10-Q 1 h05782e10vq.txt ZONAGEN, INC.- PERIOD ENDED MARCH 31, 2003 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 March 31, 2003 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------ ------------ Commission file number: 0-21198 ZONAGEN, INC. (Exact Name of Registrant as Specified in its Charter) Delaware 76-0233274 (State or other jurisdiction of (IRS Employer Identification incorporation or organization) 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 --- --- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X --- --- As of April 29, 2003, there were outstanding 11,511,849 shares of Common Stock, par value $.001 per share, of the Registrant. ZONAGEN, INC. (A development stage company) For the Quarter Ended March 31, 2003 INDEX
PAGE ---- FACTORS AFFECTING FORWARD-LOOKING STATEMENTS 3 PART I. FINANCIAL INFORMATION 4 Item 1. Financial Statements Consolidated Balance Sheets: March 31, 2003 (Unaudited) and December 31, 2002 5 Consolidated Statements of Operations: For the three months ended March 31, 2003 and 2002 and from Inception (August 20, 1987) through March 31, 2003 (Unaudited) 6 Consolidated Statements of Cash Flows: For the three months ended March 31, 2003 and 2002 and from Inception (August 20, 1987) through March 31, 2003 (Unaudited) 7 Notes to Consolidated Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Item 3. Quantitative and Qualitative Disclosures About Market Risk 17 Item 4. Controls and Procedures 17 PART II. OTHER INFORMATION Item 1. Legal Proceedings 19 Item 6. Exhibits and Reports on Form 8-K 19 SIGNATURES 20 CERTIFICATION 21
2 FACTORS AFFECTING FORWARD-LOOKING STATEMENTS This quarterly report on Form 10-Q includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The words "may," "anticipate," "believe," "expect," "estimate," "project," "suggest," "intend" and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, believed, expected, estimated, projected, suggested or intended. These risks and uncertainties include risks associated with the Company's ability to find a strategic alternative, the Company's early stage of development, approval of the Company's products by the Food and Drug Administration ("FDA") and other jurisdictions, 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, product liability risks 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, 2002 and "Part I. Financial Information - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" included elsewhere in this quarterly report on Form 10-Q. 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS The following unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all necessary adjustments (which include only normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ended December 31, 2003. For further information, refer to the financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2002. 4 ZONAGEN, INC. AND SUBSIDIARY (A development stage company) CONSOLIDATED BALANCE SHEETS (in thousands except share amounts)
MARCH 31, DECEMBER 31, 2003 2002 --------- ------------ (unaudited) ASSETS CURRENT ASSETS Cash and cash equivalents $ 14,116 $ 8,683 Marketable securities 10,362 16,455 Note receivable 1,000 1,000 Prepaid expenses and other current assets 310 532 --------- ------------ Total current assets 25,788 26,670 LAB EQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS, NET 148 191 OTHER ASSETS, NET 508 509 --------- ------------ Total assets $ 26,444 $ 27,370 ========= ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 303 $ 86 Accrued expenses 231 433 --------- ------------ Total current liabilities 534 519 --------- ------------ COMMITMENTS & CONTINGENCIES STOCKHOLDERS' EQUITY Undesignated Preferred Stock, $.001 par value, 5,000,000 shares authorized, none issued and outstanding -- -- Common Stock, $.001 par value, 20,000,000 shares authorized, 11,921,161 and 11,918,177 shares issued, respectively; 11,505,861 and 11,502,877 shares outstanding, respectively 12 12 Additional paid-in capital 114,054 114,051 Cost of treasury stock, 415,300 shares (7,484) (7,484) Deficit accumulated during the development stage (80,672) (79,728) --------- ------------ Total stockholders' equity 25,910 26,851 --------- ------------ Total liabilities and stockholders' equity $ 26,444 $ 27,370 ========= ============
The accompanying notes are an integral part of these consolidated financial statements. 5 ZONAGEN, INC. AND SUBSIDIARY (A development stage company) CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited and in thousands except per share amounts)
