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, 2003
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-10
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
As of August 11, 2003, there were outstanding 11,479,648 shares of Common
Stock, par value $.001 per share, of the Registrant.
ZONAGEN, INC.
(A development stage company)
For the Quarter Ended June 30, 2003
INDEX
Page
----
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS 3
PART I. FINANCIAL INFORMATION 4
Item 1. Financial Statements
Consolidated Balance Sheets: June 30, 2003 (Unaudited)
and December 31, 2002 5
Consolidated Statements of Operations: For the three months
ended June 30, 2003 and 2002, six months ended June 30, 2003
and 2002, and from Inception (August 20, 1987) through June
30, 2003 (Unaudited) 6
Consolidated Statements of Cash Flows: For the three months
ended June 30, 2003 and 2002, six months ended June 30, 2003
and 2002, and from Inception (August 20, 1987) through June
30, 2003 (Unaudited) 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
Item 4. Controls and Procedures 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 22
CERTIFICATION 23
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 ability to find a strategic alternative, the Company's early stage of
development, approval of the Company's products by the Food and Drug
Administration ("FDA") and other jurisdictions, 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, 2002 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, 2003 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2003. 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, 2002.
4
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
CONSOLIDATED BALANCE SHEETS
(in thousands except share amounts)
June 30, December 31,
2003 2002
----------- -----------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 3,501 $ 8,683
Marketable securities 20,696 16,455
Note receivable - 1,000
Prepaid expenses and other current assets 856 532
-------- --------
Total current assets 25,053 26,670
LAB EQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS, net - 191
OTHER ASSETS, net 520 509
-------- --------
Total assets $ 25,573 $ 27,370
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 203 $ 86
Accrued expenses 174 433
-------- --------
Total current liabilities 377 519
-------- --------
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, 11,929,048 and
11,918,177 shares issued, respectively; 11,479,648 and 11,502,877
shares outstanding, respectively 12 12
Additional paid-in capital 114,065 114,051
Cost of treasury stock, 449,400 and 415,300 shares, respectively (7,533) (7,484)
Deficit accumulated during the development stage (81,348) (79,728)
-------- --------
Total stockholders' equity 25,196 26,851
-------- --------
Total liabilities and stockholders' equity $ 25,573 $ 27,370
======== ========
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)
Three Months Ended June 30, Six Months Ended June 30,
-------------------------- -------------------------
2003 2002 2003 2002
-------- -------- --------- --------
REVENUES
Licensing fees $ - $ 528 $ - $ 1,057
Product royalties - - - -
Research and development grants 217 - 337 -
Interest income 74 182 186 415
Gain on disposal of fixed assets 102 - 102 -
------ -------- -------- --------
Total revenues and other income 393 710 625 1,472
EXPENSES
Research and development 579 5,893 1,143 6,502
General and administrative 490 433 1,102 876
Interest expense and amortization
of intangibles - - - -
------ -------- -------- --------
Total expenses 1,069 6,326 2,245 7,378
------ -------- -------- --------
Loss from continuing operations (676) (5,616) (1,620) (5,906)
Income (loss) from discontinued operations - - - -
Gain on disposal - - - -
------ -------- -------- --------
Net loss before cumulative effect of
change in accounting principle (676) (5,616) (1,620) (5,906)
Cumulative effect of change in accounting
principle - - - -
------ -------- -------- --------
NET LOSS $ (676) $ (5,616) $ (1,620) $ (5,906)
====== ======== ======== ========
INCOME (LOSS) PER SHARE - BASIC AND DILUTED:
Loss from continuing operations $ (0.06) $ (0.49) $ (0.14) $ (0.52)
Income from discontinued operations - - - -
Gain on disposal - - - -
----- ----- ----- -----
Net loss before cumulative effect of
change in accounting principle (0.06) (0.49) (0.14) (0.52)
----- ----- ----- -----
NET LOSS $ (0.06) $ (0.49) $ (0.14) $ (0.52)
======= ======= ======= =======
Shares used in loss per share calculation:
Basic 11,484 11,382 11,494 11,373
Diluted 11,484 11,382 11,494 11,373
From Inception
(August 20, 1987)
through
June 30,
2003
-----------------
REVENUES
Licensing fees $ 28,755
Product royalties 627
Research and development grants 839
Interest income 12,890
Gain on disposal of fixed assets 102
---------
Total revenues and other income 43,213
EXPENSES
Research and development 90,771
General and administrative 24,059
Interest expense and amortization
of intangibles 388
---------
Total expenses 115,218
---------
Loss from continuing operations (72,005)
Income (loss) from discontinued operations (1,828)
Gain on disposal 939
---------
Net loss before cumulative effect of
change in accounting principle (72,894)
Cumulative effect of change in accounting
principle (8,454)
