<PAGE>
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FIRST AMENDMENT TO FORM 10-K ON
FORM 10-K/A
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 0-21198
ZONAGEN, INC.
(NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 76-0233274
(STATE OR OTHER JURISDICTION (IRS EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
ZONAGEN, INC.
2408 TIMBERLOCH PLACE, SUITE B-4
THE WOODLANDS, TEXAS 77380
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(281) 367-5892
(ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE EXCHANGE ACT:
<TABLE>
<CAPTION>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED:
------------------- ------------------------------------------
<S> <C>
Common Stock, par value $.001 per share Pacific Stock Exchange
Nasdaq Small Cap Market
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE EXCHANGE ACT: None
Indicate by check mark 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 preceding 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant was approximately $108,263,000 as of March 11, 1997, based on the
closing sales price of the registrant's common stock on the Nasdaq National
Market on such date of $16.94 per share and assuming full conversion of the
registrant's Series B Convertible Preferred Stock. For purposes of the
preceding sentence only, all directors, executive officers and beneficial owners
of ten percent or more of the common stock are assumed to be affiliates. As of
March 11, 1997, 7,243,405 shares of common stock were outstanding and 995,738
shares of Series B Convertible Preferred Stock were outstanding.
Certain sections of the registrant's definitive proxy statement relating to
the registrant's 1997 annual meeting of stockholders, which proxy statement will
be filed under the Securities Exchange Act of 1934 within 120 days of the end of
the registrant's fiscal year ended December 31, 1996, are incorporated by
reference into Part III of this Form 10-K.
================================================================================
<PAGE>
TABLE OF CONTENTS
FORM 10-K
Page
----
PART I
Item
- ------
1. Description of Business 3
2. Properties 19
3. Legal Proceedings 19
4. Submission of Matters To a Vote of Security Holders 19
PART II
5. Market for Common Equity and Related Stockholder Matters 20
6. Selected Financial Data 21
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 22
8. Financial Statements 25
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 25
PART III
10. Directors and Executive Officers of the Registrant 26
11. Executive Compensation 26
12. Security Ownership of Certain Beneficial Owners and
Management 26
13. Certain Relationships and Related Transactions 26
PART IV
14. Exhibits and Reports on Form 8-K 27
Signatures 30
2
<PAGE>
When used in this document, the words "anticipate," "believe," "expect,"
"estimate," "project" and similar expressions are intended to identify forward-
looking statements. Such statements are subject to certain risks, uncertainties
and assumptions. Should one or more of these risks or uncertainties
materialize, or should underlying assumptions prove incorrect, actual results
may vary materially from those anticipated, believed, expected, estimated or
projected. For additional discussion of such risks, uncertainties and
assumptions, see "Item 1. Business -- Patents and Proprietary Information","--
Manufacturing Plans," "-- Competition," "-- Governmental Regulation" and "--
Additional Business Risks" and "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" included elsewhere in this
report.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Zonagen, Inc. ("Zonagen" or the "Company") is engaged in the research and
development of technologies targeting conditions or diseases associated with the
human reproductive system. The Company's lead product candidate, Vasomax(TM), is
in Phase III clinical trials in the United States evaluating its effectiveness
as an "on demand" oral treatment for male impotency. The Company is also active
in the research and development of adjuvants, new approaches to contraception
and the alleviation of urological diseases such as benign prostatic hyperplasia
("BPH") and prostate cancer. The Company currently markets and distributes a
variety of non-proprietary fertility-related products to obstetrics/gynecology,
urology and fertility specialists through its wholly-owned subsidiary, Fertility
Technologies, Inc. ("FTI").
The Company's goal is to become a leader in the area of human reproductive
healthcare management by providing a full array of innovative products and
services. The Company's growth strategy is to develop products based on its own
research as well as in-licensing existing and late stage development products
and technologies focused in the area of human reproductive healthcare.
The Company's corporate headquarters is located at 2408 Timberloch Place,
Suite B-4, The Woodlands, Texas 77380, and its telephone number is (281) 367-
5892.
PRODUCT DEVELOPMENT
TREATMENT FOR MALE IMPOTENCY
In April 1994, the Company acquired the rights to a patent application for
the use of phentolamine mesylate ("Phentolamine") as an "on demand" oral
treatment for male impotency. The Company believes that its anticipated
impotency product, Vasomax(TM), if successfully developed, could become the
first line therapy for male impotence and could increase the number of men who
will seek and receive medical treatment for male impotence. Vasomax's(TM) oral
method of administration offers considerable advantages over existing
treatments, most of which involve surgery or inconvenient modes of
administration. The Company's preliminary research indicates that Vasomax(TM)
may restore normal penile function within approximately 15 to 30 minutes of each
administration. In addition, Vasomax(TM) is expected to result in an erectile
response only in the presence of appropriate stimuli. Because of its ease of
administration, speed of efficacy and normal stimuli-induced penile response,
the Company believes that Vasomax(TM) has the potential to restore normal
function to achieve the greatest end-use benefit for both partners.
Vasomax(TM) uses Phentolamine as the active pharmacologic agent.
Phentolamine has been approved by the United States Food and Drug Administration
("FDA") for the treatment of hypertension and as a diagnosis of certain tumors
of the adrenal gland and has been used by urologists, both in combination with
other drugs and alone, as a penile injection therapy for the treatment of
impotent men.
3
<PAGE>
Vasomax(TM) produces an alpha-adrenergic block of relatively short duration
and vasodilative effects on vascular smooth muscles. The Company believes
Vasomax's(TM) mode of action will accordingly provide greatest benefit to men
who suffer from impotency due to vasculogenic reasons. These patients represent
a significant percentage of impotent men. The Company anticipates that, when
administered orally in an appropriate formulation, Vasomax(TM) may be capable of
restoring normal sexual performance in a significant number of impotent men.
The Company is currently conducting Phase III clinical trials of
Vasomax(TM) in the United States which it expects to complete in the second
quarter of 1997.
The Company completed a product registration study in Mexico in the fourth
quarter of 1996, in which Vasomax(TM) yielded a statistically significant result
(i.e., p less than .05) studying several parameters. Data from the Mexican study
indicated that 62% of the men participating in the study successfully achieved
orgasm during intercourse on at least one occasion while 42% achieved orgasm on
every attempt after taking Vasomax(TM).
The study included 148 men at seven centers in Mexico. The men were
selected by urologists based on a sexual questionnaire with the intent of
eliminating men who were impotent due to psychogenic causes. Twenty-three
percent of the men were diabetic. Another 10 percent of the men had either
undergone prostate surgery or were receiving prostate therapy. The remaining
patients were deemed to be impotent due to primarily organic causes, although no
single cause was identified. The average age of the men was 55 years with 70
percent of the men in the study over the age of 50. The oldest successfully
treated man in the study was 74 years old.
During the study, patients were monitored for side effects. No hypotension
or tachycardia was noted during the in-office test dose. One patient dropped
out of the study during the in-office period due to a stomach ache. One other
patient dropped out during the at-home portion of the study due to a variety of
mild side effects including insomnia, although is noteworthy that this patient
exhibited no side effects during the in-office test.
The Company completed a Phase II clinical trial of Vasomax(TM) in Germany
in March 1996, which was conducted on the Company's behalf by Pharmaco LSR
("Pharmaco"). In the trial, conducted at 10 centers in Germany, a total of 177
patients who suffered from impotency three years or less and who were diagnosed
as being impotent due primarily to vascular conditions were randomized into one
of four parallel groups (placebo, 20 milligram, 40 milligram and 60 milligram
doses). During the trial, patients attempted to achieve vaginal penetration on
three separate occasions.
The Company's analysis of the data from the German trial indicates that a
40 milligram dose provides the best balance between efficacy and safety among
the doses tested. The data from the centers enrolling at least 24 patients
indicates that the 40 milligram dose provides approximately a 50 percent
improvement in efficacy over placebo with minor side-effects, with 41 percent of
the men using the 40 milligram dose reporting successful intercourse on at least
one occasion versus 27 percent of the placebo group. Furthermore, patients for
whom the 40 milligram dose was successful indicated a higher level of
satisfaction compared to those men who achieved success on placebo. No
significant side effects were noted in the 40 milligram group (no priapism, no
prolonged erections, no hypotension, and no tachychardia). The 60 milligram
dose provided no additional benefit. However, four patients of the 41 randomized
into the 60 milligram dose group showed mild to moderate side effects
predictable by the pharmacologic action of the active ingredient in Vasomax (TM)
(Phentolamine). Although the 20 milligram dose group had no side effects, its
overall efficacy compared to placebo was marginal.
The Company is seeking a corporate partner for the marketing and sale of
Vasomax(TM).
FERTILITY RELATED PRODUCTS
Through FTI, the Company is currently distributing a variety of non-
proprietary fertility related products, including reproduction associated
diagnostic kits, fertility analysis instrumentation and disposable products and
media for laboratory use. These products are routinely used in the diagnostic
evaluation of infertile couples and for fertility procedures such as artificial
insemination and other assisted reproductive therapeutic techniques. FTI
provides the
4
<PAGE>
Company with a sales force directed at the obstetrics/gynecology, urology and
fertility specialist market segments and provides a pathway for the Company to
market its proposed in-house products.
RESEARCH PROGRAMS
CONTRACEPTIVES
The Company is developing contraceptive products for women based on
proprietary technology relating to the zona pellucida. The zona pellucida
surrounds the mammalian egg and is analogous to an eggshell. It is comprised
primarily of unique proteins which the Company believes could cause temporary
infertility or sterility in female mammals when used as a vaccine.
The Company believes that its proposed human contraceptive products could
be attractive to women because such contraceptives will likely require only a
periodic administration, will not require the surgical implant of any device
inside the female body, and will operate by creating an immune response rather
than through the hormonal treatments used in currently available long-lasting
female contraceptives. Moreover, ease of administration, long-term efficacy and
potential low cost also could make the Company's proposed human contraceptive
products attractive for use in population control in developing countries in
which few long-lasting female contraceptives are widely available. The Company
does not anticipate it will be able to market a zona pellucida-based human
contraceptive in the United States for at least ten years.
Because of the high costs associated with developing a human contraceptive
product, in December 1993 the Company entered into a License, Research,
Development, and Regulatory Filing Agreement (the "Schering Agreement") with
Schering AG, pursuant to which the Company and Schering agreed to jointly
research, develop and test zona pellucida-based human contraceptive vaccines.
The Schering Agreement applies only to products related to zona pellucida-based
human contraceptives.
The Company must bear all costs of the development of products under the
Schering Agreement until the Company has developed a "lead compound" that meets
certain specified standards for use in clinical trials of the contraceptive
vaccine being developed. Schering must bear all costs of the development of the
vaccine after formulation of the lead compound, including all costs of pre-
clinical and clinical trials, and costs associated with obtaining regulatory
approvals for sale of the vaccine in the licensed territory. The Schering
Agreement provides that upon the completion of certain research and development
milestones, Schering will make payments to the Company aggregating up to $12.5
million. The first milestone payment of $500,000 is for the development of a
"preliminary lead compound" for a zona pellucida-based human female
contraceptive.
ADJUVANTS
Through continued research and the need for an adjuvant that could be used
in conjunction with the Company's proposed immunocontraceptive vaccine, the
Company believes that it has discovered a new adjuvant, which has been named
"ImmuMAX(TM)," for the delivery of vaccines for both humans and animals. An
adjuvant is any substance used in conjunction with an antigen to enhance an
immune response. Antigens are substances that the body regards as foreign or
potentially dangerous, and against which it produces antibodies. The new
adjuvant has produced elevated immune responses compared to other known
stimulants.
The Company is testing a variety of currently available commercially
important vaccines against ImmuMAX(TM), and in many cases has achieved promising
results. Management believes that the primary advantages of ImmuMAX(TM) are the
rapid onset of immunity and its natural origin, which limits side effects. The
low cost per dose of the adjuvant may result in its acceptance in both human as
well as animal vaccine applications. The Company intends to out-license this
technology on a product-by-product basis to companies that are focused in the
vaccine industry.
5
<PAGE>
OTHER TECHNOLOGIES
The Company has conducted research through collaborations and its internal
capabilities in other areas of human reproductive healthcare, including
prophylactic approaches for the prevention of sexually transmitted diseases as
well as the detection and treatment of endometriosis and therapies to treat
prostate cancer and BPH.
MARKETS
TREATMENT FOR MALE IMPOTENCY
The National Institutes of Health (the "NIH") estimates that between 10 to
15 million men in the United States suffer from some degree of impotency, or
"erectile dysfunction." The Company believes that the total number of men
affected worldwide is several times that number. The wide range of impotency
reported in the U.S. is primarily attributable to the lack of diagnosis of this
condition in many men. Impotency can affect men as young as 40 years of age and
can be caused by both physiological and psychological factors. The Company
believes that, if successful, its oral treatment will provide advantages over
the therapies that are currently available for the treatment of impotency. In
addition, based on this technology's non-invasive nature, the Company may have
the ability to expand the current market that is presently based on products
which include direct penile injection, intraurethral suppositories, penile
implants, vacuum constriction devices and various other methods.
CONTRACEPTIVES
Approximately $1.8 billion is spent annually in the United States and
Europe on birth control pills. This represents only 18% of women of child
bearing age. The Company believes that its proposed human contraceptive
products may be attractive to women because such contraceptives will likely
require only a periodic administration, will not require the surgical
implantation of any device inside the female body and will operate by creating
an immune response rather than through the hormonal treatments used in currently
available long-lasting female contraceptives. In addition, the Company
estimates that on a worldwide basis there are approximately five million women
annually who undergo voluntary sterilization. The current procedures for female
sterilization all involve surgical procedures, some of which require fully-
equipped operating rooms and trained physician specialists. The Company
believes many women considering sterilization would view the Company's proposed
long-term contraceptive as an attractive alternative to a surgical procedure due
to decreased trauma and risk, lower cost and potential reversal for those women
who might choose to have children in the future.
In developing countries in which extreme socio-economic pressures exist to
control population growth, current efforts at population control are less
effective than desired partly because of the difficulty in administering, on a
consistent basis, current contraceptive measures. The Company's proposed human
contraceptive vaccine would eliminate many of those administration problems.
Furthermore, because of the potential low cost of manufacture of recombinant
vaccines, a contraceptive vaccine could likely be delivered at an attractive
price.
FERTILITY RELATED PRODUCTS
Published industry research studies estimated the 1995 annual worldwide
market for human infertility products to be approximately $700 million.
Infertility in the United States is a physical condition affecting approximately
5 to 6 million couples of reproductive age, and the number of infertile couples
is increasing. This increase is primarily due to various extraneous factors
such as the environment, delaying families because of two career path family
members, infections and a myriad of other socio-economic causes. Worldwide, it
is estimated that up to 60 million people are experiencing problems associated
with infertility.
6
<PAGE>
RESEARCH AND DEVELOPMENT
GENERAL
The Company's research and development expenses for the years ended
December 1996, 1995 and 1994 were $7.9 million, $2.8 million and $2.7 million,
respectively. The Company acquired the technology utilized in its development of
an oral treatment for male impotency in April 1994. Research and development
expenses relating to the Company's impotency technology, including clinical
trial and manufacturing scale-up expenses, were approximately $5,963,000,
$710,000 and $322,000 for 1996, 1995 and 1994, respectively.
COLLABORATION WITH CORPORATE PARTNERS
In December 1993, the Company entered into the Schering Agreement, pursuant
to which the Company and Schering agreed to jointly research, develop and test
zona pellucida-based human contraceptive vaccines. The Company retained
manufacturing rights to produce products developed under the Schering Agreement.
The Company granted to Schering an exclusive license in all countries of the
world except India and China to sell and distribute zona pellucida-based human
contraceptive vaccines developed under the Schering Agreement. The Company
retained certain co-promotion and sales rights in the United States. Schering
will pay the Company 30% of net sales of all products sold by Schering, and the
Company is obligated to pay Schering 30% of the net sales attributable to
products sold by the Company. The license granted under the Schering Agreement
terminates on a country-by-country basis on the later of (i) ten years after the
first commercial sale of each product covered in each such country or (ii) the
expiration of the last patent relating to such product in each such country. The
Schering Agreement is terminable by Schering on 30 days written notice before
the commencement of Phase I clinical trials relating to any covered product, and
by either party on the occurrence of a breach that is not cured within 60 days
after notice thereof has been given to the other party. If Schering terminates
the Schering Agreement without the occurrence of a breach and after commencement
of Phase I clinical trials, Schering must transfer to the Company ownership of
any investigational drug application, orphan drug designation and other
regulatory rights relating to any jointly-developed products.