FROM INCEPTION (AUGUST 20, 1987) THREE MONTHS ENDED MARCH 31, THROUGH ------------------------------ MARCH 31, 2003 2002 2003 ---------- ---------- ----------------- REVENUES AND OTHER INCOME Licensing fees $ -- $ 528 $ 28,755 Product royalties -- -- 627 Research and development grants 121 -- 623 Interest income 112 234 12,816 ---------- ---------- ----------------- Total revenues and other income 233 762 42,821 ---------- ---------- ----------------- EXPENSES Research and development 564 610 90,192 General and administrative 613 443 23,570 Interest expense and amortization of intangibles -- -- 388 ---------- ---------- ----------------- Total expenses 1,177 1,053 114,150 ---------- ---------- ----------------- Loss from continuing operations (944) (291) (71,329) Income (loss) from discontinued operations -- -- (1,828) Gain on disposal -- -- 939 ---------- ---------- ----------------- Net loss before cumulative effect of change in accounting principle (944) (291) (72,218) Cumulative effect of change in accounting principle -- -- (8,454) ---------- ---------- ----------------- NET LOSS $ (944) $ (291) $ (80,672) ========== ========== ================= INCOME (LOSS) PER SHARE - BASIC AND DILUTED: Loss from continuing operations $ (0.08) $ (0.03) Income from discontinued operations Gain on disposal ---------- ---------- Net loss before cumulative effect of change in accounting principle (0.08) (0.03) Cumulative effect of change in accounting principle -- -- ---------- ---------- NET LOSS $ (0.08) $ (0.03) ========== ========== Shares used in loss per share calculation: Basic 11,504 11,358 Diluted 11,504 11,358
The accompanying notes are an integral part of these consolidated financial statements. 6 ZONAGEN, INC. AND SUBSIDIARY (A development stage company) CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited and in thousands)
FROM INCEPTION (AUGUST 20, 1987) THREE MONTHS ENDED MARCH 31, THROUGH ------------------------------ MARCH 31, 2003 2002 2003 ---------- ---------- ----------------- CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (944) $ (291) $ (80,672) Gain on disposal of discontinued operations -- -- (939) Adjustments to reconcile net loss to net cash used in operating activities: Noncash financing costs -- -- 316 Noncash inventory impairment -- -- 4,417 Noncash patent impairment -- -- 1,031 Noncash decrease in accounts payable -- -- (1,308) Depreciation and amortization 44 50 3,730 Noncash expenses related to stock-based transactions 3 3 2,561 Common stock issued for agreement not to compete -- -- 200 Series B Preferred Stock issued for consulting services -- -- 18 Maturities (purchases) of marketable securities 6,093 666 18,173 Changes in operating assets and liabilities (net effects of purchase of businesses in 1988 and 1994): Decrease in receivables -- -- (199) Decrease (increase) in inventory -- -- (4,447) Decrease (increase) in prepaid expenses and other current assets 222 192 -- (Decrease) increase in accounts payable and accrued expenses 15 (370) 1,719 (Decrease) increase in deferred revenue -- (529) -- ---------- ---------- ----------------- Net cash used in operating activities 5,433 (279) (55,400) CASH FLOWS FROM INVESTING ACTIVITIES Maturities (purchases) of marketable securities -- -- (28,723) Capital expenditures -- -- (2,268) Purchase of technology rights and other assets -- (39) (2,206) (Increase) decrease in note receivable -- -- (1,000) Cash acquired in purchase of FTI -- -- 3 Proceeds from sale of subsidiary, less $12,345 for operating losses during 1990 phase-out period -- -- 138 Proceeds from sale of the assets of FTI -- -- 2,250 Increase in net assets held for disposal -- -- (213) ---------- ---------- ----------------- Net cash provided by (used in) investing activities -- (39) (32,019) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of common stock -- 24 84,224 Proceeds from issuance of preferred stock -- -- 23,688 Purchase of treasury stock -- -- (7,484) Proceeds from issuance of notes payable -- -- 2,839 Principal payments on notes payable -- -- (1,732) ---------- ---------- ----------------- Net cash provided by financing activities -- 24 101,535 ---------- ---------- ----------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 5,433 (294) 14,116 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 8,683 1,521 -- ---------- ---------- ----------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 14,116 $ 1,227 $ 14,116 ========== ========== =================
The accompanying notes are an integral part of these consolidated financial statements. 7 ZONAGEN, INC. AND SUBSIDIARY (A development stage company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) NOTE 1 -- ORGANIZATION AND OPERATIONS Zonagen, Inc. ("Zonagen" or the "Company") was organized on August 20, 1987 and is a development stage company. The Company is engaged in the development of pharmaceutical products that address diseases and conditions associated with the human reproductive system. From inception through March 31, 2003, the Company has been primarily engaged in research and development and clinical development. The Company signed a merger agreement on October 30, 2002, with Lavipharm Corp. which was subsequently terminated on March 27, 2003, as a result of Nasdaq's determination that the proposed merger would be deemed as a reverse merger along with other considerations. On April 15, 2003, the Company announced that its Board of Directors engaged CIBC World Markets Corp. to