<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number: 0-21198
ZONAGEN, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 76-0233274
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
2408 Timberloch Place, Suite B-4
The Woodlands, Texas 77380
(Address of principal executive
offices and zip code)
(281) 367-5892
(Registrant's telephone number,
including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
------- ------
As of November 13, 1998 there were outstanding 11,205,840 shares of Common
Stock, par value $.001 per share, of the Registrant.
<PAGE>
ZONAGEN, INC.
(A development stage company)
For the Quarter Ended September 30, 1998
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS 3
PART I. FINANCIAL INFORMATION 4
Item 1. Financial Statements
Consolidated Balance Sheets: September 30, 1998 (Unaudited)
and December 31, 1997 5
Consolidated Statements of Operations: For the three months ended
September 30, 1998 and 1997, nine months ended September 30, 1998 and 1997
and from Inception (August 20, 1987) through September 30, 1998 (Unaudited) 6
Consolidated Statements of Cash Flows: For the three months ended
September 30, 1998 and 1997, nine months ended September 30, 1998 and 1997
and from Inception (August 20, 1987) through September 30, 1998 (Unaudited) 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 5. Other Information 20
Item 6. Exhibits and Reports on Form 8-K 21
SIGNATURES 22
</TABLE>
2
<PAGE>
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. The words
"anticipate," "believe," "expect," "estimate," "project" and similar expressions
are intended to identify forward-looking statements. Such statements are
subject to certain risks, uncertainties and assumptions. Should one or more of
these risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results may vary materially from those anticipated, believed,
expected, estimated or projected. These risks and uncertainties include risks
associated with the Company's early stage of development, uncertainties related
to clinical trial results and FDA approval, the Company's substantial dependence
on one product and early stage of development of other products, the Company's
history of operating losses and accumulated deficit, the Company's future
capital needs and uncertainty of additional funding, uncertainty of protection
for the Company's patents and proprietary technology, the effects of government
regulation of and lack of assurance of regulatory approval for the Company's
products, the Company's limited sales and marketing experience and dependence on
collaborators, manufacturing uncertainties and the Company's reliance on third
parties for manufacturing, competition and technological change, product
liability and availability of insurance, the Company's reliance on contract
research organizations, and other risks and uncertainties described in the
Company's filings with the Securities and Exchange Commission. For additional
discussion of such risks, uncertainties and assumptions, see "Item 1.
Description of Business - Business Risks" and "Item 3. Legal Proceedings"
included in the Company's Annual Report on Form 10-K for the year ended December
31, 1997 and "Part I. Financial Information - Item 2. Management's Discussion
and Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources" and "Part II. Other Information Item 1. Legal Proceedings"
included elsewhere in this quarterly report on Form 10-Q.
3
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The following unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all necessary adjustments
(which include only normal recurring adjustments) considered necessary for a
fair presentation have been included. Operating results for the nine month
period ended September 30, 1998 are not necessarily indicative of the results
that may be expected for the year ended December 31, 1998. For further
information, refer to the financial statements and footnotes thereto included in
the Company's Annual Report on Form 10-K for the year ended December 31, 1997.
4
<PAGE>
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ -------------
ASSETS (Unaudited)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 57,762,154 $ 73,761,823
Accounts receivable 381,771 514,734
Product inventory 1,268,970 206,913
Deposits and other current assets 975,527 270,407
------------ ------------
Total current assets 60,388,422 74,753,877
LAB EQUIPMENT, FURNITURE AND LEASEHOLD
IMPROVEMENTS, net of accumulated depreciation
and amortization of $998,489 and $827,688, respectively 711,271 557,199
EXCESS OF COST OVER FAIR VALUE OF TANGIBLE ASSETS ACQUIRED,
net of accumulated amortization of $812,709 and
$655,582, respectively 636,700 793,827
OTHER ASSETS, net of accumulated amortization of
$207,519 and $168,317, respectively 1,179,236 835,577
------------ ------------
Total assets $ 62,915,629 $ 76,940,480
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,834,083 $ 3,285,031
Accrued expenses 1,907,536 2,662,849
Current portion of notes payable 5,031 14,160
------------ ------------
Total current liabilities 3,746,650 5,962,040
------------ ------------
LONG TERM NOTES PAYABLE - 2,639
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred Stock, $.001 par value,
5,000,000 shares authorized, none issued and
outstanding - -
Common Stock, $.001 par value, 20,000,000 shares
authorized, 11,612,410 and 11,541,923 shares issued,
respectively; 11,197,110 and 11,480,423 shares
outstanding, respectively 11,612 11,542
Additional paid-in capital 113,619,009 113,236,136
Deferred compensation (1,067,677) (1,401,389)
Cost of treasury stock, 415,300 and 61,500 shares, respectively (7,483,473) (1,286,728)
Deficit accumulated during the development stage (45,910,492) (39,583,760)
------------ ------------
Total stockholders' equity 59,168,979 70,975,801
------------ ------------
Total liabilities and stockholders' equity $ 62,915,629 $ 76,940,480
============ ============
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
