricing
competitiveness. Segment operating expenses (research and development and
selling, general and administrative) decreased in the 2006 period by
approximately $1.8 million primarily due to a decrease in the amortization of
deferred patent expenses of approximately $1.2 million, and a decrease in
compensation expense for executive officers due to the realignment of
responsibilities of $0.6 million.
The therapeutics segment's loss before income taxes was approximately
$4.2 million for the year ended July 31, 2006 as compared to $3.1 million in the
year ago period. The increase in the net loss was due to an increase of $1.0
million in clinical trial studies expenditures.
The clinical laboratory segment's income before income taxes was $0.1
million for the year ended July 31, 2006 period versus income of $2.8 million in
fiscal 2005. The 2006 period was impacted by lower revenue of $0.9 million, an
increase in cost of laboratory services of $1.4 million, as previously
explained, and a net increase in operating expenses (provision for uncollectible
accounts and selling, general and administrative) of $0.5 million primarily due
to recognition of share-based compensation charges required by the adoption of
SFAS 123(R) of $0.5 million, the inclusion of compensation expense for executive
officers of $0.6 million previously included in the other segment due to the
realignment of responsibilities, and compensation and related costs of $0.4
million relating to increased personnel, offset by a decrease in the provision
for uncollectible accounts of $1.3 million.
The other segment's loss before income taxes was $12.6 million for the
year ended July 31, 2006 versus $9.1 million in fiscal 2005. The increased loss
in fiscal 2006 of approximately $3.5 million was primarily due to the
recognition of share-based compensation charges required by the adoption of SFAS
123(R) of $0.9 million, increases in expenditures for corporate governance,
consulting, accounting and other professional fees of $1.3 million, an increase
in legal fees of $1.9 million due to ongoing patent litigation, and an increase
in compensation expense for executive officers previously included in life
sciences and therapeutics segments due to the realignment of responsibilities,
of $0.7 million. These increases were partially offset by higher interest income
earned of $1.6 million.
FISCAL 2005 COMPARED TO FISCAL 2004
CONSOLIDATED RESULTS
Fiscal 2005 Product Revenue and royalty income was $10.5 million
compared to $13.0 million in fiscal 2004, a decrease of $2.4 million or 19%. The
decrease was primarily due to the Company not recording revenue due to the
ongoing dispute with certain distributors on the sales of certain licensed
products, partially offset by the increase in direct sales of our products and
royalty income from Digene Corp. The decline in the gross profit margin on
product sales and royalties in fiscal 2005 compared to fiscal 2004 is due to the
decline in revenues from distributors with whom we had supply agreements.
Revenues from these distributors were net of manufacturing costs. See Legal
Proceedings.
Fiscal 2005 clinical laboratory revenues were $32.9 million compared to
$28.7 million in fiscal 2004, an increase of $4.2 million or 15%, primarily due
to the increase in the number of customer accounts being serviced. This increase
in new customer accounts is due to the expansion into the New Jersey and
Westchester market that commenced in the fourth quarter of fiscal 2004.
The cost of products revenues in fiscal 2005 was $2.2 million compared
to $2.5 million in fiscal 2004, a decrease of $0.3 million or 13%, primarily due
to lower royalty costs because of the expiration of a licensed patent agreement
with Yale University.
40
The cost of clinical laboratory services in fiscal 2005 was $12.5
million compared to $10.6 million in fiscal 2004, an increase of $1.9 million or
19%, primarily due to the increased number of tests performed and higher costs
incurred to perform certain esoteric tests. The increase in tests performed is
due to the new accounts being serviced through the expansion into New Jersey
markets.
Fiscal 2005 research and development expenses were $8.5 million
compared to $8.1 million in fiscal 2004, an increase of $0.4 million or 5%
primarily due to increases in clinical trial study costs for the development of
therapeutic products.
Fiscal 2005 selling, general and administrative expenses were $20.1
million compared to $14.4 million in fiscal 2004, an increase of $5.7 million or
40%. The increase was primarily due to an increase in direct selling
expenditures for our clinical laboratory and life science divisions, an increase
in information technology costs for the expansion of the information technology
connectivity system and data center personnel costs including infrastructure
expenses and accounting related fees for the compliance with the Sarbanes-Oxley
Act of 2002.
The fiscal 2005 provision for uncollectible accounts in the life
sciences division was $0 versus $1.8 million in the 2004 period, due to the
write off of a receivable from a former distributor. The fiscal 2005 provision
for uncollectible accounts receivable in the clinical laboratory segment was
$5.0 million, compared to $10.2 million in the 2004 period, a decrease of $5.2
million or 51%. The percentage of the provision for uncollectible accounts
receivable as a proportion of clinical laboratory services revenues decreased to
15.0% in fiscal 2005 compared to 36% for the 2004 period. This decrease was
primarily due to improved collection procedures and due to the change in the mix
of the demographics of the patients from the New Jersey new customer accounts.
Fiscal 2005 legal expenses were $5.5 million compared to $6.3 million
in fiscal 2004, a decrease of $0.8 million or 14%. The decrease is primarily due
to the reduction of legal activities because of the settlement with Digene
Corporation during fiscal 2005's first quarter ended October 31, 2004.
Fiscal 2005 interest income increased $0.4 million or 32% to $1.5
million compared to $1.2 million during fiscal 2004, due to the increased amount
of cash available for investment and the increase in interest rates offered on
debt securities.. The Company earns interest on its cash and cash equivalents by
investing primarily in short term (90 days or less) diverse financial
instruments with high credit ratings.
On October 14, 2004, the Company as plaintiff finalized and executed a
settlement and license agreement with Digene Corporation to settle a patent
litigation lawsuit (the "Digene agreement"). Under the terms of the agreement,
the Company received an initial payment of $16.0 million, would earn in the
first "annual period" (October 1, 2004 to September 30, 2005) a minimum royalty
payment of $2.5 million, and receive a minimum royalty of $3.5 million in each
of the next four annual periods. In addition, the agreement provides for the
Company to receive quarterly running royalties on the net sales of Digene
products subject to the license until the expiration of the patent on April 24,
2018. These quarterly running royalties will be fully creditable against the
minimum royalty payments due in the first five years of the agreement. The
balance, if any, of the minimum royalty payment will be recognized in the final
quarter of the applicable annual royalty period.
As a result of the above settlement, the Company recorded a gain on
patent litigation settlement of $14.0 million in the first quarter of fiscal
2005, and deferred $2 million which would be earned from net sales of the
Company's licensed products covered by the agreement during the first annual
period. As of July 31, 2005, the balance of the revenue deferred from the
settlement was approximately $359,000.
In fiscal 2005, the Company's provision for income taxes was $2.2
million which was based on the effective federal, state and local income tax
rates applied to the fiscal year's taxable income. The provision for income
taxes, at an effective rate of 42%, was different from the U.S. federal
statutory rate of 34% due to state income taxes, net of federal tax deduction of
approximately 6%, expenses not deductible for income tax return purposes of 2%,
a benefit for foreign sales(-1%) and other adjustments of 1%. In fiscal 2004,
the Company's benefit for income taxes was $4.8 million which was based on the
effective federal, state and local income tax rates applied to the fiscal year's
taxable income. The benefit for income taxes, at an effective rate of 44%, was
different from the U.S. federal statutory rate of 34% due to state income tax
benefit, net of federal, of approximately 4%, a benefit for foreign sales of 2%
and other benefits, net, of 4%.
41
SEGMENT RESULTS
The life science segment's income before income taxes was $14.6 million
in fiscal 2005 compared to $1.1 million in fiscal 2004. The fiscal 2005 increase
resulted from the $14 million gain and related earned royalties from the Digene
agreement. The gain was partially offset by a decline in product revenues due to
the ongoing dispute with certain distributors on the sales of certain licensed
products.
The therapeutics segment's loss before income taxes was approximately
$3.1 million for the year ended July 31, 2005 as compared to $2.4 million in the
year ago period. The increase in the net loss was due to an increase of $0.7
million in clinical trial studies expenditures.
The clinical laboratory segment's income before income taxes was $2.8
million versus a loss of $1.5 million in fiscal 2004. The increase is due to
higher revenues, due to the increase in the number of customer accounts being
serviced, and a lower provision for uncollectible accounts, due to the change in
the mix of payers and the expansion into the New Jersey markets.
The other segment's (loss) before income taxes was $9.1 million versus
$8.3 million in fiscal 2004, primarily due to accounting related fees for
compliance with the Sarbanes-Oxley Act of 2002 not incurred in the 2004 period.
LIQUIDITY AND CAPITAL RESOURCES
At July 31, 2006, our cash and cash equivalents were $69.9 million, a
decrease of $13.8 million from cash and cash equivalents and marketable
securities at July 31, 2005. We had working capital of $80.2 million at July 31,
2006 compared to $96.3 million at July 31, 2005. The decrease was the result of
the use of cash to fund operations arising from the net loss in fiscal 2006. In
fiscal 2005, as a result of the Digene agreement, the Company recorded a gain on
patent litigation settlement of $14.0 million in the first quarter of fiscal
2005.
Net cash used in operating activities for the year ended July 31, 2006
was approximately $10.1 million as compared to net cash provided by operating
activities of $13.0 million for the year ended July 31, 2005. The decrease in
net cash provided by operating activities in fiscal 2006 of $23.1 million was
primarily due to the fiscal 2006 net loss of $15.7 million as compared to net
income in fiscal 2005 of $3.0 million and by the net change in operating assets
and liabilities compared to the prior year and the impact of non cash items. In
fiscal 2006, net cash provided by investing activities decreased approximately
$6.6 million from fiscal 2005, primarily due to an increase in capital
expenditures of approximately $3.0 million, and a decline in the sales of
marketable securities of approximately $3.8 million. During fiscal 2006, all
investments in marketable securities were sold and reinvested in cash
equivalents. In fiscal 2006, the Company used cash of approximately $3.2 million
for the purchase of land and building which will be primarily utilized as the
Life Sciences and Therapeutics research and development and manufacturing
facility. In fiscal 2006, net cash provided by financing activities increased
approximately $0.1 million from fiscal 2005 primarily as a result of the
increase in proceeds from the exercise of stock options.
Accounts receivable, net of $10.4 million and $13.4 million represented
109 days and 119 days of operating revenues at July 31, 2006 and 2005,
respectively. The change in net accounts receivable is due to a decrease in
accounts receivable at the clinical laboratory of approximately $3.4 million and
an increase of life science accounts receivable of approximately $0.4 million.
The decrease in the clinical laboratory receivable is primarily due to
improvements in the collection process. The increase in the life sciences
accounts receivable is primarily due to the increase in royalty income partially
offset by a decrease in product revenues. Net accounts receivable from our
clinical laboratory operations of $9.2 million and $12.5 million represented an
average of 124 days and 147 days of clinical laboratory services revenues at
July 31, 2006 and 2005, respectively.
We believe that our current cash position is sufficient for our
foreseeable liquidity and capital resource needs over the next 12 months,
although there can be no assurance that future events will not alter such view.
42
EFFECT OF NEW PRONOUNCEMENTS
In June 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections, a replacement of APB Opinion No. 20, Accounting Changes, and
FASB Statement No. 3, Reporting Accounting Changes in Interim Financial
Statements." SFAS No. 154 changes the requirements for the accounting for and
reporting of a change in accounting principle. Previously, most voluntary
changes in accounting principles required recognition via a cumulative effect
adjustment within net income for the period of the change. SFAS No. 154 requires
retrospective application to prior periods' financial statements, unless it is
impracticable to determine either the period-specific effects or the cumulative
effect of the change. SFAS No. 154 is effective for accounting changes made in
fiscal years beginning after December 15, 2005; however, SFAS No. 154 does not
change the transition provisions of any existing accounting pronouncements. The
adoption of SFAS No. 154 is not expected to have a material impact on the
Company's financial condition or results of operations.
In June 2006, the FASB issued FASB Interpretation No. 48 ("FIN 48"),
"Accounting for Uncertainty in Income Taxes - an interpretation of FASB
Statement No. 109 ("FAS 109")", to clarify the accounting for uncertainty in
income taxes recognized in an enterprise's financial statements in accordance
with FAS 109, "Accounting for Income Taxes". This Interpretation prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return. This Interpretation also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition. The provisions of FIN 48 are effective for fiscal
years beginning after December 15, 2006. The Company has not evaluated the
impact of FIN 48 on its financial statements at this time.
CONTRACTUAL OBLIGATIONS
The Company has entered into various real estate and equipment
operating leases and has employment agreements with certain executive officers.
The real estate lease for the Company's Farmingdale headquarters is with a
related party. See Note 11 to the Consolidated Financial Statements for a
further description of these various leases.
The following is a summary of future payments under the Company's
contractual obligations as of July 31, 2006:
PAYMENTS DUE BY PERIOD
Less than
In 000'S Total 1 Year 1-3 Years 4-5 Years Over 5 Years
-------- ------- ------ --------- --------- ------------
Real estate and equipment leases $20,362 $2,662 $4,889 $4,382 $8,429
Employment agreements 2,358 1,483 875 -- --
------- ------ ------ ------ ------
Total contractual cash obligations $22,720 $4,145 $5,764 $4,382 $8,429
======= ====== ====== ====== ======
Management is not aware of any material claims, disputes or settled
matters concerning third-party reimbursements that would have a material effect
on our financial statements.
