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, 2002
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 9, 2002 there were outstanding 11,387,925 shares of Common
Stock, par value $.001 per share, of the Registrant.
ZONAGEN, INC.
(A development stage company)
For the Quarter Ended June 30, 2002
INDEX
<Table>
<Caption>
PAGE
-----
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS 3
PART I. FINANCIAL INFORMATION 4
Item 1. Financial Statements
Consolidated Balance Sheets: June 30, 2002 (Unaudited)
and December 31, 2001 5
Consolidated Statements of Operations: For the three months ended
June 30, 2002 and 2001, six months ended June 30, 2002 and 2001, and from
Inception (August 20, 1987) through June 30, 2002 (Unaudited) 6
Consolidated Statements of Cash Flows: For the three months
ended June 30, 2002 and 2001, six months ended June 30, 2002
and 2001, and from Inception (August 20, 1987) through June
30, 2002 (Unaudited) 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 6. Exhibits and Reports on Form 8-K 21
SIGNATURES 22
</Table>
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 "may," "anticipate," "believe," "expect," "estimate," "project,"
"suggest," "intend" 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, projected, suggested or intended. These risks and uncertainties
include risks associated with the Company's early stage of development,
uncertainties related to the partial clinical hold imposed by the Food and Drug
Administration (FDA) on the Company's phentolamine based products, approval of
the Company's products by the FDA and other jurisdictions, 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, product liability and availability of insurance, the Company's
reliance on contract research organizations, no assurance of adequate third
party reimbursement 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, 2001 and
"Part I. Financial Information - Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital Resources"
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 accounting principles generally accepted in the
United States 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 accounting principles generally
accepted in the United States 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, 2002 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2002. 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, 2001.
4
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
CONSOLIDATED BALANCE SHEETS
(in thousands except share amounts)
<Table>
<Caption>
JUNE 30, DECEMBER 31,
2002 2001
--------- ------------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 2,580 $ 1,521
Marketable securities - short term 25,640 28,535
Product inventory -- 4,417
Prepaid expenses and other current assets 824 787
--------- ---------
Total current assets 29,044 35,260
LAB EQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS, net 240 340
OTHER ASSETS, net 461 1,314
--------- ---------
Total assets $ 29,745 $ 36,914
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,386 $ 1,723
Accrued expenses 487 394
Deferred revenue - short term 3,171 2,114
--------- ---------
Total current liabilities 5,044 4,231
--------- ---------
DEFERRED REVENUE - LONG TERM -- 2,114
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Undesignated Preferred Stock, $.001 par value, 5,000,000
shares authorized, none issued and outstanding -- --
Common Stock, $.001 par value, 20,000,000 shares authorized, 11,803,225 and
11,765,516 shares issued, respectively; 11,387,925 and 11,350,216
shares outstanding, respectively 12 12
Additional paid-in capital 113,929 113,898
Deferred compensation (4) (11)
Cost of treasury stock, 415,300 shares (7,484) (7,484)
Deficit accumulated during the development stage (81,752) (75,846)
--------- ---------
Total stockholders' equity 24,701 30,569
--------- ---------
Total liabilities and stockholders' equity $ 29,745 $ 36,914
========= =========
</Table>
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 and in thousands except per share amounts)
<Table>
<Caption>
FROM INCEPTION
(AUGUST 20, 1987)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, THROUGH
--------------------------- ------------------------- JUNE 30,
2002 2001 2002 2001 2002
--------- ----------- --------- --------- ---------------
REVENUES
Licensing fees $ 528 $ 537 $ 1,057 $ 1,073 $ 25,584
Product royalties -- 10 -- 59 627
Research and development grants -- 17 -- 116 187
Interest income 182 399 415 890 12,408
--------- --------- --------- --------- ---------
Total revenues 710 963 1,472 2,138 38,806
EXPENSES
Research and development 5,893 657 6,502 1,399 89,710
General and administrative 433 436 876 993 21,117
Interest expense and amortization
of intangibles -- -- -- -- 388
--------- --------- --------- --------- ---------
Total expenses 6,326 1,093 7,378 2,392 111,215
--------- --------- --------- --------- ---------
Loss from continuing operations (5,616) (130) (5,906) (254) (72,409)
Income (loss) from discontinued operations -- -- -- -- (1,828)
Gain on disposal -- -- -- -- 939
--------- --------- --------- --------- ---------
Net loss before cumulative effect of