COLLABORATIONS WITH UNIVERSITIES
In November 1995, the Company entered into a research agreement and a
license agreement with The Brigham and Women's Hospital, Inc. ("BWH"), a not-
for-profit corporation in Boston, Massachusetts. The Company agreed to fund
research in the field of clinical embryotoxic factor assays for use in testing
women that are candidates of unexplained fetal loss during pregnancy and
received the right to obtain an exclusive worldwide license to market BWH's
technology and inventions, as defined, pertaining to this field. During 1996
the Company opted to pursue the rights to this technology only in the United
States, Canada and Mexico. The Company has agreed to pay BWH a royalty ranging
from 3.3% to 15% of net sales of products licensed under the agreement. The
research agreement expires in November 1997. The license agreement can be
terminated by BWH after any calendar year in which license fees or royalties are
less than $5,000.
In January 1996, the Company entered into a sponsored research agreement
with the University of Texas Southwestern Medical Center at Dallas
("Southwestern"), a component institution of the University of Texas System.
The Company agreed to fund research in the field of markers for the presence of
pelvic endometriosis. The agreement grants the Company an exclusive option to
negotiate an exclusive, worldwide, royalty-bearing license for any invention or
discovery resulting from this research. If the Company chooses to exercise the
option, the Company will be obligated to pay all patent expenses relating to the
licensed technology. The sponsored research agreement expires in April 1997.
7
<PAGE>
PATENTS AND PROPRIETARY INFORMATION
The Company's ability to compete effectively with other companies is
materially dependent on the proprietary nature of the Company's patents and
technologies. The Company actively seeks patent protection for its proprietary
technology, in the United States and abroad.
The Company has one issued patent and one pending United States patent
application with respect to its male impotency technology (Vasomax(TM)). As
with all patent applications, there is no guarantee that a patent directed to a
specific aspect of the Vasomax(TM) technology will ultimately issue.
The Company has rights to one issued patent in the United States, India,
and Australia with respect to products and methods using specific recombinant
rabbit zona pellucida peptides. The patent is based on technology acquired from
Baylor College of Medicine ("BCM") which relates to the identification and
production of recombinant zona pellucida proteins and their use in
immunocontraception (the "BCM Patent"). The BCM Patent was permitted to issue
claiming products and methods using specific recombinant rabbit zona pellucida
peptides. In addition, the Company has received notification of allowance from
the U.S. Patent and Trademark Office with respect to broader claims covering two
classes of zona proteins. Additional patent applications relating to the BCM
patent are pending in Canada, the European Patent Office, Japan and Korea. The
Company has a total of ten U.S. patent applications pending (including the
continuation of the BCM Patent) which relate to zona proteins, their
preparation, and their use that the Company believes will be useful in
developing a human zona pellucida-based contraceptive vaccine.
The Company also has two pending U.S. patent applications, a European
regional patent application, and a Patent Cooperation Treaty application for an
adjuvant (ImmuMAX(TM)) for use with vaccines, as well as a novel drug delivery
system.
The Company's ability to commercialize any products will depend, in part,
upon its or its licensors' ability to obtain patents, enforce those patents,
preserve trade secrets, and operate without infringing upon the proprietary
rights of third parties. The patent positions of biotechnology and
pharmaceutical companies are highly uncertain and involve complex legal and
factual questions. The Company's issued patent and patent application relating
to Vasomax(TM) are method-of-use patents that cover the use of certain compounds
to treat specified conditions rather than composition-of-matter patents. There
can be no assurance that the patent applications owned by or licensed to the
Company will result in issued patents, that patent protection will be secured
for any particular technology, that any patents that have been or may be issued
to the Company or its licensors will be valid or enforceable, that any patents
will provide meaningful protection to the Company, that others will not be able
to design around the patents, or that the Company's patents will provide a
competitive advantage or have commercial application.
There can be no assurance that patents owned by or licensed to the Company
will not be challenged by others. The Company could incur substantial costs in
proceedings before the United States Patent Office and other regulatory
authorities, including interference proceedings. These proceedings could result
in adverse decisions about the patentability of the Company's inventions and
products as well as about the enforceability, validity or scope of protection
afforded by the patents.
There can be no assurance that the manufacture, use or sale of the
Company's product candidates will not infringe patent rights of others. The
Company may be unable to avoid infringement of those patents and may have to
seek a license, defend an infringement action, or challenge the validity of the
patents in court. There can be no assurance that a license will be available to
the Company, if at all, upon terms and conditions acceptable to the Company or
that the Company will prevail in any patent litigation. Patent litigation is
costly and time consuming, and there can be no assurance that the Company will
have sufficient resources to bring such litigation to a successful conclusion.
If the Company does not obtain a license under such patents, is found liable for
infringement, or is not able to have such patents declared invalid, the Company
may be liable for significant money damages, may encounter significant delays in
bringing products to market, or may be precluded from participating in the
manufacture, use or sale of products or methods of treatment requiring such
licenses. The Company does not believe that the commercialization of its
products
8
<PAGE>
will infringe upon the patent rights of others. However, there can be no
assurance that the Company has identified all United States and foreign patents
that pose a risk of infringement.
The Company also relies upon trade secrets and other unpatented proprietary
information in its product development activities. To the extent the Company
relies on trade secrets and unpatented know-how to maintain its competitive
technological position, there can be no assurance that others may not
independently develop the same or similar technologies. The Company seeks to
protect trade secrets and proprietary knowledge, in part through confidentiality
agreements with its employees, consultants, advisors and collaborators.
Nevertheless, these agreements may not effectively prevent disclosure of the
Company's confidential information and may not provide the Company with an
adequate remedy in the event of unauthorized disclosure of such information.
If the Company's employees, scientific consultants or collaborators develop
inventions or processes independently that may be applicable to the Company's
products, disputes may arise about ownership of proprietary rights to those
inventions and processes. Such inventions and processes will not necessarily
become the Company's property, but may remain the property of those persons or
their employers. Protracted and costly litigation could be necessary to enforce
and determine the scope of the Company's proprietary rights. Failure to obtain
or maintain patent and trade secret protection, for any reason, would have a
material adverse effect on the Company.
Several bills affecting patent rights have been introduced in the United
States Congress. These bills address various aspects of patent law, including
publication, patent term, re-examination, subject matter and enforceability. It
is not certain whether any of these bills will be enacted into law or what form
new laws may take. Accordingly, the effect of legislative change on the
Company's intellectual property estate is uncertain.
MANUFACTURING PLANS
The Company does not have any manufacturing facilities and relies on third
party manufacturers to produce certain of its products, including Phentolamine.
On November 16, 1995, the Company entered into a development and manufacturing
services agreement with a contract manufacturing organization for the
manufacture and validation of bulk Phentolamine for use in clinical trials and
for the purpose of supporting an IND application for the oral treatment of male
impotency. The contract manufacturing organization has filed a Drug Master File
("DMF") with the U.S. Food and Drug Administration ("FDA") in connection with
the manufacturing of Phentolamine. The agreement also provides for a possible
future long term supply agreement regarding bulk Phentolamine. The Company also
contracts out the tableting and packaging of Vasomax(TM).
The Company presently produces all of the zona proteins necessary for use
in its research and development activities. The Schering Agreement requires that
at the time an IND application relating to a human immunocontraceptive product
is effective, the Company will have a facility with the capacity to manufacture
the product for worldwide sale.
The Company does not expect to establish any significant manufacturing
capacity in the near future. The Company does not operate and does not
currently plan to operate manufacturing facilities for the production of its
products in commercial quantities, and it intends to contract with third parties
for the manufacture and supply of its products. There can be no assurance that
the Company will be able to obtain supplies of its products from third-party
suppliers on terms or in quantities acceptable to the Company. Also, the
Company's dependence on third parties for the manufacture of its products may
adversely affect the Company's product margins and its ability to develop and
deliver products on a timely basis. Any such third-party suppliers or any
manufacturing facility the Company establishes will be required to meet FDA
manufacturing requirements. FDA certification of manufacturing facilities for a
drug are a prerequisite to approval of an NDA for that drug. The Company may
encounter significant delays in obtaining supplies from third-party
manufacturers or experience interruptions in its supplies. If the Company is
unable to obtain adequate supplies, its business would be materially adversely
affected.
9
<PAGE>
COMPETITION
Currently, there are a number of FDA approved products and other products
under development for the treatment of male impotence. These products include:
NEEDLE INJECTION THERAPY. This form of treatment involves the needle
injection of pharmacologic agents directly into the penis. These agents
are generally combinations of vasoactive compounds such as alprostadil
(prostaglandin E), Phentolamine and papaverine. This form of treatment
requires a prescription from a physician and instruction on self-injection.
Side effects may include pain associated with injection and local pain and
aching. Complications may include hematomas, bleeding and nodule
formation. In July 1995, the FDA approved the use of alprostadil in
Pharmacia & Upjohn Inc.'s needle injection therapy product for erectile
disfunction.
VACUUM CONSTRICTION DEVICES. This form of treatment involves the use
of a mechanical system that creates a vacuum around the penis, causing the
erectile bodies to fill with blood. Complications encountered by some
users of vacuum constriction devices include pain and difficulty
ejaculating.
PENILE IMPLANTS. This therapy involves the surgical implantation of a
semi-rigid, rigid or inflatable device into the penile structure to
mechanically simulate an erection.
ORAL MEDICATIONS. Yohimbine is the primary oral medication currently
prescribed in the United States for the treatment of male impotence. While
easily administered, Yohimbine must be taken multiple times daily and may
cause irritability, sweating, nausea and possibly hypertension. The
Company believes that for patients with physiologic male impotence the
efficacy of Yohimbine is not significantly greater than placebo.
URETHRAL CATHETER. Vivus, Inc. launched a device in January 1997 for
the transurethral administration of prostaglandin E for the treatment of
male impotency. Prostaglandin E is one of a family of naturally occurring
acidic lipids with various pharmacologic effects. Vasodilation, inhibition
of platelet aggregation, and stimulation of intestinal and uterine smooth
muscle are among the most notable of these effects. The transurethral
device has been reported to successfully treat impotency with some side
effects. The side effects noted were penile pain and some degree of
urethral burning after administration and during use. An erection is
caused with or without sexual stimulation within 15 minutes of
administration and lasts 30 to 60 minutes depending on dose effects.
ORAL THERAPIES UNDER DEVELOPMENT. Other pharmaceutical companies,
including Pfizer, Inc. ("Pfizer"), TAP Pharmaceuticals, Inc. and Pentech
Pharmaceutical, Inc., are developing orally available therapies for the
treatment of impotency. Pfizer's Viagra oral medication for the treatment
of impotency is currently in Phase III clinical trials, and the Company
believes that Pfizer may file an NDA in the United States for Viagra by the
end of 1997.
Competition in the pharmaceutical and medical products industries is
intense and is characterized by extensive research efforts and rapid
technological progress. The manufacturers of existing treatments for erectile
dysfunction, such as needle injection therapy, vacuum constriction devices,
penile implants and oral medications, will continue to improve these therapies.
These companies, Pfizer and other potential competitors have substantially
greater research and development capabilities as well as substantially greater
marketing, financial and human resources than the Company. In addition, these
companies have significantly greater experience than the Company in undertaking
preclinical testing, human clinical trials and other regulatory approval
procedures. There are also small companies, academic institutions, governmental
agencies and other research organizations that are conducting research in the
area of erectile dysfunction. These entities may also market commercial
products either on their own or through collaborative efforts. The Company's
competitors may develop technologies and products that are available for sale
prior to the Company's products or that are more effective than those being
developed by the Company. Such
10
<PAGE>
developments would render the Company's products less competitive or possibly
obsolete. If the Company is permitted to commence commercial sales of products,
it will also be competing with respect to marketing capabilities and
manufacturing efficiency, areas in which it has limited experience.
GOVERNMENTAL REGULATION
Zonagen's research and development activities, preclinical studies and
clinical trials, and ultimately the manufacturing, marketing and labeling of its
products, are subject to extensive regulation by the FDA and other regulatory
authorities in the United States and other countries. The United States Federal
Food, Drug and Cosmetic Act and the regulations promulgated thereunder and other
federal and state statutes and regulations govern, among other things, the
testing, manufacture, safety, efficacy, labeling, storage, record keeping,
approval, advertising and promotion of the Company's products. Preclinical
study and clinical trial requirements and the regulatory approval process take
years and require the expenditure of substantial resources. Additional
government regulation may be established that could prevent or delay regulatory
approval of the Company's products. Delays or rejections in obtaining
regulatory approvals would adversely affect the Company's ability to
commercialize any product the Company develops and the Company's ability to
receive product revenues or royalties. If regulatory approval of a product is
granted, the approval may include significant limitations on the indicated uses
for which the product may be marketed.
The standard process required by the FDA before a pharmaceutical agent may
be marketed in the United States includes: (i) preclinical tests; (ii)
submission to the FDA of an investigational new drug application ("IND") which
must become effective before human clinical trials may commence; (iii) adequate
and well-controlled human clinical trials to establish the safety and efficacy
of the drug in its intended application; (iv) submission of an New Drug
Application ("NDA") to the FDA; and (v) FDA approval of the NDA prior to any
commercial sale or shipment of the drug. In addition to obtaining FDA approval
for each product, each domestic drug manufacturing establishment must be
registered or licensed by the FDA. Domestic manufacturing establishments are
subject to inspections by the FDA and by other federal, state and local agencies
and must comply with established manufacturing practices which are appropriate
for production.
Preclinical tests include laboratory evaluation of product chemistry,
formulation and stability, as well as animal studies to assess the potential
safety and efficacy of each product. Preclinical safety tests must be conducted
by laboratories that comply with FDA regulations regarding Good Laboratory
Practices. The results of the preclinical tests are submitted to the FDA as
part of an IND and are reviewed by the FDA before the commencement of human
clinical trials. Unless the FDA objects to an IND, the IND will become
effective 30 days following its receipt by the FDA. There can be no assurance
that submission of an IND will result in the FDA authorization to commence
clinical trials or that the lack of an objection means that the FDA will
ultimately approve an NDA.
Clinical trials involve the administration of the investigational new drug
to humans under the supervision of a qualified principal investigator. Clinical
trials must be conducted in accordance with good clinical practices under
protocols that detail the objectives of the study, the parameters to be used to
monitor safety, and efficacy criteria to be evaluated. Each protocol must be
submitted to the FDA as part of the IND. Also, each clinical trial must be
approved and conducted under the auspices of an Institutional Review Board
("IRB"). The IRB will consider, among other things, ethical factors, the safety
of human subjects, and the possible liability of the institution conducting the
clinical trials.
Clinical trials are typically conducted in three sequential phases which
may overlap. In Phase I, the initial introduction of the drug to humans, the
drug is tested for safety (adverse effects), dosage tolerance, metabolism,
distribution, excretion and pharmacodynamics (clinical pharmacology). Phase II
involves studies of a limited patient population to gather evidence about the
efficacy of the drug for specific targeted indications, dosage tolerance and
optimal dosage, and to identify possible adverse effects and safety risks. When
a product has shown evidence of efficacy and has an acceptable safety profile in
a Phase II evaluation, Phase III clinical trials are undertaken to evaluate
clinical efficacy and to test for safety in an expanded patient population at
geographically dispersed clinical trial sites. There can be no assurance that
any of the Company's clinical trials will be completed successfully or within
any specified time period. The Company or the FDA may suspend clinical trials
at any time.
11
<PAGE>
The Company has designed the protocols for its pivotal Phase III clinical
trials of Vasomax(TM) based on its analysis of its research, including various
parts of its German Phase II clinical trial and its Mexican product registration
trial. Although copies of its Phase III clinical trial protocol have been
submitted to the FDA, there can be no assurance that the FDA, after the results
of the Phase III clinical trials have been announced, will not disagree with the
design of the Phase III clinical trial protocol. In addition, the FDA inspects
and reviews clinical trial sites, informed consent forms, data from the clinical
trial sites, including case report forms and record keeping procedures, and the
performance of the protocols by clinical trial personnel to determine compliance
with Good Clinical Practice. The FDA also looks to determine that there was no
bias in the conduct of clinical trials. The conduct of clinical trials in
general and the performance of the pivotal clinical trial protocols is complex
and difficult. There can be no assurance that the design or the performance of
the Phase III clinical trial protocols for Vasomax(TM) will be successful.