The Company does not have any "off-balance sheet arrangements" as such
term is defined in Item 303(a) (4) of Regulation S-K.
CRITICAL ACCOUNTING POLICIES
GENERAL
The Company's discussion and analysis of its financial condition and
results of operations are based upon Enzo Biochem, Inc. consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires the Company to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses; these estimates
and judgments also affect related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to contractual adjustments, allowance for uncollectible accounts,
inventory, intangible assets and income taxes. The Company bases its estimates
on experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
PRODUCT REVENUES
Revenues from product sales are recognized when the products are
shipped, the sales price is fixed or determinable and collectibility is
reasonably assured. The Company has certain non-exclusive distribution
agreements, which provide for consideration to be paid to the distributors for
the manufacture of certain products. The Company records such consideration
provided to distributors under these non-exclusive distribution agreements as a
reduction to research product revenues. The Company did not recognize any
revenue from these distributors during the year ended July 31, 2006. During the
fiscal years ended July 31, 2005, and 2004, the manufacturing and processing
cost of these products sold was $0.7 million, and $7.4 million, respectively.
The revenue from these non-exclusive distribution agreements are recognized when
shipments are made to their respective customers and reported to the Company.
43
ROYALTIES
Royalty revenues are recorded in the period earned. Royalties received
in advance of being earned are recorded as deferred revenues.
REVENUES - CLINICAL LABORATORY SERVICES
Revenues from the clinical laboratory are recognized upon completion of
the testing process for a specific patient and reported to the ordering
physician. These revenues and the associated accounts receivable are based on
gross amounts billed or billable for services rendered, net of a contractual
adjustment, which is the difference between amounts billed to payers and the
expected approved reimbursable settlements from such payers.
The following are tables of the clinical laboratory segment's net
revenues and percentages by revenue category for the years ended July 31, 2006
and 2005:
Net revenues Year ended Year ended
July 31, 2006 July 31, 2005
------------- -------------
Revenue Category (In 000'S) (in %) (In 000'S) (in %)
---------------- ---------- ------ ---------- ------
Medicare $7,462 23 $6,906 21
Third party carriers 17,680 56 17,528 53
Patient self-pay 4,925 15 6,904 21
HMO's 1,859 6 1,519 5
----- - ----- -
Total $31,926 100% $32,857 100%
======= ==== ======= ====
The Company provides services to certain patients covered by various
third-party payers, including the Federal Medicare program. Revenue, net of
contractual adjustments, from direct billings under the Federal Medicare program
during the years ended July 31, 2006, 2005 and 2004 were approximately 23%, 21%
and 26%, respectively, of the clinical lab segment's revenue. Laws and
regulations governing Medicare are complex and subject to interpretation for
which action for noncompliance includes fines, penalties and exclusion from the
Medicare programs. The Company believes that it is in compliance with all
applicable laws and regulations and is not aware of any pending or threatened
investigations involving allegations of potential wrongdoing.
CONTRACTUAL ADJUSTMENTS
The Company's estimate of contractual adjustments is based on
significant assumptions and judgments, such as its interpretation of the
applicable payer's reimbursement policies, and bears the risk of change. The
estimation process is based on the experience of amounts approved as
reimbursable and ultimately settled by payers, versus the corresponding gross
amount billed to the respective payers. The contractual adjustment is an
estimate that reduces gross revenue, based on gross billing rates, to amounts
expected to be approved and reimbursed. The Company adjusts the contractual
adjustment estimate periodically, based on its evaluation of historical
settlement experience with payers, industry reimbursement trends, and other
relevant factors.
During the years ended July 31, 2006, 2005 and 2004, the contractual
adjustment percentages, determined using average historical reimbursement
statistics, were 75.2%,and 72.5% and 70.9%, respectively, of gross billings. The
Company estimates (by using a sensitivity analysis) that each 1% point change in
the contractual adjustment percentage could have resulted in a change in
clinical laboratory services revenues of approximately $1,288,000, for the year
ended July 31, 2006, and could have resulted result in a change in the net
accounts receivable of approximately $373,000 as of July 31, 2006.
44
ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
Accounts receivable are reported at realizable value, net of allowances
for doubtful accounts, which is estimated and recorded in the period of the
related revenue.
For the clinical laboratory segment, the allowance for doubtful
accounts represents amounts that the Company does not expect to collect after
the Company has exhausted its collection procedures. The Company estimates its
allowance for doubtful accounts in the period the related services are billed
and adjusts the estimate in future accounting periods as necessary. It bases the
estimate for the allowance on the evaluation of historical collection
experience, the aging profile of accounts receivable, the historical doubtful
account write-off percentages, payer mix, and other relevant factors.
The allowance for doubtful accounts includes the balances, after
receipt of the approved settlements from third party payers for the
insufficient diagnosis information received from the ordering physician, which
result in denials of payment, and the uncollectible portion of receivables from
self payers, including deductibles and copayments, which are subject to credit
risk and patients' ability to pay. During the years ended July 31, 2006 and
2005, the Company determined an allowance for doubtful accounts less than 210
days and wrote off 100% of accounts receivable (for all payers) over 210 days,
as it assumed those accounts are uncollectible. The Company adjusts the
historical collection analysis for recoveries, if any, on an ongoing basis.
The Company's ability to collect outstanding receivables from third
party payers is critical to its operating performance and cash flows. The
primary collection risk lies with uninsured patients or patients for whom
primary insurance has paid but a patient portion remains outstanding. The
Company also assesses the current state of its billing functions in order to
identify any known collection or reimbursement issues in order to assess the
impact, if any, on the allowance estimates, which involves judgment. The Company
believes that the collectibility of its receivables is directly linked to the
quality of its billing processes, most notably, those related to obtaining the
correct information in order to bill effectively for the services provided.
Should circumstances change (e.g. shift in payer mix, decline in economic
conditions or deterioration in aging of receivables), our estimates of net
realizable value of receivables could be reduced by a material amount.
The following is a table of the Company's net accounts receivable by
segment. The clinical laboratory segment's net receivables are detailed by
billing category and as a percent to its total net receivables: At July 31, 2006
and 2005, approximately 88% and 94%, respectively, of the Company's net accounts
receivable relates to its clinical laboratory business, which operates in the
New York and New Jersey Metropolitan area.
Net accounts receivable As of As of
July 31, 2006 July 31, 2005
------------- -------------
Billing Category (In 000'S) (In %) (In 000'S) (In %)
---------------- ---------- ------ ---------- ------
Clinical laboratory
Medicare $1,367 15 $1,594 13
Third party carriers 4,025 44 6,742 54
Patient self-pay 3,294 36 3,819 30
HMO's 475 5 394 3
--- - --- -
Total clinical laboratory $9,161 100% $12,549 100%
==== ====
Total life sciences 1,286 872
----- ---
Total accounts receivable $10,447 $13,421
======= =======
Changes in the Company's allowance for doubtful accounts are as follows:
In 000'S July 31, 2006 July 31, 2005
-------- ------------- -------------
Beginning balance $2,292 $2,770
Provision for doubtful accounts 3,633 4,967
Write-offs (4,892) (5,445)
------- -------
Ending balance $1,033 $2,292
====== ======
45
INCOME TAXES
The Company accounts for income taxes under the liability method of
accounting for income taxes. Under the liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. The liability method requires
that any tax benefits recognized for net operating loss carry forwards and other
items be reduced by a valuation allowance where it is not more likely than not
the benefits will be realized in the foreseeable future. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. Under the liability method, the effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
INVENTORY
The Company values inventory at the lower of cost (first-in, first-out)
or market. Work-in-process and finished goods inventories consist of material,
labor, and manufacturing overhead. On a quarterly basis, we review inventory
quantities on hand and analyze the provision for excess and obsolete inventory
based on our estimate of sales forecasts based on sales history and anticipated
future demand. Our estimate of future product demand may not be accurate and we
may understate or overstate the provision for excess and obsolete inventory.
Accordingly, unanticipated changes in demand could have a significant impact on
the value of our inventory and results of operations. At July 31, 2006 and 2005,
our reserve for excess and obsolete inventory was $238,000 and $0, respectively.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not have an exposure to market risk from changes in
foreign currency exchange rates, commodity price risk or other market risk. We
do not engage in any hedging or market risk management tools. The Company does
not have interest risk with respect to interest rates on cash and cash
equivalents that could impact our results of operations and financial position
since the investments are in highly liquid corporate debt instruments with
maturities of three months or less. There have been no material changes with
respect to market risk previously disclosed in our Annual Report on Form 10-K
for our 2005 fiscal year.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted in a separate section of this
report. See Item 15(a) (1) and (2)
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
46
Item 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As required by Rule 13a-15(e) of the Securities Exchange Act of 1934,
as amended (the "Exchange Act"), we conducted an evaluation of the effectiveness
of the design and operation of our disclosure controls and procedures as of July
31, 2006. This evaluation was carried out under the supervision and with
participation of our Chief Executive Officer and Chief Financial Officer. There
are inherent limitations to the effectiveness of any system of disclosure
controls and procedures. Therefore, effective disclosure controls and procedures
can only provide reasonable assurance of achieving their control objectives.
Based upon our evaluation, our Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures are effective as
of June 3, 2006, to provide reasonable assurance that information required to be
disclosed in the reports that we file under the Exchange Act is recorded,
processed, summarized and reported in a timely manner and is accumulated and
communicated to management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate to allow timely decisions regarding required
disclosure.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There was no change in our internal control over financial reporting
during the fourth quarter ended July 31, 2006 that has materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting.
MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Rules
13a-15(f) under the Exchange Act.
Our internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles and includes those policies and
procedures that:
o pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions
of our assets;
o provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and
that our receipts and expenditures are being made only in
accordance with authorizations of management and our directors;
and
o provide reasonable assurance regarding prevention and timely
detection of unauthorized acquisition, use or disposition of our
assets that could have a material effect on our financial
statements.
Internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems that are determined to be effective
provide only reasonable assurance with respect to financial statement
preparation and presentation. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over
financial reporting based on criteria for effective internal control over
financial reporting described in Internal Control--Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on its assessment, management concluded that we maintained
effective internal control over financial reporting as of July 31, 2006. Ernst
and Young LLP, our independent registered public accounting firm, has issued an
attestation report on management's assessment of the effectiveness of our
internal control over financial reporting as of July 31, 2006. This report, in
which Ernst and Young has expressed an unqualified opinion, appears in this Item
9A.
47
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
Enzo Biochem, Inc.
We have audited management's assessment, included in Item 9A, that Enzo
Biochem, Inc. (the "Company") maintained effective internal control over
financial reporting as of July 31, 2006, based on criteria established in
Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). Enzo Biochem,
Inc.'s management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that Enzo Biochem, Inc.
maintained effective internal control over financial reporting as of July 31,
2006, is fairly stated, in all material respects, based on the COSO criteria.
Also, in our opinion, Enzo Biochem, Inc. maintained, in all material respects,
effective internal control over financial reporting as of July 31, 2006, based
on the COSO criteria.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheets of Enzo Biochem, Inc. (the "Company") as of July 31, 2006 and 2005, and
the related consolidated statements of operations, consolidated statements of
stockholders' equity and comprehensive (loss) income, and consolidated
statements of cash flows for each of the three years in the period ended July
31, 2006 of Enzo Biochem, Inc. and our report dated October 5, 2006 expressed an
unqualified opinion thereon.
/s/ Ernst & Young LLP
Melville, New York
October 5, 2006
48
ITEM 9B. OTHER INFORMATION
None
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS
The information required under this item will be set forth in the
Company's proxy statement to be filed with the Securities and Exchange
Commission on or before November 28, 2006 and is incorporated herein by
reference.
Item 11. EXECUTIVE COMPENSATION
The information required under this item will be set forth in the
Company's proxy statement to be filed with the Securities and Exchange
Commission on or before November 28, 2006 and is incorporated herein by
reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required under this item will be set forth in the
Company's proxy statement to be filed with the Securities and Exchange
Commission on or before November 28, 2006 and is incorporated herein by
reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required under this item will be set forth in the
Company's proxy statement to be filed with the Securities and Exchange
Commission on or before November 28, 2006 and is incorporated herein by
reference.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required under this item will be set forth in the
Company's proxy statement expected to be filed with the Securities and Exchange
Commission on or before November 28, 2006 and is incorporated herein by
reference.
PART IV
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K
(a) (1) Consolidated Financial Statements
Consolidated Balance Sheets - July 31, 2006 and 2005
Consolidated Statements of Operations- Years ended July 31,
2006, 2005 and 2004
Consolidated Statements of Stockholders' Equity and
Comprehensive (Loss) Income - Years ended July 31, 2006,
2005 and 2004
Consolidated Statements of Cash Flows - Years ended July 31,
2006, 2005 and 2004
Notes to Consolidated Financial Statements.
