UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
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: 0-21198
ZONAGEN, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 76-0233274
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
2408 Timberloch Place, Suite B-4
The Woodlands, Texas 77380
(Address of principal executive offices and zip code)
(281) 367-5892
(Registrant's telephone number, including area code)
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 past 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 [_]
As of August 7, 1998 there were outstanding 11,324,110 shares of Common
Stock, par value $.001 per share, of the Registrant.
ZONAGEN, INC.
(A development stage company)
For the Quarter Ended June 30, 1998
INDEX
Page
----
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS 3
PART I. FINANCIAL INFORMATION 4
Item 1. Financial Statements
Consolidated Balance Sheets: June 30, 1998 (Unaudited)
and December 31, 1997 5
Consolidated Statements of Operations: For the three months ended
June 30, 1998 and 1997, six months ended June 30, 1998 and 1997
and from Inception (August 20, 1987) through June 30, 1998
(Unaudited) 6
Consolidated Statements of Cash Flows: For the three months ended
June 30, 1998 and 1997, six months ended June 30, 1998 and 1997
and from Inception (August 20, 1987) through June 30, 1998
(Unaudited) 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 5. Other Information 20
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 21
2
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. The words
"anticipate," "believe," "expect," "estimate," "project" and similar expressions
are intended to identify forward-looking statements. Such statements are
subject to certain risks, uncertainties and assumptions. Should one or more of
these risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results may vary materially from those anticipated, believed,
expected, estimated or projected. These risks and uncertainties include risks
associated with the Company's early stage of development, uncertainties related
to clinical trial results and FDA approval, the Company's substantial dependence
on one product and early stage of development of other products, the Company's
history of operating losses and accumulated deficit, the Company's future
capital needs and uncertainty of additional funding, uncertainty of protection
for the Company's patents and proprietary technology, the effects of government
regulation of and lack of assurance of regulatory approval for the Company's
products, the Company's limited sales and marketing experience and dependence on
collaborators, manufacturing uncertainties and the Company's reliance on third
parties for manufacturing, competition and technological change, product
liability and availability of insurance, the Company's reliance on contract
research organizations, and other risks and uncertainties described in the
Company's filings with the Securities and Exchange Commission. For additional
discussion of such risks, uncertainties and assumptions, see "Item 1.
Description of Business - Business Risks" and "Item 3. Legal Proceedings"
included in the Company's Annual Report on Form 10-K for the year ended December
31, 1997 and "Part I. Financial Information - Item 2. Management's Discussion
and Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources" and "Part II. Other Information - Item 1. Legal Proceedings"
included elsewhere in this quarterly report on Form 10-Q.
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The following unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all necessary adjustments
(which include only normal recurring adjustments) considered necessary for a
fair presentation have been included. Operating results for the six month period
ended June 30, 1998 are not necessarily indicative of the results that may be
expected for the year ended December 31, 1998. For further information, refer to
the financial statements and footnotes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997.
4
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
1998 1997
------------ ------------
ASSETS (Unaudited)
CURRENT ASSETS
Cash and cash equivalents $ 59,980,735 $ 73,761,823
Accounts receivable 716,870 514,734
Product inventory 506,400 206,913
Deposits and other current assets 1,105,459 270,407
------------ ------------
Total current assets 62,309,464 74,753,877
LAB EQUIPMENT, FURNITURE AND LEASEHOLD
IMPROVEMENTS, net of accumulated depreciation
and amortization of $937,441 and $827,688, respectively 661,127 557,199
EXCESS OF COST OVER FAIR VALUE OF TANGIBLE ASSETS ACQUIRED,
net of accumulated amortization of $760,333 and
$655,582, respectively 689,076 793,827
OTHER ASSETS, net of accumulated amortization of
$194,452 and $168,317, respectively 1,109,195 835,577
------------ ------------
Total assets $ 64,768,862 $ 76,940,480
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 2,242,824 $ 3,285,031
Accrued expenses 1,596,232 2,662,849
Current portion of notes payable 9,051 14,160
------------ ------------
Total current liabilities 3,848,107 5,962,040
------------ ------------
LONG TERM NOTES PAYABLE - 2,639
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred Stock, $.001 par value,
5,000,000 shares authorized, none issued and
outstanding - -
Common Stock, $.001 par value, 20,000,000 shares
authorized, 11,608,095 and 11,541,923 shares issued,
respectively; 11,319,795 and 11,480,423 shares
outstanding, respectively 11,608 11,542
Additional paid-in capital 113,614,341 113,236,136
Deferred compensation (1,157,139) (1,401,389)
Cost of treasury stock, 288,300 and 61,500 shares, respectively (5,309,060) (1,286,728)
Deficit accumulated during the development stage (46,238,995) (39,583,760)
------------ ------------
Total stockholders' equity 60,920,755 70,975,801
------------ ------------
Total liabilities and stockholders' equity $ 64,768,862 $ 76,940,480
============ ============
The accompanying notes are an integral part of these consolidated financial statements.