5
<PAGE>
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED FROM INCEPTION
---------------------------- ----------------------------- (AUGUST 20, 1987)
SEPTEMBER 30, SEPTEMBER 30, TO
1998 1997 1998 1997 SEPTEMBER 30, 1998
----------- ----------- ----------- ------------ ------------------
<S> <C> <C> <C> <C> <C>
REVENUES
Product sales $ 765,477 $ 855,312 $ 2,597,769 $ 2,457,147 $ 12,714,864
Licensing fees 5,000,000 - 10,000,000 - 20,250,000
Product royalties - - 167,170 - 167,170
Interest income 748,279 734,116 2,544,752 922,004 5,397,896
----------- ----------- ----------- ------------ -------------
Total revenues 6,513,756 1,589,428 15,309,691 3,379,151 38,529,930
COSTS AND EXPENSES
Cost of products sold 508,889 584,720 1,742,462 1,652,563 8,873,641
Research and development 4,646,129 6,084,613 16,837,743 14,580,030 57,904,766
Selling, general and administrative 977,677 720,117 2,894,623 2,035,626 16,054,163
Interest expense and amortization
of intangibles 52,557 55,290 161,595 163,879 1,244,469
----------- ----------- ----------- ------------ -------------
Total costs and expenses 6,185,252 7,444,740 21,636,423 18,432,098 84,077,039
Income (loss) from continuing operations 328,504 (5,855,312) (6,326,732) (15,052,947) (45,547,109)
Loss from discontinued operations - - - - (288,104)
Loss on disposal - - - - (75,279)
----------- ----------- ----------- ------------ -------------
NET INCOME (LOSS) $ 328,504 $(5,855,312) $(6,326,732) $(15,052,947) $ (45,910,492)
=========== =========== =========== ============ =============
Income (loss) per share:
Basic $ 0.03 $ (0.57) $ (0.56) $ (1.82)
Diluted $ 0.03 $ (0.57) $ (0.56) $ (1.82)
Shares used in income (loss)
per share calculation:
Basic 11,263,484 10,307,576 11,298,478 8,270,676
Diluted 11,810,230 10,307,576 11,298,478 8,270,676
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
6
<PAGE>
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED From Inception
-------------------------- ----------------------------(August 20, 1987)
SEPTEMBER 30, SEPTEMBER 30, through
1998 1997 1998 1997 September 30, 1998
------------ ------------ ------------ ------------ -------------
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 328,504 $ (5,855,312) $ (6,326,732) $ (15,052,947) $ (45,910,492)
Loss on disposal of discontinued operations - - - - 75,279
Adjustments to reconcile net income (loss)
to net cash used in operating activities
Noncash financing costs - - - - 315,984
Depreciation and amortization 126,491 95,946 367,129 284,756 1,969,183
Noncash expenses related to stock-based transactions 89,462 135,094 333,712 178,439 1,414,838
Common stock issued for agreement not to compete - - - - 199,997
Series B Preferred Stock issued for consulting services - - - - 17,999
Changes in operating assets and liabilities
(net effects of purchase of businesses in 1988 and 1994)
(Increase) decrease in receivables 335,099 (399,240) 132,963 (311,086) (176,806)
(Increase) decrease in inventory (762,570) (34,831) (1,062,057) (21,720) (987,442)
(Increase) decrease in prepaid expenses and other
current assets 129,932 163,104 (705,120) (81,507) (834,063)
(Decrease) increase in accounts payable and
accrued expenses (97,438) 444,717 (2,206,262) 1,573,070 3,524,305
------------ ------------ ------------ ------------ -------------
Net cash provided by (used in) in operating activities 149,480 (5,450,522) (9,466,367) (13,430,995) (40,391,218)
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (111,192) (93,884) (324,873) (210,602) (1,603,015)
Purchase of technology rights and other assets (83,108) (154,318) (382,860) (204,652) (1,354,737)
Cash acquired in purchase of FTI - - - - 2,695
Proceeds from sale of subsidiary, less $12,345 for
operating losses during 1990 phase-out period - - - - 137,646
Increase in net assets held for disposal - - - - (212,925)
------------ ------------ ------------ ------------ -------------
Net cash used in investing activities (194,300) (248,202) (707,733) (415,254) (3,030,336)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock 4,672 72,830,894 382,944 72,970,978 83,868,794
Proceeds from issuance of preferred stock - - - - 23,688,522
Purchase of treasury stock (2,174,413) - (6,196,745) - (7,483,473)
Proceeds from issuance of notes payable - - - - 2,838,681
Principal payments on notes payable (4,020) (3,644) (11,768) (10,668) (1,728,816)
------------ ------------ ------------ ------------ -------------
Net cash provided by (used in) financing activities (2,173,761) 72,827,250 (5,825,569) 72,960,310 101,183,708
------------ ------------ ------------ ------------ -------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (2,218,581) 67,128,526 (15,999,669) 59,114,061 57,762,154
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 59,980,735 3,060,437 73,761,823 11,074,902 -
------------ ------------ ------------ ------------ -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 57,762,154 $ 70,188,963 $ 57,762,154 $ 70,188,963 $ 57,762,154
============ ============ ============ ============ =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
Reduction of debt due to final payment, in stock,
of FTI Acquisition $ - $ - $ - $ 93,812 $ 93,812
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
7
<PAGE>
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(Unaudited)
NOTE 1 -- ORGANIZATION AND OPERATIONS
Zonagen, Inc., a Delaware corporation (together with its subsidiary, the
"Company"), was organized on August 20, 1987 (Inception) and is a
biopharmaceutical company in the development stage engaged in the research,
development and marketing of products which address conditions and diseases
associated with the human reproductive system. In addition to its proprietary
development activities, the Company markets and distributes a variety of third-
party fertility-related products to obstetrics/gynecology, urology and fertility
specialists through its wholly-owned subsidiary, Fertility Technologies, Inc.