explore strategic alternatives for the company. The Company has four full-time employees which management believes is the minimum required to redeploy the Company's assets and continue to perform a limited amount of product development. During the first quarter ended March 31, 2003, the Company continued to focus its research efforts on three Small Business Innovative Research ("SBIR") grants that the Company received during 2002 and continued limited development of the Company's internal research projects primarily through the use of outside consulting groups. The Company is currently performing research under a Phase II $836,441 SBIR grant which is being utilized to develop a new compound which is a selective progesterone receptor modulator ("SPRMs") as an oral treatment for endometriosis and continued to perform research in the area of breast cancer under a Phase I $108,351 grant. The funding under these two grants is anticipated to be depleted in mid 2003 while the third SBIR grant totaling $98,625, was depleted early in the first quarter of 2003. As of March 31, 2003, the Company had an accumulated deficit of $80.7 million. Losses have resulted principally from costs incurred in conducting clinical trials for VASOMAX(R) and the related female sexual dysfunction product, in research and development activities related to efforts to develop our products and from the associated administrative costs required to support those efforts. The Company currently has no plans to further develop VASOMAX(R), or the related female sexual dysfunction product or any of its other phentolamine-based products. Zonagen's results of operations may vary significantly from quarter to quarter and year to year. The Company has experienced negative cash flows from operations since inception and has funded its activities to date primarily from equity financings and corporate collaborations. If the Company were to continue its operations it would require substantial funds for research and development, including preclinical studies and clinical trials of our product candidates, and to commence sales and marketing efforts if appropriate, if the FDA or other regulatory approvals are obtained. The Company believes that its existing capital resources under its current operating 8 ZONAGEN, INC. AND SUBSIDIARY (A development stage company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) plan will be sufficient to fund the Company's operations through at least the end of 2005. There can be no assurance that changes in our current strategic plans or other events will not result in accelerated or unexpected expenditures. NOTE 2 -- STOCK-BASED COMPENSATION The Company accounts for its stock option plans under APB No. 25 "Accounting for Stock Issued to Employees." Accordingly, deferred compensation is recorded for stock options based on the excess of the market value of the common stock on the measurement date over the exercise price of the options. This deferred compensation is amortized over the vesting period of each option. The Company has adopted the disclosure requirements of SFAS No. 123 "Accounting for Stock-Based Compensation" for employee stock-based compensation and has elected not to record related compensation expense in accordance with this statement. Had compensation expense for its stock option plans been determined consistent with SFAS No. 123, the Company's net loss and loss per share would have been increased to the following pro forma amounts (in thousands, except for per share amounts):
MARCH 31, --------- 2003 2002 ---------- ---------- Net loss, as reported ...................... $ (944) $ (291) Add: Stock-based employee .................. 3 3 compensation expense included in reported net income, net of related tax effects Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects .................................... (199) (497) ---------- ---------- Pro forma net loss ....................... (1,140) (785) ========== ========== Loss per share - Basic - as reported ...................... $ (0.08) $ (0.03) Basic - pro forma ........................ (0.10) (0.07) Diluted - as reported .................... (0.08) (0.03) Diluted - pro forma ...................... (0.10) (0.07)
Under SFAS No. 123, the fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model. The following weighted average assumptions were used for grants in the periods ended March 31, 2003 and 2002, respectively: risk-free interest 9 ZONAGEN, INC. AND SUBSIDIARY (A development stage company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) rates of 3.8% and 5.4%; no expected dividends; expected lives of 9.7 and 4.9 years; expected volatility of 90% and 88%. The weighted average fair value of options granted at market for the periods ended March 31, 2003 and 2002 was $0.87 and $3.22, respectively. The Black-Scholes option valuation model and other existing models were developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of and are highly sensitive to subjective assumptions