---------
NET LOSS $ (81,348)
=========
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)
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
--------- --------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (676) $ (5,616) $ (1,620) $ (5,906)
Gain on disposal of discontinued operations -- -- -- --
Adjustments to reconcile net loss to net cash
used in operating activities:
Gain on disposal of assets (102) -- (102) --
Noncash financing costs -- -- -- --
Noncash inventory impairment -- 4,417 -- 4,417
Noncash patent impairment -- 1,031 -- 1,031
Noncash decrease in accounts payable -- -- -- --
Depreciation and amortization 28 58 73 107
Noncash expenses related to stock-based
transactions 11 3 14 6
Common stock issued for agreement not to
compete -- -- -- --
Series B Preferred Stock issued for consulting
services -- -- -- --
Maturities (purchases) of marketable securities (10,334) 2,230 (4,241) 2,896
Changes in operating assets and liabilities (net effects
of purchase of businesses in 1988 and 1994):
Decrease (increase) in receivables -- -- -- --
Decrease (increase) in inventory -- -- -- --
Decrease (increase) in prepaid expenses and other
current assets (322) (221) (100) (11)
(Decrease) increase in accounts payable and
accrued expenses (157) 126 (142) (244)
(Decrease) increase in deferred revenue -- (528) -- (1,057)
--------- --------- --------- ---------
Net cash used in (provided by) operating activities (11,552) 1,500 (6,118) 1,239
CASH FLOWS FROM INVESTING ACTIVITIES
Maturities (purchases) of marketable securities -- -- -- --
Capital expenditures -- -- -- --
Purchase of technology rights and other assets (14) (155) (15) (211)
Decrease in note receivable 1,000 -- 1,000 --
Cash acquired in purchase of FTI -- -- -- --
Proceeds from sale of subsidiary, less
$12,345 for operating losses during
1990 phase-out period -- -- -- --
Proceeds from sale of the assets of FTI -- -- -- --
Increase in net assets held for disposal -- -- -- --
--------- --------- --------- ---------
Net cash provided by (used in) investing activities 986 (155) 985 (211)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock -- 8 -- 31
Proceeds from issuance of preferred stock -- -- -- --
Purchase of treasury stock (49) -- (49) --
Proceeds from issuance of notes payable -- -- -- --
Principal payments on notes payable -- -- -- --
--------- --------- --------- ---------
Net cash provided by (used by) financing activities (49) 8 (49) 31
--------- --------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (10,615) 1,353 (5,182) 1,059
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 14,116 1,227 8,683 1,521
--------- --------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,501 $ 2,580 $ 3,501 $ 2,580
========= ========= ========= =========
From Inception
(August 20, 1987)
through
June 30,
2003
-----------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss (81,348)
Gain on disposal of discontinued operations (939)
Adjustments to reconcile net loss to net cash
used in operating activities:
Gain on disposal of assets (102)
Noncash financing costs 316
Noncash inventory impairment 4,417
Noncash patent impairment 1,031
Noncash decrease in accounts payable (1,308)
Depreciation and amortization 3,759
Noncash expenses related to stock-based
transactions 2,572
Common stock issued for agreement not to
compete 200
Series B Preferred Stock issued for consulting
services 18
Maturities (purchases) of marketable securities 7,839
Changes in operating assets and liabilities (net effects of
purchase of businesses in 1988 and 1994):
Decrease (increase) in receivables (199)
Decrease (increase) in inventory (4,447)
Decrease (increase) in prepaid expenses and other
current assets (322)
(Decrease) increase in accounts payable and
accrued expenses 1,562
---------
(Decrease) increase in deferred revenue --
Net cash used in (provided by) operating activities (66,951)
CASH FLOWS FROM INVESTING ACTIVITIES
Maturities (purchases) of marketable securities (28,723)
Capital expenditures (2,268)
Purchase of technology rights and other assets (2,221)
Decrease in note receivable --
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 FTI 2,250
Increase in net assets held for disposal (213)
---------
Net cash provided by (used in) investing activities (31,034)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock 84,224
Proceeds from issuance of preferred stock 23,688
Purchase of treasury stock (7,533)
Proceeds from issuance of notes payable 2,839
Principal payments on notes payable (1,732)
---------
Net cash provided by (used by) financing activities 101,486
---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,501
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD --
---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,501
=========
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, 2003
(Unaudited)
NOTE 1 -- Organization and Operations
Zonagen, Inc. ("Zonagen" or the "Company") was organized on August 20,
1987 and is a development stage company. The Company is engaged in the
development of pharmaceutical products that address diseases and conditions
associated with the human reproductive system. From inception through June 30,
2003, the Company has been primarily engaged in research and development and
clinical development.