change in accounting principle (5,616) (130) (5,906) (254) (73,298)
Cumulative effect of change in accounting
principle -- -- -- -- (8,454)
--------- --------- --------- --------- ---------
NET LOSS $ (5,616) $ (130) $ (5,906) $ (254) $ (81,752)
========= ========= ========= ========= =========
INCOME (LOSS) PER SHARE - BASIC AND DILUTED:
Loss from continuing operations $ (0.49) $ (0.01) $ (0.52) $ (0.02)
Income from discontinued operations -- -- -- --
Gain on disposal -- -- -- --
--------- --------- --------- ---------
Net loss before cumulative effect of
change in accounting principle (0.49) (0.01) (0.52) (0.02)
Cumulative effect of change in accounting
principle -- -- -- --
--------- --------- --------- ---------
NET LOSS $ (0.49) $ (0.01) $ (0.52) $ (0.02)
========= ========= ========= =========
Shares used in income (loss) per share calculation:
Basic 11,382 11,332 11,373 11,330
Diluted 11,382 11,332 11,373 11,330
</Table>
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 and in thousands)
<Table>
<Caption>
FROM INCEPTION
(AUGUST 20, 1987)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, THROUGH
--------------------------- ------------------------- JUNE 30,
2002 2001 2002 2001 2002
--------- ------------ ---------- --------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (5,616) $ (130) $ (5,906) $ (254) $ (81,752)
Gain on disposal of discontinued operations -- -- -- -- (939)
Adjustments to reconcile net loss to net cash
used in operating activities:
Noncash financing costs -- -- -- -- 316
Noncash inventory impairment 4,417 -- 4,417 -- 4,417
Noncash patent impairment 1,031 -- 1,031 -- 1,031
Depreciation and amortization 58 76 107 154 3,567
Noncash expenses related to stock-based
transactions 3 55 6 120 2,427
Common stock issued for agreement not to
compete -- -- -- -- 200
Series B Preferred Stock issued for consulting
services -- -- -- -- 18
Changes in operating assets and liabilities
(net effects of purchase of businesses in 1988
and 1994):
(Increase) decrease in receivables -- -- -- -- (199)
(Increase) decrease in inventory -- -- -- 1 (4,447)
(Increase) decrease in prepaid expenses and
other current assets (221) (249) (11) 135 (495)
(Decrease) increase in accounts payable and
accrued expenses 126 (445) (244) (360) 1,750
(Decrease) increase in deferred revenue (528) (537) (1,057) (1,073) 3,171
--------- --------- --------- --------- ---------
Net cash used in operating activities (730) (1,230) (1,657) (1,277) (70,935)
CASH FLOWS FROM INVESTING ACTIVITIES
(Purchase) maturities of marketable securities 2,230 3,775 2,896 5,603 (25,827)
Capital expenditures -- -- -- -- (2,219)
Purchase of technology rights and other assets (155) (7) (211) (81) (2,156)
Cash acquired in purchase of FTI -- -- -- -- 3
Proceeds from sale of subsidiary, less
$12,345 for operating losses during
1990 phase-out period -- -- -- -- 138
Proceeds from sale of the assets of Fertility
Technologies, Inc., subsidiary -- -- -- -- 2,250
Increase in net assets held for disposal -- -- -- -- (213)
--------- --------- --------- --------- ---------
Net cash provided by (used in) investing activities 2,075 3,768 2,685 5,522 (28,024)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock 8 7 31 12 84,228
Proceeds from issuance of preferred stock -- -- -- -- 23,688
Purchase of treasury stock -- -- -- -- (7,484)
Proceeds from issuance of notes payable -- -- -- -- 2,839
Principal payments on notes payable -- -- -- -- (1,732)
--------- --------- --------- --------- ---------
Net cash provided by financing activities 8 7 31 12 101,539
--------- --------- --------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,353 2,545 1,059 4,257 2,580
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,227 4,223 1,521 2,511 --
--------- --------- --------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 2,580 $ 6,768 $ 2,580 $ 6,768 $ 2,580
========= ========= ========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
Reduction of debt due to final payment, in stock,
of FTI Acquisition $ -- $ -- $ -- $ -- $ 94
</Table>
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, 2002
(Unaudited)
NOTE 1 -- ORGANIZATION AND OPERATIONS
Zonagen, Inc. ("Zonagen" or the "Company"), a Delaware corporation, was
organized on August 20, 1987 ("Inception") and is a development stage company.
Zonagen is engaged in the development of pharmaceutical products that address
diseases and conditions associated with the human reproductive system. From
Inception through June 30, 2002, the Company has been primarily engaged in
research and development and clinical development.
On April 29, 2002, Zonagen announced that it had been informed by
Schering-Plough Corporation ("Schering-Plough"), the worldwide licensee of
VASOMAX(R), that the Marketing Authorization Application ("MAA") for VASOMAX(R)
which was submitted to the United Kingdom Medicines Control Agency ("MCA") by
Schering-Plough in December 2001 would be withdrawn. This decision was made
following their review of the comments received from the Committee on Safety of
Medicines regarding the VASOMAX(R) submission. VASOMAX(R) is an oral therapy for
the treatment of male erectile dysfunction ("MED").