The results of preclinical studies and clinical trials, if successful, are
submitted in an NDA to seek FDA approval to market and commercialize the drug
product for a specified use. The testing and approval process will require
substantial time and effort, and there can be no assurance that any approval
will be granted for any product or that approval will be granted according to
any schedule. The FDA may deny an NDA if it believes that applicable regulatory
criteria are not satisfied. The FDA may also require additional testing for
safety and efficacy of the drug. Moreover, if regulatory approval of a drug
product is granted, the approval will be limited to specific indications. There
can be no assurance that any of the Company's product candidates will receive
regulatory approvals for commercialization.
Even if regulatory approvals for the Company's products are obtained, the
Company, its products, and the facilities manufacturing the Company's products
are subject to continual review and periodic inspection. The FDA will require
post-marketing reporting to monitor the safety of the Company's products. Each
United States drug manufacturing establishment must be registered with the FDA.
Domestic manufacturing establishments are subject to biennial inspections by the
FDA and must comply with the FDA's Good Manufacturing Practices. To supply drug
products for use in the United States, foreign manufacturing establishments must
comply with the FDA's Good Manufacturing Practices and are subject to periodic
inspection by the FDA or by regulatory authorities in those countries under
reciprocal agreements with the FDA. In complying with Good Manufacturing
Practices, manufacturers must expend funds, time and effort in the area of
production and quality control to ensure full technical compliance. The Company
does not have any drug manufacturing capability and must rely on outside firms
for this capability. See "-- Manufacturing Plans." The FDA stringently applies
regulatory standards for manufacturing. Identification of previously unknown
problems with respect to a product, manufacturer or facility may result in
restrictions on the product, manufacturer or facility, including warning
letters, suspensions of regulatory approvals, operating restrictions, delays in
obtaining new product approvals, withdrawal of the product from the market,
product recalls, fines, injunctions and criminal prosecution.
Before the Company's products can be marketed outside of the United States,
they are subject to regulatory approval similar to FDA requirements in the
United States, although the requirements governing the conduct of clinical
trials, product licensing, pricing, and reimbursement vary widely from country
to country. No action can be taken to market any drug product in a country
until an appropriate application has been approved by the regulatory authorities
in that country. FDA approval does not assure approval by other regulatory
authorities. The current approval process varies from country to country, and
the time spent in gaining approval varies from that required for FDA approval.
In some countries, the sale price of a drug product must also be approved. The
pricing review period often begins after market approval is granted. Even if a
foreign regulatory authority approves any of the Company's products, no
assurance can be given that it will approve satisfactory prices for the
products.
The Company's research and development involves the controlled use of
hazardous materials, chemicals, viruses, and various radioactive compounds.
Although the Company believes that its procedures for handling and disposing of
those materials comply with state and federal regulations, the risk of
accidental contamination or injury from these materials cannot be eliminated.
If such an accident occurs, the Company could be held liable for resulting
damages, which could be material to the Company's financial condition and
business. The Company is also subject to numerous environmental, health and
workplace safety laws and regulations, including those governing laboratory
procedures, exposure to blood-borne pathogens, and the handling of biohazardous
materials. Additional federal, state
12
<PAGE>
and local laws and regulations affecting the Company may be adopted in the
future. Any violation of, and the cost of compliance with, these laws and
regulations could materially and adversely affect the Company.
EMPLOYEES AND CONSULTANTS
EMPLOYEES
At January 31, 1997, the Company had 35 full-time employees and utilized a
variety of consultants. Of the Company's full-time employees, 19 were engaged
in research, development, clinical research and regulatory affairs, nine were
engaged in sales and sales support and seven were engaged in finance and
administration. The Company relies on its employees to perform most research
and development activities, but also uses outside consultants as needed.
SCIENTIFIC ADVISORS AND CONSULTANTS
The Company benefits from consultation with prominent scientists active in
fields related to the Company's technology. For this purpose, the Company has
consulting relationships with several scientific advisors. At the Company's
request, these advisors review the feasibility of product development programs
under consideration, advise concerning advances in areas related to the
Company's technology and aid in recruiting personnel. These advisors are
compensated at negotiated rates for services actually performed. In addition,
certain advisors have been granted options to purchase shares of the Company's
Common Stock. All of the advisors are employed by academic institutions or
other entities and may have commitments to or advisory agreements with other
entities that may limit their availability to the Company. In addition, the
Company has funded, and plans to continue to fund, research using consultants.
Consultants provide services to the Company under written agreements and are
paid per diem fees for services actually performed. The Company's consultants
are used on an as needed basis, which allows the Company to perform certain
research activities without incurring the costs associated with full-time
employees. The Company's consultants are required to disclose and assign to the
Company any ideas, discoveries and inventions they develop in the course of
providing consulting services. The Company also uses consultants for various
administrative needs. None of the Company's consultants are otherwise
affiliated with the Company. The Company's scientific advisors and consultants
include the following persons:
DEBORAH J. ANDERSON, PH.D. Dr. Anderson is an Associate Professor of
Obstetrics, Gynecology and Reproductive Biology at Brigham and Women's
Hospital and Harvard Medical School. Dr. Anderson is also the Director of
the Fearing Research Laboratory.
SERDAR E. BULUN, M.D. Dr. Bulun has been, for over 4 years, a faculty
member of Division of Reproductive Endocrinology, Department Obstetrics
and Gynecology at the University of Texas Southwestern Medical Center. He
has a joint appointment at the Cecil H. and Ida Green Center for
Reproductive Biology Sciences of the same Institution. Dr. Bulun is board-
certified in Obstetrics and Gynecology and in Reproductive Endocrinology.
He conducts basic and clinical research involving endometriosis and breast
cancer. Dr. Bulun is an internationally recognized expert in reproductive
endocrinology. He serves on committees of Society for Gynecologic
Investigation and has been an invited speaker to many international
conferences.
M. FATHY EL ETREBY, D.V.M., B.SC. Dr. Etreby was Director of
Research and Development at the Pharmaceutical Division of Schering AG in
Berlin/Germany and at Berlex Laboratories in Wayne, New Jersey for 25
years. Currently, Dr. Etreby is Director of Clinical and Basic Research at
the Section of Urology in the Department of Surgery, Medical College of
Georgia. He holds the title of Professor of Surgery, Medical College of
Georgia. He holds the title of Professor of Surgery and Professor of
Physiology and Endocrinology at the Medical College of Georgia, Dr. Etreby
was a Senior Scientific Advisor, Oncology & Endocrinology at Berlex
Laboratories in Wayne, New Jersey.
DAVID FERGUSON, M.D., PH.D. Dr. Ferguson has been involved in
pharmaceutical research and development since 1968. He has been a bench
pharmacologist, toxicologist, teacher, consultant, medical
13
<PAGE>
director of several Phase I clinical research units, medical director of a
research outpatient clinic, Associate Director of Cardiovascular Clinical
Research at Rhone-Poulenc Rorer, Vice President of Medical Research at
National Medical Research Corporation (now SciRx), Director of Clinical
Research at Schwarz Pharma, and a Principal Investigator on numerous
studies. In these roles, he accumulated significant experience as a
representative of PhRMA drug companies, CROs, and investigators. In 1993,
he helped found Affiliated Research Centers, one of the first site
management organizations, and served as Senior Vice President for ARC until
February 1997. He has authored more than 350 study reports submitted to the
FDA and had a key role in the filing of eleven successful New Drug
Applications and numerous INDs.
IRWIN GOLDSTEIN, M.D. Dr. Goldstein has been co-director of the
Urology Research Laboratory at Boston University School of Medicine since
1980.
JOSEPH A. HILL, M.D. Dr. Hill is the Director of the Reproductive
Medicine Division and of the Reproductive Endocrinology Fellowship Program
and Clinical Director of the Reproductive Immunology Division at Brigham
and Women's Hospital and Harvard Medical School. Dr. Hill is an Associate
Professor in the Department in of Obstetrics, Gynecology and Reproductive
Biology at Brigham and Women's Hospital and Harvard Medical School.
VERNON KNIGHT, M.D., D.SC. (HON.). Dr. Knight was, for over 20 years,
Professor and Chairman, Department of Microbiology and Immunology and
Professor, Infectious Disease Section, Department of Medicine, Baylor
College of Medicine, Director of the Center for Biotechnology (1989-1994).
Dr. Knight is currently Acting Chairman, Department of Molecular Physiology
and Biophysics. Before joining Baylor College of Medicine, Dr. Knight was
Clinical Director, National Institute of Allergy and Infectious Disease at
the National Institutes of Health, Bethesda, Maryland. Dr. Knight is
Chairman, Medical Advisory Committee, The Methodist Hospital Health Care
System.
ALFRED POINDEXTER, M.D. Dr. Poindexter is Professor of Obstetrics and
Gynecology and Director of the Division of Contraceptive Development and
Research at Baylor College of Medicine. He is on the staff at St. Luke's
Episcopal Hospital and The Methodist Hospital in Houston, Texas. Dr.
Poindexter has performed clinical practice in reproductive endocrinology
and research in contraceptive technology for the past twenty years. He
has over one hundred publications in medical journals of women's
reproductive health. He is an advisor to national boards of his medical
specialty and health care provider groups.
DAVID W. RUSSELL, PH.D. Dr. Russell is McDermott Distinguished
Professor, Department of Molecular Genetics, University of Texas
Southwestern Medical Center, in Dallas, Texas. Dr. Russell has a Ph.D. in
chemistry from the University of North Carolina at Chapel Hill. His main
research interests are cholesterol and steroid hormone metabolism,
reproductive biology, molecular genetics and gene regulation.
ANTHONY SACCO, PH.D. Dr. Sacco is Professor, Department of Obstetrics
at Wayne State University School of Medicine and Director, Hutzel Hospital-
-Wayne State University In Vitro Fertilization Laboratory. Dr. Sacco is an
authority on the application of zona pellucida antigens as infertility
agents. He has a B.A. in biology from the University of Rochester and a
Masters Degree and Ph.D. in zoology from the University of Tennessee.
ROBERT S. SCHENKEN, M.D. Dr. Schenken is Professor of Obstetrics and
Gynecology and Director of the Division of Reproductive Endocrinology and
Infertility at The University of Texas Health Science Center in San
Antonio. He serves as a staff member at Women's and Children's Hospital
and St. Luke's Baptist Hospital, both of which are located in San Antonio.
He has been a consultant for the Society of Reproductive Surgeons'
Collaborative Endometriosis Treatment Trial, and program chairman of the
Annual Meeting of the Society for Gynecologic Investigation and the
American Society for Reproductive Medicine. Dr. Schenken has received
numerous national awards for his research, including the National Institute
of Child Health and Human Development Clinical Investigator Award in
Reproductive Biology. Dr. Schenken has also served as principal
investigator on research projects funded by the National Institutes of
Health, World Health
14
<PAGE>
Organization and numerous pharmaceutical companies. Dr. Schenken edited the
publication "Endometriosis: Contemporary Concepts in Clinical Management"
and is the author of over 100 abstracts and publications in the area of
reproductive infertility and endometriosis. Dr. Schenken is recognized as
one of the world's leading authorities in the field of endometriosis
research. Dr. Schenken has a B.S. in Chemistry from Stanford University and
an M.D. from Baylor College of Medicine.
EDWARD C. YUREWICZ, PH.D. Dr. Yurewicz is Associate Professor,
Department of Obstetrics and Gynecology and Associate Member of the
Graduate Faculty, Department of Biochemistry and Molecular Biology, Wayne
State University School of Medicine. Dr. Yurewicz is a leading authority on
zona pellucida protein chemistry. He has a B.A. in biology from the
University of Delaware, a Ph.D. in physiological chemistry from Johns
Hopkin University School of Medicine and postdoctoral training in
biochemistry and biophysics at University of California, Davis.
ADDITIONAL BUSINESS RISKS
DEVELOPMENT STAGE; MODIFICATION OF REPORT OF INDEPENDENT PUBLIC
ACCOUNTANTS
The Company is a development stage company. Problems, delays, expenses and
difficulties are typically encountered by companies in the development stage,
many of which may be beyond the Company's control. These include, but are not
limited to, unanticipated problems and costs relating to the development,
testing, regulatory compliance, production, marketing and competition. There
can be no assurance that the Company will successfully complete the transition
from a development stage company to profitability. As reflected in Note 1 of
the Notes to the Company's consolidated financial statements as of December 31,
1996 and 1995, such ability to complete the transition is dependent upon, among
other things, the Company's ability to obtain additional working capital to
develop, manufacture and market its products and the success of future
operations. The Company's ability to continue as a going concern is affected by
its reliance on research institutions and corporate partners, the uncertainty of
healthcare reform and the competitive environment in which the Company operates.
The Company's independent accountants have included an emphasis of a matter
paragraph in their report on the Company's consolidated financial statements as
of December 31, 1996 and 1995 concerning the Company's need to obtain additional
financing in order to complete the research and development and other activities
necessary to commercialize its products.
LIMITED CASH RESOURCES; HISTORY OF OPERATING LOSSES; NO ASSURANCE OF
ADDITIONAL NECESSARY CAPITAL
The Company has incurred losses since its inception in 1987 and expects to
incur losses for the next several years. As of December 31, 1996, the Company
had accumulated losses of $26,410,385 and had cash reserves of $11,074,902. The
Company expects to require additional capital to fund its research and
development activities in the third quarter of 1997 if it maintains its
currently planned clinical program. The Company believes that it will receive
funds sufficient to maintain its currently planned clinical program and other
operations at least through the end of 1997 if the results of its Phase III
clinical trial, expected in the second quarter of 1997, are favorable. If
sufficient cash resources are not available, management intends to reduce
expenditures for its planned clinical program and other operations. If the
results of its Phase III clinical trial are unfavorable, the Company intends to
reduce its research and development expenditures and focus on its remaining
business, in which case the Company expects that its existing capital resources
will be sufficient to fund its operations through the end of 1997. It is
difficult to determine the development costs associated with the Phase III
clinical development of Vasomax(TM) and the costs associated with an NDA
submission upon the completion of such development, if successful. Accordingly,
there can be no assurance that additional capital will not be necessary prior to
the time anticipated. The Company's future capital requirements will depend on
many factors, including continued scientific clinical assessment of products
under development. Additional financing will be required to complete the
development, and to commence the manufacturing and marketing, of the Company's
proposed products. The unavailability of such financing could delay or prevent
the development and marketing of some or all of the Company's proposed products
or cause the Company to cease operations. There can be no assurance that the
Company will be successful in obtaining additional capital in amounts sufficient
to continue to fund its operations and product development.
15
<PAGE>
UNCERTAINTIES RELATED TO CLINICAL TRIAL RESULTS
The FDA and other regulatory authorities generally require that the safety
and efficacy of a drug be supported by results from adequate and well-controlled
Phase III clinical trials before approval for commercial sale. The Company has
no prior experience in conducting and managing Phase III clinical trials. If
the results of the Company's clinical trials do not demonstrate the safety and
efficacy of its products in the treatment of patients suffering from the
diseases for which such products are being tested, the Company will not be able
to submit an NDA to the FDA. Even if the Company believes the Phase III
clinical trials demonstrate the safety and efficacy of a product in the
treatment of disease, the FDA and other regulatory authorities may not accept
the Company's assessment of the results. In either case, the Company may have
to conduct additional clinical trials in an effort to demonstrate the safety and
efficacy of the product. Without acceptable results and regulatory approval,
the Company will not be able to commercialize its products, which would have a
material adverse effect on the Company. There can be no assurance that the
results of any of the Company's clinical trials will be favorable or that its
products will obtain regulatory approval for commercialization.
The results of preclinical studies and initial clinical trials of the
Company's products are not necessarily predictive of the results from large-
scale clinical trials. The Company must demonstrate through preclinical studies
and clinical trials that its products are safe and effective before the Company
can obtain regulatory approvals for the commercial sale of those products.
These studies and trials are very costly and time-consuming. The speed with
which the Company is able to enroll patients in clinical trials is an important
factor in determining how quickly clinical trials may be completed. Many facts
affect patient enrollment, including the size of the patient population, the
proximity of patients to clinical sites, and the eligibility criteria for the
study. Delays in patient enrollment in the trials may result in increased
costs, program delays, or both, which could have a material adverse effect on
the Company. Even if the Company establishes the safety and efficacy of its
products and obtains FDA and other regulatory approvals for its products,
physicians may not prescribe the approved product.