5
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
FROM INCEPTION
THREE MONTHS ENDED SIX MONTHS ENDED (AUGUST 20, 1987)
------------------------------ ------------------------------ TO
JUNE 30, 1998 JUNE 30, 1997 JUNE 30, 1998 JUNE 30, 1997 JUNE 30, 1998
------------- ------------- ------------- ------------- -------------
REVENUES
Product sales $ 903,172 $ 780,482 $ 1,832,292 $ 1,601,835 $ 11,949,387
Licensing fees 5,000,000 - 5,000,000 - 15,250,000
Product royalties 167,170 - 167,170 - 167,170
Interest income 729,299 66,526 1,796,473 187,888 4,649,617
----------- ----------- ----------- ----------- ------------
Total revenues 6,799,641 847,008 8,795,935 1,789,723 32,016,174
COSTS AND EXPENSES
Cost of products sold 614,153 496,597 1,233,573 1,067,843 8,364,752
Research and development 5,847,455 4,483,328 12,191,614 8,495,417 53,258,637
Selling, general and administrative 948,927 717,635 1,916,945 1,315,509 15,076,485
Interest expense and amortization
of intangibles 53,135 54,647 109,038 108,589 1,191,912
----------- ----------- ----------- ----------- ------------
Total costs and expenses 7,463,670 5,752,207 15,451,170 10,987,358 77,891,786
Loss from continuing operations (664,029) (4,905,199) (6,655,235) (9,197,635) (45,875,612)
Loss from discontinued operations - - - - (288,104)
Loss on disposal - - - - (75,279)
----------- ----------- ----------- ----------- ------------
NET LOSS $ (664,029) $(4,905,199) $(6,655,235) $(9,197,635) $(46,238,995)
=========== =========== =========== =========== ============
Loss per share: $ (0.06) $ (0.65) $ (0.59) $ (1.27)
Shares used in loss per share calculation: 11,310,453 7,579,707 11,316,265 7,235,345
The accompanying notes are an integral part of these consolidated financial statements.
6
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
FROM INCEPTION
THREE MONTHS ENDED SIX MONTHS ENDED (AUGUST 20, 1987)
------------------------------ ------------------------------ THROUGH
JUNE 30, 1998 JUNE 30, 1997 JUNE 30, 1998 JUNE 30, 1997 JUNE 30, 1998
------------- ------------- ------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (664,029) $ (4,905,199) $ (6,655,235) $ (9,197,635) $(46,238,995)
Loss on disposal of discontinued operations - - - - 75,279
Adjustments to reconcile net loss to net cash used in
operating activities
Noncash financing costs - - - - 315,984
Depreciation and amortization 124,087 95,345 240,638 188,810 1,842,692
Noncash expenses related to stock-based transactions 89,462 29,653 244,250 43,345 1,325,376
Common stock issued for agreement not to compete - - - - 199,997
Series B Preferred Stock issued for consulting services - - - - 17,999
Changes in operating assets and liabilities
(net effects of purchase of businesses in 1988 and 1994)
(Increase) decrease in receivables (74,430) 85,805 (202,136) 88,154 (511,905)
(Increase) decrease in inventory (303,160) 2,270 (299,487) 13,111 (224,872)
(Increase) decrease in prepaid expenses and other
current assets (526,025) (289,896) (835,052) (244,611) (963,995)
(Decrease) increase in accounts payable and
accrued expenses (680,306) 306,095 (2,108,825) 1,128,352 3,621,742
------------ ----------- ------------ ----------- ------------
Net cash used in operating activities (2,034,401) (4,675,927) (9,615,847) (7,980,474) (40,540,698)
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (182,111) (43,531) (213,681) (116,718) (1,491,823)
Purchase of technology rights and other assets (139,018) (31,620) (299,752) (50,334) (1,271,629)
Cash acquired in purchase of FTI - - - - 2,695
Proceeds from sale of subsidiary, less $12,345 for
operating losses during 1990 phase-out period - - - - 137,646
Increase in net assets held for disposal - - - - (212,925)
------------ ----------- ------------ ----------- ------------
Net cash used in investing activities (321,129) (75,151) (513,433) (167,052) (2,836,036)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock 7,814 35,192 378,272 140,085 83,864,122
Proceeds from issuance of preferred stock - - - - 23,688,522
Purchase of treasury stock - - (4,022,332) - (5,309,060)
Proceeds from issuance of notes payable - - - - 2,838,681
Principal payments on notes payable (3,921) (3,555) (7,748) (7,024) (1,724,796)
------------ ----------- ------------ ----------- ------------
Net cash provided by (used in) financing activities 3,893 31,637 (3,651,808) 133,061 103,357,469
------------ ----------- ------------ ----------- ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (2,351,637) (4,719,441) (13,781,088) (8,014,465) 59,980,735
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 62,332,372 7,779,878 73,761,823 11,074,902 -
------------ ----------- ------------ ----------- ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 59,980,735 $ 3,060,437 $ 59,980,735 $ 3,060,437 $ 59,980,735
============ =========== ============ =========== ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
Reduction of debt due to final payment, in stock,
of FTI Acquisition $ - $ - $ - $ 93,812 $ 93,812
The accompanying notes are an integral part of these consolidated financial statements.