(2) Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts
All other schedules have been omitted because the required information
is included in the consolidated financial statements or the notes thereto or
because they are not required.
49
(3) Exhibits
The following documents are filed as Exhibits to this Annual Report on
Form 10-K:
Exhibit
No. Description
--- -----------
3(a) Certificate of Incorporation, as amended March 17, 1980.(1)
3(b) June 16, 1981 Certificate of Amendment of the Certificate of
Incorporation. (2)
3(c) Certificate of Amendment to the Certificate of Incorporation. (3)
3(d) Bylaws. (1)
10(c) Employment Agreements with Elazar Rabbani. (5)
10(d) Employment Agreement with Shahram Rabbani. (5)
10(e) Employment Agreement with Barry Weiner. (5)
10(f) 1994 Stock Option Plan. (6)
10(g) Agreement with Corange International Limited (Boehringer
Mannheim) effective April 1994. (19) (7)
10(h) Agreement with Amersham International effective February 1995. (7)
10(i) Agreement with Dako A/S effective May 1995. (7)
10(j) Agreement with Baxter Healthcare Corporation (VWR Scientific
Products) effective September 1995. (7)
10(k) Agreement with Yale University and amendments thereto. (7)
10(l) Agreement with The Research Foundation of the State of New York
effective May 1987. (7)
10(m) 1999 Stock Option Plan filed. (8)
10(n) Amendment to Elazar Rabbani's employment agreement. (9)
10(o) Amendment to Shahram Rabbani's employment agreement. (9)
10(p) Amendment to Barry Weiner's employment agreement. (9)
10(s) Settlement and License Agreement with Digene Corporation effective
as of September 30, 2004 (10) (12)
10(t) Joint Stipulation and Order of Dismissal with Prejudice dated
October 14, 2004 (10) (12).
10(u) 2005 Equity Compensation Incentive Plan (11)
10(v) Lease agreement with Pari Management (13)
10(w) Settlement and Release Agreement between the Company and
Sigma Aldrich (14)
14(a) Code of Ethics (10)
50
21 Subsidiaries of the registrant:
Enzo Clinical Labs, Inc., a New York corporation.
Enzo Life Sciences, Inc., a New York corporation.
Enzo Therapeutics, Inc., a New York corporation.
Enzo Realty, LLC, a New York Corporation
23 Consent of Independent Registered Public Accounting Firm filed
herewith.
31(a) Certification of CEO Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 filed herewith.
31(b) Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 filed herewith.
32(a) Certification of CEO Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 filed herewith.
32(b) Certification of CFO Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 filed herewith.
Notes to exhibits
(1) The exhibits were filed as exhibits to the Company's Registration
Statement on Form S-18 (File No. 2-67359) and are incorporated
herein by reference.
(2) This exhibit was filed as an exhibit to the Company's Form 10-K for
the year ended July 31, 1981 and is incorporated herein by
reference.
(3) This exhibit was filed with the Company's Annual Report on Form
10-K for the year ended July 31, 1989 and is incorporated herein by
reference.
(5) This exhibit was filed with the Company's Annual Report on Form
10-K for the year ended July 31, 1994 and is incorporated herein by
reference.
(6) This exhibit was filed with the Company's Annual Report on Form
10-K for the year ended July 31, 1995 and is incorporated herein by
reference.
(7) This exhibit was filed with the Company's Annual Report on Form
10-K for the year ended July 31, 1996 or previously filed amendment
thereto and is incorporated herein by reference.
(8) This exhibit was filed with the Company's Registration Statement on
Form S-8 (333-87153) and is incorporated herein by reference.
(9) This exhibit was filed with the Company's Annual Report on Form
10-K for the year ended July 31, 2000 and is incorporated herein by
reference.
(10) This exhibit was filed with the Company's Annual Report on Form
10-K for the year ended July 31, 2004 and is incorporated herein by
reference.
(11) This exhibit was filed as an exhibit to the Company's Proxy
Statement of Schedule 14A filed on January 19, 2005 and is
incorporated herein by reference.
(12) These exhibits are subject to a confidential treatment request
pursuant to securities exchange act rules. (13) This exhibit was
filed with the Company's Annual Report on Form 10-K for the year
ended July 31, 2006 and is incorporated herein by reference.
(14) This exhibit was filed with the Company's current report on Form
8-K on September 21, 2006 and is incorporated herein by reference.
(b) See Item 15(a) (3), above.
(c) See Item 15(a) (2), above.
51
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
ENZO BIOCHEM, INC.
Date: October 12, 2006 By: /s/ Elazar Rabbani Ph.D.
------------------------
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
By: /s/ Elazar Rabbani Ph.D. October 12, 2006
-----------------------------
Elazar Rabbani
Chairman of Board of Directors
(Principal Executive Officer)
By: /s/ Shahram K. Rabbani October 12, 2006
--------------------------
Shahram K. Rabbani,
Chief Operating Officer, Secretary and Director
By: /s/ Barry W. Weiner October 12, 2006
-----------------------
Barry W. Weiner,
President, Chief Financial Officer, and Director
By: /s/ John B. Sias October 12, 2006
--------------------
John B. Sias, Director
By: /s/ John J. Delucca October 12, 2006
-----------------------
John J. Delucca, Director
By: /s/ Irwin Gerson October 12, 2006
--------------------
Irwin Gerson, Director
By: /s/ Melvin F. Lazar October 12, 2006
-----------------------
Melvin F. Lazar, Director
52
FORM 10-K, ITEM 15(a) (1) and (2)
ENZO BIOCHEM, INC.
LIST OF CONSOLIDATED FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULE
The following consolidated financial statements and financial statement schedule
of Enzo Biochem, Inc. are included in Item 15(a):
Report of Independent Registered Public Accounting Firm F-2
Consolidated Balance Sheets -- July 31, 2006 and 2005 F-3
Consolidated Statements of Operations --
Years ended July 31, 2006, 2005 and 2004 F-4
Consolidated Statements of Stockholders' Equity and Comprehensive
(Loss) Income -- Years ended July 31, 2006, 2005 and 2004 F-5
Consolidated Statements of Cash Flows --
Years ended July 31, 2006, 2005 and 2004 F-6
Notes to Consolidated Financial Statements F-7
Schedule II - Valuation and Qualifying Accounts --
Years ended July 31, 2006, 2005 and 2004 S-1
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of
Enzo Biochem, Inc
We have audited the accompanying consolidated balance sheets of Enzo Biochem,
Inc. (the "Company") as of July 31, 2006, and 2005, and the related consolidated
statements of operations, consolidated statements of stockholders' equity and
comprehensive (loss) income and consolidated statements of cash flows for each
of the three years in the period ended July 31, 2006. Our audits also included
the financial statement schedule listed in the Index at Item 15(a). These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Enzo Biochem, Inc.
at July 31, 2006 and 2005, and the consolidated results of their operations and
their cash flows for each of the three years in the period ended July 31, 2006,
in conformity with U.S. generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Enzo Biochem,
Inc.'s internal control over financial reporting as of July 31, 2006, based on
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated October 5, 2006, expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Melville, New York
October 5, 2006
F-2
ENZO BIOCHEM, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS
July 31,
-----------------------------
Current assets: 2006 2005
--------- ---------
Cash and cash equivalents ................................................................. $ 69,854 $ 76,981
Marketable securities ..................................................................... -- 6,714
Accounts receivable, net of allowance for doubtful accounts of $1,033
in 2006 and $2,292 in 2005 ............................................................. 10,447 13,421
Inventories ............................................................................... 2,401 2,876
Prepaid expenses .......................................................................... 1,465 1,848
Recoverable and prepaid income taxes ...................................................... 1,931 1,329
Deferred taxes ............................................................................ -- 900
--------- ---------
Total current assets ......................................................................... 86,098 104,069
Property, plant, and equipment, net of accumulated depreciation
and amortization of $8,247 in 2006 and $7,279 in 2005 .................................... 5,848 2,670
Goodwill ..................................................................................... 7,452 7,452
Patent costs, net of accumulated amortization of $9,770 in 2006
and $9,695 in 2005 ........................................................................ 1,257 1,333
Other ........................................................................................ 869 942
--------- ---------
Total assets ................................................................................. $ 101,524 $ 116,466
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable - trade .................................................................. 1,304 2,414
Accrued liabilities ....................................................................... 4,403 4,866
Other current liabilities ................................................................. 230 509
--------- ---------
Total current liabilities .................................................................... 5,937 7,789
Deferred taxes ............................................................................... -- 260
Long term installment payable, net of current portion ........................................ -- 150
Commitments and contingencies
Stockholders' equity:
Preferred Stock, $.01 par value; authorized 25,000,000 shares; no
shares issued or outstanding .......................................................... -- --
Common Stock, $.01 par value; authorized 75,000,000 shares; shares
issued: 32,844,200 at July 31, 2006 and 32,526,800 at July 31, 2005 ................... 328 325
Additional paid-in capital ................................................................ 236,002 230,644
Less treasury stock at cost: 569,700 shares at July 31, 2006
and 384,400 shares at July 31, 2005 ................................................... (8,499) (5,994)
Accumulated deficit ....................................................................... (132,244) (116,577)
Accumulated other comprehensive loss ...................................................... -- (131)
--------- ---------
Total stockholders' equity ................................................................... 95,587 108,267
--------- ---------
Total liabilities and stockholders' equity ................................................... $ 101,524 $ 116,466
========= =========
F-3
The accompanying notes are an integral part of
these consolidated financial statements
ENZO BIOCHEM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Years ended July 31,
------------------------------------------------
2006 2005 2004
-------- -------- --------
Revenues:
Product revenues and royalty income ................................. $ 7,900 $ 10,546 $ 12,972
Clinical laboratory services ........................................ 31,926 32,857 28,672
-------- -------- --------
39,826 43,403 41,644
Costs and expenses and other (income):
Cost of product revenues ............................................ 2,174 2,197 2,518
Cost of clinical laboratory services ................................ 13,917 12,548 10,586
Research and development expense .................................... 7,896 8,452 8,078
Selling, general, and administrative expense ........................ 24,971 20,069 14,367
Provision for uncollectible accounts receivable ..................... 3,633 4,967 11,987
Legal expense ....................................................... 7,388 5,476 6,340
Interest income ..................................................... (3,144) (1,523) (1,152)
Gain on patent litigation settlement ................................ -- (14,000) --
-------- -------- --------
56,835 38,186 52,724
(Loss) income before income taxes ...................................... (17,009) 5,217 (11,080)
Benefit (provision) for income taxes ................................... 1,342 (2,213) 4,848
-------- -------- --------
Net (loss) income ...................................................... ($15,667) $ 3,004 ($ 6,232)
======== ======== ========
Net (loss) income per common share:
Basic ............................................................... ($ 0.49) $ 0.09 ($ 0.20)
======== ======== ========
Diluted ............................................................. ($ 0.49) $ 0.09 ($ 0.20)
======== ======== ========
Weighted average common shares outstanding:
Basic ............................................................... 32,215 32,097 31,700
======== ======== ========
Diluted ............................................................. 32,215 32,763 31,700
======== ======== ========
F-4
The accompanying notes are an integral part of
these consolidated financial statements
ENZO BIOCHEM, INC
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE (LOSS) INCOME
YEARS ENDED JULY 31, 2006, 2005 AND 2004
(IN THOUSANDS, EXCEPT SHARE DATA)
COMMON TREASURY COMMON ADDITIONAL TREASURY
STOCK STOCK STOCK PAID-IN STOCK ACCUMULATED
SHARES SHARES AMOUNT CAPITAL AMOUNT DEFICIT
------ ------ ------ ------- ------ -------
Balance at July 31, 2003................................. 29,975,100 --- $300 $199,082 --- ($89,916)
Net (loss) for the year ended July 31, 2004.............. --- --- --- --- --- (6,232)
Unrealized loss on available-for-sale
securities, net of tax............................... --- --- --- --- --- ---
Surrender of common stock for exercise of stock options.. --- 349,900 --- --- ($5,669) ---
Exercise of stock options (see Note 2)................... 873,900 --- 9 6,556 --- ---
Issuance of stock for employee 401(k) plan match......... 15,800 --- --- 282 --- ---
Comprehensive (loss)..................................... --- --- --- --- --- ---
-----------------------------------------------------------------------
Balance at July 31, 2004................................. 30,864,800 349,900 309 205,920 (5,669) (96,148)
Net income for the year ended July 31, 2005.............. --- --- --- --- --- $3,004
Unrealized gain on available-for-sale
securities, net of tax............................... --- --- --- --- --- ---
Reclassification adjustment for net loss
realized and reported in net income...................... --- --- --- --- --- ---
Valuation reserve........................................