The administration of any product the Company develops may produce
undesirable side effects in humans. The occurrence of side effects could
interrupt or delay clinical trials of products and could result in the FDA's or
other regulatory authorities' denying approval of the Company's products for any
or all targeted indications. The Company, the FDA or other regulatory
authorities may suspend or terminate clinical trials at any time. Even if the
Company receives FDA and other regulatory approvals, the Company's products may
later exhibit adverse effects that limit or prevent their widespread use or that
necessitate their withdrawal from the market. There can be no assurance that
any of the Company's products will be safe for human use.
There can be no assurance that the Phase III clinical trial for Vasomax(TM)
will be completed within any specified time period, if at all, with respect to
any of the Company's current or future product candidates. There can be no
assurance that Vasomax(TM) will prove to be safe or effective at the current
dose to be tested, or that Vasomax(TM) will be approved by the FDA for any
indication.
EARLY STAGE OF PRODUCT DEVELOPMENT
The Company has not completed the development of any proprietary product,
and all of the Company's revenues currently are derived primarily from sales by
FTI of products developed or manufactured by others. The development or
acquisition of commercially viable products will require significant further
investment, research, development, pre-clinical and clinical testing and
regulatory approvals, both foreign and domestic. There can be no assurance that
the Company will be able to produce at reasonable cost, or market successfully,
any such product. Products, if any, resulting from the Company's research and
development programs are not expected to be commercially available for several
years. Moreover, although the Company has in the past and will continue to seek
opportunities for the licensing of existing product lines in the field of human
reproductive healthcare, there can be no assurance that the Company will be able
to successfully or profitably market its current or future products under
development.
16
<PAGE>
SUBSTANTIAL DEPENDENCE ON ONE PRODUCT
Substantially all of the Company's efforts and expenditures over the next
few years will be devoted to Vasomax(TM). Accordingly, the Company's future
prospects are substantially dependent on favorable results of the Phase III
clinical trials, approval by the FDA and the successful commercialization of
Vasomax(TM).
RISKS ASSOCIATED WITH COLLABORATIVE ARRANGEMENTS
The Company's product development and commercialization strategy, including
its commercialization strategy for Vasomax(TM), involves the Company entering
into various arrangements with corporate, government and academic collaborators,
licensors, licensees and others. As a consequence, the Company's success may
depend on the success of these other parties in performing their
responsibilities. There can be no assurance that the Company will be able to
establish collaborative arrangements or license agreements that are necessary or
desirable for the Company to develop and commercialize its products or that such
collaborative agreements or license agreements will be successful.
TECHNOLOGICAL CHANGE
The biomedical field is undergoing rapid and significant technological
change. The Company's success will depend on its ability to develop and apply
its technology and on its ability to establish and maintain a competitive
position in the marketplace with its products. The Company has many potential
competitors in the United States and other countries for its technology and
products including, among others, major pharmaceutical and chemical companies,
specialized biotechnology firms, universities and other research institutions.
Many of such competitors have substantially greater financial, technical,
manufacturing and marketing capabilities than the Company. The Company's
competitors may develop products or other technologies that are more effective
than any which have been or are being developed by the Company or may obtain FDA
approval or patent protection for products more rapidly than the Company. If
the Company commences commercial sales of certain products, it will compete in
the manufacturing and marketing of such products, areas in which the Company has
no significant experience.
PRODUCT LIABILITY EXPOSURE
Product liability risk will be a major consideration in the testing,
manufacturing, marketing and sale of the Company's proposed products. Several
products relating to female contraception and other products related to the
female reproductive system have been the subject of class action lawsuits based
on product liability claims. The Company's potential product liability exposure
is heightened because the Company is currently conducting human clinical trials
on its proposed male impotency treatment. Although the Company believes that
the risks of harm to any participants in those trials is small because the drug
being used for the treatment has been approved by the FDA for the treatment of
other conditions, and because the Company employs stringent screening procedures
to assure that the subjects of its human clinical trials are not likely to have
adverse reactions to the drug, there can be no assurance that a participant in
the Company's human clinical trials might not be harmed. Product liability
insurance for the pharmaceutical and diagnostic industries, when available, is
expensive. The Company currently carries $10,000,000 of product liability
insurance for its male impotency clinical development. No assurance can be
given that this insurance coverage is adequate and that a product liability
claim would not have a material adverse effect on the business or financial
condition of the Company.
UNCERTAINTY OF MARKET ACCEPTANCE; ANTICIPATED DEPENDENCE ON THIRD PARTIES
FOR MARKETING; LIMITED MARKETING EXPERIENCE
Achieving market acceptance for the Company's proposed products will
require substantial marketing efforts and the expenditure of significant amounts
of funds to inform potential customers, including in some cases third-party
distributors, of the distinctive characteristics and benefits of such products.
There can be no assurance that the Company's proposed products will ultimately
be accepted. There can be no assurance that the Company will be able to obtain
satisfactory arrangements with third-party distributors for the marketing of its
products or that the Company will realize substantial revenues from sales by
third-party distributors. In as much as the Company had no experience
17
<PAGE>
in marketing human or veterinary pharmaceuticals before its acquisition of FTI,
there can be no assurance that the Company will be able to market its products
successfully.
NO ASSURANCE OF ADEQUATE THIRD-PARTY REIMBURSEMENT
The Company's ability to commercialize its products successfully will
depend in part on the extent to which appropriate reimbursement levels for the
cost of the products and related treatment are obtained from government
authorities, private health insurers and other organizations, such as health
maintenance organizations ("HMOs"). Third-party payers are increasingly
challenging the prices charged for medical products and services. Accordingly,
if less costly drugs are available, third-party payers may not authorize
reimbursement for the Company's products even if they offer advantages in safety
or efficiency. Also, the trend toward managed healthcare and government
insurance programs significantly influences the purchase of healthcare services
and products, resulting in lower prices and reducing demand for the Company's
products. The cost containment measures that healthcare providers are
instituting and any healthcare reform could affect the Company's ability to sell
its products and may have a material adverse effect on the Company. There can
be no assurance that reimbursement in the United States or foreign countries
will be available for any of the Company's products, that any reimbursement
granted will be maintained, or that limits on reimbursement available from
third-party payers will not reduce the demand for, or negatively affect the
price of, the Company's products. The unavailability or inadequacy of third-
party reimbursement for the Company's products would have a material adverse
effect on the Company. The Company is unable to forecast what additional
legislation or regulation relating to the healthcare industry or third party
coverage and reimbursement may be enacted in the future, or what effect the
legislation or regulation would have on the Company's business.
18
<PAGE>
ITEM 2. PROPERTIES
The Company leases approximately 12,000 square feet of laboratory and
office space in The Woodlands, Texas from a related party. The lease expires in
July 1999. The Company also leases approximately 2,000 square feet in Natick,
Massachusetts utilized by FTI. This lease expires in April 1999. The Company is
currently assessing its current and future space needs and expects to increase
the size of its Woodlands, Texas facility. The additional space will be required
for its research and development activities as well as a need for additional
administrative space. The Company intends to incorporate this additional space
into its existing lease. The Company believes that its facilities, with the
additional space and its current equipment, will be adequate for its operations
in the near future.
ITEM 3. LEGAL PROCEEDINGS
On May 16, 1994, Dr. Bonita Sue Dunbar ("Dunbar") filed suit in the 270th
District Court of Harris County, Texas, naming BCM, BCM Technologies, Inc.
("BCMT"), Fulbright & Jaworski, L.L.P., and the Company as defendants
(collectively, the "Defendants"). Dunbar is a cellular and molecular biologist
who has been employed by BCM as a teacher and research scientist since 1981.
During the course of her employment at BCM, Dunbar developed technologies
relating to the use of certain recombinant zona pellucida peptides that were
assigned to the Company and which are the subject of the BCM Patent. Dunbar
claimed, among other things, that her assignment of the patent rights was
induced by statutory and constructive fraud and a civil conspiracy on the part
of the Defendants.
The Court recently granted partial summary judgement in favor of the
Company and the other defendants in connection with the action. As a result of
the rulings, Dunbar is unable to rescind the assignment of the patent rights and
is left only with ancillary claims. Such ancillary claims are subject to a
motion to sever and abate pending Dunbar's appeal of the Court's orders granting
the Company's motion for summary judgement. The Company believes the ancillary
claims are without merit and will not have any material adverse effect on the
Company's financial condition and results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders in
the fourth quarter of 1996.
19
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Since March 25, 1993, the Company's Common Stock has been traded on the
Pacific Stock Exchange under the symbol "ZNG" and quoted on the Nasdaq Small Cap
Market under the symbol "ZONA." The following table shows the high and low bid
price for the Common Stock by quarter, as reported by the Nasdaq Small Cap
Market, for the periods indicated:
Price Range
-----------------
High Low
-------- -------
1995
- ----
First Quarter $ 7.25 $ 4.25
Second Quarter 5.00 3.38
Third Quarter 5.25 3.38
Fourth Quarter 10.88 4.88
1996
- ----
First Quarter $18.25 $ 9.00
Second Quarter 11.50 8.63
Third Quarter 9.13 6.38
Fourth Quarter 11.50 7.75
1997
- ----
First Quarter (through March 11, 1997) $19.13 $15.63
All of the foregoing prices reflect interdealer quotations, without retail
mark-up, mark-downs or commissions and may not necessarily represent actual
transactions in the Common Stock.
On March 11, 1997, the last reported sales price of the Common Stock, as
quoted by the Nasdaq Small Cap Market, was $16.94 per share. On March 11, 1997,
there were approximately 2,000 holders of the Company's Common Stock.
The Company has never paid dividends on its Common Stock and does not
anticipate paying any cash dividends in the foreseeable future.
20
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The selected historical financial data presented below as of and for each
of the years in the five year period ended December 31, 1996, are derived from
the Company's audited financial statements. The selected historical financial
data as of and for the years ended December 31, 1994, 1995 and 1996 are derived
from the financial statements, audited by Arthur Andersen LLP, independent
public accountants, which appear elsewhere herein. The selected financial data
set forth below should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Company's
Consolidated Financial Statements and the notes thereto, included elsewhere
herein.
<TABLE>
<CAPTION>
Years ended December 31,
------------------------------------------------------------------------
STATEMENTS OF OPERATIONS DATA: 1992 1993 1994 1995 1996
------------ -------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenues:
Product sales $ -- $ -- $ 800,747 $ 2,838,532 $ 3,021,940
Licensing fee 250,000 -- -- -- --
Interest income 8,018 101,079 161,171 115,843 270,906
----------- ------------ ------------ ------------ ------------
Total revenues 258,018 101,079 961,918 2,954,375 3,292,846
Expenses:
Cost of products sold -- -- 569,723 2,162,446 2,087,007
Research and development 1,047,238 1,512,331 2,702,464 2,794,928 7,936,188
Sales, general and administrative 753,599 841,382 1,603,479 2,068,115 2,515,509
Interest expense 39,989 279,249 56,649 216,203 244,476
Total expenses 1,840,826 2,632,962 4,932,315 7,241,692 12,763,180
----------- ------------ ------------ ------------ ------------
Net loss $(1,582,808) $ (2,531,883) $ (3,970,397) $ (4,287,317) $ (9,470,334)
----------- ------------ ------------ ------------ ------------
Net loss per common share $(0.83) $(0.83) $(1.07) $(1.11) $(1.92)
=========== ============ ============ ============ ============
Weighted average shares used in
computing loss per common share 1,904,432 3,066,060 3,711,559 3,857,780 4,942,623
December 31,
------------------------------------------------------------------------
BALANCE SHEET DATA: 1992 1993 1994 1995 1996
----------- ------------ ------------ ------------ ------------
Cash, cash equivalents and short term investments $ 152,824 $ 6,056,588 $ 2,477,770 $ 4,189,858 $ 11,074,902
Total assets 468,903 6,567,374 5,273,714 6,651,555 13,711,760
Long-term obligations 1,010,007 -- 83,459 66,125 16,799
Redeemable preferred stock 5,021,638 -- -- -- --
Deficit accumulated during the development stage (6,150,454) (8,682,337) (12,652,734) (16,940,051) (26,410,385)
Stockholders' equity (deficit) $(5,780,592) $ 6,457,498 $ 4,248,015 $ 5,425,126 11,576,977
</TABLE>
21
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Zonagen is a biopharmaceutical company in the development stage and is
engaged in the development of technologies targeting conditions or diseases
associated with the human reproductive system. The Company devotes a
substantial amount of its resources on the development of technologies which
include a product for the oral treatment of male impotency, research of
approaches to alleviate urological diseases such as benign prostate hyperplasia
("BPH") and prostate cancer and treatment of female conditions such as
endometriosis. The Company is also active in the research of improved
methodologies to enhance fertility as well as new approaches to contraception
and prophylaxis of sexually transmitted disease.
The Company currently has sales through its subsidiary, Fertility
Technologies, Inc. ("FTI"), a marketing and distribution organization focused on
obstetrics/gynecology and fertility specialists. The Company's goal is to
become a leader in the area of human reproductive healthcare management by
providing an expansive array of products and services. The Company's growth
strategy is to develop products based on its own research as well as in-
licensing existing and late-stage development products and technologies.
The Company has incurred losses since its inception in 1987 and expects
to continue to incur losses for several years. The Company will be required to
raise additional capital through the sale of equity securities and out-licensing
opportunities to continue to fund its operations. As a result of the foregoing,
the Company's independent public accountants have included an explanatory
paragraph in their report on the Company's consolidated financial statements as
of December 31, 1995 and 1994, to the effect that the Company's ability to
continue existence is dependent upon its ability to obtain additional working
capital to develop, manufacture and market its products.
RESULTS OF OPERATIONS
Since its inception the Company has funded its operations through the
sale of equity securities and the formation of corporate partnerships. The
Company did not have product revenues until its acquisition of FTI in October
1994. Revenues from FTI will not be adequate to fund the Company's operations.
YEARS ENDED DECEMBER 31, 1996 AND 1995
Total revenues increased to $3,293,000 for the year ended 1996 as
compared to $2,954,000 for the same period in the prior year. This represents
an increase of $339,000 or 11.5% for 1996 over the prior year. Product sales
increased to approximately $3,022,000 in 1996 as compared to $2,838,000 in 1995
representing an increase of $184,000 or 6.5% over the prior year. The increase
was due primarily to increased sales efforts beginning in mid-year 1996.
Interest revenues increased to $271,000 in 1996 as compared to $116,000 in 1995
or an increase of $155,000 or 134% over the prior year. The increase was due
primarily to additional cash on hand from the Company's private placement
completed in October 1996 and cash received from the exercise of warrants during
the first quarter of 1996.
Total expenses increased to $12,763,000 in 1996 as compared to $7,242,000
for the same period in the prior year. This represents an increase of
$5,521,000 or 76% for 1996 over the prior year. The increase was due primarily
to the additional costs associated with the development of Vasomax(TM).
Expenses associated with the development of Vasomax(TM) increased to
approximately $5,963,000 in 1996 as compared to $710,000 in 1995, representing
increase of $5,253,000 or 740% over the prior year. The Company anticipates
that it will incur substantially higher expenses in 1997 relating to expenses
associated with Vasomax(TM) development.
Research development expenses ("R&D") excluding the development expenses
associated with Vasomax(TM) were $1,973,000 and $2,085,000 in 1996 and 1995,
respectively. General R&D expenses remained relatively constant in 1996 as
compared to 1995, but are expected to increase in 1997.
22
<PAGE>
Selling, general and administrative expenses were $2,516,000 and
$2,068,000 in 1996 and 1995, respectively. A substantial portion of this
increase was due primarily to expenses associated with operating a publicly
traded company, which included public relations services and travel, and other
various expenses. The Company did not have cash reserves necessary in 1995 to
perform those necessary activities. In addition, the Company hired a Vice
President of Corporate Development to focus on the operations of its subsidiary,
Fertility Technologies, Inc.
YEARS ENDED DECEMBER 31, 1995 AND 1994
Total revenues increased to $2,954,000 in 1995 from $962,000 in 1994.
Product sales, substantially all of which were derived from FTI, increased to
$2,839,000 in 1995 from $801,000 in 1994. The Company reported FTI's sales in
its consolidated financial statements for all of 1995 and for only the fourth
quarter of 1994. The gross margin on FTI's sales reported by the Company
declined to approximately 24% in 1995 compared to 29% in 1994. This was
primarily due to a change in product mix due to the elimination of a product
line and the costs associated with disposal of expired product.