7
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(Unaudited)
NOTE 1 -- Organization and Operations
Zonagen, Inc., a Delaware corporation (together with its subsidiary, the
"Company"), was organized on August 20, 1987 (Inception) and is a
biopharmaceutical company in the development stage engaged in the research,
development and marketing of products which address conditions and diseases
associated with the human reproductive system. In addition to its proprietary
development activities, the Company markets and distributes a variety of third-
party fertility-related products to obstetrics/gynecology, urology and fertility
specialists through its wholly-owned subsidiary, Fertility Technologies, Inc.
("FTI"). From Inception through June 30, 1998, the Company has been primarily
engaged in research and development and is still in a development stage.
The Company has experienced negative cash flows from operations since its
inception and has funded its activities to date primarily from equity
financings. The Company will continue to require substantial funds to continue
research and development, including preclinical studies and clinical trials of
its products, and to commence sales and marketing efforts if FDA and other
regulatory approvals are obtained. The Company believes that its existing
capital resources will be sufficient to fund its operations through at least the
end of 1999. The Company's capital requirements will depend on many factors,
including the problems, delays, expenses and complications frequently
encountered by development stage companies; the progress of the Company's
clinical and preclinical activities; the progress of the Company's collaborative
agreements with affiliates of Schering-Plough Corporation ("Schering-Plough")
and costs associated with any future collaborative research, manufacturing,
marketing or other funding arrangements; the costs and timing of seeking
regulatory approvals of Vasomax(R), the Company's oral treatment for male
erectile dysfunction, and the Company's other products; the Company's ability to
obtain regulatory approvals; the success of the Company's sales and marketing
programs; the cost of filing, prosecuting and defending and enforcing any patent
claims and other intellectual property rights; and changes in economic,
regulatory or competitive conditions of the Company's planned business.
Estimates about the adequacy of funding for the Company's activities are based
on certain assumptions, including the assumption that the development and
regulatory approval of the Company's products can be completed at projected
costs and that product approvals and introductions will be timely and
successful. There can be no assurance that changes in the Company's research and
development plans, acquisitions or other events will not result in accelerated
or unexpected expenditures. To satisfy its capital requirements, the Company may
seek to raise additional funds in the public or private capital markets. The
Company's ability to raise additional funds in the public or private markets
will be adversely affected if Vasomax(R) is not successfully commercialized and
if the results of current or future clinical trials are not favorable. The
Company may seek additional funding through corporate collaborations and other
financing vehicles. There can be no assurance that any such funding will be
available to the Company on favorable terms or at all. If adequate funds are not
available, the Company may be required to curtail significantly one or more of
its research or development programs, or it may be required to obtain funds
through arrangements with future collaborative
8
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(Unaudited)
partners or others that may require the Company to relinquish rights to some or
all of its technologies or products. If the Company is successful in obtaining
additional financing, the terms of such financing may have the effect of
diluting or adversely affecting the holdings or the rights of the holders of the
Company's Common Stock.
NOTE 2 -- PRODUCT INVENTORY
The Company maintains an inventory of bulk phentolamine which is the active
ingredient in Vasomax(R), the Company's oral treatment for male erectile
dysfunction. Currently, Schering-Plough is manufacturing and marketing
Vasomax(R) in Mexico under the brand name Z-Max. Schering-Plough purchases bulk
phentolamine from the Company at approximately the Company's cost. As of June
30, 1998, the fair market value of this bulk raw material inventory was
$261,500. Additionally, the Company's inventory consists of products
manufactured by others for resale to obstetrics/gynecologists, urologists and
fertility clinics. Finished goods inventory at June 30, 1998 was $244,900.
Inventory is stated at the lower of cost or market using the first-in, first-out
method.
NOTE 3 -- DEPOSITS AND OTHER CURRENT ASSETS
During the second quarter of 1998, deposits and other current assets
increased to $1.1 million. The increase was due to partial prepayments on future
phentolamine purchases from the contract manufacturer. As of June 30, 1998,
prepayments held by the contract manufacturer were $612,000. Other deposits and
other current assets, substantially all of which were prepaid insurance and
interest receivable, totaled $488,000 as of June 30, 1998.
NOTE 4 -- STOCKHOLDERS' EQUITY
Common Stock
- ------------
On July 25, 1997, the Company completed a public offering of Common Stock
in which it sold 2,587,500 shares of Common Stock (including the shares issued
pursuant to the exercise of the underwriters' over-allotment option) at a price
of $30.00 per share. The net proceeds of the public offering were approximately
$72.2 million.
Warrants
- --------
During the second quarter of 1998, the Company issued an aggregate 8,049
shares of Common Stock upon the cashless exercise of stock warrants to purchase
an aggregate of 10,078 shares of common stock. No warrants were exercised
during the first quarter of 1998.