("FTI"). From Inception through September 30, 1998, the Company has been
primarily engaged in research and development and is still in a development
stage.
The Company has experienced negative cash flows from operations since its
inception and has funded its activities to date primarily from equity
financings and corporate collaborations. The Company will continue to require
substantial funds to continue research and development, including preclinical
studies and clinical trials of its products, and to commence sales and marketing
efforts if U.S. Food and Drug Administration ("FDA") and other regulatory
approvals are obtained. The Company believes that its existing capital resources
will be sufficient to fund its operations through at least the end of 2000. The
Company's capital requirements will depend on many factors, including the
problems, delays, expenses and complications frequently encountered by
development stage companies; the progress of the Company's clinical and
preclinical activities; the progress of the Company's collaborative agreements
with affiliates of Schering-Plough Corporation ("Schering-Plough") and costs
associated with any future collaborative research, manufacturing, marketing or
other funding arrangements; the costs and timing of seeking regulatory approvals
of Vasomax(R), the Company's oral treatment for male erectile dysfunction, and
the Company's other products; the Company's ability to obtain regulatory
approvals; the success of the Company's sales and marketing programs; the cost
of filing, prosecuting and defending and enforcing any patent claims and other
intellectual property rights; and changes in economic, regulatory or competitive
conditions of the Company's planned business. Estimates about the adequacy of
funding for the Company's activities are based on certain assumptions, including
the assumption that the development and regulatory approval of the Company's
products can be completed at projected costs and that product approvals and
introductions will be timely and successful. There can be no assurance that
changes in the Company's research and development plans, acquisitions or other
events will not result in accelerated or unexpected expenditures. To satisfy its
capital requirements, the Company may seek to raise additional funds in the
public or private capital markets. The Company's ability to raise additional
funds in the public or private markets will be adversely affected if Vasomax(R)
is not successfully commercialized and if the results of current or future
clinical trials are not favorable. The Company may seek additional funding
through corporate collaborations and other financing vehicles. There can be no
assurance that any such funding will be available to the Company on favorable
terms or at all. If adequate funds are not available, the Company may be
required to curtail significantly one or more of its research or development
programs, or it may be required to obtain funds through arrangements with future
collaborative
8
<PAGE>
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(Unaudited)
partners or others that may require the Company to relinquish rights to some or
all of its technologies or products. If the Company is successful in obtaining
additional financing, the terms of such financing may have the effect of
diluting or adversely affecting the holdings or the rights of the holders of the
Company's Common Stock.
NOTE 2 -- PRODUCT INVENTORY
The Company maintains an inventory of bulk phentolamine which is the active
ingredient in Vasomax(R), the Company's oral treatment for male erectile
dysfunction. Currently, Schering-Plough is manufacturing and marketing
Vasomax(R) in Mexico under the brand name Z-Max. Schering-Plough purchases bulk
phentolamine from the Company at approximately the Company's cost. As of
September 30, 1998, the fair market value of this bulk raw material inventory
was $1,060,545. Additionally, the Company's inventory consists of products
manufactured by others for resale to obstetrics/gynecologists, urologists and
fertility clinics. Finished goods inventory at September 30, 1998 was $208,425.
Inventory is stated at the lower of cost or market using the first-in, first-out
method.
NOTE 3 -- DEPOSITS AND OTHER CURRENT ASSETS
During the nine months ended September 30, 1998, deposits and other current
assets increased to approximately $976,000. The increase was due to partial
prepayments on future phentolamine purchases from the contract manufacturer. As
of September 30, 1998, prepayments held by the contract manufacturer were
$396,000. Other deposits and other current assets, substantially all of which
were prepaid insurance and interest receivable, totaled $580,000 as of
September 30, 1998.
NOTE 4 -- STOCKHOLDERS' EQUITY
Common Stock
On July 25, 1997, the Company completed a public offering of Common Stock in
which it sold 2,587,500 shares of Common Stock (including the shares issued
pursuant to the exercise of the underwriters' over-allotment option) at a price
of $30.00 per share. The net proceeds of the public offering were approximately
$72.2 million.
Warrants
No warrants were exercised during the first quarter of 1998. During the second
quarter of 1998, the Company issued an aggregate of 8,049 shares of Common Stock
upon the cashless exercise of stock warrants to purchase an aggregate of 10,078
shares of Common Stock. During the third quarter of 1998, the Company issued an
aggregate of 3,146 shares of Common Stock upon the cashless exercise of stock
warrants to purchase an aggregate of 4,373 shares of Common Stock.
9
<PAGE>
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(Unaudited)
As of September 30, 1998 there were 115,469 warrants outstanding exercisable
for an aggregate of 187,603 shares of Common Stock at prices ranging from $3.625
to $7.19 per share. All warrants outstanding have a cashless exercise provision.
Treasury Stock
On December 12, 1997 the Company announced a stock buyback of the Company's
Common Stock. The purchases are to be made from time to time in the open market
at prevailing market prices. As of December 31, 1997 the Company had purchased
a total of 61,500 shares at an aggregate purchase price of $1,286,728,
representing an average price of $20.922 per share. During the quarter ended
March 31, 1998 the Company purchased an additional 226,800 shares at an
aggregate purchase price of $4,022,332, representing an average price of $17.735
per share. The Company did not purchase any stock during the quarter ended
June 30, 1998. During the quarter ended September 30, 1998 the Company purchased
an additional 127,000 shares at an aggregate purchase price of $2,175,218,
representing an average price of $17.128 per share. Through November 13, 1998,
the Company had purchased an aggregate of 415,300 shares of Common Stock under
the stock buyback program at an aggregate purchase price of $7,484,278,
representing an average purchase price of $18.021 per share.