On March 27, 2003 the Company terminated its merger agreement with
Lavipharm Corp. On April 15, 2003, the Company announced that its Board of
Directors engaged CIBC World Markets Corp. ("CIBC") to explore strategic
alternatives for the company. The Company is in the process of reviewing and
discussing potential future transactions to redeploy its assets with various
entities.
The Company has four full-time employees which management believes is the
minimum required to redeploy the Company's assets and to continue to perform a
limited amount of product development. During the second quarter ended June 30,
2003, the Company continued to focus its research efforts on two Small Business
Innovative Research ("SBIR") grants that the Company initially received during
2002 and conducted limited development of the Company's internal research
projects primarily through the use of outside consulting groups. The Company is
currently performing research under a Phase II $836,441 SBIR grant which is
being utilized to develop a new compound, a selective progesterone receptor
modulator ("SPRMs") as an oral treatment for endometriosis, and continued to
perform research in the area of breast cancer under a Phase I $108,351 SBIR
grant. The funding under the Phase I $108,351 SBIR grantis anticipated to be
depleted during the third quarter ending September 30, 2003. The Company had
requested an extension of time under the Phase II $836,441 SBIR grant to March
1, 2004 and has been granted an extension to July 31, 2004.
Since the Company is operating primarily as a virtual company utilizing
outside consultants to perform research and development and limited clinical
development activities, the Company held an auction in June 2003 and sold
substantially all of its fixed assets for approximate net proceeds of $225,000,
which was $102,000 over their book value. In addition, the Company's lease on
its 24,000 square foot facility located in The Woodlands, Texas, which had been
partially subleased, expired on May 31, 2003. The Company continued to lease
this facility on a month-to-month basis through July 31, 2003. As of August 1,
2003, the Company will maintain a 2,539 square foot facility in its current
location under an amended lease that expires on July 31, 2004. After September
30, 2003, the landlord has the right to require the Company to relocate to other
premises. If the landlord exercises this right, the Company has the option to
continue in such new space for the same rent for the remainder of the lease term
or to terminate the lease. The Company continues to implement various activities
to reduce its core burn rate in
8
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
order to preserve cash available for redeployment.
As of June 30, 2003, the Company had an accumulated deficit of $81.3
million. Losses have resulted principally from costs incurred in conducting
clinical trials for VASOMAX(R) and the related female sexual dysfunction
product, in research and development activities related to efforts to develop
the Company's other products and from the associated administrative costs
required to support those efforts. The Company currently has no plans to further
develop VASOMAX(R), or the related female sexual dysfunction product or any of
its other phentolamine-based products.
Zonagen's results of operations may vary significantly from quarter to
quarter and year to year. The Company has experienced negative cash flows from
operations since inception and has funded its activities to date primarily from
equity financings and corporate collaborations. The Company believes that its
existing capital resources under its current operating plan will be sufficient
to fund the Company's operations through at least the end of 2005. 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.
NOTE 2 -- Stock-based Compensation
The Company accounts for its stock option plans under APB No. 25
"Accounting for Stock Issued to Employees." Accordingly, deferred compensation
is recorded for stock options based on the excess of the market value of the
common stock on the measurement date over the exercise price of the options.