As of June 30, 1998 there were 118,327 warrants outstanding exercisable for
an aggregate of 191,976 shares of Common Stock at prices ranging from $3.625 to
$7.19 per share.
9
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(Unaudited)
Treasury Stock
- --------------
On December 12, 1997 the Company announced a stock buyback of the Company's
common stock. The purchases are to be made from time to time in the open market
at prevailing market prices. As of December 31, 1997 the Company had purchased
a total of 61,500 shares at an aggregate purchase price of $1,286,728,
representing an average price of $20.922 per share. During the quarter ended
March 31, 1998 the Company purchased an additional 226,800 shares at an
aggregate purchase price of $4,022,332, representing an average price of $17.735
per share. The Company did not purchase any stock during the period from April
1, 1998 through August 7, 1998. Through August 7, 1998, the Company had
purchased an aggregate of 288,300 shares of Common Stock under the stock buyback
program at an aggregate purchase price of $5,309,060, representing an average
purchase price of $18.415 per share.
NOTE 5 -- STOCK OPTIONS
The Company records and amortizes over the related vesting periods deferred
compensation representing the difference between the exercise price of options
granted and the deemed fair market value of the Common Stock at the time of
grant. The Company recorded non-cash deferred compensation of approximately
$69,500 in the quarter ending June 30, 1998 relating to options granted under
the 1996 Non-employee Director Stock Option Plan (the "Director Plan").
During the first quarter of 1998, the Company issued an aggregate of 44,913
shares of Common Stock to current and former consultants and employees upon the
exercise of stock options, at prices ranging from $0.43 to $22.25 per share, for
total proceeds of approximately $268,000. During the second quarter of 1998,
the Company issued an aggregate of 8,210 shares of Common Stock to current
consultants and employees upon the exercise of stock options, at prices ranging
from $0.43 to $4.00 per share, for total proceeds of approximately $7,800.
On June 25, 1998, the Company granted options to employees exercisable for
an aggregate of 44,000 shares of Common Stock at an exercise price of $20.375
per share. In addition, on such date options exercisable for an aggregate of
12,500 shares of Common Stock were issued under the Director Plan to directors
who were re-elected during the Company's Annual Meeting of Shareholders, at an
exercise price of $20.375 per share.
NOTE 6 -- AGREEMENTS
In November 1997, the Company entered into exclusive license agreements
with affiliates of Schering-Plough Corporation, a major U.S.-based
pharmaceutical company (including such affiliates, "Schering-Plough"), with
respect to the exclusive license of the Company's Vasomax(R)
10
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(Unaudited)
product for the treatment of male erectile dysfunction. Under the agreement,
Schering-Plough paid Zonagen an up-front payment of $10.0 million and agreed to
make subsequent milestone payments upon the achievement of specified regulatory
goals. Zonagen will receive escalating royalties on all product sales under the
Schering-Plough agreements.
On June 30, 1998 the Company received an accelerated milestone payment of
$5.0 million from Schering-Plough that was paid at the completion of the
clinical program that was used in support of the New Drug Application ("NDA")
for Vasomax(R). The payment was due upon submission of a NDA for Vasomax(R)
with the Food and Drug Administration ("FDA"). The Company submitted the NDA on
July 14, 1998.
On June 12, 1997, the Company entered into an exclusive supply agreement
with a contract manufacturer under which the Company has agreed to purchase all
of its bulk phentolamine from the contract manufacturer for a period of five
years. The agreement will continue after the initial five-year term for
consecutive one year periods until terminated by either party. The agreement
obligates the Company to purchase specified minimum quantities of phentolamine
and the manufacturer to manufacture phentolamine exclusively for the Company.
During 1996, the Company entered into several agreements with contract
research organizations and other organizations for services relating to the
clinical development of Vasomax(R), the Company's oral treatment for male
erectile dysfunction. The Company may terminate these agreements upon written
notification and payment of expenses incurred prior to termination.
In December 1993, the Company entered into an agreement with Schering AG (a
pharmaceutical company based in Germany that is not affiliated with Schering-
Plough), pursuant to which the Company and Schering AG agreed to jointly
research, develop and test zona pellucida-based human contraceptive vaccines.
Under the agreement, the Company was required to bear all costs of the
development of all such products until the Company had developed a "lead
compound" that met certain specified standards for use in clinical trials. The
agreement required Schering AG to make payments to the Company upon certain
research and development milestones, none of which had been achieved, and to
bear all costs of the development of the vaccine after formulation of a lead
compound. Schering AG was required to purchase $2.5 million of Common Stock on
or before June 9, 1998 to retain its rights under the agreement beyond such
date. Schering AG did not purchase the shares of the Company's Common Stock
required to maintain its rights under the agreement; accordingly, the agreement
terminated on June 9, 1998. As a result of this termination, Schering AG and
the Company have no further obligations under the agreement, and all product
rights under the agreement have reverted to the Company.
