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RPRX > SEC Filings for RPRX > Form 10-K on 13-Mar-2006All Recent SEC Filings

Show all filings for ZONAGEN INC

Form 10-K for ZONAGEN INC


13-Mar-2006

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following management's discussion and analysis should be read in conjunction with our historical consolidated financial statements and their notes included elsewhere in this Form 10-K. This discussion contains forward-looking statements that reflect our current views with respect to future events and financial performance. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, such as those set forth under "Risk Factors" and elsewhere in this Form 10-K.
Overview
Zonagen, Inc. ("the Company", Zonagen, or "we, "us" or "our") was organized on August 28, 1987 and is a development stage company. We are a biopharmaceutical company focused on the development of new drugs to treat hormonal and reproductive system disorders. Our lead product candidate, Proellex, is an orally available small molecule compound that we are developing for the treatment of uterine fibroids and endometriosis. We recently commenced a Phase II clinical trial for Proellex in the United States for the treatment of uterine fibroids and a Phase II clinical trial in Europe for Proellex for the treatment of endometriosis in 2005. Our second product candidate is Androxal, an orally available small molecule compound being developed for the treatment of testosterone deficiency in men. We recently commenced a Phase III safety trial in the United States for Androxal for the treatment of men with testosterone deficiency. The FDA deems both Proellex and Androxal to be new clinical entities, so a two-year toxicology study will be required before an NDA may be filed. We also have recently begun investigating necessary measures to remove VASOMAX and our other phentolamine-based products from clinical hold in the United States and obtain marketing approval in non-United States jurisdictions.
We have 6 full-time employees who utilize the services of contract research organizations, contract manufacturers and various consultants to assist us in performing clinical and regulatory services for the clinical development of our products. We are substantially dependent on our various contract groups to adequately perform the activities required to obtain regulatory approval of our products.
The clinical development of pharmaceutical products is a complex undertaking, and many products that begin the clinical development process do not obtain regulatory approval. The costs associated with our clinical trials may be impacted by a number of internal and external factors, including the number and complexity of clinical trials necessary to obtain regulatory approval, the number of eligible patients necessary to complete our clinical trials and any difficulty in enrolling these patients, and the length of time to complete our clinical trials. Given the uncertainty of these potential costs, we recognize that the total costs we will incur for the clinical development of our product candidates may exceed our current estimates. We do, however, expect these costs to increase substantially in future periods as we continue later-stage clinical trials, initiate new clinical trials for additional indications and seek to obtain regulatory approvals. Any failure by us to obtain, or any delay in obtaining, regulatory approvals could cause our research and development expenditures to increase and, in turn, have a material adverse effect on our results of operations.
We have not generated any substantial revenue from commercial sale of our current product candidates. We will not receive any revenue from commercial sales unless we complete the clinical trial process, obtain regulatory approval, and successfully commercialize one or more of our product candidates. If we were to obtain regulatory approval of Proellex, we will need to develop a long-term, commercially viable source of bulk Proellex to successfully commercialize the product candidate. We cannot be certain when or if any net cash inflow from any of our current product candidates will commence.
We have experienced negative cash flows from operations since inception and have funded our activities to date primarily from equity financings and corporate collaborations. We believe that our existing capital resources under our current operating plan will be sufficient to fund our operations through at least December 31, 2006. There can be no assurance that changes in our current strategic plans or other events will not result in accelerated or unexpected expenditures.
We will need to raise additional capital through the sale of equity securities and/or through partnerships to continue the clinical development of our products. If we are not able to raise capital through the sale of equity securities, or cannot locate an alternative source of financing, the outcome would have a material adverse effect on us and the clinical development timeline of our product candidates. If we are not able to raise adequate capital for our clinical development plans, then we will have to adjust our plans, which will delay the approval process of our product candidates.
Our results of operations may vary significantly from year to year and quarter to quarter, and depend, among other factors, on our ability to be successful in our clinical trials, the regulatory approval process in the United States and other foreign jurisdictions and the ability to complete new licenses and product development agreements. The timing of our revenues may not match the timing of our associated product development expenses. To date, research and development expenses have generally exceeded revenue in any particular period and/or fiscal year.

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On February 1, 2005, we completed both a follow-on public offering of 4,400,000 shares of our common stock at $4.00 per share and the exercise of the over allotment provision of 660,000 for a total aggregate sale of 5,060,000 shares of our common stock. All of the shares were offered by us which resulted in net proceeds to us of approximately $18.1 million.
As of December 31, 2005, we had an accumulated deficit of $94.1 million. Due to various tax regulations, including change in control provisions in the tax code, the value of our tax assets to us can be substantially diminished. For additional information relating to our net operating loss carryforward, see "Note 6. Federal Income Taxes" of the Notes to Consolidated Financial Statements. Losses have resulted principally from costs incurred in conducting clinical trials for our product candidates, in research and development activities related to efforts to develop our products and from the associated administrative costs required to support those efforts. There can be no assurance that we will be able to successfully complete the transition from a development stage company to the successful introduction of commercially viable products. Our ability to achieve profitability will depend, among other things, on successfully completing the clinical development of our products in a reasonable time frame and at a reasonable cost, obtaining regulatory approvals, establishing marketing, sales and manufacturing capabilities or collaborative arrangements with others that possess such capabilities, our and our partners' ability to realize value from our research and development programs through the commercialization of those products and raising sufficient funds to finance its activities. There can be no assurance that we will be able to achieve profitability or that profitability, if achieved, can be sustained. See "Item 1. Business - Risk Factors" and "Note 2. Organization and Operations" of Notes to Consolidated Financial Statements.
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. Please see Note 2, "Summary of Significant Accounting Policies", for a discussion of our critical accounting policies. Investments-Trading 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 December 31, 2005 all securities were classified as trading securities. The cost basis including purchased premium for these securities was $14.7 million and $4.8 million at December 31, 2005 and 2004, respectively.
Marketable securities as of December 31, 2005 consist of only short term investments. 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. Capitalized Patent Costs
The Company capitalizes the cost associated with building its patent library. As of December 31, 2005 other assets consist of capitalized patent costs in the amount of $600,000. Patent costs, which include legal and application costs related to the patent portfolio, are being amortized over 20 years, or the lesser of the legal or the estimated economic life of the patent. Amortization of patent costs was zero, $7,000 and $9,000 in 2005, 2004 and 2003, respectively.
Of the $600,000 in capitalized patents, $327,000 related to patents for Proellex, which is being developed as an oral treatment for uterine fibroids and endometriosis and $273,000 related to Androxal, which is being developed as an oral treatment for testosterone deficiency. R&D Expense
Research and development, or R&D expenses include salaries and related employee expenses, contracted regulatory affairs activities, insurance coverage for clinical trials and prior product sales, contracted research and consulting fees, facility costs and internal research and development supplies. The Company expenses research and development costs in the period they are incurred. These 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.
Actual results could differ materially from those estimates. The items in our financial statements requiring significant estimates and judgments are as follows:

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The Company has had losses since inception and, therefore, has not been subject to federal income taxes. The Company has accumulated approximately $2.8 million of research and development tax credits. As of December 31, 2005 and 2004, the Company had approximately $84.3 million and $78.5 million, respectively, of net operating loss ("NOL") carry-forwards for federal income tax purposes. Additionally, approximately $1.3 million of NOLs, and approximately $52,000 of research and development tax credits, expired in 2005. Under SFAS No. 109, "Accounting for Income Taxes," an NOL requires the recognition of a deferred tax asset. As the Company has incurred losses since inception, and there is no certainty of future revenues, the Company's deferred tax assets have been reserved in full in the accompanying consolidated financial statements.

Marketable securities are reviewed for other-than-temporary impairment at the individual security level in each reporting period. The Company has determined that its marketable securities are not impaired as of December 31, 2005.

The Company reviews for the impairment of capitalized patent costs whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss exists when estimated undiscounted cash flows expected to result from the patent are less than its carrying amount. The impairment loss recognized represents the excess of the patent cost as compared to its estimated fair value. The Company has determined that its capitalized patent costs are not impaired as of December 31, 2005.

RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment. SFAS No. 123(R) will require that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. SFAS No. 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. SFAS No. 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based Compensation , and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123, as originally issued in 1995, established as preferable a fair value-based method of accounting for share-based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in APB Opinion No. 25, as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair value-based method been used. Public entities will be required to apply SFAS No. 123(R) as of the first annual reporting period that begins after June 15, 2005. The Company believes the impact of the adoption of SFAS No. 123(R) using the modified-prospective method of adoption based on share-based payments currently awarded to employees is expected to be approximately $600,000 in additional non-cash compensation expense in 2006.
Results of Operations
Comparison of Years Ended December 31, 2005 and 2004 Revenues. Total revenue for 2005 increased 147% to $634,000 as compared to $257,000 for 2004. Research and development grants for 2005 were $4,000 as compared to $118,000 for 2004 relating to the Company's Small Business Innovative Research, or SBIR grants.
Interest income increased 506% to $630,000 for 2005 as compared to $104,000 for 2004. The increase is primarily due to an increase in marketable securities as a result of the completion of our follow-on public offering on February 1, 2005 in which we received approximately $18.1 million in net proceeds, and an increase in interest rates.
Other income for 2005 was zero as compared to $35,000 for 2004. Other income in 2004 was from the sale of some of the Company's preclinical phentolamine data that was to be used for a purpose that does not compete with the Company's sexual dysfunction technologies.
Research and Development Expenses. R&D expenses include contracted research, regulatory affairs activities and general research and development expenses. R&D expenses increased 144% to $6.1 million in 2005 as compared to $2.5 million in 2004. The increased expenses for 2005 is primarily due to an increase in the Company's clinical development programs for Proellex in the amount of $1.9 million and Androxal in the amount of $1.9 million, partially offset by a decrease of $308,000 in costs associated with the 2004 write-off of our patent portfolio related to our vaccine adjuvants, prostate cancer vaccines and hCG immuno-contraceptive vaccine.
General and Administrative Expenses. General and administrative ("G&A") expenses increased 27% to $1.9 million for 2005 as compared to $1.5 million for 2004. The increase in expenses is primarily due to an increase in professional services in the amount of $280,000, which includes a non-recurring $200,000 reimbursement in 2004 of the deductible from the Company's directors' and officers' insurance policy relating to the Company's previous class action lawsuit, personnel costs in the amount of $185,000, costs associated with

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strategic administrative fees in the amount of $99,000 and investor relations expenses in the amount of $63,000, offset by a decrease in costs associated with potential funding activities in the amount of $117,000, and a $60,000 decrease in non-cash stock option compensation expense. Comparison of Years Ended December 31, 2004 and 2003 Revenues. Total revenues for 2004 were $257,000 as compared to $1.0 million for 2003. Research and development grants for 2004 were $118,000 as compared to $595,000 for 2003 relating to the Company's Small Business Innovative Research, or SBIR grants.
Interest income decreased 67% to $104,000 for 2004 as compared with $318,000 for 2003 primarily due to lower cash balances due to the Company's completion of its self tender offer in January 2004.
The Company sold substantially all of its fixed assets for approximate net proceeds of $225,000 and recognized a gain of $102,000 over their book value for the year ended 2003.
Other income totaled $35,000 for 2004 as compared to zero for 2003. The increase in other income was from the sale of some of the Company's preclinical phentolamine data that is to be used for a purpose that does not compete with the Company's sexual dysfunction technologies.
Research and Development Expenses. R&D expenses include contracted research, regulatory affairs activities and general research and development expenses. Following the April 2002 withdrawal of the Company's regulatory application for VASOMAX in the United Kingdom by Schering-Plough, the Company continued scaling back non-SBIR grant R&D spending activities through October 2003 to maintain its cash reserves for future redeployment. R&D expenses increased 14% to $2.5 million in 2004, as compared with $2.2 million in 2003. The increase in 2004 is primarily due to an increase of $1.0 million related to the Company's clinical development program for Proellex, an impairment charge against the Company's patent portfolio related to its vaccine adjuvants, prostate cancer vaccines and hCG immuno-contraceptive vaccine in the amount of $308,000 which was offset by a corresponding decrease of $468,000 of costs associated with the Company's SBIR grant funded R&D, a decrease of $320,000 in costs associated with Androxal clinical development, a decrease of $122,000 which occurred in 2003 relating to prior employees severance compensation and a decrease of $92,000 in facilities rent costs due to a decrease in facility size in 2004.
General and Administrative Expenses. G&A expenses decreased 32% to $1.5 million in 2004 as compared with $2.2 million in 2003. The decrease in expenses is primarily due to a decrease in the Company's directors' and officers' insurance premium of $473,000 related to the Company's self tender offer which was completed in January 2004, costs associated with potential strategic alternative opportunities of $388,000 and a reduction in professional services due to a $200,000 reimbursement of the deductible from the Company's directors' & officers' insurance policy relating to the Company's previous class action lawsuit which was received in the quarter ended December 31, 2004, partially offset by an increase in non cash stock option compensation expenses of $129,000.
Off-Balance Sheet Arrangements
As of December 31, 2005, the Company did not have any off-balance sheet arrangements.
Liquidity and Capital Resources
Since its inception, the Company has financed its operations primarily with proceeds from private placements and public offerings of equity securities and with funds received under collaborative agreements. On February 1, 2005, the Company completed a public offering of 5,060,000 shares (including the underwriters' over-allotment option) and received net proceeds of approximately $18.1 million. 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 $16.8 million as of December 31, 2005 as compared to $5.5 million as of December 31, 2004. The increase in cash balance as of December 31, 2005 as compared to December 31, 2004 is primarily due to the completion of the Company's public offering in February 2005 described above under "Overview." Excluding maturities and purchases of marketable securities, net cash of approximately $7.4 million, $3.0 million, and $3.0 million was used in operating activities during 2005, 2004, and 2003, respectively. The major uses of cash for operating activities during 2005 was to fund our clinical development programs and associated administrative costs of $7.4 million and to prepay the majority of our insurance policies. Cash used in investing activities was $191,000 in 2005 primarily for investments in technology rights related to our Proellex and Androxal patent portfolios. Cash provided by financing activities in 2005 was approximately $18.7 million relating to the follow-on public offering completed in February 2005 and the exercise of 26,700 stock options.
As of December 31, 2005, the Company had future minimum lease payments under non-cancelable leases with ongoing terms in excess of one year of $39,000, $40,000, $40,000, $40,000 and $21,000 in 2006, 2007, 2008, 2009 and 2010, respectively.

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As of December 31, 2005, the Company had non-cancelable purchase orders relating to the clinical development of both Proellex and Androxal in the amounts of $5.8 million and $4.9 million, respectively.
The Company has had losses since inception and, therefore, has not been subject to federal income taxes. The Company has accumulated approximately $2.8 million of research and development tax credits. As of December 31, 2005 and 2004, the Company had approximately $84.3 million and $78.5 million, respectively, of net operating loss ("NOL") carry-forwards for federal income tax purposes. Additionally, approximately $1.3 million of NOLs, and approximately $52,000 of research and development tax credits expired in the year 2005. Due to various tax regulations, including change in control provisions in the tax code the value of this tax asset to the Company can be substantially diminished. For additional information relating to the Company's Net Operating Loss carryforward see "Note 6. Federal Income Taxes" of the Notes to Consolidated Financial Statements."
The Company has experienced negative cash flows from operations since inception and has funded its activities to date primarily from equity financings and corporate collaborations. The Company will 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 plan will be sufficient to fund the Company's operations through at least December 31, 2006. There can be no assurance that changes in our current strategic plans or other events will not result in accelerated or unexpected expenditures.
The Company's capital requirements will depend on many factors, including the costs and timing of seeking regulatory approvals of the Company's products; the problems, delays, expenses and complications frequently encountered by development stage companies; the progress of the Company's preclinical and clinical activities; the costs associated with any future collaborative research, manufacturing, marketing or other funding arrangements; the Company's ability to obtain regulatory approvals; the success of the Company's potential future sales and marketing programs; the cost of filing, prosecuting and defending and enforcing any patent claims and other intellectual property rights; changes in economic, regulatory or competitive conditions of the Company's planned business; and additional costs associated with being a publicly-traded company. 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 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 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.

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