NOTE 5 -- STOCK OPTIONS
The Company records and amortizes over the related vesting periods deferred
compensation representing the difference between the exercise price of options
granted and the deemed fair market value of the Common Stock at the time of
grant. The Company recorded compensation expense of approximately $69,500 in the
quarter ending September 30, 1998 related to the amortization of deferred
compensation recorded in connection with options granted under the 1996 Non-
employee Director Stock Option Plan (the "Director Plan"). Amortization of
deferred compensation recorded in connection with other option grants totaled
approximately $20,000 in the quarter ending September 30, 1998.
During the nine month period ended September 30, 1998, the Company granted
options, to directors, employees, and consultants, of 220,527 shares of Common
Stock at exercise prices ranging from $13.625 to $36.750. During the nine months
ended September 30, 1998, the Company issued an aggregate of 54,291 shares of
Common Stock upon the exercise of stock options, at prices ranging from $0.43 to
$22.25.
10
<PAGE>
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(Unaudited)
NOTE 6 -- AGREEMENTS
In November 1997, the Company entered into exclusive license agreements with
affiliates of Schering-Plough Corporation, a major U.S.-based pharmaceutical
company (including such affiliates, "Schering-Plough"), with respect to the
exclusive license of the Company's Vasomax(R) product for the treatment of male
erectile dysfunction. Under the agreement, Schering-Plough paid Zonagen an up-
front payment of $10.0 million and agreed to make subsequent milestone payments
up to an additional $47.5 million upon the successful achievement of specified
regulatory goals. Zonagen will receive escalating royalties on all product sales
under the Schering-Plough agreements.
On June 30, 1998 the Company received an accelerated milestone payment of $5.0
million from Schering-Plough that was paid at the completion of the clinical
program that was used in support of the New Drug Application ("NDA") for
Vasomax (R). The payment was due upon the submission of a NDA for Vasomax(R)
with the Food and Drug Administration ("FDA"). The Company submitted the NDA on
July 14, 1998.
On September 30, 1998 the Company received a milestone payment of $5.0 million
from Schering-Plough that was paid upon FDA acceptance for filing of the NDA for
Vasomax(R).
On June 12, 1997, the Company entered into an exclusive supply agreement with
a contract manufacturer under which the Company has agreed to purchase all of
its bulk phentolamine from the contract manufacturer for a period of five years.
The agreement will continue after the initial five-year term for consecutive one
year periods until terminated by either party. The agreement obligates the
Company to purchase specified minimum quantities of phentolamine and the
manufacturer to manufacture phentolamine exclusively for the Company.
In December 1993, the Company entered into an agreement with Schering AG (a
pharmaceutical company based in Germany that is not affiliated with Schering-
Plough), pursuant
11
<PAGE>
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(Unaudited)
to which the Company and Schering AG agreed to jointly research, develop and
test zona pellucida-based human contraceptive vaccines. Under the agreement, the
Company was required to bear all costs of the development of all such products
until the Company had developed a "lead compound" that met certain specified
standards for use in clinical trials. The agreement required Schering AG to make
payments to the Company upon certain research and development milestones, none
of which had been achieved, and to bear all costs of the development of the
vaccine after formulation of a lead compound. Schering AG was required to
purchase $2.5 million of Common Stock on or before June 9, 1998 to retain its
rights under the agreement beyond such date. Schering AG did not purchase the
shares of the Company's Common Stock required to maintain its rights under the
agreement; accordingly, the agreement terminated on June 9, 1998. As a result of
this termination, Schering AG and the Company have no further obligations under
the agreement, and all product rights under the agreement have reverted to the
Company.
NOTE 7 -- COMMITMENTS AND CONTINGENCIES
On May 16, 1994, Dr. Bonita Sue Dunbar ("Dunbar") filed suit in the 270th
District Court of Harris County, Texas naming Baylor College of Medicine
("BCM"), BCM Technologies, Inc., Fulbright & Jaworski, L.L.P., The Woodlands
Venture Capital Company and the Company as defendants (collectively, the "Dunbar
Defendants"). Dunbar is a cellular and molecular biologist who has been
employed by BCM as a teacher and research scientist since 1981. During the
course of her employment at BCM, Dunbar developed technologies relating to the
use of certain recombinant zona pellucida peptides, the intellectual property
rights to which were assigned to the Company in 1987. Dunbar claimed, among
other things, that her assignment of the patent rights was induced by statutory
and constructive fraud and a civil conspiracy on the part of the Dunbar
Defendants. The court granted partial summary judgment in favor of the Company
and the other Dunbar Defendants in connection with the action. As a result of
the rulings Dunbar is unable to rescind the assignment of the patent rights and
is left only with ancillary claims regarding the Company's alleged conversion of
her ideas relating to endometriosis and ovarian cancer. Such ancillary claims
are subject to a motion to sever and abate pending Dunbar's appeal of the
court's orders granting the motion for summary judgment. The Company believes
the ancillary claims are without merit.