11
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(Unaudited)
NOTE 7 -- COMMITMENTS AND CONTINGENCIES
On May 16, 1994, Dr. Bonita Sue Dunbar ("Dunbar") filed suit in the 270th
District Court of Harris County, Texas naming Baylor College of Medicine
("BCM"), BCM Technologies, Inc., Fulbright & Jaworski, L.L.P., The Woodlands
Venture Capital Company and the Company as defendants (collectively, the "Dunbar
Defendants"). Dunbar is a cellular and molecular biologist who has been
employed by BCM as a teacher and research scientist since 1981. During the
course of her employment at BCM, Dunbar developed technologies relating to the
use of certain recombinant zona pellucida peptides, the intellectual property
rights to which were assigned to the Company in 1987. Dunbar claimed, among
other things, that her assignment of the patent rights was induced by statutory
and constructive fraud and a civil conspiracy on the part of the Dunbar
Defendants. The court granted partial summary judgment in favor of the Company
and the other Dunbar Defendants in connection with the action. As a result of
the rulings Dunbar is unable to rescind the assignment of the patent rights and
is left only with ancillary claims regarding the Company's alleged conversion of
her ideas relating to endometriosis and ovarian cancer. Such ancillary claims
are subject to a motion to sever and abate pending Dunbar's appeal of the
court's orders granting the motion for summary judgment. The Company believes
the ancillary claims are without merit.
Certain purported class action complaints alleging violations of Sections
10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder
have been filed against the Company and certain of its officers and directors.
These complaints were filed in the United States District Court for the Southern
District of Texas in Houston, Texas and were consolidated on May 29, 1998. The
plaintiffs purport to bring the suit on behalf of all purchasers of Zonagen
common stock between February 7, 1996 and January 9, 1998. The plaintiffs
assert that the defendants made materially false and misleading statements and
failed to disclose material facts about the patents and patent applications of
the Company relating to Vasomax(R) and ImmuMax(TM), and about the Company's
clinical trials of Vasomax(R). The plaintiffs seek to have the action declared
to be a class action, and to have rescissionary or compensatory damages in an
unstated amount, along with interest and attorney's fees. The Company and the
individual defendants believe that these actions are without merit and intend to
defend against them vigorously. No estimate of loss or range of estimate of
loss, if any, can be made at this time.
The Company is involved in certain other litigation matters which it
believes will not have a material adverse effect on the Company.
12
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Such statements reflect
the Company's current views with respect to future events and financial
performance and are subject to certain risks, uncertainties and assumptions.
Should one or more of these risks or uncertainties materialize, or should
underlying assumptions prove incorrect, actual results may vary materially from
those anticipated in such forward-looking statements. See "Factors Affecting
Forward-Looking Statements" included elsewhere in this Quarterly Report on Form
10-Q.
OVERVIEW
Zonagen, Inc. (the "Company") is a biopharmaceutical company in the
development stage engaged in the research, development and marketing of products
which address conditions and diseases associated with the human reproductive
system. In addition to its proprietary development activities, the Company
markets and distributes a variety of third-party fertility-related products to
obstetrics/gynecology, urology and fertility specialists through its wholly
owned subsidiary, Fertility Technologies, Inc. ("FTI"). The Company's objective
is to become a leading provider of innovative products and services for the
management of reproductive health.
On July 14, 1998, the Company submitted a New Drug Application (an "NDA")
with the U.S. Food and Drug Administration (the "FDA") for its lead product
candidate, Vasomax(R), an oral treatment for male erectile dysfunction. The
Company has dedicated a substantial portion of its resources over the last
several years to the development of Vasomax(R). The Company's future prospects
are substantially dependent on approval by the FDA and the successful
commercialization of Vasomax(R). There can be no assurance that the Company's
NDA submission for Vasomax(R) will be accepted by the FDA or that it will
ultimately be approved. Certain risks and uncertainties associated with the
filing and FDA review of the NDA are described or referenced in "Factors
Affecting Forward-Looking Statements" included elsewhere in this Quarterly
Report on Form 10-Q.
In November 1997, the Company entered into exclusive license agreements
with affiliates of Schering-Plough Corporation (including such affiliates,
"Schering-Plough") with respect to the exclusive worldwide license to market and
sell the Company's Vasomax(R) product for the treatment of male erectile
dysfunction. Schering-Plough filed a Product Registration Application in Mexico
for Vasomax(R) under the brand name Z-Max in March 1998, and commenced sales
of Z-Max in Mexico in June 1998. Schering-Plough made an accelerated
milestone payment to the Company of $5.0 million on June 30, 1998, at the
completion of the clinical program that was used in support of the NDA. The
payment was due upon the submission of a NDA for Vasomax(R) with the FDA. The
Company submitted the NDA on July 14, 1998.
13
Substantially all of the Company's product revenues are derived from sales
of third-party fertility-related products by FTI. The Company acquired FTI in
1994 to enter the market for female reproductive healthcare products and
services. Revenues from FTI will not be sufficient to fund the Company's planned
operations.