On July 15, 2002, the Company and Schering-Plough announced that they
had mutually agreed to terminate the worldwide licensing agreements dated as of
November 14, 1997 that cover Zonagen's phentolamine-based technologies for
sexual dysfunction which include VASOMAX(R). In exchange for the termination,
the Company paid to Schering-Plough a nominal cash fee upon execution of the
termination agreement and agreed to make a milestone payment to Schering-Plough
in the event that worldwide annual sales of VASOMAX(R) exceed a certain amount,
which payment may be paid in several installments. In addition, the Company
agreed to make royalty payments to Schering-Plough based on a percentage of
sales of VASOMAX(R) in Brazil and other countries in which there existed certain
patent rights at the time of the termination. The Company's obligation to make
royalty payments terminates after aggregate royalties paid under this
termination agreement reach a certain maximum amount. Also, the Company agreed
to make royalty payments to Schering-Plough based on sales of certain
combination products covered by combination patents controlled by
Schering-Plough. These royalty payments are not subject to the cap on royalty
payments for VASOMAX(R) sales described above. Included in the rights returned
to Zonagen were all licenses, options and other rights with respect to Zonagen's
phentolamine-based products, Zonagen's combination products, patent rights,
know-how and trademarks for the treatment of sexual dysfunction for both men and
women. Schering-Plough will transfer and assign to Zonagen rights, title and
interest in and to any and all New Drug Applications or similar foreign
submissions or approvals. Zonagen will thereafter be solely responsible for all
obligations in the relevant countries with respect to such submissions and
approvals.
Due to the termination of the Schering-Plough agreements in July 2002,
the future uncertainty surrounding the VASOMAX(R) product and the fact that the
Company is not presently committing resources toward the approval of VASOMAX(R),
the Company wrote-off both its bulk phentolamine inventory previously valued at
$4.4 million and its VASOMAX(R) patent estate previously valued at approximately
$1.0 million in the three-month period ended June 30, 2002.
The Company has incurred several delays relating to the regulatory
approval of its lead product VASOMAX(R). In addition to the delays encountered
by the Company in the year 2002, the Company had also encountered delays
starting in August 1999, when the U.S. Food and Drug Administration ("FDA")
placed the Company's phentolamine-based products, which include both VASOMAX(R)
and Vasofem(TM), on clinical hold in the U.S. based on a finding of brown fat
proliferations in a two-year rat study. In May 2000, the FDA upgraded the
status of VASOMAX(R) to a partial clinical hold pending additional animal data
and in October 2000, allowed Zonagen to conduct a mechanistic study to address
their concerns. In July 2002, the Company submitted the final results from the
one year mechanistic study to the FDA. The study suggests that phentolamine
administered to both old and young rats at various doses does not induce or
promote brown fat proliferations in the rat. No gross brown fat proliferations
were observed during the entire one-year period that the animals were
administered the drug. Having the U.S. partial clinical hold lifted is one of
several critical factors in the approval process for VASOMAX(R) and the
Company's other future phentolamine-based product candidates in the U.S. See
"Item 1. Description of Business -- Business Risks" in the Company's annual
report on Form 10-K for the fiscal year ended December 31, 2001 for a more
complete description of the Company's risks.
In July 2000, due to delays regarding the Company's lead product
VASOMAX(R), the Company's Board of Directors announced that it had engaged
Deutsche Banc Alex. Brown to review strategic alternatives for redeploying the
Company's assets to maximize shareholder value in the near term. The Deutsche
Banc Alex. Brown engagement was terminated in January 2002 after the Company
reported in December 2001, positive interim results from its rat mechanistic
study and the Schering-Plough submission of an amendment to the drug dossier
for approval of VASOMAX(R) in the United Kingdom. At that time it was felt that
refocusing efforts on the approval of VASOMAX(R) and the Company's small
molecule opportunities would best maximize value for its shareholders. Due to
the April 2002 withdrawal of the Marketing Authorization Application for
VASOMAX(R) in the United Kingdom by Schering-Plough, the subsequent July 2002
mutual termination of the Schering-Plough agreements and the continued
uncertainty relating to the Company's VASOMAX(R) product, the Company has
resumed a search for strategic alternatives for the redeployment of the
Company's assets to maximize shareholder value.
8
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(Unaudited)
The Company has experienced negative cash flows from operations since
its inception and has funded its activities to date primarily from equity
financings and corporate collaborations. 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 appropriate, if the FDA or other regulatory approvals are obtained.
The Company believes that its existing capital resources under its current
operating plan will be sufficient to fund its operations through at least the
end of 2004.
NOTE 2 -- REVENUE RECOGNITION
During 2000, the Company adopted U.S. Securities and Exchange
Commission Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements" ("SAB 101"). The cumulative effect of adopting SAB 101 at January 1,
2000 resulted in a one-time, non-cash charge of $8.5 million, with a
corresponding increase to deferred revenue that has been recognized in
subsequent periods. The $8.5 million represents portions of 1997 and 1998
payments received from Schering-Plough in consideration for the exclusive
license of the Company's VASOMAX(R) product for the treatment of MED. Included
in licensing fees for the three-month periods ended June 30, 2002 and 2001 is
approximately $528,000 of revenue that was recognized in prior years relating to
the adoption of SAB 101.
Deferred revenue at June 30, 2002, was $3.2 million. Due to the
termination of the Schering-Plough Agreements in July 2002, the Company will
recognize the remaining $3.2 million of deferred revenue in the quarter ending
September 30, 2002.
9
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(Unaudited)
NOTE 3 -- MARKETABLE SECURITIES-SHORT AND LONG TERM
Short term marketable securities have a remaining maturity of less than
twelve months and long term marketable securities have a remaining maturity of
greater than twelve months. All investments are stated at amortized cost which
approximates market. The Company's policy is to hold investments to maturity, to
require minimum credit ratings of A1/P1 and A2/A and to make no investments with
maturities more than three years. The average life of the investment portfolio
may not exceed 24 months.
NOTE 4 -- PRODUCT INVENTORY
The Company maintains an inventory of bulk phentolamine which is the
active ingredient in VASOMAX(R), the Company's oral treatment for MED. Due to
the termination of the Schering-Plough agreements in July 2002, the future
uncertainty surrounding the VASOMAX(R) product and the fact that the Company is
not presently committing resources toward the approval of VASOMAX(R), the
Company wrote-off its bulk phentolamine inventory previously valued at $4.4
million in the three-month period ended June 30, 2002.
NOTE 5 -- LICENSE, RESEARCH AND DEVELOPMENT AGREEMENTS
Schering-Plough Corporation
On July 15, 2002, the Company and Schering-Plough announced that they
had mutually agreed to terminate the worldwide licensing agreements dated as of
November 14, 1997 that cover Zonagen's phentolamine-based technologies for
sexual dysfunction which include Vasomax(R). See Note 1 in the notes to
consolidated financial statements in this Form 10-Q.
Deferred revenue at June 30, 2002, was $3.2 million. Due to the
termination of the Schering-Plough Agreements in July 2002, the Company will
recognize the remaining $3.2 million of deferred revenue in the quarter ending
September 30, 2002.
Included in the Company's balance sheet as of June 30, 2002 and
December 31, 2001 under the caption "accounts payable" was an obligation to
Schering-Plough of approximately $1.3 million and $1.6 million, respectively.
This obligation was originally $2.4 million prior to any repayments made by the
Company to Schering-Plough and represents costs relating to a portion of a
shared clinical development program regarding the Company's VASOMAX(R) product.
10
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(Unaudited)
During April 2001, Schering-Plough agreed to accept payment of the Company's
$2.4 million obligation to Schering-Plough via cash payments aggregating $1
million, a transfer of $933,000 in bulk phentolamine inventory and a $467,000
reduction in future royalties and milestone payments payable to the Company. In
March 2002, the Company settled its $ 1 million cash obligation with its final
cash payment of approximately $309,000. As of June 30, 2002, the Company had a
remaining obligation to Schering-Plough of approximately $1.3 million which the
Company and Schering-Plough had agreed would be satisfied through the transfer
of bulk phentolamine and a reduction in future royalty and milestone payments as
described above. Due to the termination of the Schering-Plough Agreements in
July of 2002, the $1.3 million payable will be forgiven and will be reduced to
zero on the Company's balance sheet and will be offset against research and
development expenses for the three-month period ended September 30, 2002.
NOTE 6 -- STOCK OPTIONS
In March 2002 the Company granted incentive stock options to purchase
275,000 shares of common stock at $4.34, the fair value of the stock when issued
to its President and Chief Executive Officer, Joseph Podolski. Of these options,
225,000 shares have performance-based vesting provisions tied to certain
milestones relating to the approval of VASOMAX(R). In June 2002 the Company
granted incentive stock options to purchase 30,000 shares at $1.70 per share,
the fair value of the stock when issued, to its Board of Directors due to their
re-election.
NOTE 7 -- LOSS PER SHARE
Basic EPS is computed by dividing net loss by the weighted average
number of shares of common stock outstanding during the year. Diluted EPS is
computed in the some manner as fully diluted EPS, except that, among other
changes, the average share price for the period is used in all cases when
applying the treasury stock method of potentially dilutive outstanding options.
Common stock equivalents 1,623,978 for both the three- and six-month periods
ended June 30, 2002 were excluded from the calculation of dilutive EPS as
antidilutive.
NOTE 8 -- COMMITMENTS AND CONTINGENCIES
Certain purported class action complaints alleging violations of
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and
Rule 10b-5 thereunder were 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 purported to bring the suit on behalf of all
purchasers of Zonagen common stock between February 7, 1996 and January 9, 1998.
The plaintiffs asserted 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 Chito-ZN
11
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(Unaudited)
(formerly named ImmuMax(TM)) and about the Company's clinical trials of
VASOMAX(R). The plaintiffs sought to have the action declared to be a class
action, and to have recessionary or compensatory damages in an unstated amount,
along with interest and attorney's fees. On March 30, 1999, the Court granted
the defendants' motion to dismiss and dismissed the case with prejudice. The
plaintiffs filed an appeal. On September 25, 2001, the United States Fifth
Circuit Court of Appeals affirmed the dismissal of all claims except one; the
court reversed the trial court's dismissal of a claim concerning the Company's
disclosure about a patent relating to VASOMAX(R). The defendants have filed a
motion to dismiss that one remaining claim, and that motion is still pending.
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. Management believes there
will be no material adverse effect related to this matter.
NOTE 9 -- SUBSEQUENT EVENTS
On July 15, 2002, the Company and Schering-Plough announced that they
had mutually agreed to terminate the worldwide licensing agreements dated as of
November 14, 1997 that cover Zonagen's phentolamine-based technologies for
sexual dysfunction which include Vasomax(R). See Note 1, Note 4 and Note 5 in
the notes to consolidated financial statements in this Form 10-Q.
On July 15, 2002, Zonagen also announced that the final results from
the one year mechanistic study of phentolamine induced brown fat proliferations
had been submitted to the FDA. The study suggests that phentolamine administered
to both old and young rats at various doses does not induce or promote brown fat
proliferations in the rat. No gross brown fat proliferations were observed
during the entire one-year period that the animals were administered the drug.
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. ("Zonagen" or the "Company"), a Delaware corporation, was
organized on August 20, 1987 ("Inception") and is a development stage company.
Zonagen is engaged in the development of pharmaceutical products that address
diseases and conditions associated with the human reproductive system. From
Inception through June 30, 2002, the Company has been primarily engaged in
research and development and clinical development.
On April 29, 2002, Zonagen announced that it had been informed by
Schering-Plough Corporation ("Schering-Plough"), the worldwide licensee of
VASOMAX(R), that the Marketing Authorization Application ("MAA") for VASOMAX(R)
which was submitted to the United Kingdom Medicines Control Agency ("MCA") by
Schering-Plough in December 2001 would be withdrawn. This decision was made
following their review of the comments received from the Committee on Safety of
Medicines regarding the VASOMAX(R) submission. VASOMAX(R) is an oral therapy for
the treatment of male erectile dysfunction ("MED").
On July 15, 2002, the Company and Schering-Plough announced that they
had mutually agreed to terminate the worldwide licensing agreements dated as of
November 14, 1997 that cover Zonagen's phentolamine-based technologies for
sexual dysfunction which include VASOMAX(R). In exchange for the termination,
the Company paid to Schering-Plough a nominal cash fee upon execution of the
termination agreement and agreed to make a milestone payment to Schering-Plough
in the event that worldwide annual sales of VASOMAX(R) exceed a certain amount,
which payment maybe paid in several installments. In addition, the Company
agreed to make royalty payments to Schering-Plough based on a percentage of
sales of VASOMAX(R) in Brazil and other countries in which there existed certain
patent rights at the time of the termination. The Company's obligation to make
royalty payments terminates after aggregate royalties paid under this
termination agreement reach a certain maximum amount. Also, the Company agreed
to make royalty payments to Schering-Plough based on sales of certain
combination products covered by combination patents controlled by
Schering-Plough. These royalty payments are not subject to the cap on royalty
payments for VASOMAX(R) sales described above. Included in the rights returned
to Zonagen were all licenses, options and other rights with respect to Zonagen's
phentolamine-based products, Zonagen's combination products, patent rights,
know-how and trademarks for the treatment of sexual dysfunction for both men and
women. Schering-Plough will transfer and assign to Zonagen rights, title and
interest in and to any and all New Drug Applications or similar foreign
submissions or approvals. Zonagen will
13
thereafter be solely responsible for all obligations in the relevant countries
with respect to such submissions and approvals.
Due to the termination of the Schering-Plough agreements in July 2002,
the future uncertainty surrounding the VASOMAX(R) product and the fact that the
Company is not presently committing resources toward the approval of VASOMAX(R),
the Company wrote-off both its bulk phentolamine inventory previously valued at
$4.4 million and its VASOMAX(R) patent estate previously valued at approximately
$1.0 million in the three-month period ended June 30, 2002.
The Company has incurred several delays relating to the regulatory
approval of its lead product VASOMAX(R). In addition to the delays encountered
by the Company in the year 2002, the Company had also encountered delays
starting in August 1999, when the U.S. Food and Drug Administration ("FDA")
placed the Company's phentolamine-based products, which include both VASOMAX(R)
and Vasofem(TM), on clinical hold in the U.S. based on a finding of brown fat
proliferations in a two-year rat study. In May 2000, the FDA upgraded the
status of VASOMAX(R) to a partial clinical hold pending additional animal data
and in October 2000, allowed Zonagen to conduct a mechanistic study to address
their concerns. In July 2002, the Company submitted the final results from the
one year mechanistic study to the FDA. The study suggests that phentolamine
administered to both old and young rats at various doses does not induce or
promote brown fat proliferations in the rat. No gross brown fat proliferations
were observed during the entire one-year period that the animals were
administered the drug. Having the U.S. partial clinical hold lifted is one of
several critical factors in the approval process for VASOMAX(R) and the
Company's other future phentolamine-based product candidates in the U.S. See
"Item 1. Description of Business -- Business Risks" in the Company's annual
report on Form 10-K for the fiscal year ended December 31, 2001 for a more
complete description of the Company's risks.
In July 2000, due to delays regarding the Company's lead product
VASOMAX(R), the Company's Board of Directors announced that it had engaged
Deutsche Banc Alex. Brown to review strategic alternatives for redeploying the
Company's assets to maximize shareholder value in the near term. The Deutsche
Banc Alex. Brown engagement was terminated in January 2002 after the Company
reported in December 2001, positive interim results from its rat mechanistic
study and the Schering-Plough submission of an amendment to the drug dossier
for approval of VASOMAX(R) in the United Kingdom. At that time it was felt that
refocusing efforts on the approval of VASOMAX(R) and the Company's small
molecule opportunities would best maximize value for its shareholders. Due to
the April 2002 withdrawal of the Marketing Authorization Application for
VASOMAX(R) in the United Kingdom by Schering-Plough, the subsequent July 2002
mutual termination of the Schering-Plough agreements and the continued
uncertainty relating to the Company's VASOMAX(R) product, the Company has
resumed a search for strategic alternatives for the redeployment of the
Company's assets to maximize shareholder value.
The Company has experienced negative cash flows from operations since
its inception and has funded its activities to date primarily from equity
financings and corporate collaborations.
14
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 appropriate, if the FDA or other
regulatory approvals are obtained. The Company believes that its existing
capital resources under its current operating plan will be sufficient to fund
its operations through at least the end of 2004. There can be no assurance that
changes in the Company's current strategic plans or other events will not result
in accelerated or unexpected expenditures.
Zonagen's results of operations may vary significantly from year to
year and quarter to quarter, and depend, among other factors, on the regulatory
approval process in the United States and other foreign jurisdictions, the
signing of new licenses and product development agreements, the timing of
revenues recognized pursuant to license agreements, the achievement of
milestones by licensees or the Company, the progress of clinical trials
conducted by the licensees and the Company and the levels of research, marketing
and administrative expense. The timing of the Company's revenues may not match
the timing of the Company's associated product development expenses. To date,
research and development expenses have generally exceeded revenue in any
particular period and/or fiscal year.
As of June 30, 2002, the Company had an accumulated deficit of $81.8
million. Losses have resulted principally from costs incurred conducting
clinical trials for VASOMAX(R) and Vasofem(TM), in research and development
activities related to efforts to develop the Company's products and from the
associated administrative costs required to support those efforts. There
15
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 in a reasonable time frame and at a reasonable cost, obtaining
regulatory approvals, establishing marketing, sales and manufacturing
capabilities or collaborative arrangements with others that possess such
capabilities, the Company's and its partners' ability to realize value from the
Company's research and development programs through the commercialization of
those products 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. See "Item 1. Description of
Business -- Business Risks -- Uncertainties Related to Early Stage of
Development," " -- Business Risks -- History of Operating Losses; Accumulated
Deficit" and "Note 1. Organization and Operations" of Notes to Consolidated
Financial Statements in the Company's annual report on Form 10-K for the fiscal
year ended December 31, 2001.
Results of Operations
During 2000, the Company adopted U.S. Securities and Exchange
Commission Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements" ("SAB 101"). The cumulative effect of adopting SAB 101 at January 1,
2000 resulted in a one-time, non-cash charge of $8.5 million, with a
corresponding increase to deferred revenue that has been recognized in
subsequent periods. The $8.5 million represents portions of 1997 and 1998
payments received from Schering-Plough in consideration for the exclusive
license of the Company's VASOMAX(R) product for the treatment of MED. Included
in licensing fees for the three-month periods ended June 30, 2002 and 2001 is
approximately $528,000 of revenue that was recognized in prior years relating to
the adoption of SAB 101.
Deferred revenue at June 30, 2002, was $3.2 million. Due to the
termination of the Schering-Plough Agreements in July 2002, the Company will
recognize the remaining $3.2 million of deferred revenue in the quarter ending
September 30, 2002.
As of June 30, 2002, the Company had a remaining obligation to
Schering-Plough of approximately $1.3 million representing costs associated with
a joint clinical development program for VASOMAX(R) which the Company and
Schering-Plough had previously agreed would be satisfied through the transfer of
bulk phentolamine and a reduction in future royalty and milestone payments. Due
to the termination of the Schering-Plough Agreements in July of 2002, the $1.3
million payable will be forgiven and will be reduced to zero on the Company's
balance sheet for the period ended September 30, 2002.
THREE MONTH AND SIX MONTH PERIODS ENDED JUNE 30, 2002 AND 2001
Total revenues for the three month period ended June 30, 2002 decreased
to $710,000 as compared with $963,000 for the same period in the prior year and
were approximately $1.5 million for the six-month period ended June 30, 2002 as
compared to $2.1 million for the same period in the prior year. Total revenues
reflect the adoption of SAB 101 effective January 1, 2000.
16
Licensing fees for the three month period ended June 30, 2002 were
$528,000 as compared to $537,000 for the same period in the prior year.
Licensing fees for both six-month periods ended June 30, 2002 and 2001 were
approximately $1.1 million. Included in licensing fees for the three-month
periods ended June 30, 2002 and 2001 were approximately $528,000 and for the two
six-month periods ended June 30, 2002 and 2001 were $1.1 million as a result of
the change in accounting principle under the application of SAB 101 relating to
the Company's agreements with Schering-Plough. The Company had no Small Business
Innovative Research ("SBIR") research and development grant revenue for the
three-month period ended June 30, 2002 as compared to $17,000 for the same
period in the prior year and also had no SBIR grant revenue for the six-month
period ended June 30, 2002 as compared to $116,000 for the same period in the
prior year.
Product royalties from sales of VASOMAX(R) in Latin America were zero
for the three month period ended June 30, 2002 as compared to $10,000 for the
same period in the prior year. Product royalties were also zero for the
six-month period ended June 30, 2002 as compared to $59,000 for the same period
in the prior year. Due to the ongoing partial clinical hold in the United States
of the Company's phentolamine products, and the termination of the
Schering-Plough Agreements, the Company is uncertain as to whether it will be
able to create a future revenue source regarding its phentolamine-based
products.
Interest income decreased 54% to $182,000 for the three-month period
ended June 30, 2002 as compared with $399,000 for the same period in the prior
year and decreased 53% to $415,000 for the six-month period ended June 30, 2002
as compared to $890,000 for the same period in the prior year. This decrease is
primarily due to a reduction in interest rate yields and lower cash balances.
17
Research and Development Expenses. Research and development (R&D)
expenses for the three-month period ended June 30, 2002 were $5.9 million as
compared to $657,000 for the same period last year and were $6.5 million for the
six-month period ended June 30, 2002 as compared to $1.4 million for the same
period last year. Due to the termination of the Schering-Plough agreements in
July 2002, the future uncertainty surrounding the VASOMAX(R) product and the
fact that the Company is not presently committing resources toward the approval
of VASOMAX(R), the Company wrote-off both its bulk phentolamine inventory
previously valued at $4.4 million and its VASOMAX(R) patent estate previously
valued at approximately $1.0 million in the three-month period ended June 30,
2002. In addition, R&D expenses in the three-month period ended June 30, 2002
were reduced by $188,000 due to a reimbursement of prior clinical expenses for
VASOMAX(R) that was received from a clinical research organization after a
reconciliation was completed comparing actual expenses to payments made by the
Company. R&D expenses excluding the three adjustments listed above would have
been $633,000 for the three-month period ended June 30, 2002 and $1.2 million
for the six-month period ended June 30, 2002. Due to the termination of the
Schering-Plough agreements, a liability due to Schering-Plough of $1.3 million
relating to a prior joint clinical development program for VASOMAX(R) was
forgiven and will be taken as a reduction to R&D expenses in the third quarter
ended September 30, 2002.
General and Administrative Expenses. General and administrative ("G&A")
expenses remained constant at $433,000 for the three-month period ended June 30,
2002 as compared to $436,000 for the same period in the prior year. G&A expenses
decreased by 12% to $876,000 for the six month period ended June 30, 2002 as
compared to $993,000 for the same period in the prior year. Although expenses
were constant for the three-month periods ended June 30, 2002 and 2001 the
Company incurred additional expenses due to an increase in insurance rates and
personnel expenses offset by a discontinuation of quarterly amortization
expenses relating to a non-cash compensation charge for stock options previously
issued in December 1996 that was fully amortized by December 31, 2001. The
decrease in expenses for the six-month period ended June 30, 2002 as compared to
the same period in the prior year is primarily due to the discontinuation of
quarterly amortization expenses relating to a non-cash compensation charge for
stock options previously issued in December 1996 and a reduction in costs
associated with potential prior strategic alternative opportunities that
occurred in the first half of the year ended June 30, 2001 offset by increased
insurance rate expenses.
There can be no assurance that profitability can be achieved or if
achieved, can be sustained. See "Item 1. Description of Business -- Business
Risks -- Uncertainties Related to Early Stage of Development," " -- Business
Risks -- History of Operating Losses; Accumulated Deficit" in the Company's
annual report on Form 10-K for the fiscal year ended December 31, 2001.
LIQUIDITY AND CAPITAL RESOURCES
Since Inception, the Company has financed its operations primarily with
proceeds from private placements and public offerings of equity securities and
with funds received under collaborative agreements. Zonagen has received a total
of $20.0 million from Schering-Plough from inception of its collaboration
through June 30, 2002 and has received only nominal royalty payments from the
sale of VASOMAX(R) in Mexico and Brazil.
The Company's primary use of cash to date has been in operating
activities to fund research and development, including preclinical studies and
clinical trials, and G&A expenses required to support those activities. Net cash
of approximately $730,000 was used in operating activities during the
three-month period ended June 30, 2002 as compared to $1.2 million for the same
period in the prior year. Net cash of approximately $1.7 million was used in
operating activities during the six-month period ended June 30, 2002 as compared
to $1.3 million for the same period in the prior year. Included in the $1.7
million net cash used in operating activities for the six-month period ended
June 30, 2002 is a payment of approximately $309,000 which was made to
Schering-Plough as reimbursement for prior shared clinical development costs for
VASOMAX(R). The Company had cash, cash equivalents and marketable securities of
approximately $28.2 million at June 30, 2002 as compared to approximately $30.1
million at December 31, 2001.
18
The Company believes that its existing capital resources under its
current operating plan will be sufficient to fund its operations through at
least the end of 2004. The Company's capital requirements will depend on many
factors, including whether the FDA lifts its partial clinical hold on VASOMAX(R)
and the Company's other product candidates that contain phentolamine; the
problems, delays, expenses and complications frequently encountered by
development stage companies; the progress of the Company's clinical and
preclinical activities; the Company's ability to enter into collaborative
agreements with any future collaborators and costs associated with any of those
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
including the obtaining of the timely lifting of the FDA's partial clinical hold
on the Company's phentolamine based products; 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. 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 its remaining 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. See "Item 1. Description of Business -- Business Risks"
in the Company's annual report on Form 10-K for the fiscal year ended December
31, 2001.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
19
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Certain purported class action complaints alleging violations of
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and
Rule 10b-5 thereunder were 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 purported to bring the suit on behalf of all
purchasers of Zonagen common stock between February 7, 1996 and January 9, 1998.
The plaintiffs asserted 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 Chito-ZN (formerly named
ImmuMax(TM)) and about the Company's clinical trials of VASOMAX(R). The
plaintiffs sought to have the action declared to be a class action, and to have
recessionary or compensatory damages in an unstated amount, along with interest
and attorney's fees. On March 30, 1999, the Court granted the defendants' motion
to dismiss and dismissed the case with prejudice. The plaintiffs filed an
appeal. On September 25, 2001, the United States Fifth Circuit Court of Appeals
affirmed the dismissal of all claims except one; the court reversed the trial
court's dismissal of a claim concerning the Company's disclosure about a patent
relating to VASOMAX(R). The defendants have filed a motion to dismiss that one
remaining claim, and that motion is still pending. 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. Management believes there will be no
material adverse effect related to this matter.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of the Company's Stockholders was held on June 20,
2002 to consider and vote upon the following proposals:
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.
<Table>
<Caption>
For Withheld
--------- --------
Martin P. Sutter 9,701,286 262,838
Joseph S. Podolski 9,691,850 272,274
Steven Blasnik 9,701,175 262,949
Lloyd M. Bentsen, III 9,692,728 271,396
Timothy McInerney 9,705,636 258,488
</Table>
20
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
10.1+ Letter Agreement dated July 15, 2002 between
the Company, Schering-Plough Ltd. and Schering-Plough
Corporation.
99.1 Certification pursuant 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (Chief Executive Officer).
99.2 Certification pursuant 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (Chief Financial Officer).
b. Reports on Form 8-K
The Company filed current reports on Form 8-K on June
19 and July 15, 2002 reporting events under Item 4
and a current report on Form 8-K on July 15, 2002
reporting an event under Item 5.
+ Portions of this exhibit have been omitted based on a request for confidential
treatment pursuant to Rule 24b-2 of the Exchange Act. Such omitted portions have
been filed separately with the Commission.
21
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 14, 2002
By: /s/ Joseph S. Podolski
---------------------------------------------
Joseph S. Podolski
President and
Chief Executive Officer
(Principal Executive Officer)
Date: August 14, 2002
By: /s/ Louis Ploth, Jr.
---------------------------------------------
Louis Ploth, Jr.
Vice President Business Development and
Chief Financial Officer
(Principal Financial and Accounting Officer)
22
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
10.1+ Letter Agreement dated July 15, 2002 between the Company, Schering-Plough
Ltd. and Schering-Plough Corporation.
99.1 Certification pursuant 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer).
99.2 Certification pursuant 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer).
</Table>
+ Portions of this exhibit have been omitted based on a request for confidential
treatment pursuant to Rule 24b-2 of the Exchange Act. Such omitted portions have
been filed separately with the Commission.