including the expected stock price volatility. The Company's employee stock options have characteristics significantly different from those of traded options and changes in the subjective input assumptions can materially affect the fair value estimate. NOTE 3 -- MARKETABLE SECURITIES Management determines the appropriate classification of investments in debt and equity securities at the time of purchase and re-evaluates such designation as of each subsequent balance sheet date. Securities for which the Company has the ability and intent to hold to maturity are classified as "held to maturity". Securities classified as "trading securities" are recorded at fair value. Gains and losses on trading securities, realized and unrealized, are included in earnings and are calculated using the specific identification method. Any other securities are classified as "available for sale." At March 31, 2003 all securities were classified as trading securities. The cost basis including purchased premium for these securities was $10.4 million and $16.5 million at March 31, 2003 and December 31, 2002, respectively. Short-term marketable securities have a remaining maturity of less than twelve months and long-term marketable securities have a remaining maturity of greater than twelve months. Marketable securities as of March 31, 2003 consist of only short term investments totaling $10.4 million. The Company's investments typically include corporate bonds and notes, Euro-dollar bonds, taxable auction securities and asset-backed securities. The Company's policy is to require minimum credit ratings of A2/A and A1/P1 with maturities of up to three years. The average life of the investment portfolio may not exceed 24 months. NOTE 4 -- PATENTS As of March 31, 2003, the Company had approximately $508,000 in capitalized patents reflected on its balance sheet. Of this amount $233,000 relate to patents for Zonagen's SPRMs which is being developed as an oral treatment for endometriosis through an SBIR grant; $168,000 relates to vaccine adjuvant technologies; $61,000 relates to prostate cancer vaccine technologies; and $46,000 relates to various other technologies. If Zonagen enters into a merger with an entity that does not continue to progress the technologies of Zonagen or cannot out-license these technologies to another entity, then part or all of the capitalized patents value at that time could be impaired. 10 ZONAGEN, INC. AND SUBSIDIARY (A development stage company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) NOTE 5 -- EARNINGS (LOSS) PER SHARE Basic EPS is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the year. Diluted EPS is computed in the same manner as fully diluted EPS, except that, among other changes, the average share price for the period is used in all cases when applying the treasury stock method of potentially dilutive outstanding options. Common stock equivalents of 1,479,319 and 1,592,802 for the three-month periods ended March 31, 2003 and 2002, respectively, were excluded from the calculation of diluted EPS since they were antidilutive. The following table presents information necessary to calculate earnings per share for the three-month periods ended March 31, 2003 and 2002 (in thousands, except per share amounts):
MARCH 31, --------- 2003 2002 -------- -------- Net Loss $ (944) $ (291) Average common shares outstanding 11,504 11,358 -------- -------- Basic earnings per share $ (0.08) $ (0.03) ======== ======== Average common and dilutive potential common shares outstanding: Average common shares outstanding 11,504 11,358 Assumed exercise of stock options -- -- -------- -------- Diluted earnings per share $ (0.08) $ (0.03) ======== ========
NOTE 6 -- COMMITMENTS AND CONTINGENCIES Certain purported class action complaints alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 thereunder were filed against the Company and certain of its officers and directors. These complaints were filed in the United States District Court for the Southern District of Texas in Houston, Texas and were consolidated on May 29, 1998. The plaintiffs purported to bring the suit on behalf of all purchasers of Zonagen common stock between February 7, 1996 and January 9, 1998. The plaintiffs asserted that the defendants made materially false and misleading statements and failed to disclose material facts about the patents and patent applications of the Company relating to VASOMAX(R) and Chito-ZN (formerly named ImmuMax(TM)) and about the Company's clinical trials of VASOMAX(R). The plaintiffs sought to have the action declared to be a class action, and to have recessionary or 11 ZONAGEN, INC. AND SUBSIDIARY (A development stage company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (Unaudited) compensatory damages in an unstated amount, along with interest and attorney's fees. On March 30, 1999, the Court granted the defendants' motion to dismiss and dismissed the case with prejudice. The plaintiffs filed an appeal. On September 25, 2001, the