5% stock dividend (fair value on date declared).......... 1,543,600 17,500 15 23,418 --- (23,433)
Surrender of common stock for exercise of stock options.. --- 17,000 --- (325) ---
Tax benefit for stock options exercised.................. --- --- --- 124 --- ---
Exercise of stock options (see Note 2)................... 100,300 --- 1 830 --- ---
Issuance of stock for employee 401(k) plan match......... 18,100 --- 0 352 --- ---
Comprehensive income..................................... --- --- --- --- --- ---
-----------------------------------------------------------------------
Balance at July 31, 2005................................. 32,526,800 384,400 325 230,644 (5,994) (116,577)
Net (loss) for the year ended July 31, 2006.............. --- --- --- --- --- (15,667)
Realized loss on available-for-sale
securities, net of tax............................... --- --- --- --- --- ---
Surrender of common stock for exercise of stock options.. --- 185,300 --- --- (2,505) ---
Exercise of stock options (see Note 2)................... 285,030 --- 3 3,113 --- ---
Issuance of stock for employee 401(k) plan match......... 32,370 --- --- 402 --- ---
Share based compensation charges......................... --- --- --- 1,763 --- ---
Stock options issued for consulting services............. --- --- --- 80 --- ---
Comprehensive (loss)..................................... --- --- --- --- --- ---
------------------------------------------------------------------------
Balance at July 31, 2006................................. 32,844,200 569,700 $328 $236,002 ($8,499) ($132,244)
=======================================================================
ACCUMULATED
OTHER TOTAL
COMPREHENSIVE STOCKHOLDERS' COMPREHENSIVE
(LOSS) INCOME EQUITY (LOSS) INCOME
------------- ------ -------------
Balance at July 31, 2003................................. ($85) $109,381
Net (loss) for the year ended July 31, 2004.............. --- (6,232) ($6,232)
Unrealized loss on available-for-sale
securities, net of tax............................... (161) (161) (161)
Surrender of common stock for exercise of stock options.. --- (5,669) ---
Exercise of stock options (see Note 2)................... --- 6,565 ---
Issuance of stock for employee 401(k) plan match......... --- 282 ---
--------
Comprehensive (loss)..................................... --- --- ($6,393)
-------------------------------- ========
Balance at July 31, 2004................................. (246) 104,166
Net income for the year ended July 31, 2005.............. --- 3,004 $3,004
Unrealized gain on available-for-sale
securities, net of tax............................... 43 43 43
Reclassification adjustment for net loss
realized and reported in net income...................... 122 122 122
Valuation reserve........................................ (50) (50) (50)
5% stock dividend (fair value on date declared).......... --- --- ---
Surrender of common stock for exercise of stock options.. --- (325) ---
Tax benefit for stock options exercised.................. --- 124 ---
Exercise of stock options (see Note 2)................... --- 831 ---
Issuance of stock for employee 401(k) plan match......... --- 352 ---
--------
Comprehensive income..................................... --- --- $3,119
-------------------------------- ========
Balance at July 31, 2005................................. (131) 108,267
Net (loss) for the year ended July 31, 2006.............. --- (15,667) $(15,667)
Realized loss on available-for-sale
securities, net of tax............................... 131 131 131
Surrender of common stock for exercise of stock options.. --- (2,505) ---
Exercise of stock options (see Note 2)................... --- 3,116 ---
Issuance of stock for employee 401(k) plan match......... --- 402 ---
Share based compensation charges......................... --- 1,763 ---
Stock options issued for consulting services............. --- 80 ---
--------
Comprehensive (loss)..................................... --- --- ($15,536)
-------------------------------- ========
Balance at July 31, 2006................................. --- $95,587
================================
F-5
The accompanying notes are an integral part of
these consolidated financial statements
ENZO BIOCHEM, INC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Years ended July 31,
-----------------------------------
2006 2005 2004
---- ---- ----
OPERATING ACTIVITIES
Net (loss) income ................................................................... ($15,667) $ 3,004 ($ 6,232)
Adjustments to reconcile net (loss) income to net cash (used in) provided by
operating activities:
Depreciation and amortization of property, plant and equipment ............... 1,049 1,020 1,076
Amortization of patent costs ................................................. 75 1,312 1,286
Provision for uncollectible accounts receivable .............................. 3,633 4,967 11,987
Write-off and/or reserve for obsolete inventory .............................. 596 -- --
Deferred taxes ............................................................... 640 891 (1,651)
Share based compensation charges ............................................. 1,763 -- --
Options issued to consultant ................................................. 80 -- --
Issuance of stock for 401(k) employer match .................................. 402 352 282
Deferred rent ................................................................ -- (87) (233)
Realized loss on sales of marketable securities .............................. 154 200 --
Tax benefit on stock option exercises ........................................ -- 124 --
Other ........................................................................ -- (51) 2
Changes in operating assets and liabilities:
Accounts receivable ......................................................... (659) (3,593) (9,515)
Inventories ................................................................. (120) 558 (13)
Prepaid expenses ............................................................ 383 (747) 400
Recoverable and prepaid income taxes ........................................ (602) 2,578 (3,365)
Accounts payable - trade .................................................... (1,110) 322 771
Accrued liabilities ......................................................... (463) 1,620 (377)
Other current liabilities ................................................... (279) 509 --
------------------------------------
Adjustments ........................................................................ 5,542 9,975 650
Net cash (used in) provided by operating activities ...................... (10,125) 12,979 (5,582)
INVESTING ACTIVITIES
Capital expenditures ............................................................ (4,227) (1,276) (1,304)
Patent costs .................................................................... -- (20) (444)
Sales of marketable securities .................................................. 6,760 10,692 (2,349)
Purchases of marketable securities .............................................. (69) (249) --
Security deposits and other ..................................................... 73 -- --
------------------------------------
Net cash provided by (used in) investing activities ...................... 2,537 9,147 (4,097)
FINANCING ACTIVITIES
Proceeds from the exercise of stock options ..................................... 611 506 896
Payment of long term installment payable ........................................ (150) (150) --
Other ........................................................................... -- -- 14
------------------------------------
Net cash provided by financing activities ................................ 461 356 910
Net (decrease) increase in cash and cash equivalents ................................ (7,127) 22,482 (8,769)
Cash and cash equivalents at the beginning of year .................................. 76,981 54,499 63,268
------------------------------------
Cash and cash equivalents at the end of year ........................................ $ 69,854 $ 76,981 $ 54,499
====================================
F-6
The accompanying notes are an integral part of
these consolidated financial statements
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
NOTE 1 - BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Enzo Biochem, Inc. (the "Company") is engaged in research, development,
manufacturing and marketing of diagnostic and research products based on genetic
engineering, biotechnology and molecular biology. These products are designed
for the diagnosis of and/or screening for infectious diseases, cancers, genetic
defects and other medically pertinent diagnostic information and are distributed
in the United States and internationally. The Company is conducting research and
development activities in the development of therapeutic products based on the
Company's technology platform of genetic modulation and immune modulation. The
Company also operates a clinical laboratory that offers and provides diagnostic
medical testing services to the health care community in the greater New York
and New Jersey area. The Company operates in three segments (see Note 13).
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries, Enzo Clinical Labs, Enzo Life
Sciences, Enzo Therapeutics and Enzo Realty LLC ("Realty") Realty was formed in
fiscal 2006 to acquire a building (see Note 5). All intercompany transactions
and balances have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and amounts of income and expenses during the reporting period.
Actual results could differ from those estimates.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations of
credit risk primarily consist of cash and cash equivalents, accounts receivable,
accounts payable and accrued liabilities. The Company's cash equivalents are
invested in diverse financial instruments with high credit ratings. The Company
believes the fair value of the aforementioned financial instruments approximates
the current value due to the immediate or short-term nature of these items.
Concentration of credit risk with respect to the Company's life sciences segment
is mitigated by the diversity of the Company's clients and their dispersion
across many different geographic regions. To reduce risk, the Company routinely
assesses the financial strength of these customers and, consequently, believes
that its accounts receivable credit exposure, with respect to these customers,
is limited.
The Company believes that the concentration of credit risk with respect to
clinical laboratory's accounts receivable is limited due to the diversity of the
Company's client base, the number of insurance carriers it deals with, and its
numerous individual patient accounts. As is standard in the health care
industry, substantially all of the Company's clinical laboratory's accounts
receivable is with numerous third party insurance carriers and individual
patient accounts. The Company also provides services to certain patients covered
by various third-party payers, including the Federal Medicare program. The
clinical laboratory industry is characterized by a significant amount of
uncollectible accounts receivable resulting from the inability to receive
accurate and timely billing information in order to forward it to the third
party payers for reimbursement, and the inaccurate information received from the
covered individual patients for unreimbursed unpaid amounts.
F-7
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
REVENUE RECOGNITION
Product revenues
Revenues from product sales are recognized when the products are shipped, the
sales price is fixed or determinable and collectibility is reasonably assured.
The Company has certain non-exclusive distribution agreements, which provide for
consideration to be paid to the distributors for the manufacture of certain
products. The Company records such consideration provided to distributors under
these non-exclusive distribution agreements as a reduction to product revenues.
The Company did not recognize any revenue from these distributors during the
year ended July 31, 2006. During the years ended July 31, 2005, and 2004, the
manufacturing and processing cost of these products sold was $0.7 million, and
$7.4 million, respectively. The revenue from these non-exclusive distribution
agreements are recognized when shipments are made to their respective customers
and reported to the Company.
Royalties
Royalty revenues are recorded in the period earned. Royalties received in
advance of being earned are recorded as deferred revenues.
Clinical laboratory services
Revenues from the clinical laboratory are recognized upon completion of the
testing process for a specific patient and reported to the ordering physician.
These revenues and the associated accounts receivable are based on gross amounts
billed or billable for services rendered, net of a contractual adjustment, which
is the difference between amounts billed to payers and the expected approved
reimbursable settlements from such payers.
The following are tables of the clinical laboratory segment's net revenues and
revenue percentages by revenue category for the years ended July 31, 2006 and
2005:
Net revenues Year ended Year ended
July 31, 2006 July 31, 2005
------------- -------------
Revenue Category (In 000'S) (In %) (In 000'S) (In %)
---------------- ---------- ------ ---------- ------
Medicare $7,462 23 $6,906 21
Third party carriers 17,680 56 17,528 53
Patient self-pay 4,925 15 6,904 21
HMO's 1,859 6 1,519 5
----- - ----- -
Total $31,926 100% $32,857 100%
======= ==== ======= ====
The Company provides services to certain patients covered by various third-party
payers, including the Federal Medicare program. Revenue, net of contractual
expense, from direct billings under the Federal Medicare program during the
years ended July 31, 2006, 2005 and 2004 were approximately 23%, 21% and 26%,
respectively, of the Clinical Lab segment's revenue. Laws and regulations
governing Medicare are complex and subject to interpretation for which action
for noncompliance includes fines, penalties and exclusion from the Medicare
programs. The Company believes that it is in compliance with all applicable laws
and regulations and is not aware of any pending or threatened investigations
involving allegations of potential wrongdoing.
F-8
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
CONTRACTUAL ADJUSTMENTS
The Company's estimate of contractual adjustments is based on significant
assumptions and judgments, such as its interpretation of the applicable payer's
reimbursement policies, and bears the risk of change. The estimation process is
based on the experience of amounts approved as reimbursable and ultimately
settled by payers, versus the corresponding gross amount billed to the
respective payers. The contractual expense is an estimate that reduces gross
revenue, based on gross billing rates, to amounts expected to be approved and
reimbursed. The Company adjusts the contractual expense estimate periodically,
based on its evaluation of historical settlement experience with payers,
industry reimbursement trends, and other relevant factors.
ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
Accounts receivable are reported at realizable value, net of allowances for
doubtful accounts, which is estimated and recorded in the period of the related
revenue.
For the Clinical Labs segment, the allowance for doubtful accounts represents
amounts that the Company does not expect to collect after the Company has
exhausted its collection procedures. The Company estimates its allowance for
doubtful accounts in the period the related services are billed and adjusts the
estimate in future accounting periods as necessary. It bases the estimate for
the allowance on the evaluation of historical collection experience, the aging
profile of accounts receivable, the historical doubtful account write-off
percentages, payer mix, and other relevant factors.
The allowance for doubtful accounts includes the balances, after receipt of the
approved settlements from third party payers for the insufficient diagnosis
information received from the ordering physician which result in denials of
payment, and the uncollectible portion of receivables from self payers,
including deductibles and copayments, which are subject to credit risk and
patients' ability to pay. During the years ended July 31, 2006 and 2005, the
Company determined an allowance for doubtful accounts less than 210 days and
wrote off 100% of accounts receivable (for all payers) over 210 days, as it
assumed those accounts are uncollectible. The Company adjusts the historical
collection analysis for recoveries, if any, on an ongoing basis.
The Company's ability to collect outstanding receivables from third party payers
is critical to its operating performance and cash flows. The primary collection
risk lies with uninsured patients or patients for whom primary insurance has
paid but a patient portion remains outstanding. The Company also assesses the
current state of its billing functions in order to identify any known collection
issues in order to assess the impact, if any, on the allowance estimates which
involves judgment. The Company believes that the collectibility of its
receivables is directly linked to the quality of its billing processes, most
notably, those related to obtaining the correct information in order to bill
effectively for the services provided. Should circumstances change (e.g. shift
in payer mix, decline in economic conditions or deterioration in aging of
receivables), our estimates of net realizable value of receivables could be
reduced by a material amount.
F-9
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
The following is a table of the Company's net accounts receivable by segment.
The Clinical Labs segment's net receivables are detailed by billing category and
as a percent to its total net receivables: At July 31, 2006 and 2005,
approximately 88% and 94%, respectively, of the Company's net accounts
receivable relates to its clinical labs business, which operates in the greater
New York and New Jersey area.
Net accounts receivable As of As of
July 31, 2006 July 31, 2005
------------- -------------
Billing Category (In 000'S) (In %) (In 000'S) (In %)
----------------- ---------- ------ ---------- ------
Clinical Labs
-------------
Medicare $1,367 15 $1,594 13
Third party carriers 4,025 44 6,742 54
Patient self-pay 3,294 36 3,819 30
HMO's 475 5 394 3
--- - --- -
Total Clinical Labs 9,161 100% 12,549 100%
==== ====
Total Life Sciences 1,286 872
----- ---
Total accounts receivable $10,447 $13,421
======= =======
Changes in the Company's allowance for doubtful accounts are as follows:
In 000's July 31, 2006 July 31, 2005
-------- ------------- -------------
Beginning balance $2,292 $2,770
Provision for doubtful accounts 3,633 4,967
Write-offs (4,892) (5,445)
------ ------
Ending balance $1,033 $2,292
====== ======
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include highly liquid corporate debt instruments with
maturities of three months or less at the time acquired by the Company.
MARKETABLE SECURITIES
Investments with a maturity greater than three months at the date of purchase
are designated as marketable securities. During the year ended July 31, 2006,
the Company sold all investments designated as marketable securities and had no
investments in marketable securities as of July 31, 2006.
At July 31, 2005, management designated marketable securities held by the
Company as available-for-sale securities, in accordance with of Statement of
Financial Accounting Standards ("SFAS") No. 115 "Accounting for Certain
Investments in Debt and Equity Securities". Available-for-sale securities were
carried at fair value with the unrealized losses reported in stockholders'
equity under the caption "Accumulated other comprehensive loss". The Company
periodically reviewed its investment portfolio to determine if there was an
impairment that is other than temporary. In testing for impairment, the Company
considers, among other factors, the length of time and the extent of a
security's unrealized loss, the financial condition and near term prospects of
the issuer, economic forecasts and market or industry trends. The cost of
marketable securities sold was based on the original cost basis plus any
reinvested dividends.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out) or market.
Work-in-process and finished goods inventories consist of material, labor and
manufacturing overhead.
F-10
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at cost, and depreciated on the
straight-line basis over the estimated useful lives of the various asset
classes. The useful life for the building is 30 years. The useful life for
laboratory machinery and equipment and office furniture and computer equipment
ranges from 3-5 years. Leasehold improvements are amortized over the term of the
related leases or estimated useful lives of the assets, whichever is shorter.
GOODWILL
Goodwill represents the cost of acquired businesses in excess of the fair value
of assets acquired, including separately recognized intangible assets, less the
fair value of liabilities assumed in the business acquisition. The Company uses
a non-amortization approach to account for purchased goodwill. Under this
approach, goodwill is not amortized, but instead is reviewed for impairment. All
of the Company's goodwill is related to its clinical laboratory segment. Prior
to adopting SFAS No. 142, "Goodwill and Other Intangibles" ("SFAS 142"), the
Company recorded amortization of goodwill aggregating approximately $9.8
million.
Under the non-amortization provisions of SFAS 142, goodwill is subject to at
least an annual assessment for impairment by applying a fair-value based test.
The Company performs the annual impairment testing during the fourth quarter of
its fiscal year. Based on this testing, there has been no impairment to Goodwill
recorded on the accompanying balance sheets as of July 31, 2006 and 2005.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews the recoverability of the carrying value of long-lived
assets, primarily property, plant and equipment, for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be fully recoverable. Should indicators of impairment exist, the carrying
values of the assets are evaluated in relation to the operating performance and
future undiscounted cash flows of the underlying business. The net book value of
an asset is adjusted to fair value if its expected future undiscounted cash flow
is less than its book value. No impairment losses were identified during the
years ended July 31, 2006, 2005 or 2004.
PATENT COSTS
The Company capitalizes certain legal costs directly incurred in pursuing patent
applications as patent costs. When such applications result in an issued patent,
the related costs are amortized over a ten year period or the life of the
patent, whichever is shorter, using the straight-line method. The Company
reviews its issued patents and pending patent applications, and if it determines
to abandon a patent application or that an issued patent no longer has economic
value, the unamortized balance in deferred patent costs relating to that patent
is immediately expensed. The Company estimates amortization for patent costs at
July 31, 2006 to be at approximately $79,000 in each of the next five fiscal
years.
COMPREHENSIVE (LOSS) INCOME
SFAS No. 130, "Reporting Comprehensive Income" (SFAS 130"), requires reporting
and displaying of comprehensive loss and its components. In accordance with SFAS
130, the Accumulated Other Comprehensive Loss, which is comprised of net
unrealized losses on marketable securities, is disclosed as a separate component
of stockholders' equity.
SHIPPING AND HANDLING COSTS
Product revenue shipping and handling costs included in selling expense amounted
to approximately $226,000, $299,000, and $384,000 for years ended July 31, 2006,
2005, and 2004, respectively.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to expense as incurred.
F-11
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
ADVERTISING
All costs associated with advertising are expensed as incurred. Advertising
expense, included in Selling, general and administrative expense approximated
$128,000, $57,000 and $18,000 for the years ended July 31, 2006, 2005 and 2004,
respectively.
INCOME TAXES
The Company accounts for income taxes under the liability method of accounting
for income taxes. Under the liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. The liability method requires
that any tax benefits recognized for net operating loss carryforwards and other
items be reduced by a valuation allowance when it is more likely than not that
the benefits may not be realized. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. Under the liability method, the effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date.
SEGMENT REPORTING
The Company follows SFAS No. 131, "Disclosures About Segments of an Enterprise
and Related Information" ("SFAS 131") which establishes standards for reporting
information on operating segments in interim and annual financial statements. An
enterprise is required to separately report information about each operating
segment that engages in business activities from which the segment may earn
revenues and incur expenses, whose separate operating results are regularly
reviewed by the chief operating decision maker regarding allocation of resources
and performance assessment and which exceed specific quantitative thresholds
related to revenue and profit or loss. The Company's operating activities are
reported in three segments (see Note 13).
NET (LOSS) INCOME PER SHARE
The Company applies SFAS No. 128, "Earnings per Share."("SFAS 128"). SFAS 128
establishes standards for computing and presenting earnings per share. Basic net
income (loss) per share represents net income (loss) divided by the weighted
average number of common shares outstanding during the period. The dilutive
effect of potential common shares, consisting of outstanding stock options, is
determined using the treasury stock method in accordance with SFAS 128. Diluted
weighted average shares outstanding for 2006 and 2004 do not include the
potential common shares from stock options because to do so would have been
antidilutive. Accordingly, basic and diluted net loss per share is the same in
fiscal 2006 and 2004. The number of potential common shares ("in the money
options") excluded from the calculation of diluted earnings per share during the
years ended July 31, 2006, 2005 and 2004 was 423,000, 0, and 798,000 shares,
respectively.
F-12
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
The following table sets forth the computation of basic and diluted net (loss)
income per share pursuant to SFAS 128 for the years ended July 31:
IN 000'S 2006 2005 2004
-------- ---- ---- ----
Numerator:
Net (loss) income $(15,667) $3,004 $(6,232)
========= ====== ========
Denominator:
Weighted-average common shares outstanding- Basic
32,215 32,097 31,700
Effect of dilutive stock options - - 666 - -
--- --- ---
Weighted-average common shares outstanding - Diluted
32,215 32,763 31,700
====== ====== ======
Net (loss) income per share
Basic $(.49) $.09 $(.20)
====== ==== ======
Diluted $(.49) $.09 $(.20)
====== ==== ======
For the years ended July 31, 2006, 2005 and 2004, the effect of approximately
1,916,000, 818,000, and 554,000 respectively, of outstanding "out of the money"
options to purchase common shares were excluded from the calculation of diluted
net (loss) income per share because their effect would be anti-dilutive.
SHARE-BASED COMPENSATION
Effective August 1, 2005, the Company adopted SFAS No. 123(R), "Share-Based
Payment" ("SFAS 123(R)") and related interpretations which superseded the
provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees" ("APB 25") and related interpretations. SFAS
123(R) requires that all share-based compensation be recognized as an expense in
the financial statements and that such cost be measured at the fair value of the
award. SFAS 123(R) was adopted using the modified prospective method, which
requires the Company to recognize compensation expense on a prospective basis.
Therefore, prior period financial statements have not been restated. Under this
method, in addition to reflecting compensation expense for new share-based
awards, expense is also recognized to reflect the remaining service period of
awards that had been included in pro-forma disclosures in prior periods.
With the adoption of SFAS 123(R), the Company is required to record the fair
value of share-based compensation awards as an expense. In order to determine
the fair value of stock options on the date of grant, the Company utilizes the
Black-Scholes option-pricing model. Inherent in this model are assumptions
related to expected stock-price volatility, option life, risk-free interest rate
and dividend yield. While the risk-free interest rate and dividend yield are
less subjective assumptions, typically based on factual data derived from public
sources, the expected stock-price volatility and option life assumptions require
a greater level of judgment which make them critical accounting estimates. The
Company uses an expected stock-price volatility assumption that is primarily
based on historical realized volatility of the underlying stock during a period
of time. No employee or director stock options were granted during the year
ended July 31, 2006.
F-13
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
In November 2005, the FASB issued FSP FAS 123(R)-3, "Transition Election Related
to Accounting for the Tax Effects of Share-Based Payment Awards", to provide an
alternate transition method for the implementation of SFAS No. 123(R). Because
some entities do not have, and may not be able to re-create, information about
the net excess tax benefits that would have qualified as such had those entities
adopted SFAS No. 123(R) for recognition purposes, this FSP provides an elective
alternative transition method. The method comprises (a) a computational
component that establishes a beginning balance of the additional paid in capital
pool ("APIC pool") related to employee compensation and (b) a simplified method
to determine the subsequent impact on the APIC pool of employee awards that are
fully vested and outstanding upon the adoption of SFAS No. 123(R). The Company
is evaluating the principles set forth in this FSP to determine its APIC pool.
The implementation date is one year from the later of the initial adoption of
SFAS No. 123(R) or the effective date of FSP FAS 123(R)-3.
Prior to August 1, 2005, the Company accounted for employee stock option plans
under the intrinsic value method in accordance with APB 25. Under APB 25,
generally no compensation expense is recorded when terms of the award are fixed
and the exercise price of employee and director stock options equals or exceeds
the fair value of the underlying stock on the date of the grant.
As a result of adopting SFAS 123(R), the Company's net loss for the year ended
July 31, 2006 was approximately $1.6 million higher, than if the Company had
continued to account for share-based compensation under APB No. 25. Basic and
diluted loss per share for the year ended July 31, 2006 were increased by $0.05
per share as a result of adopting SFAS 123(R). SFAS 123(R) also requires that
excess tax benefits related to stock option exercises be reflected as financing
cash inflows instead of operating cash inflows. For the year ended July 31,
2006, no excess tax benefits were recognized. Other share-based compensation
expense relating to the fair value of restricted shares and restricted stock
units issued and vested during the year ended July 31, 2006 was approximately
$172,000 (see Note 8).
The following table sets forth the amount of expense related to share-based
payment arrangements included in specific line items in the accompanying
Statement of operations for the year ended July 31, 2006:
In 000's
--------
Cost of products $21
Research and development 249
Selling, general and administrative 1,493
------
$1,763
======
As of July 31, 2006, there was $2.0 million of total unrecognized compensation
cost related to nonvested share-based compensation arrangements granted under
the Company's stock option and restricted stock plans, which will be recognized
over a weighted average remaining life of approximately one and a half years.
During the years ended July 31, 2005 and 2004, the Company followed the
provisions of FASB Statement No. 148 ("SFAS 148"), "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation," ("SFAS 123") to provide alternative
methods of transition to SFAS 123's fair value method of accounting for
stock-based employee compensation. SFAS 148 also amends the disclosure
provisions of SFAS 123 to require disclosure in the summary of significant
accounting policies of the effects of an entity's accounting policy with respect
to stock-based employee compensation on reported net income. While SFAS 148 did
not amend SFAS 123 to require companies to account for employee stock options
using the fair value method, as SFAS 123(R) did, the disclosure provisions of
SFAS 148 are applicable to all companies with share-based employee compensation
method of SFAS 123 or the intrinsic value method of APB 25.
F-14
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
On June 3, 2005, the Board of Directors approved the acceleration of vesting of
unvested "out of the money" stock options held by employees, including executive
officers and directors. The stock options considered as out of the money were
those with an exercise price that was $1.50 or more than the closing price of
the Company's common stock on June 3, 2005 of $14.82. All other terms and
conditions of these "out of the money" options remain unchanged. As a result of
the acceleration, options to purchase approximately 666,000 shares of the
Company's common stock (which represented approximately 21% of the Company's
then outstanding stock options) became exercisable immediately. The accelerated
options ranged in exercise prices from $16.39 to $19.02 and the weighted average
exercise price of the accelerated options was $17.55 per share. The total number
of options subject to acceleration included options to purchase 575,000 shares
held by executive officers and directors of the Company. This action was taken
to avoid expense recognition in future financial statements upon adoption of
SFAS 123(R). The accelerated vesting of the "out of the money" options did not
result in a charge in the Company's statement of operations for the year ended
July 31, 2005 based on U.S. generally accepted accounting principles. The
Company reported approximately $10.1 million of pro forma compensation expense
for the year ended July 31, 2005, of which $6.0 million was applicable to the
accelerated "out of the money" options.
Pro forma information regarding net income (loss) applicable to common
stockholders is required under SFAS 123, as if the Company has accounted for its
stock options under the fair value method. For purposes of pro forma
disclosures, the estimated fair value of the options is amortized to expense
over the options' vesting period. The fair value for these options was estimated
using the Black-Scholes option-pricing model with the following weighted-average
assumptions used for all grants in the years ended July 31, 2005 and 2004: no
dividend yield, weighted-average expected life of the option of seven years,
risk-free interest rate ranges of 3% to 6.88% and a volatility of 71% and 74%,
respectively, for all grants.
The following table illustrates the effect on net income (loss) if the Company
had applied the fair value recognition provisions of SFAS 123 (in 000's, except
per share):
Years Ended July 31, 2005 2004
-------------------- ---- ----
Reported net income (loss) $3,004 $(6,232)
Pro forma compensation expense (10,129) (3,239)
-------- -------
Pro forma net (loss) $(7,125) $(9,471)
======== =======
Pro forma net (loss) per share:
Basic $(.22) $(.30)
Diluted $(.22) $(.30)
EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections ("SFAS 154"), a replacement of APB Opinion No. 20, Accounting
Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim
Financial Statements." SFAS 154 changes the requirements for the accounting for
and reporting of a change in accounting principle. Previously, most voluntary
changes in accounting principles required recognition via a cumulative effect
adjustment within net income for the period of the change. SFAS 154 requires
retrospective application to prior periods' financial statements, unless it is
impracticable to determine either the period-specific effects or the cumulative
effect of the change. SFAS 154 is effective for accounting changes made in
fiscal years beginning after December 15, 2005; however, SFAS 154 does not
change the transition provisions of any existing accounting pronouncements. The
adoption of SFAS 154 is not expected to have a material impact on the Company's
financial condition or results of operations.
F-15
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
In June 2006, the FASB issued FASB Interpretation No. 48 ("FIN 48"), "Accounting
for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109,
"Accounting for Income Taxes" ("SFAS 109")", to clarify the accounting for
uncertainty in income taxes recognized in an enterprise's financial statements
in accordance with SFAS 109. This Interpretation prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. FIN
48 also provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure, and transition. The
provisions of FIN 48 are effective for fiscal years beginning after December 15,
2006. The Company has not evaluated the impact of FIN 48 on its financial
statements at this time.
RECLASSIFICATIONS
Certain amounts in prior years have been reclassified to conform to current year
presentation.
NOTE 2 - SUPPLEMENTAL DISCLOSURE FOR STATEMENT OF CASH FLOWS
In the years ended July 31, 2006, 2005 and 2004, net income taxes paid by or
(refunded to) the Company approximated ($1,374,000), $3,566,000 and $219,000
respectively.
In fiscal 2006, certain officers of the Company exercised 227,800 stock options
in a non-cash transaction. The officers surrendered 185,300 shares of previously
owned shares of the Company's common stock to exercise the stock options. The
Company recorded approximately $2.5 million, the market value of the surrendered
shares, as treasury stock.
In fiscal 2005, a director of the Company exercised 31,660 stock options in a
non-cash transaction. The director surrendered 17,000 previously owned shares of
the Company's common stock to exercise the stock options. The Company recorded
approximately $325,000, the market value of surrendered shares, as treasury
stock.
In fiscal 2004, certain officers of the Company exercised 769,300 stock options
in a non-cash transaction. The officers surrendered 349,900 of previously owned
shares of the Company's common stock to exercise the stock options. The Company
recorded approximately $5.7 million, the market value of the surrendered shares,
as treasury stock.
In fiscal 2004, the Company purchased the assets of a privately held company for
$650,000, of which $350,000 was paid during fiscal 2004 and $150,000 during
fiscal 2006. The remaining $150,000 is to be paid in fiscal 2007 on the
thirty-sixth month anniversary date of the acquisition.
NOTE 3 - MARKETABLE SECURITIES
Marketable securities are recorded at fair value. The Company had no investments
in marketable securities at July 31, 2006. The following is a summary of
available-for-sale securities at July 31, 2005:
In 000's Fair Value Unrealized Holding (Loss)
-------- ---------- -------------------------
Income bond mutual fund $5,639 $(126)
Marketable debt securities:
U.S. Government and agency securities 449 -
Corporate debt securities 626 (5)
--- -
(Average of remaining maturity of debt $6,714 $(131)
securities was approximately four months at ====== ======
July 31, 2005)
F-16
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
During fiscal 2006, the Company realized proceeds of approximately $6.8 million
from maturities and sales of marketable securities, on which it realized a loss
of approximately $154,000, based on the average cost. During fiscal 2005, the
Company realized proceeds of approximately $10.7 million from maturities and
sales of marketable securities, on which it realized a loss of approximately
$200,000, based on the average cost. There were no realized gains or losses on
marketable security transactions during fiscal 2004. The Company's cost basis in
marketable securities as of July 31, 2005 was approximately $6.8 million.
The following is a summary of accumulated other comprehensive loss, relating to
the Company's investments in marketable securities which were classified as
available for sale securities:
In 000's Accumulated Loss Tax (Expense) Accumulated Loss
-------- Before Tax or Benefit Net of Tax
---------- ---------- ----------
Fiscal 2003 - unrealized losses $(139) $54 $(85)
------ --- -----
Balance - July 31, 2003 $(139) $54 $(85)
Fiscal 2004 - unrealized losses (262) 101 (161)
----- --- -----
Balance - July 31, 2004 $(401) $155 $(246)
Fiscal 2005 - realized losses 200 (78)
Fiscal 2005 - unrealized gain
and valuation allowances 70 (77) 115
-- ---- ---
Balance - July 31, 2005 (131) -- (131)
Fiscal 2006 - realized losses, net 131 -- 131
--- -- ---
Balance - July 31, 2006 $-- $-- $--
==== ==== ===
NOTE 4 - INVENTORIES
At July 31, 2006 and 2005 inventories - net of reserves of $238,000 and $0,
respectively, consist of:
In 000's 2006 2005
-------- ---- ----
Raw materials $38 $52
Work in process 1,518 1,767
Finished products 845 1,057
--- -----
$2,401 $2,876
====== ======
NOTE 5 - PROPERTY, PLANT, AND EQUIPMENT
At July 31, 2006 and 2005 property, plant, and equipment consist of:
In 000's 2006 2005
-------- ---- ----
Building $2,470 --
Laboratory machinery 2,242 $2,098
Office furniture and computer equipment 5,696 5,080
Leasehold improvements 2,975 2,771
----- -----
13,383 9,949
Accumulated depreciation and amortization (8,247) (7,279)
------- -------
5,136 $2,670
Land and land improvements 712 --
--- --
$5,848 $2,670
====== ======
In June 2006, the Company acquired land and building aggregating $3,182,000,
which upon completion of improvements, will be primarily used for the Company's
Life Sciences and Therapeutics research and development and manufacturing
operations.
F-17
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
NOTE 6 - INCOME TAXES
The Company accounts for income taxes under the provisions of SFAS 109. The
benefit (provision) for income taxes is as follows:
Fiscal Year Ended July 31, (In 000's) 2006 2005 2004
------------------------------------- ---- ---- ----
Current benefit (provision):
Federal $2,047 $(1,386) $3,287
State and local (65) 64 (191)
Deferred (provision) benefit (640) (891) 1,752
----- ----- -----
Benefit (provision) for income taxes $1,342 $(2,213) $4,848
====== ======== ======
Deferred tax assets and liabilities arise from temporary differences between the
tax basis of assets and liabilities and their reported amounts in the financial
statements. The components of deferred tax assets (liabilities) as of July 31,
2006 and 2005 are as follows:
In 000's July 31, 2006 July 31, 2005
-------- ------------- -------------
Deferred tax assets:
Federal tax carryforward losses $3,315 --
Provision for uncollectible accounts receivable 404 $889
State and local tax carry forward losses 1,080 245
Depreciation 14 33
Research and development and other tax credit carryforwards 405 -
Realized and unrealized losses on marketable securities 138 129
--- ---
Gross deferred tax assets 5,356 1,296
----- -----
Deferred tax liabilities:
Deferred patent costs (280) (293)
Other, net (220) (234)
----- -----
Gross deferred tax liabilities (500) (527)
----- -----
Net deferred tax assets - before valuation allowance $4,856 $769
Less: valuation allowance (4,856) (129)
------- -----
Deferred tax assets, net -- $640
== ====
Pursuant to SFAS 109, the Company recorded a valuation allowance during the year
ended July 31, 2006 equal to its net deferred tax assets at July 31, 2005 and
for net deferred tax assets generated in fiscal 2006. The Company believes that
the valuation allowance is necessary as it is not more likely than not that the
deferred tax assets will be realized in the foreseeable future based on positive
and negative evidence available at this time. This conclusion was reached
because of uncertainties relating to future taxable income, in terms of both its
timing and its sufficiency, which would enable the Company to realize the
deferred tax assets. During fiscal 2005, the Company determined that it was not
more likely than not that it would generate taxable income against which the
deferred tax asset for the realized and unrealized losses on marketable
securities could be applied. Therefore, the Company established a valuation
reserve against that deferred tax asset.
As of July 31, 2006, the Company had a U.S. federal net operating loss
carryforward of approximately $9.7 million. The U.S. federal tax loss expires in
2024 if not fully utilized by then. Utilization is dependent on generating
sufficient taxable income prior to expiration of the tax loss carryforward.
There was no U.S. federal net operating loss carryforward as of July 31, 2005.
As of July 31, 2006 and 2005, the Company has state and local tax carry forward
losses of approximately $21.1 million and $5.1 million, respectively.
F-18
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
The benefit (provision) for income taxes were at rates different from U.S.
federal statutory rates for the following reasons:
Year Ended July 31, 2006 2005 2004
------------------- ---- ---- ----
Federal statutory rate 34% (34%) 34%
Expenses not deductible for income tax return purposes (4%) (2%) (3%)
State income taxes, net of (benefit) of federal tax deduction. 5% (6%) 4%
Change in valuation allowance (28%) -- --
Benefit of foreign sales -- 1% 2%
Fixed asset basis difference -- -- 8%
Other 1% (1%) (1%)
-- ---- ----
8% (42%) 44%
== ===== ===
NOTE 7 - ACCRUED LIABILITIES AND OTHER CURRENT LIABILITIES
At July 31, 2006 and 2005, Accrued liabilities consist of:
In 000's 2006 2005
-------- ---- ----
Legal $1,974 $2,717
Payroll, benefits, and commissions 868 652
Research and development 408 286
Professional fees 369 413
Outside reference lab testing 122 30
Other 662 768
--- ---
$4,403 $4,866
====== ======
At July 31, 2006 and 2005 other current liabilities consist of:
In 000's 2006 2005
-------- ---- ----
Installment payable $150 $150
Deferred revenue 80 359
-- ---
$230 $509
==== ====
NOTE 8 - STOCKHOLDERS' EQUITY
TREASURY STOCK
In fiscal 2006, certain officers of the Company exercised 227,800 stock options
in a non-cash transaction. The officers surrendered 185,300 shares of previously
owned shares of the Company's common stock to exercise the stock options. The
Company recorded approximately $2.5 million, the market value of the surrendered
shares, as treasury stock.
In fiscal 2005, a director of the Company exercised 31,660 stock options in a
non-cash transaction. The director surrendered 17,000 previously owned shares of
the Company's common stock to exercise the stock options. The Company recorded
approximately $325,000, the market value of surrendered shares, as treasury
stock.
In fiscal 2004, certain officers of the Company exercised 769,300 stock options
in a non-cash transaction. The officers surrendered 349,900 of previously owned
shares of the Company's common stock to exercise the stock options. The Company
recorded approximately $5.7 million, the market value of the surrendered shares,
as treasury stock.
F-19
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
INCENTIVE STOCK OPTION PLANS
The Company has incentive stock option plans ("1994 plan","1999 plan" and "2005
plan") under which the Company may grant options for up to 1,336,745 shares
(1994 plan), up to 2,312,356 shares (1999 plan) and up to 1,000,000 shares (2005
plan) of common stock. No additional options may be granted under the 1994 plan.
The exercise price of options granted under such plans is equal to or greater
than fair market value of the common stock on the date of grant. The options
granted pursuant to the plans may be either incentive stock options or non
statutory options. Stock options generally become exercisable at 25% per year
after one year and expire ten years after the date of grant. The 2005 plan
provide for the issuance of restricted stock and restricted stock unit awards
which generally vest over a two to four year period.
A summary of the information pursuant to the Company's stock option plans for
the years ended July 31, 2006, 2005 and 2004 is as follows:
2006 2005 2004
-------------------------------------------------------------------------------
Weighted - Weighted - Weighted -
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
--------- ---------- ------- ---------- ------- ----------
Outstanding at
beginning of year 3,154,125 $12.61 2,856,801 $11.86 3,397,087 $9.88
Granted 100,000 $24.84 431,975 $16.57 428,925 $17.02
Exercised (285,030) $10.93 (100,332) $7.39 (917,539) 7.16
Cancelled (91,368) $12.61 (34,319) $11.64 (51,672) $10.13
--------- --------- ----------
Outstanding at
end of year 2,877,727 $13.20 3,154,125 $12.61 2,856,801 $11.86
========= ========= ==========
Exercisable at
end of year 2,554,148 $12.78 2,126,442 $11.28 1,770,492 $10.54
========= ========= ==========
Weighted average fair value of
options
granted during year $1.01 $11.76 $12.40
====== ====== ======
The aggregate intrinsic value of stock options exercised during the years ended
July 31, 2006 and 2005, including the non-cash transactions (see Note 2) was
$0.7 million and $0.9 million, respectively. The aggregate intrinsic value of
options both outstanding and exercisable at July 31, 2006 is approximately $3.7
million.
The following table summarizes information for stock options outstanding at July
31, 2006:
Options outstanding Options exercisable
------------------- --------------------------
Weighted-Average Weighted- Weighted-
Range of Exercise Remaining Average Exercise Average Exercise
prices Shares Contractual Life Price Shares Price
----- ------ ---------------- ----- ------ -----
$5.45-8.08 289,020 2.2 years $5.64 289,020 $5.64
$8.33-12.25 1,502,111 4.4 years $11.09 1,378,906 $10.91
$12.93-19.02 906,719 7.4 years $16.82 806,345 $16.60
$20.20-24.84 161,644 2.9 years $23.02 61,644 $21.42
$36.05 18,233 3.4 years $36.05 18,233 $36.05
--------- ------
2,877,727 2,554,148
========= =========
F-20
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
During the year ended July 31, 2006, the Company granted 100,000 options to a
consultant with an exercise price of $24.84, which vest over six months and have
a two year term. The fair value of these options at July 31, 2006 is $101,000.
The fair value of the options, which will be accounted for as a variable
instrument, will be fair valued and recognized as expense over the six month
vesting term. The assumptions used to fair value this option grant as of July
31, 2006 were as follows: risk free interest rate of 4.97%, expected term of 2
years, expected volatility of 49%, and no dividend yield. In connection with the
options issued to this consultant, the Company recognized an expense of
approximately $80,000 in selling, general and administrative expense in the
accompanying statements of operations for the year ended July 31, 2006.
RESTRICTED STOCK AWARDS
During fiscal 2006, the compensation committee of the Company's board of
directors approved grants of 84,950 restricted stock and restricted stock unit
awards (the "Awards") under the 2005 Plan to the Company's directors and certain
officers and employees. The Awards vest in full upon the recipient's continued
employment or director service over either two, three or four years. Share-based
compensation expense is recorded over the vesting period on a straight-line
basis. The Awards will be forfeited if the recipient ceases to be employed by or
serve as a director of the Company, as defined in the Award grants. The Awards
settle in shares of the Company's common stock on a one-for-one basis. As of
July 31, 2006, all Awards were unvested.
A summary of the information pursuant to the Company's Awards for the year ended
July 31, 2006 is as follows:
Weighted - Average
Awards Award Price
------ -----------
Outstanding at
beginning of year -- --
Awarded 84,950 $12.29
Forfeited (7,500) $13.13
------ ------
Outstanding at end of year 77,450 $12.21
====== ======
Weighted average market value of Awards
granted during year $12.29
======
As of July 31, 2006, there were approximately 629,000 shares available for grant
under the Company's stock option plans.
STOCK DIVIDENDS
During fiscal 2005, the Company's board of directors declared a 5% stock
dividend on October 5, 2004 payable November 15, 2004 to shareholders of record
as of October 25, 2004. The fiscal 2004 per share data was adjusted
retroactively to reflect the stock dividend declared on October 5, 2004. The
Company recorded a charge to accumulated deficit and offsetting credits to both
common stock and additional paid-in capital of $23,433,400 in fiscal 2005, which
reflects the fair value of the stock dividends on the dates of declaration.
NOTE 9 - EMPLOYEE BENEFIT PLAN
The Company has a qualified Salary Reduction Profit Sharing Plan (the "Plan")
for eligible employees under Section 401(k) of the Internal Revenue Code. The
Plan provides for voluntary employee contributions through salary reduction and
voluntary employer contributions at the discretion of the Company. For the years
ended July 31, 2006, 2005 and 2004, the Company authorized employer matched
contributions of 50% of the employees' contribution up to 10% of the employees'
compensation, payable in Enzo Biochem, Inc. common stock. The 401(k) employer
matched contributions expense was $402,300, $351,600, and $282,200, in fiscal
years 2006, 2005, and 2004, respectively.
F-21
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
NOTE 10 - GAIN ON PATENT LITIGATION SETTLEMENT, LICENSE AGREEMENT AND ROYALTY
INCOME
In fiscal 2005, the Company as plaintiff finalized and executed a settlement and
license agreement with Digene Corporation to settle a patent litigation lawsuit
(the "Agreement"). Under the terms of the Agreement, the Company received an
initial payment of $16.0 million, would earn in the first "annual period"
(October 1, 2004 to September 30, 2005) a minimum royalty payment of $2.5
million, and receive a minimum royalty of $3.5 million in each of the next four
annual periods. In addition, the Agreement provides for the Company to receive
quarterly running royalties on the net sales of Digene products subject to the
license until the expiration of the patent on April 24, 2018. These quarterly
running royalties are fully creditable against the minimum royalty payments due
in the first five years of the Agreement. The balance, if any, of the minimum
royalty payment is recognized in the final quarter of the applicable annual
royalty period.
As a result of the Digene Agreement, the Company recorded a gain on patent
litigation settlement of $14.0 million during the year ended July 31, 2005 and
deferred $2 million, which was earned from net sales of the Company's licensed
products covered by the Agreement during the first annual period. During the
years ended July 31, 2006 and 2005, the Company recorded royalty income under
the Agreement of approximately $3.1 million and $1.6 million, respectively,
which is included in the Life Sciences segment.
NOTE 11 - COMMITMENTS
LEASES
The Company leases equipment, office and laboratory space under several
non-cancelable operating leases that expire between January 2007 and March 2017.
An entity owned by certain executive officers/directors of the Company owns the
building that the Company leases as its main facility for laboratory, research,
and manufacturing operations. In March 2005, the Company amended and extended
the lease for another 12 years. In addition to the minimum annual rentals of
space, the lease is subject to annual increases, based on the consumer price
index. Annual increases are limited to 3% per year. Rent expense, inclusive of
real estate taxes, under this renewed lease and the prior lease approximated
$1,337,000, $1,289,000, and $1,370,000 during fiscal years 2006, 2005, and 2004,
respectively.
Total consolidated rent expense incurred by the Company during fiscal 2006,
2005, and 2004 was approximately $2,257,000, $2,140,000, and $1,801,000
respectively. Minimum future annual rentals under non-cancelable operating
leases as of July 31, 2006, are as follows:
Years ended July 31, In 000's
-------------------- --------
2007 $2,663
2008 2,505
2009 2,384
2010 2,337
2011 2,044
Thereafter 8,429
-----
$20,362
=======
Employment Agreements
The Company has employment agreements with certain executive officers that are
cancelable at any time but provide for severance pay in the event an executive
officer is terminated by the Company without cause, as defined in the
agreements. Unless cancelled earlier, the contracts expire through May 2008.
Aggregate minimum compensation commitments, exclusive of any severance
provisions, for the years ended July 31, 2007 and 2008 are $1,490,000 and
$870,000, respectively
F-22
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
NOTE 12- CONTINGENCES
LITIGATION
In October 2002, the Company filed suit in the United States District Court of
the Southern District of New York against Amersham plc, Amersham Biosciences,
Perkin Elmer, Inc., Perkin Elmer Life Sciences, Inc., Sigma-Aldrich Corporation,
Sigma Chemical Company, Inc., Molecular Probes, Inc. and Orchid Biosciences,
Inc. In January 2003, the Company amended its Complaint to include defendants
Sigma Aldrich Co. and Sigma Aldrich, Inc. The counts set forth in the suit are
for breach of contract; patent infringement; unfair competition under state law;
unfair competition under federal law; tortious interference with business
relations; and fraud in the inducement of contract. The Complaint alleges that
these counts arise out of the defendants' breach of distributorship agreements
with the Company concerning labeled nucleotide products and technology, and the
defendants' infringement of patents covering the same. In April, 2003, the Court
directed that individual Complaints be filed separately against each defendant.
The defendants have answered the individual Complaints and asserted a variety of
affirmative defenses and counterclaims. Fact discovery is ongoing. The Court
issued a claim construction opinion on July 10, 2006. The Company and Sigma
Aldrich ("Sigma") entered into a Settlement Agreement and Release effective
September 15, 2006 (the "Agreement"). Pursuant to the Agreement, the Company's
litigation with Sigma was dismissed and the Company will recognize $2 million on
settlement in the first quarter ending October 31, 2006. There can be no
assurance that the Company will be successful with the remaining outstanding
litigation. However, even if the Company is not successful, management does not
believe that there will be a significant adverse monetary impact to the Company.
The Company has not recorded revenue under these distribution agreements in
fiscal 2006. The Company recorded revenue from only Perkin Elmer in fiscal 2005.
On October 28, 2003, the Company and Enzo Life Sciences, Inc., a subsidiary of
the Company, filed suit in the United States District Court of the Eastern
District of New York against Affymetrix, Inc. The Complaint alleges that
Affymetrix improperly transferred or distributed substantial business assets of
the Company to third parties, including portions of the Company's proprietary
technology, reagent systems, detection reagents and other intellectual property.
The Complaint also charges that Affymetrix failed to account for certain
shortfalls in sales of the Company's products, and that Affymetrix improperly
induced collaborators and customers to use the Company's products in
unauthorized fields or otherwise in violation of the agreement. The Complaint
seeks full compensation from Affymetrix to the Company for its substantial
damages, in addition to injunctive and declaratory relief to prohibit, among
other things, Affymetrix's unauthorized use, development, manufacture, sale,
distribution and transfer of the Company's products, technology, and/or
intellectual property, as well as to prohibit Affymetrix from inducing
collaborators, joint venture partners, customers and other third parties to use
the Company's products in violation of the terms of the agreement and the
Company's rights. Subsequent to the filing of the Complaint against Affymetrix,
Inc. referenced above, on or about November 10, 2003, Affymetrix, Inc. filed its
own Complaint against the Company and its subsidiary, Enzo Life Sciences, Inc.,
in the United States District Court for the Southern District of New York,
seeking among other things, declaratory relief that Affymetrix, Inc., has not
breached the parties' agreement, that it has not infringed certain of Enzo's
Patents, and that certain of Enzo's patents are invalid. The Affymetrix
Complaint also seeks damages for alleged breach of the parties' agreement,
unfair competition, and tortuous interference, as well as certain injunction
relief to prevent alleged unfair competition and tortuous interference. The
Company does not believe that the Affymetrix Complaint has any merit and intends
to defend vigorously. Affymetrix also moved to transfer venue of Enzo's action
to the Southern District of New York, where other actions commenced by Enzo were
pending as well as Affymetrix's subsequently filed action. On January 30, 2004,
Affymetrix's motion to transfer was granted. Accordingly, the Enzo and
Affymetrix actions are now both pending in the Southern District of New York.
Initial pleadings have been completed and discovery has commenced. The Court
issued a Markman (claim construction) opinion on July 10, 2006. The Company did
not record any revenue from Affymetrix during the fiscal years ended July 31,
2006, 2005 and 2004.
F-23
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
On June 2, 2004 Roche Diagnostic GmbH and Roche Molecular Systems, Inc.
(collectively "Roche") filed suit in the U.S. District Court of the Southern
District of New York against Enzo Biochem, Inc. and Enzo Life Sciences, Inc.
(collectively "Enzo"). The Complaint was filed after Enzo rejected Roche's
latest cash offer to settle Enzo's claims for, INTER ALIA, alleged breach of
contract and misappropriation of Enzo's assets. The Complaint seeks declaratory
judgment (i) of patent invalidity with respect to Enzo's 4,994,373 patent (the
"'373 patent"), (ii) of no breach by Roche of its 1994 Distribution and Supply
Agreement with Enzo (the "1994 Agreement"), (iii) that non-payment by Roche to
Enzo for certain sales of Roche products does not constitute a breach of the
1994 Agreement, and (iv) that Enzo's claims of ownership to proprietary
inventions, technology and products developed by Roche are without basis. In
addition, the suit claims tortious interference and unfair competition. The
Company does not believe that the Complaint has merit and intends to vigorously
respond to such action with appropriate affirmative defenses and counterclaims.
Enzo filed an Answer and Counterclaims on November 3, 2004 alleging multiple
breaches of the 1994 Agreement and related infringement of Enzo's `373 patent.
Discovery has commenced. The Court issued a Markman opinion on July 10, 2006.
The Company did not record any revenue from Roche during the fiscal year ended
July 31, 2006. The Roche agreement remains in force to date.
On March 6, 2002, the Company was named, along with certain of its officers and
directors among others, in a complaint entitled Lawrence F. Glaser and Maureen
Glaser, individually and on behalf of Kimberly, Erin, Hannah, and Benjamin
Glaser v. Hyman Gross, Barry Weiner, Enzo Biochemical Inc., Elazar Rabbani,
Shahram Rabbani, John Delucca, Dean Engelhardt, Richard Keating, Doug Yates, and
Does I-50, Case No. CA-02-1242-A (the "Glasser Action"), in the U.S. District
Court for the Eastern District of Virginia. This complaint was filed by an
investor in the Company who had filed for bankruptcy protection and his family.
The complaint alleged securities fraud, breach of fiduciary duty, conspiracy,
and common law fraud and sought in excess of $150 million in damages. On August
22, 2002, the complaint was voluntarily dismissed; however a new substantially
similar complaint was filed at the same time. On October 21, 2002, the Company
and the other defendants filed a motion to dismiss the complaint, and the
plaintiffs responded by amending the complaint and dropping their claims against
defendants Keating and Yates. On November 18, 2002, the Company and the other
defendants again moved to dismiss the Amended Complaint. On July 16, 2003, the
Court issued a Memorandum Opinion dismissing the Amended Complaint in its
entirety with prejudice. Plaintiffs thereafter moved for reconsideration but the
Court denied the motion on September 8, 2003. Plaintiffs thereafter appealed the
decision to the United States Court of Appeals for the Fourth Circuit. On March
21, 2005, the Fourth Circuit affirmed the lower Court's prior dismissal of all
claims asserted in the action, with the sole exception of a portion of the claim
for common law fraud and remanded that remaining portion of the action to the
U.S. District Court for the Eastern District of Virginia. On May 20, 2005,
defendants again moved the District Court to dismiss the sole remaining claim
before it. On July 14, 2005, the District Court granted defendants' renewed
motion to dismiss. On July 29, 2005, Plaintiffs moved to amend their Complaint
for reconsideration. On August 19, 2005, the Court denied Plaintiffs' motion to
amend and entered final judgment dismissing the complaint. Thereafter,
Plaintiffs appealed the order and judgment to the Fourth Circuit. On September
16, 2006, the United States Court of Appeals for the Fourth Circuit affirmed the
dismissal of the Complaint relating to the Glasser Action. Although the Glasser
plaintiffs still have the option of requesting a rehearing before the Fourth
Circuit or petitioning for a writ of certiorari from the United States Supreme
Court, absent such further relief, the Glasser Action will be closed. The
Company continues to believe that the Glasser Action and the remaining complaint
have no merit whatsoever and intends to continue to defend the actions
vigorously.
On June 7, 2004, the Company and its wholly-owned subsidiary, Enzo Life
Sciences, Inc., filed suit in the United States District Court for the District
of Connecticut against Applera Corporation and its wholly-owned subsidiary
Tropix, Inc. The complaint alleges infringement of six patents (relating to DNA
sequencing systems, labelled nucleotide products, and other technology). Yale
University is the owner of four of the patents and the Company is the exclusive
licensee. Accordingly, Yale is also a plaintiff in the lawsuit. Yale and Enzo
are aligned in protecting the validity and enforceability of the patents. Enzo
Life Sciences is the owner of the remaining two patents. The complaint seeks
permanent injunction and damages (including treble damages for wilful
infringement). Defendants answered the complaint on July 29, 2004. The answer
pleads affirmative defences of invalidity, estoppels and laches and asserts
counterclaims of non-infringement and invalidity. Fact discovery is ongoing. A
one-day Markman hearing was held on May 25, 2006 and the parties are currently
waiting for a Markman ruling. Dispositive motions due dates are based on the
Markman ruling date.
F-24
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
The trial date is currently scheduled for December 1, 2006. There can be no
assurance that the Company will be successful in this litigation. Even if the
Company is not successful, management does not believe that there will be a
significant adverse monetary impact on the Company.
NOTE 13 - SEGMENT REPORTING
The Company has three reportable segments: Life Sciences, Therapeutics, and
Clinical Labs. The Company's Life Sciences segment develops, manufactures, and
markets products to research and pharmaceutical customers. The Company's
Therapeutic segment conducts research and development activities for therapeutic
drug candidates. The Clinical Labs segment provides diagnostic services to the
health care community. Prior to fiscal 2006, the Life Sciences and Therapeutics
segments were reported together as the Research and Development segment. The
fiscal 2005 and 2004 segment information has been restated to reflect this
change. The Company evaluates segment performance based on segment income (loss)
before taxes. Costs excluded from segment income (loss) before taxes and
reported as other consist of corporate general and administrative costs which
are not allocable to the three reportable segments.
Management of the Company assesses assets on a consolidated basis only and
therefore, assets by reportable segment have not been included in the reportable
segments below. The accounting policies of the reportable segments are the same
as those described in the summary of significant accounting policies.
The following financial information (in thousands) represents the operating
results of the reportable segments of the Company:
YEAR ENDED JULY 31, 2006
Revenues: Life Sciences Therapeutics Clinical Labs Other Consolidated
-------- ------------- ------------ ------------- ----- ------------
Product revenues and royalty income $7,900 -- -- -- $7,900
Clinical laboratory services -- -- $31,926 -- 31,926
------ -------- ------- --------- ---------
7,900 -- 31,926 -- 39,826
Cost and expenses and other (income):
-------------------------------------
Cost of products 2,174 -- -- -- 2,174
Cost of clinical laboratory services -- -- 13,917 -- 13,917
Research and development 3,659 $4,237 -- -- 7,896
Provision for uncollectible accounts -- -- 3,633 -- 3,633
Selling, general and administrative and legal 2,260 -- 14,322 15,777 32,359
Interest income -- -- -- (3,144) (3,144)
------ -------- ------- --------- ---------
(Loss) income before income taxes ($193) ($4,237) $54 $(12,633) $(17,009)
====== ======== === ========= =========
Depreciation and amortization included above $180 $12 $897 $35 $1,124
==== === ==== === ======
Share-based compensation included in above:
-------------------------------------------
Cost of products $21 -- -- -- $21
Research and development 106 $143 -- -- 249
Selling, general and adminstrative and legal 87 -- $539 $867 1,493
-- -- ---- ---- -----
Total $214 $143 $539 $867 $1,763
==== ==== ==== ==== ======
Capital expenditures $3,332 $6 $860 $29 $4,227
====== == ==== === ======
F-25
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
YEAR ENDED JULY 31, 2005
Life Sciences Therapeutics Clinical Labs Other Consolidated
------------- ------------ ------------- ----- ------------
REVENUES:
Product revenues and royalty income $10,546 -- -- -- $10,546
Clinical laboratory services -- -- $32,857 -- 32,857
-------- -------- ------ -------- -------
10,546 -- 32,857 -- 43,403
Cost and expenses and other (income):
-------------------------------------
Cost of products 2,197 -- -- -- 2,197
Cost of clinical laboratory services -- -- 12,548 -- 12,548
Research and development 5,340 $3,112 -- -- 8,452
Provision for uncollectible accounts -- -- 4,967 -- 4,967
Selling, general and administrative and legal 2,405 -- 12,505 $10,635 25,545
Interest income -- -- -- (1,523) (1,523)
Gain on patent litigation settlement (14,000) -- -- -- (14,000)
-------- -------- ------ -------- -------
Income (loss) before income taxes $14,604 ($3,112) $2,837 ($9,112) $5,217
======= ======== ====== ======== ======
Depreciation and amortization included above $1,382 $13 $887 $50 $2,332
====== === ==== === ======
Capital expenditures $126 $40 $1,100 $10 $1,276
====== === ====== === ======
YEAR ENDED JULY 31, 2004
Life Sciences Therapeutics Clinical Labs Other Consolidated
------------- ------------ ------------- ----- ------------
REVENUES:
Product revenues $12,972 -- -- -- $12,972
Clinical laboratory services -- -- $28,672 -- 28,672
-------- ------- -------- ------- --------
12,972 -- 28,672 -- 41,644
Cost and expenses and other (income):
-------------------------------------
Cost of products 2,518 -- -- -- 2,518
Cost of clinical laboratory services -- -- 10,586 -- 10,586
Research and development 5,661 $2,417 -- -- 8,078
Provision for uncollectible accounts 1,753 -- 10,234 -- 11,987
Selling, general and administrative and legal 1,922 -- 9,331 $9,454 20,707
Interest income -- -- -- (1,152) (1,152)
-------- ------- -------- ------- --------
(Loss) income before income taxes $1,118 $(2,417) ($1,479) ($8,302) ($11,080)
====== ======= ======= ======= ========
Depreciation and amortization included above $1,397 $17 $903 $45 $2,362
====== === ==== === ======
Total capital expenditures $70 $7 $1,142 $85 $1,304
====== === ====== === ======
The Company's reportable segments are determined based on the services they
perform, the products they sell, and the royalties they earn, not on the
geographic area in which they operate. The Company's Clinical Labs segment
operates 100% in the United States with all revenue derived from this country.
The Life Sciences segment earns product revenue both in the United States and
foreign countries and royalty income in the United States. The following is a
summary of the Life Sciences segment revenues attributable to customers located
in the United States and foreign countries:
In 000's 2006 2005 2004
-------- ---- ---- ----
United States $6,361 $7,985 $8,029
Foreign countries 1,539 2,561 4,943
----- ----- -----
$7,900 $10,546 $12,972
====== ======= =======
F-26
ENZO BIOCHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 2006 AND 2005
NOTE 14 - SUMMARY OF SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table contains statement of operations information for each
quarter of the years ended July 31, 2006 and 2005. The Company believes that the
following information reflects all normal recurring adjustments necessary for a
fair presentation of the information for the periods presented. The operating
results for any quarter are not necessarily indicative of results for any future
period.
Unaudited quarterly financial data (in thousands, except per share amounts) for
fiscal 2006 and 2005 is summarized as follows:
Quarter Ended
---------------------------------------------------------------------------
FISCAL 2006 OCTOBER 31, JANUARY 31, APRIL 30, JULY 31,
2005 2006 2006 2006
---- ---- ---- ----
Total revenues $10,165 $10,116 $9,630 $9,915
Gross profit 6,143 6,300 5,658 5,634
Loss before income taxes (3,163) (5,098) (3,793) (4,955)
Net loss (3,286) (4,439) (3,436) (4,506)
Basic loss per common share ($0.10) ($0.14) ($0.11) ($0.14)
Diluted loss per common share ($0.10) ($0.14) ($0.11) ($0.14)
Quarter Ended
---------------------------------------------------------------------------
FISCAL 2005 OCTOBER 31, JANUARY 31, APRIL 30, JULY 31,
2004 2005 2005 2005
---- ---- ---- ----
Total revenues $10,301 $11,235 $11,000 $10,867
Gross profit 6,812 7,820 7,035 6,991
Income (loss) before income taxes 12,173 (944) (2,553) (3,459)
Net income (loss) 7,021 (528) (1,497) (1,992)
Basic income (loss) per common share $0.22 ($0.02) ($0.05) ($0.06)
Diluted income (loss) per common share $0.22 ($0.02) ($0.05) ($0.06)
F-27
ENZO BIOCHEM, INC
SCHEDULE II - VALUATION
AND QUALIFYING ACCOUNTS
Years ended July 31, 2006, 2005 and 2004
(in thousands)
Charged Charged
Balance at (credited) to other
Year ended Beginning to costs accounts- Deductions- Balance at
July 31, Description of period and expenses describe describe end of period
-------- ----------- --------- ------------ --------- ----------- -------------
2006 Allowance for doubtful accounts receivable $2,292 $3,633 --- $4,892 (1) $1,033
2005 Allowance for doubtful accounts receivable 2,770 4,967 --- 5,445 (1) 2,292
2004 Allowance for doubtful accounts receivable 2,257 11,987 --- 11,474 (1) 2,770
2006 Deferred tax asset valuation allowance 129 4,727 --- - 4,856
2005 Deferred tax asset valuation allowance - 129 --- - 129
2006 Reserve for obsolete inventory - 596 --- 358 (2) 238
(1) Write-off of uncollectible accounts receivable.
(2) Write-off of obsolete inventory.
S-1