Certain purported class action complaints alleging violations of Sections
10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder
have been filed against the Company and certain of its officers and directors.
These complaints were filed in the United States District Court for the Southern
District of Texas in Houston, Texas and were consolidated on May 29, 1998. The
plaintiffs purport to bring the suit on behalf of all purchasers of Zonagen
common stock between February 7, 1996 and January 9, 1998. The plaintiffs
assert that the defendants made materially false and misleading statements and
failed to disclose material facts
12
<PAGE>
ZONAGEN, INC. AND SUBSIDIARY
(A development stage company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(Unaudited)
about the patents and patent applications of the Company relating to Vasomax(R)
and ImmuMax(TM), and about the Company's clinical trials of Vasomax(R). The
plaintiffs seek to have the action declared to be a class action, and to have
rescissionary or compensatory damages in an unstated amount, along with interest
and attorney's fees. The Company and the individual defendants believe that
these actions are without merit and intend to defend against them vigorously. No
estimate of loss or range of estimate of loss, if any, can be made at this time.
The Company is involved in certain other litigation matters which it believes
will not have a material adverse effect on the Company.
13
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Such statements reflect
the Company's current views with respect to future events and financial
performance and are subject to certain risks, uncertainties and assumptions.
Should one or more of these risks or uncertainties materialize, or should
underlying assumptions prove incorrect, actual results may vary materially from
those anticipated in such forward-looking statements. See "Factors Affecting
Forward-Looking Statements" included elsewhere in this Quarterly Report on Form
10-Q.
OVERVIEW
Zonagen, Inc. (the "Company") is a biopharmaceutical company in the
development stage engaged in the research, development and marketing of products
which address conditions and diseases associated with the human reproductive
system. In addition to its proprietary development activities, the Company
markets and distributes a variety of third-party fertility-related products to
obstetrics/gynecology, urology and fertility specialists through its wholly
owned subsidiary, Fertility Technologies, Inc. ("FTI"). The Company's objective
is to become a leading provider of innovative products and services for the
management of reproductive health.
On July 14, 1998, the Company submitted a New Drug Application (an "NDA")
with the U.S. Food and Drug Administration (the "FDA") for its lead product
candidate, Vasomax(R), an oral treatment for male erectile dysfunction. The
Company has dedicated a substantial portion of its resources over the last
several years to the development of Vasomax(R). The Company's future prospects
are substantially dependent on approval by the FDA and the successful
commercialization of Vasomax(R). On September 24, 1998 the Company announced
FDA acceptance for filing of the NDA for Vasomax(R). There can be no assurance
that the Company's NDA filing for Vasomax(R) will be approved by the FDA or that
Vasomax(R) will be successfully commercialized. Certain risks and uncertainties
associated with the filing and FDA review of the NDA are described or referenced
in "Factors Affecting Forward-Looking Statements" included elsewhere in this
Quarterly Report on Form 10-Q.
In November 1997, the Company entered into exclusive license agreements
with affiliates of Schering-Plough Corporation (including such affiliates,
"Schering-Plough") with respect to the exclusive worldwide license to market and
sell the Company's Vasomax(R) product for the treatment of male erectile
dysfunction. Schering-Plough filed a Product Registration Application in
Mexico for Vasomax(R) under the brand name Z-Max in March 1998, and commenced
sales of Z-Max in Mexico in June 1998. Schering-Plough made an accelerated
milestone payment to the Company of $5.0 million on June 30, 1998, at the
completion of the clinical program that was used in support of the NDA. The
payment was due upon the submission of a NDA for Vasomax(R) with the FDA. The
Company submitted the NDA on July 14, 1998.
On September 30, 1998 the Company received a milestone payment of $5.0
million from Schering-Plough that was paid upon FDA acceptance for filing of the
NDA for Vasomax(R). Schering-Plough filed a Marketing Authorization Application
with the Medicines Control Agency
14
<PAGE>
("MCA") in the United Kingdom for Vasomax(R) in August 1998. Schering-Plough
intends to file Market Authorization Applications in all other countries in the
European Union ("EU") using the EU Mutual Recognition Procedure following
approval in the U.K.
Substantially all of the Company's product revenues are derived from sales of
third-party fertility-related products by FTI. The Company acquired FTI in 1994
to enter the market for female reproductive healthcare products and services.
Revenues from FTI will not be sufficient to fund the Company's planned
operations.
As of September 30, 1998, the Company had an accumulated deficit of
approximately $45.9 million. There can be no assurance that the Company will be
able to successfully complete the transition from a development stage company to
the successful introduction of commercially viable products. The Company's
ability to achieve profitability will depend, among other things, on
successfully completing the development of its products, obtaining regulatory
approvals, establishing marketing, sales and manufacturing capabilities or
collaborative arrangements with others which possess such capabilities, and
raising sufficient funds to finance its activities. There can be no assurance
that the Company will be able to achieve profitability or that profitability, if
achieved, can be sustained.
The Company is working to resolve the potential impact of the year 2000
issue on the ability of the Company's computerized information systems to
accurately process information that may be date sensitive. Any of the
Company's programs that recognize a date using the "00" as the year 1900 rather
than the year 2000 could result in errors or system failures. The Company
utilizes a number of computer programs across its entire operation. The Company
has not completed its assessment, but currently believes that costs of
addressing this issue will not have a material adverse impact on the Company's
financial position. However, if the Company and third parties upon which it
relies are unable to address this issue in a timely manner, it could result in a
material financial risk to the Company. In order to assure that this does not
occur, the Company plans to devote all resources required to resolve any
significant year 2000 issues in a timely manner.