This deferred compensation is amortized over the vesting period of each option.
The Company has adopted the disclosure requirements of SFAS No. 123
"Accounting for Stock-Based Compensation" for employee stock-based compensation
and has elected not to record related compensation expense in accordance with
this statement. Had compensation expense for its stock option plans been
determined consistent with SFAS No. 123, the Company's net loss and loss per
share would have been increased to the following pro forma amounts (in
thousands, except for per share amounts):
9
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
------- --------- --------- ---------
Net loss, as reported $ (676) $ (5,616) $ (1,620) $ (5,906)
Add: Stock-based employee
compensation expense included in
reported net income, net of related
tax effects 11 3 14 6
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects $ (163) $ (586) $ (362) (1,084)
------- --------- --------- ---------
Pro forma net loss (828) (6,199) (1,968) $ (6,984)
======= ========= ========= =========
Loss per share -
Basic - as reported $ (0.06) $ (0.49) $ (0.14) $ (0.52)
Basic - pro forma (0.07) (0.54) (0.17) (0.61)
Diluted - as reported (0.06) (0.49) (0.14) (0.52)
Diluted - pro forma (0.07) (0.54) (0.17) (0.61)
Under SFAS No. 123, the fair value of each option grant was estimated on
the date of grant using the Black-Scholes option-pricing model. The following
weighted average assumptions were used for grants in the three-month periods
ended June 30, 2003 and 2002, respectively: risk-free interest rates of 3.8% and
4.85%; no expected dividends; expected lives of 9.7 and 9.6 years; expected
volatility of 89% and 92%. The weighted average fair value of options granted at
market for the three-month periods ended June 30, 2003 and 2002 was $1.23 and
$1.49, respectively. The following weighted average assumptions were used for
grants in the six-month periods ended June 30, 2003 and 2002, respectively:
risk-free interest rates of 3.8% and 5.3%; no expected dividends; expected lives
of 9.7 and 5.3 years; expected volatility of 90% and 88%. The weighted average
fair value of options granted at market for the six-month periods ended June 30,
2003 and 2002 was $1.06 and $3.04, respectively.
The Black-Scholes option valuation model and other existing models were
developed for use in estimating the fair value of traded options that have no
vesting restrictions and are fully transferable. In addition, option valuation
models require the input of and are highly sensitive to subjective assumptions
including the expected stock price volatility. The Company's employee stock
options have characteristics significantly different from those of traded
options and changes in the subjective input assumptions can materially affect
the fair value estimate.
10
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
NOTE 3 -- Marketable Securities
Management determines the appropriate classification of investments in
debt and equity securities at the time of purchase and re-evaluates such
designation as of each subsequent balance sheet date. Securities for which the
Company has the ability and intent to hold to maturity are classified as "held
to maturity". Securities classified as "trading securities" are recorded at fair
value. Gains and losses on trading securities, realized and unrealized, are
included in earnings and are calculated using the specific identification
method. Any other securities are classified as "available for sale." At June 30,
2003 all securities were classified as trading securities. The cost basis
including purchased premium for these securities was $20.7 million and $16.5
million at June 30, 2003 and December 31, 2002, respectively.
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. Marketable securities as of June 30, 2003 consist of
only short-term investments totaling $20.7 million. The Company's investments
typically include corporate bonds and notes, Euro-dollar bonds, taxable auction
securities and asset-backed securities. The Company's policy is to require
minimum credit ratings of A2/A and A1/P1 with maturities of up to three years.
The average life of the investment portfolio may not exceed 24 months.
NOTE 4 -- Patents
As of June 30, 2003, the Company had approximately $520,000 in capitalized
patents reflected on its balance sheet. Of this amount $233,000 relates to
patents for Zonagen's SPRMs which are being developed as an oral treatment for
endometriosis through an SBIR grant; $179,000 relates to vaccine adjuvant
technologies; $61,000 relates to prostate cancer vaccine technologies; and
$47,000 relates to various other technologies. If Zonagen enters into a merger
with an entity that does not continue to develop the technologies of Zonagen or
cannot out-license these technologies to another entity, then part or all of the
capitalized patents value at that time could be impaired.
NOTE 5 -- Earnings (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 same 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 of 1,437,064 and 1,647,973 for the periods ended June 30, 2003 and
2002, respectively, were excluded from the calculation of diluted EPS since they
were antidilutive.
11
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
The following table presents information necessary to calculate earnings
per share for the three-month and six-month periods ended June 30, 2003 and 2002
(in thousands, except per share amounts):
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
-------- -------- -------- ---------
Net Loss $ (676) $ (5,616) $ (1,620) $ (5,906)
Average common shares outstanding 11,484 11,382 11,494 11,373
-------- -------- -------- ---------
Basic earnings per share $ (0.06) $ (0.49) $ (0.14) $ (0.52)
======== ======== ======== =========
Average common and dilutive potential
common shares outstanding:
Average common shares outstanding 11,484 11,382 11,494 11,373
Assumed exercise of stock options -- -- -- --
-------- -------- -------- ---------
Diluted earnings per share $ (0.06) $ (0.49) $ (0.14) $ (0.52)
======== ======== ======== =========
NOTE 6 -- Stockholders' Equity
On April 2, 2003, the Company announced that its Board of Directors had
authorized the Company to repurchase up to $2.5 million of the Company's common
stock from time to time through privately negotiated third party transactions or
in the open market. From April 2, 2003 through August 11, 2003 the Company
repurchased 34,100 shares of its common stock for $49,137.
NOTE 7 -- 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 in 1998. 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
12
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
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). After remand, the case was certified as a class action by the
Court. Following the close of discovery, the Court granted the defendants'
motion for summary judgment as to that last remaining claim, and entered a
judgment dismissing the case with prejudice. The plaintiffs have filed an appeal
challenging both the Court's refusal to allow them to amend their complaint and
the Court's summary judgment order. The Company's management 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 loss, if any,
can be made at this time.
13
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") was organized on August 20,
1987 and is a development stage company. The Company is engaged in the
development of pharmaceutical products that address diseases and conditions
associated with the human reproductive system. From inception through June 30,
2003, the Company has been primarily engaged in research and development and
clinical development.
On March 27, 2003 the Company terminated its merger agreement with
Lavipharm Corp. On April 15, 2003, the Company announced that its Board of
Directors engaged CIBC World Markets Corp. ("CIBC") to explore strategic
alternatives for the company. The Company is in the process of reviewing and
discussing potential future transactions to redeploy its assets with various
entities.
The Company has four full-time employees which management believes is the
minimum required to redeploy the Company's assets and to continue to perform a
limited amount of product development. During the second quarter ended June 30,
2003, the Company continued to focus its research efforts on two Small Business
Innovative Research ("SBIR") grants that the Company received during 2002 and
conducted limited development of the Company's internal research projects
primarily through the use of outside consulting groups. The Company is currently
performing research under a Phase II $836,441 SBIR grant which is being utilized
to develop a new compound, a selective progesterone receptor modulator
("SPRM's") as an oral treatment for endometriosis, and continued to perform
research in the area of breast cancer under a Phase I $108,351 SBIR grant. The
funding under the Phase I $108,351 SBIR grant is anticipated to be depleted
during the third quarter ending September 30, 2003. The Company had requested an
extension of time under the Phase II $836,441 SBIR grant to March 1, 2004 and
has been granted an extension to July 31, 2004.
On April 16, 2003, the Company initiated a 50 patient Phase I/II efficacy
and safety study with its product candidate, Androxal(TM), which is being
developed as an oral treatment for testosterone deficiency in men. This study
was designed to provide a head-to-head comparison of Androxal(TM) versus an
existing topical testosterone therapy and is anticipated to be completed during
the fourth quarter ending December 31, 2003.