United States Fifth Circuit Court of Appeals affirmed the dismissal of all claims except one; the court reversed the trial court's dismissal of a claim concerning the Company's disclosure about a patent relating to VASOMAX(R). Discovery is proceeding. The Company's management and the individual defendants believe that these actions are without merit and intend to defend against them vigorously. No estimate of loss or range of estimate loss, if any, can be made at this time. NOTE 7 -- SUBSEQUENT EVENTS On April 15, 2003, the Company announced that its Board of Directors engaged CIBC World Markets Corp. to explore strategic alternatives for the company. On April 2, 2003, the Company announced that its Board of Directors had authorized the Company to repurchase up to $2.5 million of the Company's common stock from time to time through privately negotiated third party transactions or in the open market. Through May 5, 2003 the Company repurchased 34,100 shares of its common stock for $49,137. On April 9, 2003, Lavipharm repaid $1,037,151 to the Company representing all principal and accrued interest relating to a note receivable from Lavipharm that was advanced to Lavipharm on November 8, 2002. 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements reflect the Company's current views with respect to future events and financial performance and are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated in such forward-looking statements. See "Factors Affecting Forward-Looking Statements" included elsewhere in this quarterly report on Form 10-Q. OVERVIEW Zonagen, Inc. ("Zonagen" or the "Company") was organized on August 20, 1987 and is a development stage company. The Company is engaged in the development of pharmaceutical products that address diseases and conditions associated with the human reproductive system. From inception through March 31, 2003, the Company has been primarily engaged in research and development and clinical development. The Company signed a merger agreement on October 30, 2002, with Lavipharm Corp. which was subsequently terminated on March 27, 2003, as a result of Nasdaq's determination that the proposed merger would be deemed a reverse merger along with other considerations. On April 15, 2003, the Company announced that its Board of Directors engaged CIBC World Markets Corp. to explore strategic alternatives for the company. The Company has four full-time employees which management believes is the minimum required to redeploy the Company's assets and continue to perform a limited amount of product development. During the first quarter ended March 31, 2003, the Company continued to focus its research efforts on three Small Business Innovative Research ("SBIR") grants that the Company received during 2002 and continued limited development of the Company's internal research projects primarily through the use of outside consulting groups. The Company is currently performing research under a Phase II $836,441 SBIR grant which is being utilized to develop a new compound which is a selective progesterone receptor modulator ("SPRM's") as an oral treatment for endometriosis and continued to perform research in the area of breast cancer under a Phase I $108,351 grant. The funding under these two grants is anticipated to be depleted in mid 2003 while the third SBIR grant totaling $98,625, was depleted early in the first quarter of 2003. An Investigational New Drug ("IND") application for a 50 patient Phase I/II efficacy and safety study is on file at the FDA for the Company's product candidate Androxal(TM), which is being developed as an oral treatment for testosterone deficiency in men. This study was initiated on April 16, 2003 and is anticipated to be completed in approximately six months. The study is anticipated to provide a head-to-head comparison of Androxal(TM) versus an existing topical testosterone therapy. As of March 31, 2003, the Company had an accumulated deficit of $80.7 million. Losses have resulted principally from costs incurred in conducting clinical trials for VASOMAX(R) and the related female sexual dysfunction product, in research and development activities related to 13 efforts to develop our products and from the associated administrative costs required to support those efforts. The Company currently has no plans to further develop VASOMAX(R), or the related female sexual dysfunction product or any of its other phentolamine-based products. Zonagen's results of operations may vary significantly from quarter to quarter and year to year. The Company has experienced negative cash flows from operations since inception and has funded its activities to date primarily from equity financings and corporate collaborations. If the Company were to continue its operations it would require substantial funds for research and development, including preclinical studies and clinical trials of our product candidates, and to commence sales and marketing efforts as needed, if the FDA or other regulatory approvals are