R&D expenses were $2,795,000 and $2,702,000 in 1995 and 1994,
respectively. R&D expenses relating to the Company's oral treatment for male
impotency, including clinical trial and manufacturing scale-up expenses, were
approximately $710,000 and $322,000 for 1995 and 1994, respectively. R&D
expenses excluding costs associated with the male impotence project were
$2,085,000 and $2,380,000 for 1995 and 1994, respectively. In the second and
third quarters of 1995, the Company took various actions to reduce activities
due to its declining cash balances. Third quarter expenses were 31% lower in
1995 compared to 1994. In the fourth quarter of 1995, the Company had funds
available to accelerate its research and development activities. Fourth quarter
expenses were 20% higher in 1995 compared to 1994. Clinical trial expense and
manufacturing scale-up expenses associated with the Company's male impotence
product were $710,000 and $217,000 in 1995 and 1994, respectively. The increase
in clinical trials was due to Phase II clinical trial expenses being conducted
in Europe in 1995 for the Company's oral treatment for male impotency.
Selling, general and administrative expenses were $2,068,000 and
$1,603,000 in 1995 and 1994, respectively. The increase in 1995 was primarily
due to a full year of expenses associated with the operations of FTI.
Interest expense and amortization of intangibles increased to $216,000 in
1995 as compared to $57,000 in 1994. This increase was due primarily to the
amortization of the excess of cost over fair value of tangible assets acquired
in connection with the acquisition of FTI.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations since inception primarily through
the private and public sale of stock and through additional funds received from
out-licensing its proprietary technologies. In April 1993, the Company received
net proceeds of approximately $7,039,000 from its initial public offering of
1,535,000 shares of Common Stock. The Company used approximately $1,603,000 of
the net proceeds from its initial public offering to repay debt owed to certain
of its affiliates and others. In December 1993, the Company entered into an
agreement with Schering AG in which the Company and Schering agreed to jointly
research, develop and test zona pellucida based human contraceptive vaccines.
In December 1993, in accordance with this agreement, Schering Berlin Venture
Corporation purchased 239,933 shares of the Company's Common Stock for
$2,500,000, or approximately $10.42 per share. In October 1995, the Company
received net proceeds of $5,300,000 from the sale of 598,850 shares of Series
A Preferred Stock. The offering price per share for the Series A Preferred
Stock was $10.00 per share and each share is convertible into Common Stock based
on a conversion price of $3.625 per share of Common Stock. In September and
October 1996, the Company received aggregate net proceeds of $14,400,000 from
the sale of 1,692,500 shares of Series B Preferred Stock. The offering price
per share for the Series B Preferred Stock was $10.00 per share and each share
is convertible into Common Stock based on a conversion price of $6.625 per share
of Common Stock.
The Company used net cash of $7,990,000 for operating activities in the
year ended December 31, 1996 as compared to $3,249,000 for the year ended
December 31, 1995. The Company had cash and cash equivalents of $11,075,000 at
December 31, 1996. The increased use of cash for the year ended December 31,
1996 was primarily
23
<PAGE>
due to the increase in expenses related the clinical development of the
Company's oral treatment for male impotency, capital expenditures of
approximately $101,000 for leasehold improvements to 3,600 square feet of
additional space that the Company leased in March 1996 and additional research
and administrative equipment expenditures.
Current liabilities were $2,118,000 at December 31, 1996 compared with
$1,160,000 at December 31, 1995. This increase of $958,000 is primarily due to
accrued expenses associated with the development of Vasomax(TM).
During 1996, the Company entered into agreements with two contract
research organizations, PPD Pharmaco and Affiliated Research Centers, Inc., for
the U.S. clinical development of Vasomax(TM), the Company's oral treatment for
male impotency. The Company may terminate these agreements upon written
notification and payment of expenses incurred prior to termination. During 1996,
the Company made cash payments aggregating $3,162,000 and recorded payables and
accrued expenses of $821,000 as of December 31, 1996. Upon continued success of
the U.S. Vasomax(TM) clinical program, it is anticipated that the Company could
spend in excess of $10,000,000 in 1997 to continue the U.S. clinical development
program. If sufficient cash resources are not available, management intends to
reduce expenditures under these agreements.
In April 1994, the Company entered into an assignment agreement with
Gamogen, Inc. (the "Gamogen Agreement") and Dr. Adrian Zorgniotti pursuant to
which the Company purchased the rights to a technology for the treatment of male
impotence, including rights to a U.S. patent application. In consideration for
the assignment of the subject technology, the Company provided Gamogen, Inc.
("Gamogen") with a cash payment of $100,000 in 1994. As consideration for
Gamogen's agreement not to compete, the Company delivered $200,000 or 19,512
shares of the Company's common stock in April 1996 pursuant to the Gamogen
Agreement. Gamogen is to receive a predetermined royalty based on the aggregate
net sales of any product developed from the subject technology. In addition,
the Company is required to conduct $100,000 per year of research through April
1997 in the area of male impotency. The Company has a right of first
negotiation to purchase or exclusively license improvements to any royalty-
bearing product or competing product developed by Gamogen.
On January 24, 1997, the Company signed an amendment to the Gamogen
Agreement. This amendment expires in 2000 and provides the Company with an
option to purchase back the royalty stream. The Company made an initial payment
of $75,000 upon execution of the amendment and is required to make additional
payments of $150,000 each year through 1999 or until the final purchase is
completed. The Company can cancel the amendment at any time through nonpayment.
The final purchase price, inclusive of amended payments previously made, is
dependent upon the date the option is exercised and will range from $750,000 up
to $1,750,000.
In November 1995, the Company entered into a one-year agreement with a
physician in Mexico to conduct a study to determine the effectiveness and safety
of oral tablets of phentolamine mesylate for the treatment of impotence in
humans. Under this agreement, the Company pays an hourly rate for services plus
certain other costs. That trial was completed in November 1996. Subsequently,
the Company has entered into an agreement to run an open label study with
Vasomax(TM) in Mexico that is expected to last through the first quarter of 1998
and cost approximately $436,000 during that period. Also, the Company
anticipates conducting studies in Mexico in 1997 for other product development
opportunities.
The Company has experienced negative cash flows from operations since its
inception and has funded its activities to date primarily from equity
financings. The Company has expended, and will continue to require, substantial
funds to continue research and development, including preclinical studies and
clinical trials of its products, and to commence sales and marketing efforts if
FDA and other regulatory approvals are obtained. The Company expects to require
additional capital to fund its research and development activities in the third
quarter of 1997 if it maintains its currently planned clinical program. The
Company believes that it will be able to obtain funds sufficient to maintain its
currently planned clinical programs and other operations at least through the
end of 1997 if the results of its Phase III clinical trials of Vasomax(TM),
expected in the second quarter of 1997, are favorable. If sufficient cash
resources are not available, management intends to reduce expenditures for its
planned clinical program and other operations. If the results of its Phase III
clinical trials are unfavorable, the Company intends to reduce its research and
development expenditures and focus on its remaining business, in which case the
Company expects that its existing capital resources
24
<PAGE>
will be sufficient to fund its operations through the end of 1997. The Company's
capital requirements will depend on many factors, including the problems,
delays, expenses and complications frequently encountered by development stage
companies; the progress of the Company's future collaborative research,
manufacturing, marketing or other funding arrangements; the costs and timing of
seeking regulatory approvals of the Company's products; the Company's ability to
obtain regulatory approvals; the success of the Company's sales and marketing
programs; the cost of filing, prosecuting and defending and enforcing any patent
claims and other intellectual property rights; and changes in economic,
regulatory or competitive conditions or 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 testing and regulatory
procedures relating to the Company's products can be conducted at projected
costs. There can be no assurance that changes in the Company's research and
development plans, acquisitions or other events will not result in accelerated
or unexpected expenditures. To satisfy its capital requirements, the Company may
seek to raise additional funds in the public or private capital markets. The
Company's ability to raise additional funds in the public or private markets
will be adversely affected if the results of its current or future clinical
trials are not favorable. The Company may seek additional funding through
corporate collaborations and other financing vehicles. There can be no assurance
that any such funding will be available to the Company on favorable terms or at
all. If adequate funds are not available, the Company may be required to curtail
significantly one or more of its research or development programs, or it may be
required to obtain funds through arrangements with future collaborative partners
or others that may require the Company to relinquish rights to some or all of
its technologies or products. If the Company is successful in obtaining
additional financing, the terms of such financing may have the effect of
diluting or adversely affecting the holdings or the rights of the holders of the
Company's Common Stock.
ITEM 8. FINANCIAL STATEMENTS
The financial statements required by this item are presented following
Item 14 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Arthur Andersen LLP, an independent public accounting firm ("Arthur
Andersen"), began serving as the independent public accountants of the Company
on February 1, 1995. Before February 1, 1995, Ernst & Young LLP, an independent
auditing firm ("Ernst & Young"), had been the independent auditors for the
Company. During 1994, the Company's Board of Directors considered several
independent public accounting firms for possible selection as the Company's
auditors for fiscal year 1994, including Ernst & Young. After considerable
review, the Board unanimously voted to select Arthur Andersen as the Company's
independent public accountants for fiscal year 1994. Accordingly, Ernst & Young
was dismissed as the Company's auditors on February 1, 1995.
Management has had no disagreement with Ernst & Young on any material
matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedure. Ernst & Young's report on the financial statements
for the year ended December 31, 1993 did not contain an adverse opinion or a
disclaimer of opinion and was not qualified or modified as to uncertainty, audit
scope or accounting principles.
25
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item as to the directors and executive
officers of the Company is hereby incorporated by reference from the information
appearing under the caption "Election of Directors" in the Company's proxy
statement (the "Proxy Statement") for its annual meeting with stockholders.
Such Proxy Statement will be filed with the Securities and Exchange Commission
pursuant to the Securities and Exchange Act of 1934 within 120 days of the end
of the Company's fiscal year on December 31, 1996.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item as to the management of the Company
is hereby incorporated by reference from the information appearing under the
captions "Executive Compensation" and "Election of Directors - Director
Compensation" in the Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item as to the ownership by management
and others of securities of the Company is hereby incorporated by reference from
the information appearing under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the Company's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item as to certain business
relationships and transactions with management and other related parties of the
Company is hereby incorporated by reference from the information appearing under
the caption "Certain Transactions" in the Company's Proxy Statement.
26
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents Filed as a Part of this Report
1. Financial Statements
See Index to Financial Statements on page F-1.
All schedules are omitted because they are not applicable, not required, or
because the required information is included in the financial statements or
the notes thereto.
2. Exhibits
Exhibits to the Form 10-K have been included only with the copies of the
Form 10-K filed with the Securities and Exchange Commission. Upon request
to the Company and payment of a reasonable fee, copies of the individual
exhibits will be furnished.
EXHIBIT
NUMBER IDENTIFICATION OF EXHIBIT
- ------- -------------------------
2.1 --Stock Exchange Agreement dated October 13, 1994, effective October
1, 1994, among Zonagen, Inc., Fertility Technologies, Inc. and J.
Tyler Dean. Exhibit 2.1 to the Company's Current Report on Form
8-K dated October 13, 1994, is incorporated herein by reference.
3.1 --Restated Certificate of Incorporation. Exhibit 3.3 to the
Company's Registration Statement No. 33-57728-FW, as amended, is
incorporated herein by reference.
3.2 --Restated Bylaws of the Company. Exhibit 3.4 to the Company's
Registration Statement No. 33-57728-FW, as amended, is
incorporated herein by reference.
4.1 --Specimen Certificate of Common Stock, $.001 par value, of the
Company. Exhibit 4.1 to the Company's Registration Statement No.
33-57728-FW, as amended, is incorporated herein by reference.
4.2 --Representative's Warrant Agreement dated March 25, 1993. Exhibit
4.3 to the Company's Registration Statement No, 33-57728-FW, as
amended, is incorporated herein by this reference.
4.3 --Certificate of Designation for the Company's Series A Convertible
Preferred Stock. Exhibit 4.1 to the Company's Current Report on
Form 8-K dated October 19, 1995 is incorporated herein by
reference.
4.4 --Form of Subscription Agreement between the Company and purchasers
of the Company's Series A Convertible Preferred Stock. Exhibit 4.2
to the Company's Current Report on Form 8-K dated October 19, 1995
is incorporated herein by reference.
4.5 --Form of Warrants issued to the designees of the placement agent
for the Company's Series A Convertible Preferred Stock. Exhibit
4.5 to the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1995 is incorporated herein by reference.
4.6 --Certificate of Designation for the Company's Series B Convertible
Preferred Stock. Exhibit 4.1 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1996 is incorporated
herein by reference.
27
<PAGE>
4.7 --Form of Subscription Agreement between the Company and purchasers
of the Company's Series B Convertible Preferred Stock . Exhibit
4.2 to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1996 is incorporated herein by reference.
4.8 --Form of Warrant issued to the Placement Agent for the Company's
Series B Convertible Preferred Stock. Exhibit 4.3 to the Company's
quarterly Report on Form 10-Q for the quarter ended September 30,
1996 is incorporated herein by reference.
10.1 --Confidentiality Agreement dated July 19, 1991, between the Company
and the Regents of the University of California. Exhibit 10.1 to
the Company's Registration Statement No. 33-5778-FW, as amended,
is incorporated herein by reference.
10.2 --Agreement dated July 23, 1991, between the Company and Wayne State
University. Exhibit 10.2 to the Company's Registration Statement
No. 33-5778-FW, as amended, is incorporated herein by reference.
10.3+ --Amended and Restated 1993 Employee and Consultant Stock Option
Plan. Exhibit 10.3 to the Company's Registration Statement No. 33-
5778-FW, as amended, is incorporated herein by reference.
10.4 --Lease Agreement dated March 22, 1990, between the Company and The
Woodlands Equity Partnership-89. Exhibit 10.4 to the Company's
Registration Statement No. 33-5778-FW, as amended, is incorporated
herein by reference.
10.5+ --Employment Agreement between the Company and Joseph S. Podolski.
Exhibit 10.5 to the Company's Registration Statement No. 33-5778-
FW, as amended, is incorporated herein by reference.
10.6 --Exclusive License Agreement dated as of September 11, 1992,
between the Company and Dainippon Pharmaceuticals Co., Ltd.
Exhibit 10.7 to the Company's Registration Statement No. 33-57728-
FW, as amended, is incorporated herein by reference.
10.7 --Advisory Agreement dated March 25, 1993 between the Company and
Reich & Co., Inc. Exhibit 10.8 to the Company's Registration
Statement No. 33-57728-FW, as amended, is incorporated herein by
reference.
10.8 --Extension, Modification and Ratification of Lease dated July 12,
1993 between the Company and Woodlands Equity Partnership-89.
Exhibit 10.10 to the Company's Annual Report on Form 10-KSB for
the fiscal year ended December 31, 1993, is incorporated herein by
reference.
10.9+ --The Company's 1993 Non-Employee Director Stock Option Plan.
Exhibit 10.11 to the Company's Annual Report of Form 10-KSB for
the fiscal year ended December 31, 1993, is incorporated herein by
reference
10.10+ --Employment Agreement between the Company and Louis Ploth. Exhibit
10.12 to the Company's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1993, is incorporated herein by reference.
10.11 --Stock Purchase Agreement dated December 6, 1993, between the
Company and Schering Berlin Venture Corporation. Exhibit 10.13 to
the Company's Annual Report on Form 10-KSB for the fiscal year
ended December 31, 1993, is incorporated herein by reference.
10.12 --License, Research, Development and Regulatory Filing Agreement
dated December 13, 1993, between the Company and Schering AG.
Exhibit 10.14 to the Company's Annual Report on Form 10-KSB for
the fiscal year ended December 31, 1993, is incorporated herein by
reference.
10.13 --Agreement dated November 30, 1993, between the Company and the
University of North Carolina at Chapel Hill. Exhibit 10.15 to the
Company's Annual Report on Form 10-KSB for the fiscal year ended
December 31, 1993, is incorporated herein by reference.
10.14 --Agreement between the Company and Reproductive Biotechnologies
PVT., Ltd. Exhibit 10.16 to the Company's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1993, is
incorporated herein by reference
28
<PAGE>
10.15 --Assignment Agreement among Zonagen, Inc., Gamogen, Inc. and Dr.