Since the Company is operating primarily as a virtual company utilizing
outside
14
consultants to perform research and development and limited clinical development
activities, the Company held an auction in June 2003 and sold substantially all
of its fixed assets for approximate net proceeds of $225,000, which was $102,000
over their book value. In addition, the Company's lease on its 24,000 square
foot facility located in The Woodlands, Texas, which was partially subleased,
expired on May 31, 2003. The Company continued to lease this facility on a
month-to-month basis through July 31, 2003. As of August 1, 2003, the Company
will maintain a 2,539 square foot facility in its current location under an
amended lease that expires on July 31, 2004. After September 30, 2003, the
landlord has the right to require the Company to relocate to other premises. If
the landlord exercises this right, the Company has the option to continue in
such new space for the same rent for the remainder of the lease term or to
terminate the lease. The Company continues to implement various activities to
reduce its core burn rate in order to preserve cash available for redeployment.
As of June 30, 2003, the Company had an accumulated deficit of $81.3
million. Losses have resulted principally from costs incurred in conducting
clinical trials for VASOMAX(R) and the related female sexual dysfunction
product, in research and development activities related to efforts to develop
the Company's other products and from the associated administrative costs
required to support those efforts. The Company currently has no plans to further
develop VASOMAX(R), or the related female sexual dysfunction product or any of
its other phentolamine-based products.
Zonagen's results of operations may vary significantly from quarter to
quarter and year to year. The Company has experienced negative cash flows from
operations since inception and has funded its activities to date primarily from
equity financings and corporate collaborations. The Company believes that its
existing capital resources under its current operating plan will be sufficient
to fund the Company's operations through at least the end of 2005. 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. 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, 2002.
Critical Accounting Policies and the Use of Estimates
The preparation of the Company's financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the Company's financial statements and accompanying notes. Actual results could
differ materially from those estimates. The items in the Company's financial
statements requiring significant estimates and judgments are as follows:
- - Management determines the appropriate short and long-term classification
of investments in debt and equity securities at the time of purchase and
re-evaluates such designation as of each subsequent balance sheet date.
Securities for which the Company has the ability and intent to hold to
maturity are recorded at amortized cost in the Company's consolidated
balance sheets, which approximates fair value. Securities classified as
15
"trading securities" are recorded at fair value. Gains and losses on
trading securities, realized and unrealized, are included in earnings and
are calculated using the specific identification method. The Company holds
no securities classified as "available for sale." 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. Marketable securities as of June 30, 2003 were all
classified as trading securities and consist of only short term
investments totaling $20.7 million.
- - The Company is currently involved in certain legal proceedings as
discussed in the "Commitments and Contingencies" in the Notes to
Consolidated Financial Statements. The Company does not believe these
legal proceedings will have a material adverse effect on its consolidated
financial position, results of operations or cash flows. However, were an
unfavorable ruling to occur in any quarterly period, there exists the
possibility of a material impact on the operating results of that period.
- - Research and development ("R&D") costs consist of direct and indirect
costs associated with specific projects as well as fees paid to various
entities that perform research on behalf of the Company. Expenses include
salaries and related employee costs, insurance coverage for clinical
trials and product sales, contracted research and consulting fees,
facility costs and direct costs associated with specific projects. The
Company expenses R&D costs in the period they are incurred.
Recent Accounting Pronouncements
In November 2002, FASB issued Interpretation, or FIN, No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, including Indirect
Guarantees of Indebtedness of Others." FIN 45 elaborates on the existing
disclosure requirements for most guarantees, including residual value guarantees
issued in conjunction with operating lease agreements. It also clarifies that at
the time a company issues a guarantee, the company must recognize an initial
liability for the fair value of the obligation it assumes under the guarantee
and must disclose that information in its interim and annual financial
statements. The initial recognition and measurement provisions apply on a
prospective basis to guarantees issued or modified after December 31, 2002. The
disclosure requirements are effective for the financial statements of interim or
annual periods ending after December 15, 2002. The Company's adoption of FIN 45
did not have a material impact on the Company's results of operations and
financial position.
In December 2002, FASB issued Statement of Financial Accounting Standards,
or SFAS, No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure." This statement amends SFAS 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this statement amends the disclosure requirements of
SFAS 123 to require prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based accounting for
employee compensation and the effect of the method used on reported results. The
Company is currently evaluating whether to adopt the fair value based method.
