### **U.S.SECURITIES AND EXCHANGE COMMISSION**Washington, D.C.  20549

 

### **FORM10-Q**

 

 

**(MarkOne)**

 
| **ý**                                                                                                  |   | **QUARTERLY REPORT UNDER SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------|
|                                                                                                        |   |                                                                                    |
| **FOR THE QUARTERLY PERIOD ENDED JUNE 30,  2002**                                                           |
|                                                                                                        |   |                                                                                    |
| **o**                                                                                                       |   | **TRANSITION REPORT UNDER SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                        |   |                                                                                    |
| **FOR THE TRANSITION PERIOD FROM**        **TO        .** |

 

 

**Commission File Number 000-30493**

 
| **Restoragen,  Inc.**                                              |
|--------------------------------------------------------------------|
| (Exact  name of small business issuer as specified in its charter) |

 
| **Delaware**                                 |   | **47-0727668**      |
|----------------------------------------------|--------|---------------------|
| (State or  other jurisdiction                |   | (I.R.S. Employer    |
| of  incorporation or organization)           |   | Identification No.) |
|                                         |   |                |
| **3820 N.W. 46th Street, Lincoln, Nebraska** |   | **68524-1637**      |
| (Address of  principal executive offices)    |   | Zip Code            |
|                                         |   |                |
| **(402) 470-2100**                           |
| (Issuer's Telephone Number)                  |

 

 

 

Check whether the issuer (1)filed all reports required to be filed by Section 13 or 15(d) of the ExchangeAct during the past 12 months (or for such shorter period that the registrantwas required to file such report), and (2) has been subject to such filingrequirements for the past 90 days.      YES ý   NO  o

 

As of July 22, 2002, theCompany had 7,379,408 shares of Common Stock, $.01 par value per share,outstanding.

 

 

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**RESTORAGEN, INC.**

**INDEX**
|           |   |                                                                                                              |   |   |   |
|----------------|--------|-------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| **PART I.**    |   | **FINANCIAL INFORMATION**                                                                                         |   |   |   |
|           |   |                                                                                                              |   |   |   |
| ITEM 1.        |   | FINANCIAL  STATEMENTS                                                                                             |   |   |   |
|           |   | Condensed  Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001                                  |   |   |   |
|           |   | Condensed Consolidated Statements of  Operations for the three and six month periods ended June 30, 2002 and 2001 |   |   |   |
|           |   | Condensed Consolidated Statements of Cash  Flows for the six month periods ended June 30, 2002 and 2001           |   |   |   |
|           |   | Notes to Condensed Consolidated Financial  Statements                                                             |   |   |   |
|           |   |                                                                                                              |   |   |   |
| ITEM 2.        |   | MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS                       |   |   |   |
|           |   | Cautionary Statement About Forward-Looking  Statements                                                            |   |   |   |
|           |   | Overview                                                                                                          |   |   |   |
|           |   | Results of Operations                                                                                             |   |   |   |
|           |   | Liquidity and Capital Resources                                                                                   |   |   |   |
|           |   | New Accounting Pronouncements                                                                                     |   |   |   |
|           |   | Critical Accounting Policies                                                                                      |   |   |   |
|           |   | Contractual Obligations and Commitments                                                                           |   |   |   |
|           |   | Market Risk                                                                                                       |   |   |   |
|           |   |                                                                                                              |   |   |   |
| ITEM 3.        |   | QUALITATIVE AND QUANTITATIVE DISCLOSURE  ABOUT MARKET RISK                                                        |   |   |   |
|           |   |                                                                                                              |   |   |   |
| **PART II.**   |   | **OTHER INFORMATION**                                                                                             |   |   |   |
|           |   |                                                                                                              |   |   |   |
| ITEM 1.        |   | LEGAL PROCEEDINGS                                                                                                 |   |   |   |
|           |   |                                                                                                              |   |   |   |
| ITEM 2.        |   | CHANGES IN SECURITIES                                                                                             |   |   |   |
|           |   |                                                                                                              |   |   |   |
| ITEM 3.        |   | DEFAULTS UPON SENIOR SECURITIES                                                                                   |   |   |   |
|           |   |                                                                                                              |   |   |   |
| ITEM 4.        |   | SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS                                                              |   |   |   |
|           |   |                                                                                                              |   |   |   |
| ITEM 5.        |   | OTHER INFORMATION                                                                                                 |   |   |   |
|           |   |                                                                                                              |   |   |   |
| ITEM 6.        |   | EXHIBITS AND REPORTS ON FORM 8-K                                                                                  |   |   |   |
|           |   |                                                                                                              |   |   |   |
| **SIGNATURES** |   |                                                                                                              |   |   |   |

 

2

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| **RESTORAGEN, INC.**                  |
|---------------------------------------|
| (a development stage company)         |
| Condensed Consolidated Balance Sheets |
| (unaudited)                           |

 
|                                                                                                                                                              |   | **June 30,  2002** |      | **December  31,  2001** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|-----------|-------------------------|--------|
| ASSETS                                                                                                                                                            |   |               |      |                    |   |
|                                                                                                                                                              |   |               |      |                    |   |
| Current assets                                                                                                                                                    |   |               |      |                    |   |
| Cash and cash equivalents                                                                                                                                         |   | $                  | 4,429,856 |                    | $      | 13,010,711 |   |
| Short-term investments                                                                                                                                            |   | —             |      | 1,999,314               |   |
| Prepaid expenses                                                                                                                                                  |   | 26,609             |      | 146,655                 |   |
| Property and equipment held for sale                                                                                                                              |   | 1,200,000          |      | —                  |   |
| Other current assets                                                                                                                                              |   | 20,360             |      | 41,100                  |   |
| Total current assets                                                                                                                                              |   | 5,676,825          |      | 15,197,780              |   |
|                                                                                                                                                              |   |               |      |                    |   |
| Property and equipment, net of accumulated  depreciation $6,762 and $3,798,251                                                                                    |   | 21,169             |      | 5,845,068               |   |
| Patents and patents licensed, net of  accumulated amortization of $222,007                                                                                        |   | —             |      | 663,637                 |   |
|                                                                                                                                                              |   |               |      |                    |   |
| Deferred financing costs, net of  accumulated amortization of $637,689 and $384,516                                                                               |   | 375,000            |      | 628,173                 |   |
| Other assets                                                                                                                                                      |   | 73,055             |      | 76,118                  |   |
|                                                                                                                                                              |   |               |      |                    |   |
| Total assets                                                                                                                                                      |   | $                  | 6,146,049 |                    | $      | 22,410,776 |   |
|                                                                                                                                                              |   |               |      |                    |   |
| LIABILITIES AND SHAREHOLDERS’ DEFICIT                                                                                                                        |   |               |      |                    |   |
|                                                                                                                                                              |   |               |      |                    |   |
| Current liabilities:                                                                                                                                              |   |               |      |                    |   |
| Accounts payable                                                                                                                                                  |   | $                  | 1,065,240 |                    | $      | 2,803,131 |   |
| Accrued expenses                                                                                                                                                  |   | 2,870,191          |      | 427,817                 |   |
| Capital lease obligations—current portion                                                                                                                    |   | 524,957            |      | 564,362                 |   |
| Notes payable—current portion                                                                                                                                |   | 722,573            |      | 696,127                 |   |
| Total current liabilities                                                                                                                                         |   | 5,182,961          |      | 4,491,437               |   |
|                                                                                                                                                              |   |               |      |                    |   |
| Long-term liabilities:                                                                                                                                            |   |               |      |                    |   |
| Capital lease obligations—less current  portion                                                                                                              |   | 386,260            |      | 649,984                 |   |
| Notes payable—less current portion                                                                                                                           |   | 496,561            |      | 859,338                 |   |
| Convertible notes payable                                                                                                                                         |   | 18,000,000         |      | 18,000,000              |   |
| Total long-term liabilities                                                                                                                                       |   | 18,882,821         |      | 19,509,322              |   |
|                                                                                                                                                              |   |               |      |                    |   |
| Total liabilities                                                                                                                                                 |   | 24,065,782         |      | 24,000,759              |   |
|                                                                                                                                                              |   |               |      |                    |   |
| Redeemable preferred stock                                                                                                                                        |   |               |      |                    |   |
| Series A and A,F ($0.01 par value, 11,750  and 211,750 shares authorized, 11,750 and 20,092 issued and outstanding, at  redemption value)                         |   | 1,975,469          |      | 3,050,277               |   |
|                                                                                                                                                              |   |               |      |                    |   |
| Shareholders’ deficit                                                                                                                                        |   |               |      |                    |   |
| Common stock, ($0.01 par value, 40,000,000  shares authorized, 7,379,408 shares issued and outstanding)                                                           |   | 73,794             |      | 73,794                  |   |
| Convertible preferred stock, Series  B,C,D,E,F,G,H ($0.01 par value; 706,500 shares authorized, 354,442 and  346,100 shares issued and outstanding, respectively) |   | 3,544              |      | 3,461                   |   |
| Additional paid-in capital                                                                                                                                        |   | 81,373,481         |      | 80,281,920              |   |
| Deficit accumulated during development  stage                                                                                                                     |   | (101,346,021       | )         | (84,999,435             | )      |
| Total shareholders’ deficit                                                                                                                                  |   | (19,895,202        | )         | (4,640,260              | )      |
|                                                                                                                                                              |   |               |      |                    |   |
| Total liabilities and shareholders’ deficit                                                                                                                  |   | $                  | 6,146,049 |                    | $      | 22,410,776 |   |

 
| See accompanying notes to  condensed consolidated financial statements |
|------------------------------------------------------------------------|

 

3

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| **RESTORAGEN, INC.**                            |
|-------------------------------------------------|
| (a development stage company)                   |
| Condensed Consolidated Statements of Operations |
| (unaudited)                                     |

 
|                                                                  |   | **Three  Months Ended  June 30,** |        | **Six Months  Ended  June 30,** |     | **Cumulative  period  From April 15, 1988  (date of incorporation)  to June 30, 2002** |   |
|-----------------------------------------------------------------------|--------|-----------------------------------|-------------|---------------------------------|----------|----------------------------------------------------------------------------------------|--------|
| **2002**                                                              |   | **2001**                          | **2002**    |                            | **2001** |
|                                                                  |   |                              |        |                            |     |                                                                                   |   |   |   |   |   |
| Revenues                                                              |   | $                                 | 200,000     |                            | $        | 1,175                                                                                  |   | $ | 200,000 |   | $ | 2,493 |   | $ | 3,869,163 |   |
|                                                                  |   |                              |        |                            |     |                                                                                   |   |   |   |   |   |
| Operating costs and expenses:                                         |   |                              |        |                            |     |                                                                                   |   |   |   |   |   |
| General and administrative                                            |   | 665,422                           |        | 753,202                         |     | 1,516,683                                                                              |   | 1,555,397 |   | 24,041,158 |   |
| Research and development                                              |   | 2,254,515                         |        | 3,651,304                       |     | 6,001,020                                                                              |   | 6,658,462 |   | 71,697,033 |   |
| Corporate restructuring costs                                         |   | 6,905,556                         |        | —                          |     | 8,086,660                                                                              |   | — |   | 8,086,660 |   |
|                                                                  |   |                              |        |                            |     |                                                                                   |   |   |   |   |   |
| Total operating costs and expenses                                    |   | 9,825,493                         |        | 4,404,506                       |     | 15,604,363                                                                             |   | 8,213,859 |   | 103,824,851 |   |
|                                                                  |   |                              |        |                            |     |                                                                                   |   |   |   |   |   |
| Operating loss                                                        |   | (9,625,493                        | )           | (4,403,331                      | )        | (15,404,363                                                                            | )      | (8,211,366 | ) | (99,955,688 | ) |
|                                                                  |   |                              |        |                            |     |                                                                                   |   |   |   |   |   |
| Other income (expense)                                                |   |                              |        |                            |     |                                                                                   |   |   |   |   |   |
| Interest income                                                       |   | 38,150                            |        | 93,489                          |     | 74,410                                                                                 |   | 203,642 |   | 1,939,350 |   |
| Interest expense                                                      |   | (501,761                          | )           | (198,182                        | )        | (1,016,632                                                                             | )      | (403,630 | ) | (3,329,682 | ) |
|                                                                  |   | (463,611                          | )           | (104,693                        | )        | (942,222                                                                               | )      | (199,988 | ) | (1,390,332 | ) |
|                                                                  |   |                              |        |                            |     |                                                                                   |   |   |   |   |   |
| NET LOSS                                                              |   | $                                 | (10,089,104 | )                               | $        | (4,508,024                                                                             | )      | $ | (16,346,586 | ) | $ | (8,411,354 | ) | $ | (101,346,021 | ) |
|                                                                  |   |                              |        |                            |     |                                                                                   |   |   |   |   |   |
| Preferred stock dividends accreted and  accumulating but not declared |   | $                                 | (810,984    | )                               | $        | (810,984                                                                               | )      | $ | (1,621,967 | ) | $ | (1,501,968 | ) | $ | (14,401,088 | ) |
|                                                                  |   |                              |        |                            |     |                                                                                   |   |   |   |   |   |
| Net loss applicable to common stock                                   |   | $                                 | (10,900,088 | )                               | $        | (5,319,008                                                                             | )      | $ | (17,968,553 | ) | $ | (9,913,322 | ) | $ | (115,747,109 | ) |
|                                                                  |   |                              |        |                            |     |                                                                                   |   |   |   |   |   |
| Basic and diluted loss per common share                               |   | $                                 | (1.48       | )                               | $        | (0.72                                                                                  | )      | $ | (2.43 | ) | $ | (1.35 | ) | $ | (27.53 | ) |
|                                                                  |   |                              |        |                            |     |                                                                                   |   |   |   |   |   |
| Average number of common shares  outstanding—basic and diluted   |   | 7,379,408                         |        | 7,354,929                       |     | 7,379,408                                                                              |   | 7,355,974 |   | 4,205,107 |   |

 
| See accompanying notes to  condensed consolidated financial statements |
|------------------------------------------------------------------------|

 

4

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|   | **RESTORAGEN, INC.**                            |   |
|--------|-------------------------------------------------|--------|
|   | (a development stage company)                   |   |
|   | Condensed Consolidated Statements of Cash Flows |   |
|   | (unaudited)                                     |   |

 
|                                                                                    |   | **Six Months  Ended  June 30,** |        | **Cumulative  period  from April 15, 1988  (date of incorporation)** |   |
|-----------------------------------------------------------------------------------------|--------|---------------------------------|-------------|----------------------------------------------------------------------|--------|
|                                                                                    |   | **2002**                        |        | **2001**                                                             |   | **to June  30, 2002** |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                   |   |                            |        |                                                                 |   |   |   |
|    Net loss                                                                        |   | $                               | (16,346,586 | )                                                                    | $      | (8,411,354 | ) | $ | (101,346,021 | ) |
|    Adjustments to reconcile net loss to net cash flows from operating  activities: |   |                            |        |                                                                 |   |   |   |
|    Depreciation and amortization                                                   |   | 389,313                         |        | 379,608                                                              |   | 4,649,393 |   |
|    Restructuring charges                                                           |   | 4,995,777                       |        | —                                                               |   | 4,995,777 |   |
|    Amortization of deferred financing costs                                        |   | 253,173                         |        | 128,172                                                              |   | 1,137,689 |   |
|    Acquired in process research and development                                    |   | —                          |        | —                                                               |   | 1,200,000 |   |
|    Stock-based compensation expense                                                |   | 16,836                          |        | 174,174                                                              |   | 6,254,588 |   |
|    Changes in operating assets and liabilities:                                    |   |                            |        |                                                                 |   |   |   |
| Accounts receivable and other current  assets                                           |   | 122,215                         |        | (30,621                                                              | )      | (565,538 | ) |
| Accounts payable and accrued expenses                                                   |   | 704,483                         |        | (49,491                                                              | )      | 4,891,808 |   |
|                                                                                    |   |                            |        |                                                                 |   |   |   |
| Net cash flows from operating activities                                                |   | (9,864,789                      | )           | (7,809,512                                                           | )      | (78,782,304 | ) |
|                                                                                    |   |                            |        |                                                                 |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                   |   |                            |        |                                                                 |   |   |   |
|    Purchase of property and equipment                                              |   | (78,983                         | )           | (721,233                                                             | )      | (9,723,150 | ) |
|    (Increase) / decrease in deposits and other assets                              |   | 3,063                           |        | (5,000                                                               | )      | (304,734 | ) |
|    Increase in patents                                                             |   | —                          |        | (51,678                                                              | )      | (892,938 | ) |
|    Acquisition of R&C, Inc. and GRFCo                                          |   | —                          |        | —                                                               |   | (1,200,000 | ) |
|                                                                                    |   |                            |        |                                                                 |   |   |   |
| Net cash flows from investing activities                                                |   | (75,920                         | )           | (777,911                                                             | )      | (12,120,822 | ) |