As of June 30, 1998, the Company had an accumulated deficit of
approximately $46.2 million. There can be no assurance that the Company will be
able to successfully complete the transition from a development stage company to
the successful introduction of commercially viable products. The Company's
ability to achieve profitability will depend, among other things, on
successfully completing the development of its products, obtaining regulatory
approvals, establishing marketing, sales and manufacturing capabilities or
collaborative arrangements with others which possess such capabilities, and
raising sufficient funds to finance its activities. There can be no assurance
that the Company will be able to achieve profitability or that profitability, if
achieved, can be sustained.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1998 AND 1997
Revenues. Total revenues increased 702% to $6.8 million for the quarter
ended June 30, 1998 as compared to $847,000 for the same period in the prior
year. License fees revenue increased to $5.0 million during the quarter ended
June 30, 1998 from none during the second quarter of 1997. This increase was
due to the Company's receipt of an accelerated milestone payment under its
agreements with Schering-Plough with respect to Vasomax(R). Schering-Plough
commenced sales of Vasomax(R) in Mexico under the brand name of Z-Max in
June 1998. Product royalties for the quarter ended June 30, 1998, all of which
were attributable to the first month of net sales of Z-Max in Mexico, were
$167,170 as compared to none for the quarter ended June 30, 1997. Product
sales, substantially all of which were derived from FTI, increased 16% to
$903,000 in the quarter ended June 30, 1998 as compared to $780,000 for the same
period in the prior year. The increase was due to continued growth in a new
product line and an increase in instruments and lab disposables. Interest
revenues increased to $729,000 for the quarter ended June 30, 1998 as compared
to $66,500 for the same period in the prior year. The increase was due to
increased cash balances as a result of a public offering completed in July 1997
and the completion of the Schering-Plough agreements in November 1997.
Cost of Products Sold. Cost of products sold increased 24% to $614,000 for
the quarter ended June 30, 1998 as compared to $497,000 for the same period in
the prior year. The increase was due to increased product sales by FTI. Gross
margin from product sales decreased to 32% during the second quarter of 1998 as
compared to 36% for the same period in the prior year due to a change in product
mix which included a higher percentage of lower margin capital equipment.
14
Research and Development Expenses. Total research and development ("R&D")
expenses increased 29% to $5.8 million for the quarter ended June 30, 1998 as
compared to $4.5 million for the same period in the prior year. The increase was
due primarily to the additional costs associated with the development of
Vasomax(R). Expenses associated with the development of Vasomax(R) increased
26% to approximately $4.9 million during the quarter ended June 30, 1998 as
compared to approximately $3.9 million during the same period in the prior year.
The increase was primarily due to the preparation of the NDA filing which was
completed on July 14, 1998. General R&D expenses increased 66% to approximately
$934,000 as compared to $561,000 during the same period in the prior year. This
increase was primarily due to new hires and an increase in research facility
space to expand the Company's research and drug screening capabilities. The
Company expects its research and development expenses to increase during the
remainder of 1998 and for at least the next several years.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 32% to $949,000 during the quarter ended June
30, 1998 from $718,000 in the second quarter of 1997. The increase was
primarily due to additional legal expenses relating to recently-filed
litigation, non-cash compensation relating to options granted under the 1996
Non-employee Director Stock Option Plan, increased expenses associated with
operating a public company with an increase in shareholders and additional
professionals to strengthen its current management team and to assist in
achieving the Company's goals.
Interest Expense and Amortization of Intangibles. Interest expense and
amortization of intangibles remained relatively constant in the second quarter
of 1998 as compared to 1997. The Company recorded $53,000 of amortization
during the second quarter of 1998 related to the excess of cost over fair value
of tangible assets associated with the acquisition of FTI.
15
SIX MONTHS ENDED JUNE 30, 1998 AND 1997
Revenues. Total revenues increased 389% to $8.8 million for the six months
ended June 30, 1998 as compared to $1.8 million for the same period in the prior
year. License fees revenue increased to $5.0 million during the period ended
June 30, 1998 from none during the same period in the prior year. This increase
was due to the Company's receipt of an accelerated milestone payment under its
agreements with Schering-Plough with respect to Vasomax(R). Schering-Plough
commenced sales of Vasomax(R) in Mexico under the brand name of Z-Max in
June 1998. Product royalties for the six months ended June 30, 1998, all of
which were attributable to the first month of net sales of Z-Max in Mexico, were
$167,170 as compared to none for the six months ended June 30, 1997. Product
sales, substantially all of which were derived from FTI, increased 13% to $1.8
million in the six months ended June 30, 1998 as compared to $1.6 million for
the same period in the prior year. The increase was due to continued growth in
a new product line and an increase in the instruments and lab disposables
product lines. Interest revenues increased to $1.8 million for the six months
ended June 30, 1998 as compared to $188,000 for the same period in the prior
year. The increase was due to increased cash balances as a result of a public
offering completed in July 1997 and the completion of the Schering-Plough
agreements in November 1997.