obtained. The Company believes that its existing capital resources under its current operating plan will be sufficient to fund the Company's operations through at least the end of 2005. There can be no assurance that changes in our current strategic plans or other events will not result in accelerated or unexpected expenditures. See "Item 1. Description of Business -- Business Risks -- Uncertainties Related to Early Stage of Development," " -- Business Risks -- History of Operating Losses; Accumulated Deficit" and "Note 1. Organization and Operations" of Notes to Consolidated Financial Statements in the Company's annual report on Form 10-K for the fiscal year ended December 31, 2002. CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES The preparation of our financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Actual results could differ materially from those estimates. The items in our financial statements requiring significant estimates and judgments are as follows: o Management determines the appropriate short and long-term classification of investments in debt and equity securities at the time of purchase and re-evaluates such designation as of each subsequent balance sheet date. Securities for which the Company has the ability and intent to hold to maturity are recorded at amortized cost in the Company's consolidated balance sheets, which approximates fair value. Securities classified as "trading securities" are recorded at fair value. Gains and losses on trading securities, realized and unrealized, are included in earnings and are calculated using the specific identification method. The Company holds no securities classified as "available for sale." Short-term marketable securities have a remaining maturity of less than twelve months and long-term marketable securities have a remaining maturity of greater than twelve months. Marketable securities as of March 31, 2003 were all classified as trading securities and consist of only short term investments totaling $10.4 million. o We are currently involved in certain legal proceedings as discussed in the "Commitments and Contingencies" in the Notes to Consolidated Financial Statements. We do not believe these legal proceedings will have a material adverse effect on our consolidated financial position, results of operations or cash flows. However, were an unfavorable ruling to occur in any quarterly period, there exists the possibility of a material impact on the operating results of that period. 14 o Research and development ("R&D") costs consist of direct and indirect costs associated with specific projects as well as fees paid to various entities that perform research on behalf of the Company. Expenses include salaries and related employee costs, insurance coverage for clinical trials and product sales, contracted research and consulting fees, facility costs and direct costs associated with specific projects. The Company expenses R&D costs in the period they are incurred. RECENT ACCOUNTING PRONOUNCEMENTS In November 2002, FASB issued Interpretation, or FIN, No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others." FIN 45 elaborates on the existing disclosure requirements for most guarantees, including residual value guarantees issued in conjunction with operating lease agreements. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value of the obligation it assumes under the guarantee and must disclose that information in its interim and annual financial statements. The initial recognition and measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for the financial statements of interim or annual periods ending after December 15, 2002. Our adoption of FIN 45 will not have a material impact on our results of operations and financial position. In December 2002, the FASB issued Statement of Financial Accounting Standards, or SFAS, No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." This statement amends SFAS 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based accounting for employee compensation and the effect of the method used on reported results. The Company is currently evaluating whether to adopt the fair value based method. In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities." FIN No. 46 requires that unconsolidated variable interest entities be consolidated by their primary beneficiaries. A primary beneficiary is the party that absorbs a majority of the entity's expected losses or residual benefits. FIN No. 46 applies immediately to variable interest entities created after January 31, 2003 and to existing variable interest entities in the periods beginning after June 15, 2003. Our adoption of FIN No. 46 will not have a material impact on our results of operations and financial position. In April, 2003 the FASB issued Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (FAS 149). FAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement 133. FAS 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003, and should be applied