RESULTS OF OPERATIONS
Three months ended September 30, 1998 and 1997
Revenues. Total revenues increased 306% to $6.5 million for the quarter
ended September 30, 1998 as compared to $1.6 million for the same period in the
prior year. License fee revenue increased to $5.0 million during the quarter
ended September 30, 1998 from none during the third quarter of 1997. This
increase was due to the Company's receipt of a milestone payment under its
agreements with Schering-Plough with respect to Vasomax(R). Schering-Plough
commenced sales of Vasomax(R) in Mexico under the brand name of Z-Max in June
1998. There were no product royalties earned for the quarter ended
September 30, 1998, due to the product launch loading into the distribution
channel in June 1998. Product sales, substantially all of which were derived
from FTI, decreased 10% to $765,000 in the quarter ended September 30, 1998 as
compared to $855,000 for the same period in the prior year. The decrease was due
primarily to vendor backorders which were shipped to customers in the fourth
quarter of 1998. Interest revenues remained relatively constant for the quarter
ended September 30, 1998 as compared to the same period in the prior year.
15
<PAGE>
Cost of Products Sold. Cost of products sold decreased 13% to $509,000 for
the quarter ended September 30, 1998 as compared to $585,000 for the same period
in the prior year. The decrease was mainly due to a change in the composition
of products sold. Gross margin from product sales increased to 34% during the
third quarter of 1998 as compared to 32% for the same period in the prior year
due to a change in product mix which included a higher percentage of higher
margin disposable products.
Research and Development Expenses. Research and development ("R&D") expenses
include internal and contracted research and regulatory affairs. R&D expenses
decreased 25% to $4.6 million for the quarter ended September 30, 1998 as
compared to $6.1 million for the same period in the prior year. The decrease was
due primarily to a decline in contracted costs associated with the development
of Vasomax(R). These contracted costs decreased 38% to approximately $3.5
million during the quarter ended September 30, 1998 as compared to approximately
$5.6 million during the same period in the prior year. The reduction in
contracted costs associated with the development of Vasomax(R) is a result of
a reduction in contract research and regulatory activity following the July 14,
1998 NDA submission to the FDA for Vasomax(R). The Company will continue to
incur costs in connection with the further development of Vasomax(R) until the
regulatory process is complete. General R&D expenses increased 145% to
approximately $1.2 million as compared to $489,000 during the same period in the
prior year. This increase was mainly due to expenses associated with hiring
additional personnel and expansion of the Company's research and drug screening
capabilities. During the second and third quarters of 1998 the Company
established an in-house regulatory group. This group currently consists of five
individuals that manage the Company's regulatory issues and contract research
organizations ("CRO") that are utilized to conduct current and future clinical
development projects. The Company expects its research and development expenses
to increase during the remainder of 1998 and for at least the next several
years.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 36% to $978,000 during the quarter ended
September 30, 1998 from $720,000 in the third quarter of 1997. The increase was
primarily due to legal expenses relating to litigation, filed in 1998 and
additional professionals to strengthen its current management team to assist in
achieving the Company's goals.
Interest Expense and Amortization of Intangibles. Interest expense and
amortization of intangibles remained relatively constant in the third quarter of
1998 as compared to 1997. The Company recorded $53,000 of amortization during
the third quarter of 1998 related to the excess of cost over fair value of
tangible assets associated with the acquisition of FTI.
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
Revenues. Total revenues increased 350% to $15.3 million for the nine months
ended September 30, 1998 as compared to $3.4 million for the same period in the
prior year. License fee revenue increased to $10.0 million during the period
ended September 30, 1998 from none during the same period in the prior year.
This increase was due to the Company's receipt of a $5 million milestone
payment in June 1998 under its agreements with Schering-Plough with respect to
Vasomax(R). Schering-Plough commenced sales of Vasomax(R) in Mexico under the
brand name of Z-Max in June 1998. On September 30, 1998 the Company received
another milestone payment of $5.0 million from Schering-Plough that was paid
upon FDA acceptance for filing of the NDA for
16
<PAGE>
Vasomax(R). Product royalties from sales of Vasomax(R) in Mexico for the nine
months ended September 30, 1998, were $167,170 as compared to none for the nine
months ended September 30, 1997. Product sales, substantially all of which were
derived from FTI, increased 4% to $2.6 million in the nine months ended
September 30, 1998 as compared to $2.5 million for the same period in the prior
year. Interest revenues increased to $2.5 million for the nine months ended
September 30, 1998 as compared to $922,000 for the same period in the prior
year. The increase was due to increased cash balances as a result of a public
offering completed in July 1997, a $10 million up-front payment under the
Schering-Plough agreements in November 1997 and the $10 million milestone
payments received relating to the Schering-Plough agreements in 1998.
Cost of Products Sold. Cost of products sold increased 5% to $1.74 million
for the nine months ended September 30, 1998 as compared to $1.65 million for
the same period in the prior year. The increase was due to increased product
sales by FTI. Gross margin from product sales remained relatively constant at
approximately 33% during the nine months of 1998 as compared to the same period
in the prior year.