In January 2003, FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." FIN
16
No. 46 requires that unconsolidated variable interest entities be consolidated
by their primary beneficiaries. A primary beneficiary is the party that absorbs
a majority of the entity's expected losses or residual benefits. FIN No. 46
applies immediately to variable interest entities created after January 31, 2003
and to existing variable interest entities in the periods beginning after June
15, 2003. The Company's adoption of FIN No. 46 did not have a material impact on
the Company's results of operations and financial position.
In April 2003, FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities (SFAS 149). SFAS 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under
Statement 133. SFAS 149 is effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships designated after June 30,
2003, and should be applied prospectively. The provisions of SFAS 149 that
relate to Statement 133 Implementation Issues that have been effective for
fiscal quarters that began prior to June 15, 2003, should continue to be applied
in accordance with their respective effective dates. The Company's adoption of
SFAS 149 did not have a material effect on the Company's results of operations.
Results of Operations
Three Month and Six Month Periods Ended June 30, 2003 and 2002
Total revenues for the three month period ended June 30, 2003 decreased to
$393,000 as compared with $710,000 for the same period in the prior year and
were approximately $625,000 for the six-month period ended June 30, 2003 as
compared to $1.5 million for the same period in the prior year.
Licensing fees for the three-month period ended June 30, 2003 were zero as
compared to $528,000 for the same period in the prior year and were zero for the
six-month period ended June 30, 2003 as compared to $1.1 million for the same
period in the prior year. Due to the Company's January 1, 2000, adoption of U.S.
Securities and Exchange Commission Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements" ("SAB 101") which requires up-front,
non-refundable license fees to be deferred and recognized over the performance
period, the Company recognized $528,000 in licensing fees in the three-month
period ended June 30, 2002 and $1.1 million in the six-month period ended June
30, 2002, which it had received in prior periods from Schering-Plough
Corporation due to their prior exclusive license of the Company's VASOMAX(R)
product for the treatment of male erectile dysfunction. Due to the July 2002
mutual termination of the agreements with Schering-Plough, the Company does not
expect to receive any royalties relating to VASOMAX(R) in the foreseeable
future.
Research and development grants for the three-month period ended June 30,
2003 were $217,000 as compared to zero for the same period in the prior year
relating to the Company's SBIR grants and were $337,000 for the six-month period
ended June 30, 2003 as compared to zero for the same period in the prior year.
The Company was awarded three SBIR grants in the third quarter ended September
30, 2002 and performed a portion of that paid research during the six-month
period ended June 30, 2003. Interest income decreased 59% to $74,000 for the
three-month period ended June 30, 2003, as compared to $182,000 for the same
period in the prior year and
17
decreased 55% to $186,000 for the six-month period ended June 30, 2003 as
compared to $415,000 for the same period in the prior year. This decrease is due
to a reduction in interest rate yields and lower cash balances, offset by
interest income on a prior $1.0 million loan receivable from Lavipharm
Corp. which was repaid in April 2003. The Company sold substantially all of its
fixed assets, which management felt were not required to redeploy the Company's
overall assets, for approximate net proceeds of $225,000, which was $102,000
over their book value. These proceeds were collected in July 2003.
Research and Development Expenses. Research and development ("R&D")
expenses include contracted research, regulatory affairs activities and general
research and development expenses. R&D expenses decreased 90% to $579,000 for
the three-month period ended June 30, 2003 as compared to $5.9 million for the
same period in the prior year and decreased 82% to $1.1 million for the
six-month period ended June 30, 2003 as compared to $6.5 million for the same
period in the prior year. Due to the mutual termination of the Schering-Plough
agreements in July 2002 and the future uncertainty surrounding the VASOMAX(R)
product, 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.
General and Administrative Expenses. General and administrative ("G&A")
expenses increased 13% to $490,000 for the three-month period ended June 30,
2003, as compared to $433,000 for the same period in the prior year and
increased 26% to $1.1 million as compared to $876,000 for the same period in the
prior year. The increase in expenses is primarily due to the increase in costs
associated with potential strategic alternative opportunities which were $99,000
for the three-month period ended June 30, 2003 as compared to $13,000 for the
same period in the prior year and were $277,000 for the six-month period ended
June 30, 2003 as compared to $15,000 for the same period in the prior year.
Liquidity and Capital Resources
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 general and administrative expenses. The Company had cash, cash
equivalents and marketable securities of approximately $24.2 million at June 30,
2003, as compared to $25.1 million at December 31, 2002.