Adrian Zorgniotti dated April 13, 1994. Exhibit 10.17 to the
Company's Annual Report on Form 10-KSB for the fiscal year ended
December 31, 1994, is incorporated herein by reference.
10.16 --Registration Rights Agreement dated October 13, 1994, effective
October 1, 1994, among Zonagen, Inc. and J. Tyler Dean. Exhibit
10.1 to the Company's Current Report on Form 8-K dated October 13,
1994, is incorporated herein by reference.
10.17 --Pledge and Security Agreement dated October 13, 1994 between
Zonagen, Inc. and J. Tyler Dean. Exhibit 10.2 to the Company's
Current Report on Form 8-K dated October 13, 1994, is incorporated
herein by reference.
10.18 --Guaranty of Zonagen, Inc. dated October 13, 1994. Exhibit 10.4 to
the Company's Current Report on Form 8-K dated October 13, 1994,
is incorporated herein by reference.
10.19 --Agreement between the Company and Pharmaco, LSR to conduct
clinical trials dated January 25, 1995. Exhibit 10.23 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995 is incorporated herein by reference.
10.20 --Research Agreement between the Company and The Brigham and Women's
Hospital, Inc. dated November 6, 1995. Exhibit 10.24 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995 is incorporated herein by reference.
10.21 --License Agreement between the Company and The Brigham and Women's
Hospital, Inc. dated November 6, 1995. Exhibit 10.25 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995 is incorporated herein by reference.
11.1* --Statement regarding computation of per share earnings
23.1* --Consent of Arthur Andersen LLP.
27.1* --Financial Data Schedule.
- ---------------
*Filed herewith.
+Management contract or compensatory plan.
(b) Reports on Form 8-K
The Company filed one Current Report on Form 8-K, dated October 15, 1996,
during the three months ended December 31, 1996. The Current Report on Form 8-K
related to the closing of the private placement of shares of the Company's
Series B Convertible Preferred Stock.
29
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
ZONAGEN, INC.
Date: May 16, 1997 By: /s/ Joseph S. Podolski
---------------------------
Joseph S. Podolski
President and Chief Executive Officer
30
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Public Accountants F-2
Consolidated Balance Sheets as of December 31, 1996 and 1995 F-3
Consolidated Statements of Operations for the Years Ended December 31, 1996, 1995, and 1994,
and for the Period From Inception (August 20, 1987) Through December 31, 1996 F-4
Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1996, 1995,
and 1994, and for the Period From Inception (August 20, 1987) Through December 31, 1996 F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994,
and for the Period From Inception (August 20, 1987) Through December 31, 1996 F-8
Notes to Consolidated Financial Statements F-9
</TABLE>
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Zonagen, Inc.:
We have audited the accompanying balance sheets of Zonagen, Inc. (a Delaware
corporation in the development stage), and subsidiary as of December 31, 1996
and 1995, and the related statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31, 1996.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted audited standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
As discussed in Note 1 to the financial statements, the Company has operated as
a development stage enterprise since its inception by devoting substantially all
of its efforts to raising capital and performing research and development. In
order to complete the research and development and other activities necessary to
commercialize its products, additional financing will be required. Management's
current projections indicate that the Company can conserve its cash resources to
maintain the Company's operations through 1997. Management's plans in regard to
those matters are also described in Note 1.
In our opinion, based on our audits and the reports of the other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of Zonagen, Inc., and subsidiary as of December 31, 1996
and 1995, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
ARTHUR ANDERSEN LLP
Houston, Texas
March 11, 1997
F-2
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31
----------------------------
1996 1995
------------- -------------
<S> <C> <C>
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $ 11,074,902 $ 4,189,858
Accounts receivable 420,149 327,975
Product inventory 174,073 230,380
Prepaids and other current assets 141,223 69,232
------------ ------------
Total current assets 11,810,347 4,817,445
LAB EQUIPMENT, FURNITURE AND LEASEHOLD
IMPROVEMENTS, net of accumulated
depreciation and amortization of
$706,351 and $601,792, respectively 311,093 233,315
EXCESS OF COST OVER FAIR VALUE OF
TANGIBLE ASSETS ACQUIRED, net of
accumulated amortization of $446,080
and $240,845, respectively 1,003,329 1,153,939
OTHER ASSETS, net of accumulated
amortization of $116,048 and $67,532,
respectively 586,991 446,856
------------ ------------
Total assets $ 13,711,760 $ 6,651,555
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 1,169,999 $ 660,673
Accrued liabilities 867,459 499,631
Current portion of notes payable 80,526
------------ ------------
Total current liabilities 2,117,984 1,160,304
------------ ------------
NOTES PAYABLE 16,799 66,125
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Undesignated preferred stock, $.001 par
value, 2,305,000 and 4,230,000 shares
authorized, respectively, none issued
and outstanding -- --
Series A preferred stock, $.001 par
value, 770,000 shares authorized, none
and 504,850 shares outstanding,
respectively -- 505
Series B preferred stock, $.001 par
value, 1,925,000 and none authorized,
respectively, 1,514,906 and none
outstanding, respectively 1,515 --
Common stock, $.001 par value,
20,000,000 shares authorized,
6,033,396 and 4,098,124 shares issued
and outstanding, respectively 6,033 4,098
Additional paid-in capital 38,124,532 22,473,074
Deferred compensation (144,718) (112,500)
Deficit accumulated during the
development stage (26,410,385) (16,940,051)
------------ ------------
Total stockholders' equity 11,576,977 5,425,126
------------ ------------
Total liabilities and
stockholders' equity $ 13,711,760 $ 6,651,555
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Period
From Inception
For the Year Ended December 31 (August 20, 1987)
------------------------------------------- Through
1996 1995 1994 December 31, 1996
------------- ------------- ------------- ------------------
(Unaudited)
<S> <C> <C> <C> <C>
REVENUES:
Product sales $ 3,021,940 $ 2,838,532 $ 800,747 $ 6,661,219
Licensing fee -- -- -- 250,000
Interest income 270,906 115,843 161,171 892,699
----------- ----------- ----------- ------------
Total revenues 3,292,846 2,954,375 961,918 7,803,918
COSTS AND EXPENSES:
Cost of products sold 2,087,007 2,162,446 569,723 4,819,176
Research and development 7,936,188 2,794,928 2,702,464 18,767,924
Selling, general and administrative 2,515,509 2,068,115 1,603,479 9,403,235
Interest expense and amortization of
intangibles 224,476 216,203 56,649 860,585
----------- ----------- ----------- ------------
Total costs and expenses 12,763,180 7,241,692 4,932,315 33,850,920
----------- ----------- ----------- ------------
LOSS FROM CONTINUING OPERATIONS (9,470,334) (4,287,317) (3,970,397) (26,047,002)
LOSS FROM DISCONTINUED OPERATIONS -- -- -- (288,104)
LOSS ON DISPOSAL OF DISCONTINUED
OPERATIONS -- -- -- (75,279)
------------ ------------ ------------ ------------
Net loss $(9,470,334) $(4,287,317) $(3,970,397) $(26,410,385)
=========== =========== =========== ============
LOSS PER COMMON SHARE $(1.92) $(1.11) $(1.07)
=========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES USED IN
COMPUTING LOSS PER COMMON SHARE 4,924,623 3,857,780 3,711,559
=========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Deficit
Accumulated
Preferred Stock Common Stock Additional During the Total
----------------- ------------------- Paid-in Defered Development Stockholders'
Shares Amount Shares Amount Capital Compensation Stage Equity
------- ------- -------- --------- -------------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Exchange of common stock
($.004 per share) for
technology rights and
services from founding
stockholders -- $ -- 245,367 $ 245 $ 805 $ -- $ -- $ 1,050
Net loss -- -- -- -- -- -- (27,613) (27,613)
----- ------ --------- ------ ---------- ------- ----------- -----------
BALANCE AT DECEMBER 31, 1987
(unaudited) -- -- 245,367 245 805 -- (27,613) (26,563)
Net loss -- -- -- -- -- -- (327,412) (327,412)
----- ------ --------- ------ ---------- ------- ----------- -----------
BALANCE AT DECEMBER 31, 1988
(unaudited) -- -- 245,367 245 805 -- (355,025) (353,975)
Proceeds from issuance of
common stock -- -- 65,431 65 2,735 -- -- 2,800
Net loss -- -- -- -- -- -- (966,681) (966,681)
----- ------ --------- ------ ---------- ------- ----------- -----------
BALANCE AT DECEMBER 31, 1989
(unaudited) -- -- 310,798 310 3,540 -- (1,321,706) (1,317,856)
Proceeds from issuance of
common stock -- -- 467 1 19 -- -- 20
Net loss -- -- -- -- -- -- (1,426,320) (1,426,320)
----- ------ --------- ------ ---------- ------- ----------- -----------
BALANCE AT DECEMBER 31, 1990
(unaudited) -- -- 311,265 311 3,559 -- (2,748,026) (2,744,156)
Net loss -- -- -- -- -- -- (1,819,620) (1,819,620)
----- ------ --------- ------ ---------- ------- ----------- -----------
BALANCE AT DECEMBER 31, 1991
(unaudited) -- -- 311,265 311 3,559 -- (4,567,646) (4,563,776)
Conversion of 391,305 shares
of Series C preferred stock
into common stock -- -- 91,442 92 359,908 -- -- 360,000
Purchase of retirement of
common stock -- -- (23,555) (24) (984) -- -- (1,008)
Proceeds from issuance of
common stock -- -- 16,946 17 6,983 -- -- 7,000
Net loss -- -- -- -- -- -- (1,582,808) (1,582,808)
----- ------ --------- ------ ---------- ------- ----------- -----------
BALANCE AT DECEMBER 31, 1992
(unaudited) -- -- 396,098 396 369,466 -- (6,150,454) (5,780,592)
Issuance of common stock for
cash, April 1, 1993, and
May 12, 1993 ($5.50 per
share), net of offering
costs of $1,403,400 -- -- 1,534,996 1,535 7,037,543 -- -- 7,039,078
Issuance of common stock for
cash and license agreement,
December 9, 1993 ($10.42
per share), net of offering
costs of $46,833 -- -- 239,933 240 2,453,017 -- -- 2,453,257
Conversion of Series A
preferred stock to common
stock -- -- 179,936 180 600,420 -- -- 600,600
Conversion of Series B
preferred stock to common
stock -- -- 96,013 96 377,903 -- -- 377,999
Conversion of Series C
preferred stock to common
stock -- -- 876,312 877 3,442,530 -- -- 3,443,407
Conversion of Series D
preferred stock to common
stock -- -- 280,248 280 599,352 -- -- 599,632
Conversion of bridge loan
to common stock -- -- 64,000 64 255,936 -- -- 256,000
Net loss -- -- -- -- -- -- (2,531,883) (2,531,883)
----- ------ --------- ------ ----------- ------- ----------- -----------
</TABLE>
F-5
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Continued)
<TABLE>
<CAPTION>
Deficit
Accumulated
Preferred Stock Common Stock Additional During the Total
----------------- ------------------- Paid-in Defered Development Stockholders'
Shares Amount Shares Amount Capital Compensation Stage Equity
------- ------- -------- --------- -------------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1993
(unaudited) -- $ -- 3,667,536 $3,668 $15,136,167 $ -- $(8,682,337) $ 6,457,498
Deferred compensation
resulting from grant of
options -- -- -- -- 187,500 (187,500) -- --
Amortization of deferred
compensation -- -- -- -- -- 37,500 -- 37,500
Exercise of warrants to
purchase common stock for
cash, June 30, 1994
($3.94 per share) -- -- 39,623 40 156,079 -- -- 156,119
Issuance of common stock
for purchase of FTI,
October 13, 1994 -- -- 111,111 111 1,567,184 -- -- 1,567,295
Net loss -- -- -- -- -- -- (3,970,397) (3,970,397)
----- ------ --------- ------ ----------- -------- ----------- -----------
BALANCE AT DECEMBER 31, 1994 -- -- 3,818,270 3,819 17,046,930 (150,000) (12,652,734) 4,248,015
Amortization of deferred
compensation -- -- -- -- -- 37,500 -- 37,500
Exercise of options to
purchase common stock for
cash, January and April 1995
($.10 to $6.13 per share -- -- 4,546 4 13,919 -- -- 13,923
Issuance of common stock
for cash and a financing
charge, March 9, 1995 -- -- 16,000 16 75,984 -- -- 76,000
Issuance of Series A
preferred stock for cash,
October 4, 1995, and
October 19, 1995 ($10.00
per share), net of offering
costs of $651,495 598,850 599 -- -- 5,336,406 -- -- 5,337,005
Conversion of warrants to
purchase common stock as
a result of offering under
antidilution clause,
October 19, 1995
($3.63 per share) -- -- -- -- -- -- -- --
Conversion of Series A
preferred stock into
common stock, November
and December 1995 (94,000) (94) 259,308 259 (165) -- -- --
Net loss -- -- -- -- -- -- (4,287,317) (4,287,317)
----- ------ --------- ------ ----------- -------- ----------- -----------
</TABLE>
F-6
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Continued)
<TABLE>
<CAPTION>
Deficit
Accumulated
Preferred Stock Common Stock Additional During the Total
---------------- ------------------- Paid-in Defered Development Stockholders'
Shares Amount Shares Amount Capital Compensation Stage Equity
------ ------ -------- -------- ----------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1995 504,850 $ 505 4,098,124 $4,098 $22,473,074 $(112,500) $(16,940,051) $ 5,425,126
Deferred compensation
resulting from grant of
options -- -- -- -- 86,250 (86,250) -- --
Amortization of deferred
compensation -- -- -- -- -- 54,032 -- 54,032
Exercise of warrants to
purchase common stock for
cash, January through
December 1996 ($3.63 per
share) -- -- 227,776 228 826,595 -- -- 826,823
Conversion of Series A
preferred stock into common
stock, January through
November 1996 (507,563) (508) 1,396,826 1,397 (889) -- -- --
Issuance of options for
services, January 12, 1996 -- -- -- -- 98,745 -- -- 98,745
Exercise of options to
purchase common stock for
cash, February through
November 1996 ($.001 to
$5.50 per share) -- -- 23,100 23 75,005 -- -- 75,028
Issuance of common stock for
agreement not to compete,
April 13, 1996 -- -- 19,512 19 199,978 -- -- 199,997
Exercise of warrant to purchase
Series A preferred stock under
cashless exercise provision,
June 5, 1996 2,713 3 -- -- (3) -- -- --
Issuance of Series B preferred
stock for cash, September 30,
1996, and October 11, 1996,
($10.00 per share), net of
offering costs of
$2,557,440 1,692,500 1,693 -- -- 14,365,867 -- -- 14,367,560
Conversion of Series B
preferred stock into common
stock, November through
December 1996 (177,594) (178) 268,058 268 (90) -- -- --
Net loss -- -- -- -- -- -- (9,470,334) (9,470,334)
--------- ------ --------- ------ ----------- --------- ------------ -----------
BALANCE AT DECEMBER 31, 1996 1,514,906 $1,515 6,033,396 $6,033 $38,124,532 $(144,718) $(26,410,385) $11,576,977
========= ====== ========= ====== =========== ========= ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Period
From Inception
(August 20, 1987)
For the Year Ended December 31 Through
------------------------------------------- December 31,
1996 1995 1994 1996
------------- ------------- ------------- -----------------
(unaudited)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(9,470,333) $(4,287,317) $(3,970,397) $(26,410,384)
Loss on disposal of discontinued
operations -- -- -- 75,279
Adjustments to reconcile net loss to
net cash used in operating activities-
Noncash financing costs -- 75,984 -- 315,984
Depreciation and amortization 358,310 317,050 224,843 1,218,946
Noncash expenses related to
stock-based transactions 152,777 37,500 37,500 227,797
Common stock issued for agreement not
to compete 199,997 -- -- 199,997
Series B preferred stock issued for
consulting services -- -- -- 17,999
Changes in operating assets and
liabilities, net of effects of
purchase of businesses in 1988,
1994 and 1996
(Increase) decrease in receivables (119,893) 146,120 (168,370) (153,962)
(Increase) decrease in product
inventory 56,307 79,570 (28,422) 107,455
(Increase) decrease in prepaids and
other current assets (44,273) (1,005) (167) (60,981)
(Decrease) increase in accounts
payable and accrued liabilities 877,154 383,444 421,983 1,792,457
----------- ----------- ----------- ------------
Net cash used in operating
activities (7,989,954) (3,248,654) (3,483,030) (22,669,413)
----------- ----------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (182,337) (43,500) (35,985) (910,699)
Purchase of technology rights and other
assets (203,651) (133,988) (189,002) (671,022)
Cash acquired in purchase of FTI -- -- 2,695 2,695
Proceeds from sale of subsidiary, less
$12,345 for operating losses during
1990 phase-out period -- -- -- 137,646
Increase in net assets held for disposal -- -- -- (212,925)
----------- ----------- ----------- ------------
Net cash used in investing
activities (385,988) (177,488) (222,292) (1,654,305)
----------- ----------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 901,851 13,939 156,119 10,574,064
Proceeds from issuance of preferred
stock 14,367,560 5,337,005 -- 23,688,522
Proceeds from issuance of notes payable -- -- -- 2,838,681
Principal payments on notes payable (8,425) (182,714) (59,615) (1,702,647)
----------- ----------- ----------- ------------
Net cash provided by financing
activities 15,260,986 5,168,230 96,504 35,398,620
----------- ----------- ----------- ------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 6,885,044 1,742,088 (3,608,818) 11,074,902
CASH AND CASH EQUIVALENTS, beginning of
period 4,189,858 2,447,770 6,056,588 --
----------- ----------- ----------- ------------
CASH AND CASH EQUIVALENTS, end of period $11,074,902 $ 4,189,858 $ 2,447,770 $ 11,074,902
=========== =========== =========== ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid during the period for
interest $ -- $ -- $ 5,660 $ 129,243
Acquisition of FTI -- -- 1,567,295 1,567,295
Assumed debt in purchase of Zygotek
assets 39,625 -- -- 39,625
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-8
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND OPERATIONS:
Zonagen, Inc., and subsidiary (the Company), a Delaware corporation, was
organized on August 20, 1987 (Inception), and is engaged in the development of
technologies targeting conditions or diseases associated with the human
reproductive system. These technologies include the development of products for
the oral treatment of male impotency, alleviation of urological diseases such as
benign prostatic hyperplasia and prostate cancer, and the treatment of female
conditions such as endometriosis. The Company is also active in the research of
improved methodologies to enhance fertility as well as new approaches to
contraception and prophylaxis of sexually transmitted disease. The Company's
growth strategy is to develop products based on its own research as well as in-
licensing existing and late-stage development products and technologies focused
in the area of human reproductive health care. From Inception through
December 31, 1996, the Company has been primarily engaged in research and
development and is still in a development stage. On April 1, 1993, the Company
completed its initial public offering (the Offering).