Research and Development Expenses. Research and development ("R&D") expenses
include internal and contracted research and regulatory affairs. R&D increased
15% to $16.8 million for the nine months ended September 30, 1998 as compared to
$14.6 million for the same period in the prior year. The increase was due
primarily to contracted costs associated with the development of Vasomax(R)
prior to the submission of the NDA to the FDA. Contracted costs associated with
the development of Vasomax(R) decreased 5% to approximately $13.8 million during
the nine months ended September 30, 1998 as compared to approximately $14.6
million during the same period in the prior year. General R&D expenses increased
76% to approximately $3.0 million as compared to $1.7 million during the same
period in the prior year. This increase was primarily due to expenses associated
with hiring additional personnel and expanding the Company's research and drug
screening capabilities. During the second and third quarters of 1998, the
Company established an in-house regulatory group. This group currently consists
of five individuals that manage the Company's regulatory issues and contract
research organizations ("CRO") that are utilized to conduct current and future
clinical development projects. The Company expects its research and development
expenses to increase during the remainder of 1998 and for at least the next
several years.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 45% to $2.9 million during the nine months
ended September 30, 1998 from $2.0 million for the same period in the prior
year. The increase was primarily due to expenses associated with litigation
filed in 1998, increased expenses associated with operating a public company due
to an increase in shareholders and the hiring of additional professionals to
strengthen its current management team to assist in achieving the Company's
goals. Additionally, the increase was due to non-cash director stock option
expenses which will be recognized over the twelve month period of 1998 as
compared to the total expense for the year of 1997 which was recognized all in
the fourth quarter of 1997.
Interest Expense and Amortization of Intangibles. Interest expense and
amortization of intangibles remained relatively constant during the nine months
ended September 30, 1998 as compared to the same period in the prior year. The
Company recorded $162,000 of amortization during the nine months ended September
30, 1998 related to the excess of cost over fair value of tangible assets
associated with the acquisition of FTI.
17
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has financed its operations primarily with
proceeds from the private placement and public offering of equity securities and
with funds received under collaborative agreements. In April 1993, the Company
received net proceeds of approximately $7.0 million from its initial public
offering. In December 1993, the Company received net proceeds of $2.5 million
from the sale of Common Stock to an affiliate of Schering AG in connection with
the Company's collaboration with Schering AG. In October 1995, the Company
received net proceeds of $5.3 million from the private placement of Series A
Preferred Stock. In September and October 1996, the Company received aggregate
net proceeds of $14.4 million from the private placement of Series B Preferred
Stock. In July 1997, the Company received net proceeds of approximately $72.2
million from a public offering of Common Stock. In December 1997, the Company
received a $10.0 million up-front license fee from Schering-Plough for the right
to market and sell Vasomax(R) for the treatment of male erectile dysfunction.
On June 30, 1998, the Company received an accelerated $5.0 million milestone
payment from Schering-Plough with respect to Vasomax(R). On September 30, 1998,
the Company received an additional $5.0 million milestone payment from Schering-
Plough with respect to Vasomax(R).
The Company used net cash of approximately $9.5 million for operating
activities in the nine months ended September 30, 1998 as compared to
approximately $13.4 million in the nine months ended September 30, 1997. The
Company had cash and cash equivalents of approximately $57.8 million at
September 30, 1998. The variance for the nine months ended September 30, 1998
was due primarily to the receipt of milestone payments from Schering-Plough
partially offset by higher research and development and general and
administrative expenses.
The Company has experienced negative cash flows from operations since its
inception and has funded its activities to date primarily from equity
financings and corporate collaborative agreements. The Company will continue to
require substantial funds to continue research and development, including
preclinical studies and clinical trials of its products, and to commence sales
and marketing efforts if FDA and other regulatory approvals are obtained. The
Company believes that its existing capital resources will be sufficient to fund
its operations through at least the end of 2000. The Company's capital
requirements will depend on many factors, including the problems, delays,
expenses and complications frequently encountered by development stage
companies; the progress of the Company's clinical and preclinical activities;
the progress of the Company's collaborative agreements with affiliates of
Schering-Plough and costs associated with any future collaborative research,
manufacturing, marketing or other funding arrangements; the costs and timing of
seeking regulatory approvals of Vasomax(R) and the Company's other products; the
Company's ability to obtain regulatory approvals; the success of the Company's
sales and marketing programs; the cost of filing, prosecuting and defending and
enforcing any patent claims and other intellectual property rights; and changes
in economic, regulatory or competitive conditions of the Company's planned
business. Estimates about the adequacy of funding for the Company's activities
are based on certain assumptions, including the assumption that the development
and regulatory approval of the Company's products can be completed at projected
costs and that product approvals and introductions will be timely and
successful. There can be no assurance 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
18
<PAGE>
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 and the commercialization of Vasomax(R) 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.
19
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On May 16, 1994, Dr. Bonita Sue Dunbar ("Dunbar") filed suit in the 270th
District Court of Harris County, Texas naming Baylor College of Medicine
("BCM"), BCM Technologies, Inc., Fulbright & Jaworski, L.L.P., The Woodlands
Venture Capital Company and the Company as defendants (collectively, the "Dunbar
Defendants"). Dunbar is a cellular and molecular biologist who has been
employed by BCM as a teacher and research scientist since 1981. During the
course of her employment at BCM, Dunbar developed technologies relating to the
use of certain recombinant zona pellucida peptides, the intellectual property
rights to which were assigned to the Company in 1987. Dunbar claimed, among
other things, that her assignment of the patent rights was induced by statutory
and constructive fraud and a civil conspiracy on the part of the Dunbar
Defendants. The court granted partial summary judgment in favor of the Company
and the other Dunbar Defendants in connection with the action. As a result of
the rulings Dunbar is unable to rescind the assignment of the patent rights and
is left only with ancillary claims regarding the Company's alleged conversion of
her ideas relating to endometriosis and ovarian cancer. Such ancillary claims
are subject to a motion to sever and abate pending Dunbar's appeal of the
court's orders granting the motion for summary judgment. The Company believes
the ancillary claims are without merit.