Cost of Products Sold. Cost of products sold increased 9% to $1.2 million
for the six months ended June 30, 1998 as compared to $1.1 million for the same
period in the prior year. The increase was due to increased product sales by
FTI. Gross margin from product sales remained relatively constant at
approximately 33% during the six months of 1998 as compared to the same period
in the prior year.
Research and Development Expenses. Total research and development ("R&D")
expenses increased 44% to $12.2 million for the six months ended June 30, 1998
as compared to $8.5 million for the same period in the prior year. The increase
was due primarily to the additional costs associated with the development of
Vasomax(R). Expenses associated with the development of Vasomax(R) increased
41% to approximately $10.3 million during the six months ended June 30, 1998 as
compared to approximately $7.3 million during the same period in the prior year.
General R&D expenses increased 58% to approximately $1.9 million as compared to
$1.2 million during the same period in the prior year. This increase was
primarily due to new hires and an increase in research facility space to expand
the Company's research and drug screening capabilities. The Company expects its
research and development expenses to increase during the remainder of 1998 and
for at least the next several years.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 46% to $1.9 million during the six months
ended June 30, 1998 from $1.3 million for the same period in the prior year.
The increase was primarily due to expenses associated with recently-filed
litigation, increased expenses associated with operating a public company with
an increase in shareholders and additional hiring of professionals to strengthen
its current management team and to assist in achieving the Company's goals.
Additionally, the increase was due to non-cash director stock option expenses
which will be recognized over the twelve month period of 1998 as compared to the
total expense for the year of 1997 which was recognized all in the fourth
quarter of 1997.
16
Interest Expense and Amortization of Intangibles. Interest expense and
amortization of intangibles remained relatively constant during the six months
June 30, 1998 as compared to the same period in the prior year. The Company
recorded $109,000 of amortization during the six months ended June 30, 1998
related to the excess of cost over fair value of tangible assets associated with
the acquisition of FTI.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has financed its operations primarily with
proceeds from the private placement and public offering of equity securities and
with funds received under collaborative agreements. In April 1993, the Company
received net proceeds of approximately $7.0 million from its initial public
offering. In December 1993, the Company received net proceeds of $2.5 million
from the sale of Common Stock to an affiliate of Schering AG in connection with
the Company's collaboration with Schering AG. In October 1995, the Company
received net proceeds of $5.3 million from the private placement of Series A
Preferred Stock. In September and October 1996, the Company received aggregate
net proceeds of $14.4 million from the private placement of Series B Preferred
Stock. In July 1997, the Company received net proceeds of approximately $72.2
million from a public offering of Common Stock. In December 1997, the Company
received a $10.0 million up-front license fee from Schering-Plough for the right
to market and sell Vasomax(R) for the treatment of male erectile dysfunction.
On June 30, 1998, the Company received an accelerated $5.0 million milestone
payment from Schering-Plough with respect to Vasomax(R).
The Company used net cash of approximately $9.6 million for operating
activities in the six months ended June 30, 1998 as compared to approximately
$8.0 million in the six months ended June 30, 1997. The Company had cash and
cash equivalents of approximately $60.0 million at June 30, 1998. The increased
use of cash for the six months ended June 30, 1998 was primarily due to the
increase in expenses related to the clinical development of Vasomax(R).
The Company has experienced negative cash flows from operations since its
inception and has funded its activities to date primarily from equity
financings. The Company will continue to require substantial funds to continue
research and development, including preclinical studies and clinical trials of
its products, and to commence sales and marketing efforts if FDA and other
regulatory approvals are obtained. The Company believes that its existing
capital resources will be sufficient to fund its operations through at least the
end of 1999. The Company's capital requirements will depend on many factors,
including the problems, delays, expenses and complications frequently
encountered by development stage companies; the progress of the Company's
clinical and preclinical activities; the progress of the Company's collaborative
agreements with affiliates of Schering-Plough and costs associated with any
future collaborative research, manufacturing, marketing or other funding
arrangements; the costs and timing of seeking regulatory approvals of Vasomax(R)
and the Company's other products; the Company's ability to obtain regulatory
approvals; the success of the Company's sales and marketing programs; the cost
of filing, prosecuting and defending and enforcing any patent claims and other
intellectual property rights; and changes in economic, regulatory or competitive
conditions of the Company's planned business. Estimates about the adequacy of
funding for the Company's activities are based on certain assumptions, including
the assumption that the development and regulatory approval of the Company's
products can be completed at projected costs and that product approvals and
introductions will be timely and successful. There can be no assurance
17
that changes in the Company's research and development plans, acquisitions or
other events will not result in accelerated or unexpected expenditures. To
satisfy its capital requirements, the Company may seek to raise additional funds
in the public or private capital markets. The Company's ability to raise
additional funds in the public or private markets will be adversely affected if
the results of its current or future clinical trials are not favorable. The
Company may seek additional funding through corporate collaborations and other
financing vehicles. There can be no assurance that any such funding will be
available to the Company on favorable terms or at all. If adequate funds are not
available, the Company may be required to curtail significantly one or more of
its research or development programs, or it may be required to obtain funds
through arrangements with future collaborative partners or others that may
require the Company to relinquish rights to some or all of its technologies or
products. If the Company is successful in obtaining additional financing, the
terms of such financing may have the effect of diluting or adversely affecting
the holdings or the rights of the holders of the Company's Common Stock.
18
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On May 16, 1994, Dr. Bonita Sue Dunbar ("Dunbar") filed suit in the 270th
District Court of Harris County, Texas naming Baylor College of Medicine
("BCM"), BCM Technologies, Inc., Fulbright & Jaworski, L.L.P., The Woodlands
Venture Capital Company and the Company as defendants (collectively, the "Dunbar
Defendants"). Dunbar is a cellular and molecular biologist who has been
employed by BCM as a teacher and research scientist since 1981. During the
course of her employment at BCM, Dunbar developed technologies relating to the
use of certain recombinant zona pellucida peptides, the intellectual property
rights to which were assigned to the Company in 1987. Dunbar claimed, among
other things, that her assignment of the patent rights was induced by statutory
and constructive fraud and a civil conspiracy on the part of the Dunbar
Defendants. The court granted partial summary judgment in favor of the Company
and the other Dunbar Defendants in connection with the action. As a result of
the rulings Dunbar is unable to rescind the assignment of the patent rights and
is left only with ancillary claims regarding the Company's alleged conversion of
her ideas relating to endometriosis and ovarian cancer. Such ancillary claims
are subject to a motion to sever and abate pending Dunbar's appeal of the
court's orders granting the motion for summary judgment. The Company believes
the ancillary claims are without merit.
Certain purported class action complaints alleging violations of Sections
10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder
have been filed against the Company and certain of its officers and directors.
These complaints were filed in the United States District Court for the Southern
District of Texas in Houston, Texas and were consolidated on May 29, 1998. The
plaintiffs purport to bring the suit on behalf of all purchasers of Zonagen
common stock between February 7, 1996 and January 9, 1998. The plaintiffs
assert that the defendants made materially false and misleading statements and
failed to disclose material facts about the patents and patent applications of
the Company relating to Vasomax(R) and ImmuMax(TM), and about the Company's
clinical trials of Vasomax(R). The plaintiffs seek to have the action declared
to be a class action, and to have rescissionary or compensatory damages in an
unstated amount, along with interest and attorney's fees. The Company and the
individual defendants believe that these actions are without merit and intend to
defend against them vigorously. No estimate of loss or range of estimate of
loss, if any, can be made at this time.
The Company is involved in certain other litigation matters which it
believes will not have a material adverse effect on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of the Company's Stockholders was held on June 25, 1998
to consider and vote upon the following proposals:
(i) Election of Directors. The following individuals were nominated
and elected as directors, with the following number of shares
voted for and withheld with respect to each director.
19
For Withheld
--------- --------
Martin P. Sutter 9,940,801 20,130
Joseph S. Podolski 9,942,401 18,530
Steven Blasnik 9,942,390 18,541
Jeffrey M. Jonas, M.D. 9,940,551 20,380
Timothy McInerney 9,942,851 18,080
David B. McWilliams 9,942,901 18,030
(ii) Approval of the Appointment of Arthur Andersen LLP as the
Company's independent public accountants for 1998.
For 9,944,239 Against 12,592 Abstain 4,100
ITEM 5. OTHER INFORMATION
In December 1993, the Company entered into an agreement with Schering AG (a
pharmaceutical company based in Germany that is not affiliated with Schering-
Plough), pursuant to which the Company and Schering AG agreed to jointly
research, develop and test zona pellucida-based human contraceptive vaccines.
Schering AG was required to purchase $2.5 million of Common Stock on or before
June 9, 1998 to retain its rights under the agreement beyond such date.
Schering AG did not purchase the shares of the Company's Common Stock required
to maintain its rights under the agreement; accordingly, the agreement
terminated on June 9, 1998. As a result of this termination, Schering AG and
the Company have no further obligations under the agreements, and all product
rights under the agreement have reverted to the Company.
On July 23, 1998 the Company announced that the United States Patent Office
had issued a Notice of Allowance to the Company for a patent application
directed to one of the Company's chitosan-based adjuvants and immunogens
collectively known as the ImmuMax(TM) System. In addition, during July 1998 the
Company also received an issued patent for the ImmuMax(TM) System in Australia.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
Exhibit No. Identification of Exhibit
11.1 Statement Regarding Computation of Net Loss Per Share
27.1 Financial Data Schedule
b. Reports on Form 8-K
None.
20
SIGNATURES
----------
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
ZONAGEN, INC.
Date: August 10, 1998
By: /s/ Joseph S. Podolski
----------------------------
Joseph S. Podolski
President and
Chief Executive Officer
(Principal Executive Officer)
Date: August 10, 1998
By /s/ Louis Ploth
---------------------
Louis Ploth
Vice President of Business Development and
Chief Financial Officer
(Principal Financial and Accounting Officer)
21