ENZO BIOCHEM INC - Quarter Report: 2019 April (Form 10-Q)

The provision for income taxes and the effective tax rates for the three months ended April 30, 2019 and 2018 is $0. The provision (benefit) for income taxes for the nine months ended April 30, 2019 and 2018 is $0 and ($1,097), respectively. The effective tax rate for the nine months ended April 30, 2018 was (19.4%). The primary differences between the Company’s effective tax rates and the statutory rates for the three and nine months ended April 30, 2019 and 2018 are due to the utilization of net operating losses for which a full valuation allowance was maintained and for a tax benefit recorded in the nine month period ended April 30, 2018 of $1.1 million. The $1.1 million tax benefit in the 2018 period is due to the Tax Act, signed into law December 22, 2017, in which the legislation provided for a credit for alternative minimum taxes (AMT) paid in prior periods. 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.

Note 2 – Net income (loss) 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. As a result of the net loss for the three months ended April 30, 2018 and nine months ended April 30, 2018 diluted weighted average shares outstanding are the same as basic weighted average shares outstanding, and do not include the potential common shares from stock options and unvested restricted stock because to do so would be antidilutive. For the three and nine months ended April 30, 2018, approximately 431,000, and 694,000, respectively of potential common shares (“in the money options”) and unvested restricted stock were excluded from the calculation of diluted earnings per share.

For the three and nine months ended April 30, 2019, the effect of approximately 1,640,000 and 1,541,000 of outstanding “out of the money” options to purchase common shares were excluded from the calculation of diluted net income per share because their effect would be anti-dilutive. For the three and nine months ended April 30, 2018, the effect of approximately 581,000 and 194,000 of outstanding “out of the money” options to purchase common shares were excluded from the calculation of diluted net income per share because their effect would be anti-dilutive.

Note 3 – Revenue Recognition

Clinical Services Revenue

Net revenues in the Company’s clinical services business accounted for 63% and 72% of the Company’s total net revenues for the nine months ended April 30, 2019 and 2018, respectively and are primarily comprised of a high volume of relatively low-dollar transactions. The services business, which provides clinical testing services, satisfies its performance obligation and recognizes revenues upon completion of the testing process for a specific patient and reporting to the ordering physician. The Company may also perform clinical testing services for other laboratories and will recognize revenue from those services when reported to the ordering laboratory. The Company estimates the amount of consideration it expects to receive from customer groups using the portfolio approach. These estimates of the expected consideration include the impact of contractual allowances and price concessions on our customer group portfolios consisting of healthcare insurers, government payers, client payers and patients as described below. Contracts with customers in our laboratory services business do not contain a financing component, based on the typically limited period of time between performance of services and collection of consideration. The transaction price includes variable consideration in the form of the contractual allowance and price concessions as well as the collectability of the transaction based on the patient intent and ability to pay. The Company uses the expected value method in estimating the amount of the variability included in the transaction price.

The following are descriptions of our laboratory services business portfolios:

Third party payers and Health Maintenance Organizations (HMO’s)

Reimbursements from third party payers, primarily healthcare insurers, and HMO’s are based on negotiated fee-for-service schedules. Revenues consist of amounts billed net of contractual allowances for differences between amounts billed and the estimated consideration the Company expects to receive from such payers, which considers historical collection and denial experience and the terms of the Company’s contractual arrangements. Adjustments to the allowances, based on actual receipts from the third-party payers, are recorded upon settlement.

Collection of the consideration the Company expects to receive is normally a function of providing complete and correct billing information to these third party payers within the various filing deadlines, and typically occurs within 60 to 90 days of billing. Provided the Company has billed healthcare insurers accurately with complete information prior to the established filing deadline, there has historically been little to no collection risk. If there has been a delay in billing, the Company determines if the amounts in question will likely go past the filing deadline, and if so, will reserve accordingly for the billing.

Third-party payers, including government programs, may decide to deny payment or recoup payments for testing that they contend was improperly billed or not medically necessary, against their coverage determinations, or for which they believe they have otherwise overpaid (including as a result of their own error), and we may be required to refund payments already received. Our revenues may be subject to adjustment as a result of these factors among others, including without limitation, differing interpretations of billing and coding guidance and changes by government agencies and payers in interpretations, requirements, and “conditions of participation” in various programs.

Government Payer - Medicare

Reimbursements from Medicare are based on fee-for-service schedules set by Medicare, which is funded by the government. Revenues consist of amounts billed net of contractual allowances for differences between amounts billed and the estimated consideration the Company expects to receive from Medicare, which considers historical collection and denial experience and other factors. Adjustments to the allowances, based on actual receipts from the government payers, are recorded upon settlement.

Collection of consideration the Company expects to receive is normally a function of providing the complete and correct billing information within the various filing deadlines and typically occurs within 60 days of billing. Provided the Company has billed the government payer accurately with complete information prior to the established filing deadline, there has historically been little to no collection risk. If there has been a delay in billing, the Company determines if the amounts in question will likely go past the filing deadline, and, if so, it will reserve accordingly for the billing.

Patient self-pay

Uninsured patients are billed based on established patient fee schedules or fees negotiated with physicians on behalf of their patients. Coinsurance and deductible responsibilities based on fees negotiated with healthcare insurers are also billed to insured patients and included in this portfolio. Collection of billings from patients is subject to credit risk and ability of the patients to pay. Revenues consist of amounts billed net of discounts provided to uninsured patients in accordance with the Company’s policies and implicit price concessions. Implicit price concessions represent differences between amounts billed and the estimated consideration the Company expects to receive from patients, which considers historical collection experience and other factors including current market conditions. Adjustments to the estimated allowances, based on actual receipts from the patients, are recorded upon settlement. Patient billings are generally fully reserved for when the related billing reaches 210 days outstanding. Balances are automatically written off when they are sent to collection agencies. Allowances are further adjusted for estimated recoveries of amounts sent to collection agencies based on historical collection experience, which is regularly monitored. Collection of consideration the Company expects to receive typically occurs within 180 days of billing.

The following table represents clinical services net revenues and percentages by type of customer:

For the three and nine months ended April 30, 2019 and 2018, all of the Company’s clinical services were provided within the United States.

Products Revenue and royalty income

Products revenues consist of the sale of single-use products used in the identification of genomic information and are recognized at a point in time following the transfer of control of such products to the customer, which generally occurs upon shipment. Payment terms for shipments to end-user and distributor customers may range from 30 to 90 days. Any claims for credit or return of goods may be made generally within 30 days of receipt. Revenues are reduced to reflect estimated credits and returns, although historically these adjustments have not been material. Taxes collected from customers relating to product sales and remitted to governmental authorities are excluded from revenue. Amounts billed to customers for shipping and handling are included in revenue, while the related shipping and handling costs are reflected in cost of products.

Royalty income is based on net sales of the Company’s licensed products by a third party. We recognize royalty income in the period the sales occur based on third party evidence received. During the three and nine months ended April 30, 2019 there was no royalty income. For the three and nine months ended April 30, 2018, royalty income was $78 and $639, respectively.

Products revenue by geography is as follows:

Note 4 - Supplemental disclosure for statement of cash flows

For the nine months ended April 30, 2019 and 2018, tax on capital paid by the Company were $94 and $65, respectively.

For the nine months ended April 30, 2019 and 2018, interest paid by the Company was $138 and $61, respectively.

During the nine months ended April 30, 2019, there was a total of $381 in capital lease agreements. During the nine months ended April 31, 2018, the Company did not enter into any material capital lease agreements.

During the nine months ended April 30, 2019, certain directors and officers of the Company exercised 203,511 stock options in a non-cash transaction. The officers and directors received 23,376 net shares of common stock. The Company did not receive any proceeds from this exercise. The net shares issued represent the difference between the fair market value of the options on the date of exercise less the strike price cost to exercise the options.

During the nine months ended April 30, 2019 the Company issued common stock in connection with its share based 401(k) employer match in the amount of $832. For the 2018 period, the Company issued shares of common stock in the amount of $782.

Note 5 – Inventories

Inventories consist of the following:

Note 6 – Goodwill and intangible assets

At April 30, 2019 and July 31, 2018, the Company has goodwill of $7,452 allocated to the Clinical Services reporting unit.

The Company’s change in the carrying amount of intangible assets, all in the Products segment is as follows:

Intangible assets, all finite lived, consist of the following:

At April 30, 2019, information with respect to intangibles assets acquired is as follows:

At April 30, 2019, the weighted average remaining useful life of intangible assets is approximately one year.

Note 7 - Loan Payable

In connection with the purchase of our new facility, on November 27, 2018, a wholly-owned subsidiary (the ““mortgagor subsidiary”) of the Company entered into a Fee Mortgage and Security Agreement (the “mortgage agreement”) with Citibank, N.A. (the “mortgagee”). The mortgage agreement provides for a loan of $4,500 for a term of 10 years, bears a fixed interest rate of 5.09% per annum and requires monthly mortgage payments of principal and

interest of $30. Debt issuance costs of $72 are being amortized over the life of the mortgage agreement. The balance of unamortized debt issuance cost was $69 at April 30, 2019. At April 30, 2019, the balance owed by the subsidiary under the mortgage agreement was $4.4 million. The Company’s obligations under the mortgage agreement are secured by the new facility and by a $750 cash collateral deposit with the mortgagee as additional security. This restricted cash is included in other assets as of April 30, 2019.

The mortgage agreement includes affirmative and negative covenants and events of default, as defined. Events of default include non-payment of principal and interest on debt outstanding, non-performance of covenants, material changes in business, breach of representations, bankruptcy or insolvency, and changes in control. The mortgage includes certain financial covenants. As of April 30, 2019, required financial covenants have been met.

We assumed from the seller an operating lease for a current tenant at the facility which runs to December 2019. Rental income from the assumed lease is included in other income.

Minimum future annual principal payments under the mortgage agreement as of April 30, 2019, are as follows:

Note 8 – Accrued Liabilities

Accrued liabilities consist of the following:

Note 9 – Stockholders’ Equity

Controlled Equity Offering

The Company has a Controlled Equity Offering^SM Sales Agreement (the “Sales Agreement”) with Cantor Fitzgerald & Co., as sales agent (“Cantor”). Under the Sales Agreement, the Company may offer and sell, from time to time, through Cantor, shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”). The Company pays Cantor a commission of 3.0% of the aggregate gross proceeds received under the Sale Agreement. The Company is not obligated to make any sales of the shares under the Sales Agreement. The offering of shares pursuant to the Sales Agreement will terminate upon the earlier of (a) the sale of all of the shares subject to the Sales Agreement or (b) the termination of the Sales Agreement by Cantor or the Company, as permitted therein. The initial agreement contemplated the sale of shares of the Company’s common stock having an aggregate offering price of up to $20.0 million. In December 2014, the Sales Agreement was amended in order for the Company to offer and sell additional shares of Common Stock having an aggregate offering price of $20.0 million.

On September 1, 2017, the Company filed with the SEC a “shelf” registration and sales agreement prospectus covering the offering, issuance and sale of our Common Stock that may be issued and sold under the existing Sales Agreement in an aggregate amount of up to $19.15 million. A total of $150 million of securities may be sold under this shelf registration, which was declared effective September 15, 2017.

During the nine months ended April 30, 2019 and 2018, the Company did not sell any shares of Common Stock under the Sales Agreement.

Share-based compensation

On January 14, 2011, the Company’s stockholders approved the adoption of the 2011 Incentive Plan (the “2011 Plan”) which provides for the issuance of equity awards, including among others, options, restricted stock and restricted stock units for up to 3,000,000 Common Shares. The exercise price of options granted under the 2011 Plan, and consistent with other Plans, is equal to or greater than fair market value of the Common Stock on the date of grant. Unless terminated earlier by the Board of Directors, the 2011 Plan will terminate at the earliest of; (a) such time as no shares of Common Stock remain available for issuance under the 2011 Plan or (b) tenth anniversary of the effective date of the 2011 Plan. On January 5, 2018, the Company’s stockholders approved the amendment and restatement of the 2011 Plan to increase the number of shares available for issuance by 2,000,000 bringing the total number of shares available for award under the 2011 Plan to 5,000,000. Awards outstanding upon expiration of the 2011 Plan shall remain in effect until they have been exercised, terminated, or have expired.

The amounts of share-based compensation expense recognized in the periods presented are as follows:

The following table sets forth the amount of expense related to share-based payment arrangements included in specific line items in the accompanying statements of operations:

No excess tax benefits were recognized during the nine month periods ended April 30, 2019 and 2018.

Stock Option Plans

The following table summarizes stock option activity during the nine month period ended April 30, 2019:

As of April 30, 2019, the total future compensation cost related to non-vested options, not yet recognized in the statements of operations, was $1.2 million and the weighted average period over which the remaining expense of these awards is expected to be recognized is seventeen months.

The intrinsic value of in the money stock option awards at the end of the period represents the Company’s closing stock price on the last trading day of the period in excess of the exercise price multiplied by the number of options.

During the three months ended April 30, 2019 certain directors and officers of the Company exercised 203,511 stock options in non-cash transactions. The officers and directors received 23,376 net shares of common stock. The Company did not receive any proceeds from this exercise. The net shares issued represent the difference between the fair market value of the options on the date of exercise less the strike price cost to exercise the options.

Performance Stock Units

To better align the long-term interest of executives with growing U.S. practices, beginning in fiscal 2018, the Company granted long-term incentive awards in the form of time based stock options and performance-based restricted stock units (“Performance Stock Units” or “PSUs”). The PSUs earned will be determined over a three-year performance period. The primary performance metrics will be revenue and Adjusted EBITDA growth. Payouts based on revenue and adjusted EBITDA goals will be modified based on Total Shareholder Return (“TSR”) performance relative to Enzo’s peer group.

During fiscal year 2018 and 2019, the Company awarded PSUs to its executive officers, this award provides for the grant of shares of our common stock at the end of a three–year period based on the achievement of average revenue growth and adjusted EBITDA growth over that period. As of April 30, 2019, the Company did not accrue any compensation expense for these PSU’s as the three-year performance period has just begun and achievement of the growth goals is currently not probable.

The following table summarizes PSU’s granted:

Restricted Stock Awards

The fair value of a restricted stock award is determined based on the closing stock price on the award date. As of April 30, 2019, there were 1,628 shares of unvested restricted stock which have a weighted average award price of $6.00 per share. As of April 30, 2019, there was approximately $10 of unrecognized compensation cost related to these unvested shares of restricted stock to be recognized over a weighted average remaining period of approximately twenty-one months. There were no awards made during the nine months ended April 30, 2019. During the nine months ended April 30, 2019, 985 restricted stock awards vested whose fair value was approximately $4.

The total number of shares available for grant as equity awards from the 2011 Incentive Plan is approximately 1,222,000 shares as of April 30, 2019.

During the nine months ended April 30, 2019, the Company contributed $832 to match its employees’ 401(k) contributions by issuing 315,472 shares of its common stock representing the fair value of the shares at the match date, and adjusted common stock and additional paid in capital by the same amount.

During the nine months ended April 30, 2018, the Company contributed $782 to match its employees’ 401(k) contributions with 106,911 shares of treasury stock and by issuing 37,580 shares of its common stock, representing the fair value of the shares at the match date, and adjusted treasury stock, common stock and additional paid in capital by the same amount.

Note 10 – Segment reporting

The Company has three reportable segments: Products, Clinical Services and Therapeutics. The Company’s Products segment develops, manufactures, and markets products to research and pharmaceutical customers. The Clinical Services segment provides diagnostic services to the health care community. The Company’s Therapeutics segment conducts research and development activities for therapeutic drug candidates. 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.

Legal fee expense incurred to defend the Company’s intellectual property, which may result in settlements recognized in another segment and other general corporate matters are considered a component of the Other segment. Legal fee expense specific to other segments’ activities have been allocated to those segments.

Legal settlements, net, represent activities for which royalties would have been received in the Company’s Products segment and expenses related to an investigation within the Clinical Services segment. 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 represents the operating results of the reportable segments of the Company:

Three months ended April 30, 2019

Three months ended April 30, 2018

Nine months ended April 30, 2019

Nine months ended April 30, 2018

Note 11 – Contingencies

There are three cases that are on appeal, which were originally brought by the Company in the United States District Court for the District of Delaware (“the Court”), alleging patent infringement against various companies. In 2017, the Court entered summary judgment against the Company that the asserted claims of the ‘180 and ‘405 Patents are invalid for nonenablement in cases involving Abbott, Becton Dickinson, Gen-Probe, Hologic, and Roche. The Company appealed the Court’s final judgment of invalidity in those cases to the United States Court of Appeals for the Federal Circuit (“Federal Circuit”), which were subsequently consolidated (“the Consolidated Appeals”). The Federal Circuit heard oral argument in the Consolidated Appeals on January 7, 2019, but it has not issued a ruling or opinion. In the Consolidated Appeals, the Company has asked the Federal Circuit to reverse the Court’s grants of final and summary judgment of invalidity of the asserted claims of the ‘180 and ‘405 patents and to remand the cases against Abbott, Becton Dickinson, and Roche to the Court. In April 2019, the Company entered into an agreement with Hologic and Grifols, resolving litigation resulting from four cases originally brought by the Company in the Court. As a result, Enzo dismissed (1) a stayed patent litigation regarding the ‘180 and ‘197 Patent against Hologic in the Court; (2) the Consolidated Appeals against Gen-Probe and Hologic resulting from two cases filed in the Court, and (3) the Company’s appeal in the Hologic III matter regarding the ‘581 Patent that involved both Hologic and Grifols; Hologic withdrew from Enzo’s Federal Circuit appeal of the Patent Trial and Appeal Board’s adverse rulings in two inter partes review proceedings regarding the ‘197 Patent filed by Hologic (“the ‘197 PTAB Appeals”). Of the original cases filed in the Court, the Abbott, Becton Dickinson, and Roche cases remain on appeal to the Federal Circuit. The ‘197 PTAB Appeals remain pending and are scheduled for argument on July 9, 2019.

Enzo Biochem, Inc. (the “Company”), along with its subsidiaries Enzo Life Sciences, Inc. entered into a Settlement Agreement as of February 5,2019 (the “Agreement) with Roche Diagnostics GmbH and Roche Molecular Systems, Inc. (together, “Roche”) with respect to an action between the Company and Roche before the U.S. District Court, Southern District of New York, Case No 04-CV4046. Roche agreed to pay the Company $21 million in settlement pursuant to the Agreement. The Company received $19.4 million net of attorney contingency payments. This settlement does not affect Enzo’s civil action for patent infringement against Roche in the U.S. District Court for the State of Delaware, Enzo Life Sciences Inc. v. Roche Molecular Systems Inc., et al., civil action No. 12 cv-00106, which remains pending on appeal.

Enzo Biochem, Inc. (the “Company”), along with its subsidiaries Enzo Life Sciences, Inc. entered into a settlement and license agreement as of April 16, 2019 (the “Agreement”) with Hologic, Inc. (“Hologic”), Grifols, S.A., and Grifols Diagnostic Solutions Inc. (together, “Grifols”) to settle all outstanding patent disputes among the parties. The terms of the agreement include one-time payments totaling $14 million to Enzo in exchange for fully paid-up, worldwide licenses to Hologic and Grifols. The Company received $9.5 million net of attorney contingency payments.

There can be no assurance that the Company will be successful in these litigations. Even if the Company is not successful, management does not believe that there will be a significant adverse monetary impact on the Company.

The Company is party to other claims, legal actions, complaints, and contractual disputes that arise in the ordinary course of business. The Company believes that any liability that may ultimately result from the resolution of these matters will not, individually or in the aggregate, have a material adverse effect on its financial position or results of operations.

As described in Note 3, third-party payers, including government programs, may decide to deny payment or recoup payments for testing that they contend was improperly billed or not medically necessary, against their coverage determinations, or for which they believe they have otherwise overpaid (including as a result of their own error), and we may be required to refund payments already received. During the third fiscal quarter of 2019, a significant third-party payer informed us outside of their typical business practice that they believe it overpaid the Company during certain periods of fiscal 2018. The Company disputes these claims and has formally sent legal appeal letters to the payer. At this time, the Company is unable to determine the probability of the outcome of these appeals or reasonably estimate a range of potential losses associated with this claim.

Item 2. 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 consolidated financial statements and related notes and other information included elsewhere in this Quarterly Report on Form 10-Q.

Forward-Looking Statements

Our disclosure and analysis in this report, including but not limited to the information discussed in this Item 2, contain forward-looking information about our Company’s financial results and estimates, business prospects and products in research and development that involve substantial risks and uncertainties. From time to time, we also may provide oral or written forward-looking statements in other materials we release to the public. Forward-looking statements give our current expectations or forecasts of future events. You can identify these statements by the fact that they do not relate strictly to historic or current facts. They use words such as “anticipate”, “estimate”, “expect”, “project”, “intend”, “plan”, “believe”, “will”, and other words and terms of similar meaning in connection with any discussion of future operations or financial performance.

In particular, these include statements relating to future actions, prospective products or product approvals, future performance or results of current and anticipated products, sales efforts, expenses, interest rates, foreign currency rates, intellectual property matters, the outcome of contingencies, such as legal proceedings, and financial results.

We cannot guarantee that any forward-looking statement will be realized, although we believe we have been prudent in our plans and assumptions. Achievement of future results is subject to risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from past results and those anticipated, estimated or projected. As a result, investors are cautioned not to place undue reliance on any of our forward-looking statements. Investors should bear this in mind as they consider forward-looking statements. We do not assume any obligation to update or revise any forward-looking statement that we make, even if new information becomes available or other events occur in the future. We are also affected by other factors that may be identified from time to time in our filings with the Securities and Exchange Commission, some of which are set forth in Item 1A - Risk Factors in our Form 10-K filing for the July 31, 2018 fiscal year and updated in Item 1A. “Risk Factors in this Form 10-Q, You are advised to consult any further disclosures we make on related subjects in our Forms 10-Q, 8-K and 10-K reports to the Securities and Exchange Commission. Although we have attempted to provide a list of important factors which may affect our business, investors are cautioned that other factors may prove to be important in the future and could affect our operating results.

You should understand that it is not possible to predict or identify all such factors or to assess the impact of each factor or combination of factors on our business. Consequently, you should not consider any such list to be a complete set of all potential risks or uncertainties.

Overview

Enzo Biochem, Inc. (the “Company” “we”, “our” or “Enzo”) is an integrated diagnostic bioscience company focusing on delivering and applying advanced technology capabilities to produce affordable reliable products and services to allow our customers to meet their clinical needs. We are leading the convergence of clinical laboratories, life sciences, and intellectual property through the development of unique diagnostic platform technologies that provide numerous advantages over previous standards. Utilizing cross-functional teams, we develop, manufacture and sell our proprietary technology solutions and platforms to clinical laboratories, specialty clinics and researchers and physicians globally. Enzo’s structure and business strategy represent the culmination of years of extensive planning and work. The Company now has the unique ability to offer low cost, high performance products and services in molecular diagnostics, which ideally positions us to capitalize on the reimbursement pressures facing diagnostic labs. Our pioneering work in genomic analysis coupled with our extensive patent estate and enabling platforms have positioned the Company to continue to play an important role in the rapidly growing molecular medicine marketplaces.

Enzo technology solutions and platforms and unique operational structure are designed to reduce overall healthcare costs for both government and private insurers. Our proprietary technology platforms reduces our customers’ need for multiple, specialized instruments, and offer a variety of high throughput capabilities together with a demonstrated high level of accuracy and reproducibility. Our genetic test panels are focused on large and growing markets primarily in the areas of personalized medicine, women’s health, infectious diseases and genetic disorders. For example, our AMPIPROBE® technology platform can lead to the development of an entire line of nucleic acid clinical products that can allow laboratories to offer a complete menu of services at a cost that allows them to enjoy an acceptable margin.

Our technology solutions provide tools to physicians, clinicians and other healthcare providers to improve detection, treatment and monitoring of a broad spectrum of diseases and conditions. In addition, reduced patient to physician office visits translates into lower healthcare processing costs and greater patient services.

In the course of our research and development activities, we have built a substantial portfolio of intellectual property assets, comprised of 343 issued patents worldwide and over 157 pending patent applications, along with extensive enabling technologies and platforms.

Below are brief descriptions of each of our operating segments (See Note 10 in the Notes to Consolidated Financial Statements):

Clinical Services is a clinical reference laboratory providing a wide range of clinical services to physicians, medical centers, other clinical labs and pharmaceutical companies. The Company believes having a CLIA-certified and a College of American Pathologists (“CAP”) accredited medical laboratory located in New York provides us the opportunity to more rapidly introduce cutting edge products and services to the clinical marketplace. Enzo Clinical Services offers an extensive menu of molecular and other clinical laboratory tests and procedures used in patient care by physicians to establish or support a diagnosis, monitor treatment or medication, and search for an otherwise undiagnosed condition. Our laboratory is equipped with state-of-the-art communication and connectivity solutions enabling the rapid transmission, analysis and interpretation of generated data. We operate a full service clinical laboratory in Farmingdale, New York, a network of over 30 patient service centers throughout New York, New Jersey and expanding into Connecticut, a free standing “STAT” or rapid response laboratory in New York City and a full service phlebotomy, in-house logistics department, and an information technology department. Given our license in New York State, we are able to offer testing services to clinical laboratories and physicians in the majority of states nationwide.

Products manufactures, develops and markets products and tools for clinical research, drug development and bioscience research customers worldwide. Underpinned by broad technological capabilities, Enzo Life Sciences has developed proprietary products used in the identification of genomic information by laboratories around the world. Information regarding our technologies can be found in the “Core Technologies” section of our Form 10-K. We are internationally recognized and acknowledged as a leader in the development, manufacturing validation and commercialization of numerous products serving not only the clinical research market, but also the life sciences markets in the fields of cellular analysis and drug discovery, among others. Our operations are supported by global operations allowing for the efficient marketing and delivery of our products around the world.

Therapeutics is a biopharmaceutical venture 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. Enzo Therapeutics has focused its efforts on developing treatment regimens for diseases and conditions for 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 154 patents and patent applications.

Results of Operations

Three months ended April 30, 2019 compared to April 30, 2018
(in 000s)

Comparative Financial Data for the Three Months Ended April 30,

** not meaningful

Consolidated Results:

The “2019 period” and the “2018 period” refer to the three months ended April 30, 2019 and 2018, respectively.

Clinical services revenues for the 2019 period were $11.7 million compared to $17.7 million in the 2018 period, a decrease of $6.0 million or 34%. Services revenues were negatively affected by lower genetics testing volume approximating $2.2 million of the total decrease, attributable to increased competition. Services revenues were negatively affected by lower reimbursement rates of $3.6 million, of which $1.7 million is attributable to reduced genetics testing reimbursements as a result of an increase in denial rates and changes to medical and procedural requirements, and $1.9 million attributable to reimbursement rate declines from third party payers and the impact from Protecting Access to Medicare Act (“PAMA”). During the 2019 period, adjustments to estimated collection amounts from third party payers and HMO’s also decreased services revenues by $0.2 million. Total diagnostic testing volume measured by the number of accessions increased approximately 1%. In the normal course of business, estimated collection amounts are subject to the complexities and ambiguities of third party payer billing, reimbursement regulations and claims processing, as well as issues unique to Medicare and Medicaid programs, and require us to consider the potential for adjustments when estimating variable consideration in the recognition of revenue in the period that the related services are rendered.

Products revenues for the 2019 period was $7.9 million compared to $7.5 million in the 2018 period, an increase of $0.4 million or 6% due to higher product order volume in the U.S. partially offset by the negative impact of foreign exchange translation. There was no royalty income in the 2019 period as the license agreement expired near the end of the 2018 period. Royalty income in the 2018 period was $0.1 million.

The cost of clinical services during both the 2019 and 2018 periods was $11.0 million. During the 2019 period, the cost of outside reference lab testing for genetic testing decreased $0.4 million as compared to the 2018 period, but was offset by an increase of $0.3 million for reagent and other test supplies, and an increase in lab salaries of $0.1 million.

Clinical services gross profit margin was 6.7% in the 2019 period and 38.0% in the 2018 period. The decline was due to a change in the mix of tests from higher reimbursed genetic testing in the 2018 period to lower reimbursed routine or esoteric testing in the 2019 period. In addition, gross margin was also negatively impacted by reimbursement pressure from PAMA which has resulted in declining government and third party payer reimbursement rates, and by adjustments described above. PAMA calls for further downward revision of reimbursement rates effective January 1, 2020 and so we expect reimbursement rate pressure to continue to impact our industry and our operations.

The cost of products revenues was $3.4 million in the 2019 period and $3.6 million in the 2018 period, a decrease of $0.2 million or 5% due to mix of products sold and lower compensation expense. The gross profit margin on products was 57.1% in the 2019 period and 52.0% in the 2018 period.

Research and development expenses were $0.8 million in the 2019 and 2018 periods. The expense for Life Sciences Products was $0.6 million in both periods and the expense for the Enzo Therapeutics was $0.2 million in both periods.

Selling, general and administrative expenses were approximately $10.9 million during the 2019 period versus $11.0 million during the 2018 period, a decrease of $0.1 million or 1%. Clinical Services expense decreased $0.3 million as the cost of outside billing and collections activities decreased $0.4 million, partially offset by an increase of $0.1 million in other expenses. The cost of increased sales headcount to market our new molecular diagnostic products for use by other reference labs was offset by lower commissions paid on lower cash collections. The Products expense was unchanged. The Other segment expense increased $0.2 million, due to an increase in office and occupancy related expenses.

Legal fee expense was $0.3 million during the 2019 period compared to $1.7 million in the 2018 period, a decrease of $1.4 million due to the timing of legal activity and related costs associated with on-going litigation and contract dispute where the Company is the plaintiff.

Legal settlements, net were $28.9 million in the 2019 period versus none in the 2018 period. During the 2019 period the Company as plaintiff finalized and executed settlement agreements with Roche ($19.4 million, net), and Hologic Inc. ($9.5 million, net).

Interest income, net was approximately $0.2 million in both the 2019 and 2018 periods and is earned on cash and cash equivalents.

The foreign currency loss during the 2019 period was $0.3 million compared to $0.4 million in the 2018 period, an improvement of $0.1 million or 28%, due to lesser depreciation of the Euro, British pound and Swiss franc versus the U.S. dollar experienced within the Products segment during the 2019 period compared to that of the 2018 period.

Results of Operations

Nine months ended April 30, 2019 compared to April 30, 2018
(in 000s)

Comparative Financial Data for the Nine Months Ended April 30,

** not meaningful

Consolidated Results:

The “2019 period” and the “2018 period” refer to the nine months ended April 30, 2019 and 2018, respectively.

Clinical services revenues for the 2019 period were $38.0 million compared to $56.0 million in the 2018 period, a decrease of $18.0 million or 32%. Services revenues were negatively affected by lower total testing volume approximating $8.3 million, of which $7.6 million is attributed to genetics testing due to increased competition. Services revenues were negatively affected by lower reimbursement rates of $8.0 million, of which $5.1 million is attributable to reduced genetics testing reimbursements as a result of an increase in denial rates and changes to medical and procedural requirements, and $3.2 million attributable to reimbursement rate declines from third party payers and the impact from PAMA. During the 2019 period, adjustments to estimated collection amounts from third party payers and HMO’s also decreased services revenues by $1.3 million. There were no adjustments in the 2018 period. In the normal course of business, estimated collection amounts are subject to the complexities and ambiguities of third party payer billing, reimbursement regulations and claims processing, as well as issues unique to Medicare and Medicaid programs, and require us to consider the potential for adjustments when estimating variable consideration in the recognition of revenue in the period that the related services are rendered.

Products revenues for the 2019 period was $22.2 million compared to $21.6 million in the 2018 period, an increase of $0.6 million or 3% due to higher product order volume in the U.S. market, which was partially offset by lower product order volume in the international market and the negative impact of foreign exchange translation. There was no royalty income in the 2019 period as the license agreement expired at the end of the 2018 period. Royalty income in 2018 period was $0.6 million.

The cost of clinical services during the 2019 period was $33.0 million as compared to $34.8 million in the 2018 period, a decrease of $1.8 million or 5% primarily due to the change in test mix, especially the decline in genetic testing volume. The components of the decrease are $2.8 million for outside reference lab testing costs and internalizing the use of our AMPIPROBE® technology platform, partially offset by increases in reagent and other test supplies of $0.4 million, compensation related expenses of $0.4 million and other lab expenses of $0.2 million.

Gross profit margin was 13.4% in the 2019 period and 37.9% in the 2018 period. The decline was due to a change in the mix of tests from higher reimbursed genetic testing in the 2018 period to lower reimbursed routine or esoteric testing in the 2019 period. In addition, gross margin was also negatively impacted by reimbursement pressure from PAMA which has resulted in declining government and third party payer reimbursement rates and by adjustments

described above. PAMA calls for further downward revision of reimbursements rates effective January 1, 2020 and so we expect reimbursement rate pressure to continue to impact our industry and our operations.

The cost of products revenues was $10.4 million in the 2019 period and $10.8 million in the 2018 period, a decrease of $0.4 million or 4% due to the mix of products sold and lower compensation expense. The gross profit margin on products was 53.2% in the 2019 period and 50.0% in the 2018 period.

Research and development expenses were $2.3 million in the 2019 and 2018 periods. The expense for Life Sciences Products was $1.6 million in both periods and the expense for the Enzo Therapeutics was $0.7 million in both periods.

Selling, general and administrative expenses were approximately $33.3 million during the 2019 period versus $33.0 million during the 2018 period, an increase of $0.3 million or 1%. Clinical Services expense decreased $0.3 million, due to a decrease of $1.1 million in outside billing and collections expenses, partially offset by the cost of increased headcount to market our new molecular diagnostic products for use by other reference labs of approximately $0.3 million, and increases in the cost of information technology, billing operations, and professional fees totalling $0.5 million. The Products expense increased $0.3 million due to increased headcount focused on sales, marketing and business development of our diagnostic platform technologies. The Other segment expense increased $0.3 million due to office and occupancy related expenses and health care costs.

Legal fee expense was $2.7 million during the 2019 period compared to $3.8 million in the 2018 period, an increase of $1.1 million due to the timing of legal activity and related costs associated with on-going litigation and contract dispute where the Company is the plaintiff.

Legal settlements, net were $28.9 million in the 2019 period versus none in the 2018 period. During the 2019 period the Company as plaintiff finalized and executed settlement agreements with Roche ($19.4 million, net), and Hologic Inc. ($9.5 million, net).

Interest income, net increased $0.2 million in the 2019 period due to increased interest rates earned on cash and cash equivalents.

The foreign currency loss during the 2019 period was $0.5 million compared to a gain of $0.2 million in the 2018 period, an unfavorable variance of $0.7 million, due to the significant depreciation of the Euro, British pound and Swiss franc versus the U.S. dollar experienced within the Products segment during the 2019 period compared to that of the 2018 period.

Liquidity and Capital Resources

At April 30, 2019, the Company had cash and cash equivalents and restricted cash of $64.8 million of which $0.4 million was in foreign accounts, as compared to cash and cash equivalents of $60.0 million, of which $0.4 million was in foreign accounts at July 31, 2018. It is the Company’s current intent to permanently reinvest these funds outside of the United States, and its current plans do not demonstrate a need to repatriate them to fund its United States operations. The Company had working capital of $70.5 million at April 30, 2019 compared to $63.0 million at July 31, 2018. The increase in working capital of $7.5 million was primarily due to the legal settlements offset by net changes in operating assets and liabilities.

Net cash provided by operating activities during the 2019 period was approximately $8.0 million as compared to cash used in operating activities of $0.5 million during the 2018 period, an increase of approximately $8.5 million. The increase is mainly due to the change in net income of $12.4 million as a result of two legal settlement agreements offset by net changes in assets and liabilities of $4.7 million.

Net cash used in investing activities in fiscal 2019 and 2018 was approximately $7.6 million and $1.7 million, respectively. The increase in the 2019 period is mainly due to the purchase of our new facility.

Net cash provided by financing activities in fiscal 2019 $4.4 million as compared to $0.5 million in fiscal 2018. The change of $3.9 million is mainly due to a mortgage agreement entered into for the purchase of our new facility.

The mortgage agreement, which provides for a loan of $4.5 million for a term of 10 years, bears a fixed interest rate of 5.09% per annum and requires monthly mortgage payments of $30. At April 30, 2019, the balance owed under the mortgage agreement was $4.4 million. The Company’s obligations under the mortgage agreement are secured by the new facility and by a $750 cash collateral deposit with the mortgagee as additional security. This restricted cash is included in other assets as of April 30, 2019. See Note 7 – Loan Payable.

The Company believes that its current cash and cash equivalents level, utilization of the Controlled Equity Offering program if necessary, and the net proceeds received under the legal settlement agreements with Roche, Hologic and Grifols during fiscal 2019 are sufficient for its foreseeable liquidity and capital resource needs over at least the next twelve (12) months, although there can be no assurance that future events will not alter such view. We expect our cash reserves will be reduced over the next four quarters as we implement our strategy of developing innovative diagnostic platforms and assays for use by independent labs. Although there can be no assurances, in the event additional capital is required, the Company believes it has the ability to raise additional funds through equity offerings or other sources. Our liquidity plans are subject to a number of risks and uncertainties, including those described in the Item 1A. “Risk Factors” section of our Form 10-K for the year ended July 31, 2018, and updated in Item 1A. “Risk Factors” in this Form 10-Q, some of which are outside our control. Macroeconomic conditions could limit our ability to successfully execute our business plans and therefore adversely affect our liquidity plans.

Contractual Obligations

The Company completed the $6 million purchase of a 36,000 square foot commercial facility and as part of the purchase entered into a mortgage of $4.5 million with a 10 year term and bearing a fixed interest rate of 5.09%. See Note 7 – Loan Payable. There have been no other material changes to our Contractual Obligations as reported in our Form 10-K for the fiscal year ended July 31, 2018.

Management is not aware of any material claims, disputes or settled matters concerning third party reimbursement that would have a material effect on our financial statements, except as disclosed in Note 11 to the Consolidated Financial Statements.

Off-Balance Sheet Arrangements

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