Certain purported class action complaints alleging violations of Sections
10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder
have been filed against the Company and certain of its officers and directors.
These complaints were filed in the United States District Court for the Southern
District of Texas in Houston, Texas and were consolidated on May 29, 1998. The
plaintiffs purport to bring the suit on behalf of all purchasers of Zonagen
common stock between February 7, 1996 and January 9, 1998. The plaintiffs
assert that the defendants made materially false and misleading statements and
failed to disclose material facts about the patents and patent applications of
the Company relating to Vasomax(R) and ImmuMax(TM), and about the Company's
clinical trials of Vasomax(R). The plaintiffs seek to have the action declared
to be a class action, and to have rescissionary or compensatory damages in an
unstated amount, along with interest and attorney's fees. The Company and the
individual defendants believe that these actions are without merit and intend to
defend against them vigorously. No estimate of loss or range of estimate of
loss, if any, can be made at this time.
The Company is involved in certain other litigation matters which it
believes will not have a material adverse effect on the Company.
ITEM 5. OTHER INFORMATION
In December 1993, the Company entered into an agreement with Schering AG (a
pharmaceutical company based in Germany that is not affiliated with Schering-
Plough), pursuant to which the Company and Schering AG agreed to jointly
research, develop and test zona pellucida-based human contraceptive vaccines.
Schering AG was required to purchase $2.5 million of Common Stock on or before
June 9, 1998 to retain its rights under the agreement beyond such date.
Schering AG did not purchase the shares of the Company's Common Stock required
to maintain its rights under the agreement; accordingly, the agreement
terminated on
20
<PAGE>
June 9, 1998. As a result of this termination, Schering AG and the Company have
no further obligations under the agreements, and all product rights under the
agreement have reverted to the Company.
On July 23, 1998 the Company announced that the United States Patent Office
had issued a Notice of Allowance to the Company for a patent application
directed to one of the Company's chitosan-based adjuvants and immunogens
collectively known as the ImmuMax(TM) System. In addition, during July 1998 the
Company also received an issued patent for the ImmuMax(TM) System in Australia.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
--------
Exhibit No. Identification of Exhibit
----------- -------------------------
11.1 Statement Regarding Computation
of Net Loss Per Share
27.1 Financial Data Schedule
b. Reports on Form 8-K
-------------------
None.
21
<PAGE>
SIGNATURES
----------
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
ZONAGEN, INC.
Date: November 16, 1998
By: /s/ Joseph S. Podolski
-------------------------------
Joseph S. Podolski
President and
Chief Executive Officer
(Principal Executive Officer)
Date: November 16, 1998
By: /s/ Louis Ploth
-------------------------------
Louis Ploth
Vice President of Business
Development and Chief Financial Officer
(Principal Financial and Accounting Officer)
22
<PAGE>
EXHIBIT 11.1
STATEMENT REGARDING COMPUTATION OF NET INCOME (LOSS) PER SHARE
THREE MONTHS ENDED SEPTEMBER 30, 1998
- -------------------------------------
<TABLE>
<CAPTION>
Net Income Weighted Average Shares Outstanding Income per Share
---------- ----------------------------------- ----------------
<S> <C> <C> <C>
Basic $328,504 divided by 11,263,484 = $0.03
Diluted $328,504 divided by 11,810,230 = $0.03
</TABLE>
NINE MONTHS ENDED SEPTEMBER 30, 1998
- ------------------------------------
<TABLE>
<CAPTION>
Net Loss Weighted Average Shares Outstanding Loss per Share
---------- ----------------------------------- --------------
<S> <C> <C> <C>
Basic $6,326,732 divided by 11,298,478 = $0.56
Diluted $6,326,732 divided by 11,298,478 = $0.56
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted from
the consolidated balance sheets and consolidated statements of operations found
on page 5 and 6 of the Company's 10-Q for the year-to-date, and is qualified in
its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 57,762,154
<SECURITIES> 0
<RECEIVABLES> 381,771
<ALLOWANCES> 0
<INVENTORY> 1,268,970
<CURRENT-ASSETS> 60,388,422
<PP&E> 1,709,760
<DEPRECIATION> (998,489)
<TOTAL-ASSETS> 62,915,629
<CURRENT-LIABILITIES> 3,746,650
<BONDS> 0
<COMMON> 11,612
0
0
<OTHER-SE> 59,157,367
<TOTAL-LIABILITY-AND-EQUITY> 62,915,629
<SALES> 2,597,769
<TOTAL-REVENUES> 15,309,691
<CGS> 1,742,462
<TOTAL-COSTS> 1,742,462
<OTHER-EXPENSES> 19,732,366
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 161,595
<INCOME-PRETAX> (6,326,732)
<INCOME-TAX> 0
<INCOME-CONTINUING> (6,326,732)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,326,732)
<EPS-PRIMARY> (0.56)
<EPS-DILUTED> (0.56)
</TABLE>