There can be no assurance that the Company will successfully complete the
transition from a development stage company to profitability. Such ability to
complete the transition is dependent upon, among other things, the Company's
ability to obtain additional working capital to develop, manufacture and market
its products and the success of future operations. The Company requires
substantial capital for research, product development and market development
activities. The ability of the Company to successfully develop, manufacture and
market its proprietary products is dependent upon many factors. The Company's
business is subject to significant risks consistent with biotechnology companies
that are developing products for human therapeutic use. These risks include, but
are not limited to, uncertainties regarding research and development, access to
financing, obtaining and enforcing patents, receiving regulatory approval
product liability exposure, dependence on third parties for marketing and
manufacturing, and competition with other biotechnology and pharmaceutical
companies. Other than through Fertility Technologies, Inc. (FTI), the Company
has not generated revenues from operations nor is there any assurance of
significant revenues in the future.
The Company has incurred losses since its inception in 1987 and expects to incur
losses for the next several years. As of December 31, 1996, the Company had
accumulated losses of $26,410,385 and had cash reserves of $11,074,902. The
Company expects that it can conserve its capital resources sufficient to fund
its operations through the end of 1997. If the results of Phase III clinical
trials are favorable, the Company expects to require additional capital to fund
its "open label studies" in the third quarter of 1997. The Company believes that
it will receive funds sufficient to maintain its clinical program and other
operations at least through the end of 1997. If sufficient cash resources are
not available, management intends to reduce expenditures for its clinical
program and other operations. If the results of its Phase III clinical trial are
unfavorable, the Company intends to reduce its research and development
expenditures and focus on its remaining business, in which case the Company
expects that its existing capital resources will be sufficient to fund its
operations through the end of 1997.
On October 13, 1994, the Company purchased all of the outstanding common stock
of FTI (a Massachusetts corporation). The Company currently has sales through
this subsidiary, a marketing and distribution organization focused on
obstetrics/gynecology and fertility specialists. The Company's goal is to become
a leader in the area of human reproductive health care management by providing a
full array of innovative products and services.
F-9
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following unaudited pro forma information shows the results of operations
for the year ended December 31, 1994, as if the acquisition had occurred on
January 1, 1994 after giving effect to certain adjustments, including
amortization of excess of cost over fair value of tangible assets acquired,
interest expense related to the assumption of debt and intercompany
eliminations.
<TABLE>
<CAPTION>
Pro Forma Amounts
(Unaudited)
1994
------------------
<S> <C>
Total revenues $2,785,165
Net loss 4,119,886
Pro forma net loss per share 0.97
Shares used in computing loss per 4,256,056
common share
</TABLE>
The pro forma results of operations are not necessarily indicative of the actual
results of operations that would have occurred had the purchase been made at
January 1, 1994, or of the results which may occur in the future.
On June 7, 1996, FTI purchased substantially all of the assets of Zygotek, Inc.
(Zygotek) (a Massachusetts corporation), for cash of $15,000 and the assumption
of notes payable of $39,625. FTI also received the rights to a proprietary
product in connection with the purchase.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
FTI, its wholly owned subsidiary. All significant intercompany balances and
transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, the Company considers
all cash accounts and highly liquid investments having original maturities of
three months or less to be cash and cash equivalents.
F-10
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Product Inventory
Product inventory consists primarily of products manufactured by others for
resale to obstetrics/gynecologists, urologists and fertility clinics. Inventory
at December 31, 1996, also includes finished goods manufactured by the Company
for sale to fertility clinics. Inventory is stated at the lower of cost or
market using the first-in, first-out method.
Lab Equipment, Furniture
and Leasehold Improvements
Lab equipment, furniture and leasehold improvements are recorded at cost, less
accumulated depreciation and amortization. Depreciation is computed on the
straight-line method over an estimated useful life of five years or, in the case
of leasehold improvements, amortized over the remaining term of the lease.
Depreciation and amortization for tax reporting purposes is computed using the
accelerated cost recovery system. Maintenance and repairs that do not improve
or extend the life of assets are expensed as incurred.
Excess of Cost Over Fair Value
of Tangible Assets Acquired
Excess of cost over fair value of tangible assets acquired was recorded in
conjunction with the purchase of FTI and the Zygotek assets and is amortized
using the straight-line method over a seven-year period and six-year period,
respectively.
Other Assets
Other assets consist primarily of patent costs, primarily legal fees. These
costs are being amortized over 17 years, or the lesser of the legal or the
estimated economic life of the patent.
Revenue Recognition
The Company recognizes revenues from product sales upon shipment. Revenues from
licensing activities are recognized as these revenues are earned.
Research and Development Costs
The Company expenses research and development costs in the period they are
incurred.
Loss Per Common Share
Loss per common share is computed by dividing the net loss for the period by the
weighted average number of shares of common stock outstanding during each
period. In all applicable years, all common stock equivalents, including Series
A preferred stock and Series B preferred stock, were antidilutive and,
accordingly, were not included in the computation.
In March 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." SFAS No.
128 establishes standards for computing and presenting earnings per share (EPS)
of common stock. This statement simplifies the standards for computing EPS,
previously found in Accounting Priciples Board Opinion (APB) No. 15, "Earnings
Per Share," and makes them comparable to international EPS standards. The
statement also retroactively revises the presentation of EPS in the financial
statements. The Company will adopt SFAS No. 128 for the year ended December 31,
1997, and has not currently quantified the effect of adoption.
F-11
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. LAB EQUIPMENT, FURNITURE
AND LEASEHOLD IMPROVEMENTS:
Lab equipment, furniture and leasehold improvements at December 31, 1996 and
1995, are classified as follows:
<TABLE>
<CAPTION>
1996 1995
----------- ----------
<S> <C> <C>
Laboratory equipment $ 592,479 $ 475,162
Furniture and fixtures 137,235 138,720
Office equipment 101,427 76,043
Leasehold improvements 186,303 145,182
---------- ---------
1,017,444 835,107
Less- Accumulated depreciation and
amortization (706,351) (601,792)
---------- ---------
Total $ 311,093 $ 233,315
========== =========
</TABLE>
Depreciation expense of $104,559, $96,667 and $209,259 was recorded in 1996,
1995 and 1994, respectively.
4. OPERATING LEASES:
The Company leases laboratory and office space. Rental expense for the years
ended December 31, 1996, 1995 and 1994, was $179,335, $179,640 and $91,577,
respectively. Future minimum lease payments under noncancelable leases with
original terms in excess of one year as of December 31, 1996, are as follows:
1997 $168,053
1998 169,979
1999 89,603
2000 1,763
2001 --
5. NOTES PAYABLE:
In connection with the acquisition of FTI, the Company assumed two note
agreements from the former sole stockholder of FTI. One note agreement required
the payment of four equal quarterly installments of $62,500, beginning
December 31, 1994, through September 30, 1995. The second note agreement
required the payment of a number of shares of common stock on January 31, 1997,
determined based upon the market price of common stock at that date. Interest
was imputed at a rate of 11 percent. On January 31, 1997, the Company issued
19,842 shares of common stock to satisfy the remaining note obligation.
In connection with the purchase of Zygotek in June 1996, FTI assumed two note
agreements totaling $39,625, one of which was to the former sole stockholder of
Zygotek. The notes bear interest at 8 percent and 11 percent and mature on May
1, 1999, and October 1, 1998, respectively. Principal and interest payments of
approximately $1,400 are due monthly. The notes are guaranteed by Zonagen, Inc.
F-12
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. FEDERAL INCOME TAXES:
The Company had losses since inception and, therefore, has not been subject to
federal income taxes. The Company has accumulated approximately $520,000 of
research and development tax credits which will begin to expire in 2002. As of
December 31, 1996, the Company has net operating loss (NOL) carryforwards for
income tax purposes, subject to limitations described below, expiring as
follows:
Year expires-
2002 $ 27,613
2003 288,615
2004 614,044
2005 1,347,926
2006 1,839,889
2007 1,476,055
2008 2,360,658
2009 3,388,940
2010 3,889,500
2011 9,085,559
-----------
Total $24,318,799
===========
The Tax Reform Act of 1986 provided for a limitation on the use of NOL and tax
credit carryforwards following certain ownership changes that could limit the
Company's ability to utilize these NOLs and tax credits. Accordingly, the
Company's ability to utilize the above NOL and tax credit carryforwards to
reduce future taxable income and tax liabilities may be limited. Additionally,
because U.S. tax laws limit the time during which NOLs and tax credit
carryforwards may be applied against future taxable income and tax liabilities,
the Company may not be able to take full advantage of its NOLs and tax credit
carryforwards for federal income tax purposes.
The FASB has issued SFAS No. 109, "Accounting for Income Taxes." As the Company
has incurred losses since inception, and there is no certainty of future
revenues, a deferred tax asset has been recorded and reserved in full in the
accompanying financial statements for the Company's NOL carryforward.
F-13
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and liabilities at December 31, 1996 and 1995, are as
follows:
1996 1995
---- ----
Deferred tax assets and liabilities-
Net operating loss carryforwards $ 8,268,000 $ 5,179,000
Book/tax difference on basis of
assets and license agreements 133,000 57,000
Research and development tax credits 520,000 505,000
Accruals/expenses not currently
deductible 26,000 68,000
----------- -----------
Total deferred tax assets 8,947,000 5,809,000
Less- Valuation allowance (8,947,000) (5,809,000)
----------- -----------
Net deferred tax asset $ -- $ --
=========== ===========
7. STOCKHOLDERS' EQUITY:
Series A Preferred Stock
In October 1995, the Company authorized 770,000 shares and issued 598,850 shares
of Series A convertible preferred stock (Series A Preferred Stock) for $10.00
per share. Net proceeds to the Company were approximately $5,337,000. Each
share of Series A Preferred Stock is convertible at the option of the holder
into shares of common stock at an initial conversion price of $3.625 per share.
Holders of the Series A Preferred Stock are entitled to liquidation preference
of $13.00 per share upon the liquidation, sale or other disposition of all or
substantially all of the assets of the Company. Series A stockholders are
entitled to vote as if their shares had been converted into common stock and are
entitled to approve (a) additional securities of the Company, (b) changes to the
rights and preferences of the Series A Preferred Stock and (c) declaration of
dividends or repurchases of securities of the Company.
On November 1, 1996, the Company exercised its right to cause the mandatory
conversion of the Series A Preferred Stock, with the result that all such shares
not previously converted were converted into common stock effective November 25,
1996.
Series B Preferred Stock
In September 1996, the Company authorized 1,925,000 shares of Series B
convertible preferred stock (Series B Preferred Stock). On September 30, 1996,
the Company completed an initial closing of a private placement for its Series B
Preferred Stock in which it sold 1,137,750 shares at a price of $10.00 per
share. Net proceeds to the Company from the initial closing of the private
placement were approximately $9.7 million. On October 11, 1996, the Company
completed the final closing of its private placement of Series B Preferred
Stock, in which it sold an additional 554,750 shares of Series B Preferred Stock
at a price of $10.00 per share. Net proceeds from the final closing of the
private placement were approximately $4.7 million. The aggregate offering
consisted of 1,692,500 shares of Series B Preferred Stock with net proceeds of
approximately $14.4 million.
F-14
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Each share of Series B Preferred Stock is convertible at the option of the
holder into shares of common stock at an initial conversion price of $6.625 per
share. In October 1997, the conversion price is subject to adjustment if the
common stock is trading, as defined, less than 130 percent of the conversion
price. Beginning in October 1997, the Company can cause the Series B Preferred
Stock to be converted into common stock if the common stock is trading, as
defined, for more than 150 percent of the conversion price. Holders of the
Series B Preferred Stock are entitled to a liquidation preference of $13.00 per
share upon the liquidation of the Company. Holders of Series B Preferred Stock
are entitled to vote as if their shares had been converted into common stock and
are entitled to approve (a) additional securities of the Company that are senior
to or on parity with the Series B Preferred Stock, (b) changes to the rights and
preferences of the Series B Preferred Stock and (c) declaration of dividends on
junior stock or repurchases of securities of the Company.
Through December 31, 1996, 177,594 shares of Series B Preferred Stock had been
converted into 268,058 shares of common stock. From January 1, 1997, through
March 11, 1997, 519,168 shares of Series B Preferred Stock have been submitted
by their holders for conversion into 783,609 shares of common stock.
Common Stock
In March 1995, the Company issued 16,000 shares of common stock to The Woodlands
Venture Fund, L.P., for a purchase price of $.001 per share. These shares were
issued in consideration for providing additional financing pending the
completion of the offering of Series A Preferred Stock. The Company recorded an
expense of $75,984 for the difference between the market value of these shares
and the amount received.
The acquisition of FTI required a final payment based upon the market price per
share of common stock at January 31, 1997, and whether FTI achieves certain
earnings milestones. On January 31, 1997, the Company issued 305,095 shares of
common stock as final payment.
Warrants
In connection with the Offering, the Company issued to the underwriter warrants
to purchase 135,000 shares of common stock at an initial price per share equal
to 120 percent of the initial public offering price per share. These warrants
contain certain antidilution provisions providing for adjustment of the initial
exercise price and the number and type of securities issuable upon exercise of
the warrants upon certain conditions. These warrants were recorded at zero
value in the accompanying financial statements because the value was determined
to be de minimis when issued. In 1995, as a result of the sale of Series A
Preferred Stock, these warrants were converted into warrants to purchase 245,459
shares of common stock for $3.63 per share. In November 1996, as a result of the
sale of Series B Preferred Stock, the remaining warrants were converted into
warrants to purchase 37,898 shares of common stock for $2.46 per share. During
1996, warrants for 227,776 shares were exercised for total proceeds of $826,823.
From January 1, 1997, through March 11, 1997, warrants for 12,228 shares of
common stock were exercised by their holders.
In connection with the October 1995 sale of Series A Preferred Stock, the
Company issued warrants to the placement agent to purchase 59,885 shares of
Series A Preferred Stock at a price of $11.00 per share. These warrants expire
in 2000. These warrants were recorded at zero value in the accompanying
financial statements because the value was determined to be de minimis when
issued. During 1996, Series A warrants were exercised and converted into 4,168
shares of common stock under a cashless exercise provision. From January 1,
1997, through March 11, 1997, 33,521 Series A warrants were exercised and
converted into 70,112 shares of common stock under a cashless exercise
provision.
F-15
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In connection with the issuance of Series B Preferred Stock, the Company issued
warrants to the placement agent to purchase 169,250 shares of Series B Preferred
Stock at a price of $11.00 per share. These warrants expire in 2001. These
warrants were recorded at estimated fair value of $405,269. The fair value of
these warrants is estimated on the date of grant using the Black Sholes option
pricing model with the following weighted average assumptions; risk-free
interest rates of 5.67 percent; no expected dividend yield, expected life of one
year and expected volatility of 65 percent.
8. STOCK OPTIONS:
The Company has two stock option plans for the granting of options to purchase a
minimum of 1,007,000 shares of common stock by its employees and consultants.
There are no significant differences between the provisions of each plan.
Options are generally granted with an exercise price per share equal to the fair
market value per share of common stock on the grant date. Vesting provisions
for each grant are determined by the board of directors and have generally been
20 percent on each anniversary of the grant date. All options expire no later
than the tenth anniversary of the grant date. At December 31, 1996, 275,866
options are available to be granted under these plans.
The Company also has a stock option plan for its nonemployee directors that may
grant options to purchase up to 115,000 shares of common stock. The plan
provides that each director receive options to purchase 5,000 shares of common
stock upon initial election to the board of directors and receive options to
purchase 2,500 shares at each reelection. These options are fully vested when
granted and expire no later than the tenth anniversary of the grant date. At
December 31, 1996, 26,658 options were available to be granted under this plan.
The Company accounts for its stock option plans under APB No. 25 and the related
Interpretations. 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.
In January 1994, the president of the Company was granted an option to purchase
50,000 shares of common stock. This option vests at 20 percent per year. The
difference between the market value of common stock at the date of grant and the
exercise price per common share was recorded as deferred compensation. Related
compensation expense is recognized over the five-year vesting period.
In January 1996, the Company granted a consultant stock options to purchase
10,000 shares of common stock as compensation for services rendered in 1996.
As a result of this option issuance, the Company recorded $98,745 of general and
administrative expense in 1996.
In December 1996, the executive committee of the board of directors approved the
adoption of a new nonemployee director stock option plan, subject to approval by
the full board of directors and the Company's stockholders. Upon execution of
this plan, stock options to purchase 175,000 shares of common stock will be
granted to the members of its board of directors.
F-16
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," which, if fully adopted, requires the Company to record stock-
based compensation at fair value. The Company has adopted the disclosure
requirements of SFAS No. 123 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 net loss per share
would have been increased to the following pro forma amounts:
For the Year Ended
December 31
------------------------
1996 1995
----------- -----------
Net loss-
As reported $9,470,334 $4,287,317
Pro forma 9,790,780 4,384,651
Loss per share-
As reported $ 1.92 $ 1.11
Pro forma 1.99 1.14
Because the SFAS No. 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years.
The following is a summary of all stock option activity:
Common Weighted
Shares Average
Under Exercise
Options Price
-------- --------
Outstanding at December 31, 1993 367,323 $3.831
Options granted 165,000 7.039
Options canceled (3,001) 4.119
-------
Outstanding at December 31, 1994 529,322 4.771
Options granted 172,500 4.156
Options exercised (4,546) 3.063
Options canceled (49,421) 5.881
-------
Outstanding at December 31, 1995 647,855 4.518
Options granted 206,650 7.794
Options exercised (23,100) 3.248
Options canceled (56,400) 6.105
-------
Outstanding at December 31, 1996 775,005 6.405
=======
Exercisable at December 31, 1994 169,742 3.332
Exercisable at December 31, 1995 249,986 3.816
Exercisable at December 31, 1996 349,364 4.093
F-17
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The exercise price of options outstanding at December 31, 1996, range from $.001
to $9.00. The weighted average contractual life of options outstanding at
December 31, 1996, was eight years.
The weighted average fair value of options granted in 1996 and 1995 was $5.39
and $2.14, respectively. The fair value of each option grant is estimated on
the date of grant using the Black-Scholes option pricing model with the
following weighted average assumptions used for grants in 1996 and 1995,
respectively, risk-free interest rates of 6.19 percent and 6.06 percent; no
expected dividend yields for both years, expected lives of 6 years and expected
volatility of 65 percent and 44 percent.
9. LICENSE, RESEARCH AND
DEVELOPMENT AGREEMENTS:
During 1996, the Company entered into agreements with two contract research
organizations, PPD Pharmaco and Affiliated Research Centers, Inc., for the U.S.
clinical development of Vasomax(TM), the Company's oral treatment for male
impotency. The Company may terminate these agreements upon written notification
and payment of expenses incurred prior to termination. During 1996, the Company
made cash payments aggregating $3,162,000 and recorded payables and accrued
expenses of $821,000 as of December 31, 1996. Upon continued success of the U.S.
Vasomax(TM) clinical program, it is anticipated that the Company could spend in
excess of $10,000,000 in 1997 to continue the U.S. clinical development program.
If sufficient cash resources are not available, management intends to reduce
expenditures under these agreements.
In April 1994, the Company entered into an assignment agreement with Gamogen,
Inc. (the Gamogen Agreement), and Dr. Adrian Zorgniotti pursuant to which the
Company purchased the rights to a technology for the treatment of male
impotence, including rights to a U.S. patent application. In consideration for
the assignment of the subject technology, the Company provided Gamogen, Inc.
(Gamogen), with a cash payment of $100,000 in 1994. As consideration for
Gamogen's agreement not to compete, the Company delivered $200,000 or 19,512
shares of the Company's common stock in April 1996. Pursuant to the Gamogen
Agreement, Gamogen is to receive a predetermined royalty, based on the aggregate
net sales of any product developed from the subject technology. In addition,
the Company is required to conduct $100,000 per year of research through 1997 in
the area of male impotency. The Company has a right of first negotiation to
purchase or exclusively license improvements to any royalty-bearing product or
competing product developed by Gamogen.
On January 24, 1997, the Company signed an amendment to the Gamogen Agreement.
This amendment expires in 2000 and provides the Company with an option to
purchase back the royalty stream. The Company made an initial payment of
$75,000 upon execution of the amendment and is required to make additional
payments of $150,000 each year through 1999 or until the final purchase is
completed. The Company can cancel the amendment at any time through nonpayment.
The final purchase price, inclusive of amended payments previously made, is
dependent upon the date the option is exercised and will range from $750,000 up
to $1,750,000.
In November 1995, the Company entered into a one-year agreement with a physician
in Mexico to conduct a study to determine the effectiveness and safety of oral
tablets of phentolamine mesylate for the treatment of impotence in humans.
Under this agreement, the Company pays an hourly rate for services plus certain
other costs. That trial was completed in November 1996. Subsequently, the
Company has entered into an agreement
F-18
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
to run an open label study with Vasomax(TM) in Mexico that is expected to last
through the first quarter of 1998 and cost approximately $436,000 during that
time period. Also, the Company anticipates conducting studies in Mexico in 1997
for other product development opportunities.
In November 1995, the Company entered into a development and manufacturing
services agreement with a contract manufacturing organization for the
manufacture and validation of phentolamine mesylate for use in clinical trials
for the purpose of supporting an Investigational New Drug (IND) application.
Phentolamine mesylate is used in the Company's product which is in development
for the oral treatment of male impotence. The contract manufacturing
organization is also responsible for filing and in 1996 did file a Drug Master
File (DMF) with the U.S. Food and Drug Administration (FDA) in connection with
the manufacturing of phentolamine mesylate. The Company will be responsible for
manufacturing and packaging products in finished pharmaceutical form. The
agreement also provides for a possible future long-term supply agreement
regarding bulk phentolamine mesylate. The Company was required to pay the
contract manufacturing organization $447,000 payable in three installments
ending during the first quarter of 1996. Through December 31, 1996, the Company
has paid the total amount required under the contract.
On December 13, 1993, the Company entered into a corporate collaboration
agreement with Schering AG (Schering), a German company, to develop and
commercialize the human application of immunocontraceptive zona pellucida
technology. Under the agreement, the Company will continue to conduct research
studies of its zona pellucida technology, with a focus on identifying and
selecting a lead immunocontraceptive product for humans. Schering will then
conduct the necessary preclinical and clinical development studies of this and
subsequent immunocontraceptive products and will seek the necessary regulatory
approvals. The Company retains the manufacturing rights to the products, as
well as the responsibility to develop scaled-up manufacturing processes and
production capabilities. The Company also retains certain marketing and
manufacturing rights in India and China, and the right to co-promote the product
in the United States. Schering has exclusive marketing rights in all other
countries worldwide. Upon execution of this agreement, the Company sold 239,933
shares of common stock to Schering Berlin Venture Corporation (SBVC) for $2.5
million, or $10.42 per share. SBVC is a subsidiary of Schering AG.
10. RELATED PARTIES:
The Company leases office space from an affiliate of a stockholder of the
Company. The Company recorded rent expense of approximately $110,000, $67,000
and $68,000 during 1996, 1995 and 1994, respectively, related to this lease.
11. COMMITMENTS AND CONTINGENCIES:
On May 16, 1994, Dr. Bonita Sue Dunbar (Dunbar) filed suit in Harris County,
Texas, naming Baylor College of Medicine (BCM), BCM Technologies, Inc. (BCMT),
Fulbright & Jaworski, a Texas limited liability partnership, and the Company as
defendants (collectively, the Defendants). Dunbar is a cellular and molecular
biologist who has been employed by BCM as a teacher and research scientist since
1981. During the course of her employment at BCM, Dunbar developed technologies
relating to the use of certain recombinant zona pellucida peptides that were
assigned to the Company and which are the subject of the Company's only existing
patent. Dunbar claimed, among other things, that her assignment of the patent
rights was induced by statutory and constructive fraud and a civil conspiracy on
the part of the Defendants.
F-19
<PAGE>
ZONAGEN, INC., AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Court granted partial summary judgment in favor of the Company and
the other defendants in connection with the action. As a result of the rulings,
Dunbar is unable to rescind the assignment of the patent rights and is left only
with ancillary claims. Such ancillary claims are subject to a motion to sever
and abate pending Dunbar's appeal of the Court's orders granting the Company's
motion for summary judgment. The Company believes, based on discussions with
legal counsel, that the ancillary claims are without merit and will not have any
material adverse effect on the Company's financial condition and results of
operations.
F-20
<PAGE>
EXHIBIT 11.1
ZONAGEN, INC.
YEAR-TO-DATE WEIGHTED AVERAGE SHARES OUTSTANDING
AS OF DECEMBER 31, 1996
AVERAGE
SHARES
DATE SHARES DAYS OUTSTANDING
01/01/96 4,098,124 X 9= 36,883,116 101,050
01/10/96 4,102,251 X 7= 28,715,827 78,673
01/17/96 4,180,596 X 1= 4,180,596 11,454
01/18/96 4,188,871 X 6= 25,133,226 68,858
01/24/96 4,197,146 X 2= 8,394,292 22,998
01/26/96 4,207,146 X 4= 16,828,584 46,106
01/30/96 4,216,237 X 1= 4,216,237 11,551
01/31/96 4,224,512 X 1= 4,224,512 11,574
02/01/96 4,228,512 X 1= 4,228,512 11,585
02/02/96 4,248,198 X 3= 12,744,594 34,917
02/05/96 4,381,994 X 1= 4,381,994 12,005
02/06/96 4,400,176 X 3= 13,200,528 36,166
02/09/96 4,401,279 X 3= 13,203,837 36,175
02/12/96 4,456,451 X 1= 4,456,451 12,209
02/13/96 4,458,270 X 1= 4,458,270 12,214
02/14/96 4,468,270 X 1= 4,468,270 12,242
02/15/96 4,475,770 X 6= 26,854,620 73,574
02/21/96 4,558,528 X 7= 31,909,696 87,424
02/28/96 4,611,803 X 2= 9,223,606 25,270
03/01/96 4,625,596 X 6= 27,753,576 76,037
03/07/96 4,684,668 X 8= 37,477,344 102,678
03/15/96 4,698,461 X 3= 14,095,383 38,617
03/18/96 4,719,150 X 2= 9,438,300 25,858
03/20/96 4,724,150 X 5= 23,620,750 64,714
03/25/96 4,736,563 X 1= 4,736,563 12,977
03/26/96 4,751,563 X 2= 9,503,126 26,036
03/28/96 4,753,769 X 5= 23,768,845 65,120
04/02/96 4,828,526 X 2= 9,657,052 26,458
04/04/96 4,831,974 X 5= 28,991,844 79,430
04/10/96 4,846,320 X 3= 14,538,960 39,833
04/13/96 4,865,832 X 17= 82,719,144 226,628
04/30/96 4,872,728 X 23= 112,072,744 307,049
05/23/96 4,876,176 X 5= 24,380,880 66,797
05/28/96 4,880,178 X 8= 39,041,424 106,963
06/05/96 4,884,346 X 13= 63,496,498 173,963
06/18/96 4,925,725 X 20= 98,514,500 269,903
07/08/96 4,927,104 X 9= 44,343,936 121,490
07/17/96 4,927,504 X 7= 34,492,528 94,500
07/24/96 4,999,917 X 8= 39,999,336 109,587
08/01/96 5,006,813 X 6= 30,040,878 82,304
08/07/96 5,020,606 X 9= 45,185,454 123,796
08/16/96 5,021,206 X 4= 20,084,824 55,027
08/20/96 5,090,171 X 29= 147,614,959 404,425
09/18/96 5,117,757 X 5= 25,588,785 70,106
09/23/96 5,130,446 X 15= 76,956,690 210,840
10/08/96 5,137,337 X 2= 10,274,674 28,150
10/10/96 5,151,130 X 22= 113,324,860 310,479
11/01/96 5,151,730 X 13= 66,972,490 183,486
11/14/96 5,213,798 X 4= 20,855,192 57,138
11/18/96 5,227,591 X 2= 10,455,182 26,644
11/20/96 5,234,487 X 2= 10,468,974 28,682
11/22/96 5,241,383 X 3= 15,724,149 43,080
11/25/96 5,757,337 X 1= 5,757,337 15,774
11/28/96 5,764,884 X 15= 86,473,260 236,913
12/11/96 5,795,072 X 2= 11,590,144 31,754
12/13/96 5,803,072 X 3= 17,409,216 47,696
12/16/96 5,878,542 X 2= 11,757,084 32,211
12/18/96 5,904,956 X 1= 5,904,856 16,178
12/19/96 5,912,644 X 7= 41,388,508 113,393
12/26/96 5,927,738 X 1= 5,927,738 16,240
12/27/96 5,973,019 X 3= 17,919,057 49,093
12/30/96 6,033,395 X 1= 6,033,395 16,530
----- ------------- -----------
12/31/96 365 1,804,057,307 4,942,623
===== ============= ===========
Net Loss $(9,470,334)
-----------
Loss Per Share $ (1.92)
===========
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report included in this Form 10-K, into the Company's
previously filed Form S-8 dated May 17, 1993, Form S-8 dated August 29, 1994,
Form S-3 dated November 17, 1995 and Form S-3 dated December 9, 1996.
ARTHUR ANDERSEN LLP
The Woodlands, Texas
May 16, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF ZONAGEN, INC. SET FORTH IN THE COMPANY'S FORM 10-K FOR
THE TWELVE MONTHS ENDED DECEMBER 31, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 11,074,902
<SECURITIES> 0
<RECEIVABLES> 420,149
<ALLOWANCES> 0
<INVENTORY> 174,073
<CURRENT-ASSETS> 11,810,347
<PP&E> 1,017,444
<DEPRECIATION> 706,351
<TOTAL-ASSETS> 13,711,760
<CURRENT-LIABILITIES> 2,117,984
<BONDS> 0
0
1,515
<COMMON> 6,033
<OTHER-SE> 11,569,429
<TOTAL-LIABILITY-AND-EQUITY> 13,711,760
<SALES> 3,021,940
<TOTAL-REVENUES> 3,292,846
<CGS> 2,087,007
<TOTAL-COSTS> 12,763,180
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 224,476
<INCOME-PRETAX> (9,470,334)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,470,334)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,470,334)
<EPS-PRIMARY> (1.92)
<EPS-DILUTED> (1.92)
</TABLE>