Excluding maturities and purchases of marketable securities of ($10.3)
million and $2.2 million in the three-month period ended June 30, 2003 and 2002,
respectively, net cash of approximately $1.2 million was used in operating
activities during the three-month period ended June 30, 2003 as compared to
$730,000 for the same period in the prior year. The increased use of cash for
the three-month period ended June 30, 2003 as compared to the same period in the
prior year included a reduction in accrued liabilities of $157,000, a decrease
in interest yield on its investment portfolio of $108,000, an increase in costs
associated with potential strategic alternative opportunities of $86,000 and an
increase in prepaid insurance of $60,000. The majority of the Company's
insurance policy premiums came due during the second quarter ended June 30,
2003. During the three-month period ended June 30, 2003, the Company paid
approximately $510,000
18
in prepaid insurance premiums as compared to $450,000 for the same period in the
prior year. On April 9, 2003 Lavipharm Corp. ("Lavipharm") repaid $1,037,151 to
the Company representing all principal and accrued interest relating to a note
receivable from Lavipharm that was advanced to Lavipharm on November 8, 2002.
Excluding maturities and purchases of marketable securities of ($4.2)
million and $2.9 million in the six-month period ended June 30, 2003 and 2002,
respectively, net cash of approximately $1.9 million was used in operating
activities during the six-month period ended June 30, 2003 as compared to $1.7
million for the same period in the prior year. The increased use of cash for
the six-month period ended June 30, 2003 as compared to the same period in the
prior year included an increase in costs associated with potential strategic
alternative opportunities of $262,000, a decrease in interest yield on its
investment portfolio of $229,000, a reduction in accrued liabilities of
$142,000 and an increase in prepaid insurance of $60,000, partially offset by
an increase in SBIR grant revenue of $337,000 and a gain on the sale of fixed
assets of $102,000.
The Company has experienced negative cash flows from operations since
inception and has funded its activities to date primarily from equity financings
and corporate collaborations. The Company believes that its existing capital
resources under its current operating plan will be sufficient to fund the
Company's operations through at least the end of 2005. There can be no assurance
that changes in our current strategic plans or other events will not result in
accelerated or unexpected expenditures.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not Applicable.
Item 4. Controls and Procedures
Based on their evaluation as of the end of the period covered by this
Quarterly Report on Form 10-Q, the Company's Chief Executive Officer and Chief
Financial Officer have concluded that the Company's disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934, as amended) are effective in insuring that the information required to be
disclosed by the Company in the reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported within the required
time periods.
In connection with the evaluation described above, the Company identified
no change in internal control over financial reporting that occurred during the
fiscal quarter ended June 30, 2003 that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
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 in 1998. 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). After remand, the case was certified as a class action
by the Court. Following the close of discovery, the Court granted the
defendants' motion for summary judgment as to that last remaining claim, and
entered a judgment dismissing the case with prejudice. The plaintiffs have filed
an appeal challenging both the Court's refusal to allow them to amend their
complaint and the Court's summary judgement order. The Company's management 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 loss, if any, can be made at this time.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
31.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 (Chief Executive Officer).
31.2 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 (Chief Financial Officer).
32.1 Certification furnished pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (Chief Executive Officer).
32.2 Certification furnished pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (Chief Financial Officer).
20
b. Reports on Form 8-K
The Company filed two current reports on Form 8-K on April 2
and May 12, 2003 reporting events under Item 9 and one current report on Form
8-K on April 3, 2003 reporting an event under Item 5.
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, 2003
By: /s/ Joseph S. Podolski
--------------------------------------------
Joseph S. Podolski
President and
Chief Executive Officer
(Principal Executive Officer)
Date: August 14, 2003
By: /s/ Louis Ploth, Jr.
--------------------------------------------
Louis Ploth, Jr.
Vice President Business Development and
Chief Financial Officer
(Principal Financial and Accounting Officer)
22
Exhibits
31.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Chief
Executive Officer).
31.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Chief
Financial Officer).
32.1 Certification furnished pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(Chief Executive Officer).
32.2 Certification furnished pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(Chief Financial Officer).