prospectively. The provisions of FAS 149 that relate to Statement 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. The 15 company does not expect the impact of adoption of SFAS No. 149 to have a material effect on the Company's results of operations. RESULTS OF OPERATIONS Comparison of Quarters Ended March 31, 2003 and 2002 Revenues. Total revenues for the three-month period ended March 31, 2003 were $233,000 as compared to $762,000 for the same period in the prior year. Licensing fees for the three-month period ended March 31, 2003 were zero as compared to $528,000 for the same period in the prior year. Due to the Company's January 1, 2000, adoption of U.S. Securities and Exchange Commission Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB 101") which requires up-front, non-refundable license fees to be deferred and recognized over the performance period, the Company recognized $528,000 in licensing fees in the three-month period ended March 31, 2002, which it had received in prior periods from Schering-Plough Corporation due to their prior exclusive license of the Company's VASOMAX(R) product for the treatment of male erectile dysfunction. These agreements were mutually terminated in July 2002. Research and development grants for the three-month period ended March 31, 2003 were $121,000 as compared to zero for the same period in the prior year relating to the Company's SBIR grants. Due to the mutual termination of the agreements with Schering-Plough, which are described above, the Company does not expect to receive any royalties relating to VASOMAX(R) in the near future. Interest income decreased 52% to $112,000 for the three-month period ended March 31, 2003, as compared to $234,000 for the same period in the prior year. This decrease is due to a reduction in interest rate yields and lower cash balances, offset by interest income on a $1.0 million loan receivable from Lavipharm Corp. which was repaid in April 2003. Research and Development Expenses. Research and development ("R&D") expenses include contracted research, regulatory affairs activities and general research and development expenses. During the three-month period ended March 31, 2003, the Company continued scaling back R&D spending activities by terminating all but one scientist, to maintain its cash reserves for future redeployment. R&D expenses decreased 8% to $564,000 for the three-month period ended March 31, 2003 as compared to $610,000 for the same period in the prior year. During the three-month period ended March 31, 2003, the Company incurred severance expenses of $122,000 and incurred $85,000 of non-capitalized charges to maintain its patent portfolio. The Company also billed $121,000 against its SBIR grants for R&D expenses incurred relating to SBIR grant activities. General and Administrative Expenses. General and administrative ("G&A") expenses increased 38% to $613,000 for the three-month period ended March 31, 2003, as compared to $443,000 for the same period in the prior year. The increase in expenses is primarily due to the increase in costs associated with potential strategic alternative opportunities which were $178,000 for the three-month period ended March 31, 2003 as compared to $2,000 for the same period in the prior year. The Company expects these expenses to be greater during the three-month periods ending June 30th and September 30th, 2003, due to increased activities following the termination of 16 the merger agreement with Lavipharm Corp. in March 2003 and the hiring of CIBC World Markets in April 2003. In addition, the Company has incurred increased insurance costs for this period. LIQUIDITY AND CAPITAL RESOURCES The Company's primary use of cash to date has been in operating activities to fund research and development, including preclinical studies and clinical trials, and general and administrative expenses. The Company had cash, cash equivalents and marketable securities of approximately $24.5 million at March 31, 2003, as compared to $25.1 million at December 31, 2002. Excluding maturities and purchases of marketable securities of $6.1 million and $666,000 in 2003 and 2002, respectively, net cash of approximately $660,000 was used in operating activities during the three-month period ended March 31, 2003 as compared to $945,000 for the same period in the prior year. The decreased use of cash for the three-month period ended March 31, 2003 as compared to the same period in the prior year was primarily due to a payment of $309,000 made to Schering-Plough during the three-month period ended March 31, 2002 for previously incurred shared clinical development expenses relating to VASOMAX(R). The Company has experienced negative cash flows from operations since inception and has funded its activities to date primarily from equity financings and corporate collaborations. If the Company were to continue its operations it would require substantial funds for research and development, including preclinical studies and clinical trials of our product candidates, and to commence sales and marketing efforts as needed, if the FDA or other regulatory approvals are obtained. The Company believes that its existing capital resources under its current operating plan will be sufficient to fund the Company's operations through at least the end of 2005. There can be no assurance that changes in our current strategic plans or other events will not result in accelerated or unexpected expenditures. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not Applicable. ITEM 4. CONTROLS AND PROCEDURES The Company's chief executive officer and chief financial officer have evaluated the Company's disclosure controls and procedures (as defined in Rule 13a-14(c) and Rule 15d-14(c) under the Exchange Act) as of March 31, 2003 and concluded that those disclosure controls and procedures are effective. There have been no changes in the Company's internal controls or in other factors known to the Company that could significantly affect these controls subsequent to their evaluation, nor any corrective actions with regards to significant deficiencies and material weaknesses. While the Company believes that its existing disclosure controls and procedures have been effective to accomplish the objectives, the Company intends to continue to examine, refine 17 and formalize its disclosure controls and procedures and to monitor ongoing developments in this area. 18 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Certain purported class action complaints alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 thereunder were filed against the Company and certain of its officers and directors. These complaints were filed in the United States District Court for the Southern District of Texas in Houston, Texas and were consolidated on May 29, 1998. The plaintiffs purported to bring the suit on behalf of all purchasers of Zonagen common stock between February 7, 1996 and January 9, 1998. The plaintiffs asserted that the defendants made materially false and misleading statements and failed to disclose material facts about the patents and patent applications of the Company relating to VASOMAX(R) and Chito-ZN (formerly named ImmuMax(TM)) and about the Company's clinical trials of VASOMAX(R). The plaintiffs sought to have the action declared to be a class action, and to have recessionary or compensatory damages in an unstated amount, along with interest and attorney's fees. On March 30, 1999, the Court granted the defendants' motion to dismiss and dismissed the case with prejudice. The plaintiffs filed an appeal. On September 25, 2001, the United States Fifth Circuit Court of Appeals affirmed the dismissal of all claims except one; the court reversed the trial court's dismissal of a claim concerning the Company's disclosure about a patent relating to VASOMAX(R). Discovery is proceeding. The Company and the individual defendants believe that these actions are without merit and intend to defend against them vigorously. No estimate of loss or range of estimate of loss, if any, can be made at this time. Management believes there will be no material adverse effect related to this matter. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits 99.1 Certification furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer). 99.2 Certification furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer). b. Reports on Form 8-K The Company filed a current report on Form 8-K on March 28, 2003 reporting an event under Item 5. 19 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: May 13, 2003 By: /s/ Joseph S. Podolski ------------------------------------------- Joseph S. Podolski President and Chief Executive Officer (Principal Executive Officer) Date: May 13, 2003 By: /s/ Louis Ploth, Jr. ------------------------------------------- Louis Ploth, Jr. Vice President Business Development and Chief Financial Officer (Principal Financial and Accounting Officer) 20 CERTIFICATION I, Joseph S. Podolski, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Zonagen, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant is made known to us by others, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 13, 2003 By: /s/ Joseph S. Podolski ---------------------------------------- Joseph S. Podolski President and Chief Executive Officer (Principal Executive Officer) 21 CERTIFICATION I, Louis Ploth, Jr., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Zonagen, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant is made known to us by others, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 13, 2003 By: /s/ Louis Ploth, Jr. ------------------------------------------ Louis Ploth, Jr. Vice President Business Development and Chief Financial Officer (Principal Financial and Accounting Officer) 22 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION ------- ----------- 99.1 Certification furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer). 99.2 Certification furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer).