12:00 AM
Feb 04, 2002
 |  BioCentury  |  Finance

Ebb & Flow

With the Enron scandal raising sensitivity to complicated accounting practices, biotech companies with less than plain vanilla P&Ls can expect increased scrutiny, and investors are likely to sell first and ask later. First hit was Elan, prompted by a Wall Street Journalarticle on Wednesday that raised old questions about how ELN books revenue for its many joint ventures.

The magnitude of ELN's loss on the week - the company shed $2.2 billion, or 19% of its market cap - clearly shows the market's current distrust. ELN is now valued at $9.7 billion.

Whether there's any "there there" on ELN's accounting issues - management steadfastly says it isn't cooking its books - the company for years has used a complex accounting system under which it transfers technology to the joint venture in return for a fee that ELN books as revenue.

After falling as low as $22.40 intraday on Wednesday, ELN rebounded to close the day down $5.95 (17%) at $29.25 on 37.1 million shares. Helping stanch the tide was a statement issued by Chairman and CEO Donal Geaney on Wednesday stating that "Elan's accounting practices are in accordance with U.S. GAAP and Irish GAAP. The company's accounting practices were thoroughly reviewed by the SEC in 1999."

ELN was slated to report fourth quarter and full-year earnings prior to market open today. Consensus estimates are $0.56 and $1.92, respectively.

Maybe the easiest thing for investors is to ignore the revenue line and focus on actual sales and operating earnings. For the first nine months of 2001, ELN's sales increased to $1.1 billion, up $323.6 million (44%) from $737.9 million in in the first nine months of 2000. Over that same period, operating income increased to $408.7 million, up $169.5 million (71%) from $239.2 million posted in the first nine months of 2000.

The company's cash coffers remain robust, too. ELN had $2.7 billion in cash as of Sept. 30, $900 million more than it had as of the start of the year. The balance sheet also shows shareholders' equity at $3 billion as of Sept. 30, up from $2.3 billion at the start of 2001.

Last week's drubbing puts ELN off $14.85 (33%) from its Jan. 17 price of $44.80, prior to news that ELN and partner American Home Products (AHP) temporarily suspended dosing in a Phase IIa study of their AN-1792 Alzheimer's vaccine after four patients treated with the vaccine showed signs of CNS inflammation (see BioCentury, Jan. 22).

Leave nothing to chance

Given the current environment, biotech companies may go to great lengths to maintain transparency of business arrangements that at first blush may look a bit hand-in-glove. For example, Affymetrix (AFFX) spent a significant amount of time on its fourth quarter conference call discussing the impact of its business dealings with Perlegen, which it formed in 2000 to identify patterns in genetic variations among different human genomes.

AFFX is selling its GeneChips to Perlegen at cost, and thus the transaction has no impact on its bottom line. However, AFFX, included two separate line items on its P&L: one that booked the $5.6 million in product revenue from Perlegen and another - on the expense side - that accounted for the $5.6 million in cost AFFX incurred to generate that revenue.

Carol Werther, analyst at Adams, Harkness & Hill, sees companies making attempts to be more forthcoming. However, she noted that most biotechs have fairly straightforward P&Ls, especially since "off balance sheet financings of the 90s have largely gone away."

Reality bites

Market watchers have been saying for months that ZymoGenetics (ZGEN) had gotten ahead of itself on valuation and would end up taking a haircut on its IPO, and they were right. The protein-based drug developer priced its 10 million share IPO Thursday night at $12, well below the $16-$18...

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