|                                                                                    |   |                            |        |                                                                 |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                   |   |                            |        |                                                                 |   |   |   |
|    Net proceeds from issuance of common stock                                      |   | —                          |        | 214,263                                                              |   | 39,710,261 |   |
|    Net proceeds from issuance of preferred stock                                   |   | —                          |        | 7,360,000                                                            |   | 34,591,371 |   |
|    Proceeds from long-term obligations                                             |   | —                          |        | 71,841                                                               |   | 23,125,426 |   |
|    Payments on notes payable and capital leases                                    |   | (639,460                        | )           | (611,971                                                             | )      | (3,495,076 | ) |
|    Proceeds from bridge notes payable                                              |   | —                          |        | —                                                               |   | 3,765,500 |   |
|    Payments on bridge notes payable                                                |   | —                          |        | —                                                               |   | (2,364,500 | ) |
|                                                                                    |   |                            |        |                                                                 |   |   |   |
| Net cash flows from financing activities                                                |   | (639,460                        | )           | 7,034,133                                                            |   | 95,332,982 |   |
|                                                                                    |   |                            |        |                                                                 |   |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS                                   |   | (10,580,169                     | )           | (1,553,290                                                           | )      | 4,429,856 |   |
|                                                                                    |   |                            |        |                                                                 |   |   |   |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF  PERIOD                                       |   | 15,010,025                      |        | 9,492,135                                                            |   | — |   |
|                                                                                    |   |                            |        |                                                                 |   |   |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                              |   | $                               | 4,429,856   |                                                                 | $      | 7,938,845 |   | $ | 4,429,856 |   |
|                                                                                    |   |                            |        |                                                                 |   |   |   |
| Supplemental Disclosures of Investing  Financing Activities:                            |   |                            |        |                                                                 |   |   |   |
|                                                                                    |   |                            |        |                                                                 |   |   |   |
|    Interest paid                                                                   |   | $                               | 190,959     |                                                                 | $      | 275,458 |   | $ | 1,840,921 |   |

 
| See accompanying notes to  condensed consolidated financial statements |
|------------------------------------------------------------------------|

 

5

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**Restoragen,Inc.**Notes to Condensed Consolidated Financial StatementsJune 30, 2002 and 2001(unaudited)

 

(1)           **Summary of Significant Accounting Policies**

 

**Basis of Presentation —**The condensed consolidated balance sheet as of June30, 2002, the condensed consolidated statements of operations for the three andsix month periods ended June 30, 2002 and 2001 and the condensed consolidatedstatements of cash flows for the six month periods ended June 30, 2002 and 2001have been prepared by the Company without audit in accordance with accountingprinciples generally accepted in the United States of America.  Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States of America.  In theopinion of management, all adjustments (all of which are normal and recurringin nature) considered necessary to present fairly the financial position atJune 30, 2002, and results of operations and cash flows for the periods presentedhave been included.  Results ofoperations for the interim periods are not necessarily indicative of theresults that may be expected for the full fiscal year, or any other period.  These financial statements and notes shouldbe read in conjunction with the audited financial statements for the year endedDecember 31, 2001, included in the Company’s Form 10-K filed with theSecurities and Exchange Commission.

 

In July 2001, the FASBissued Statement of Financial Accounting Standards No. 142 (“SFAS 142”),“Goodwill and Other Intangible Assets”, which was effective January 1,2002.  SFAS 142 requires, among otherthings, the discontinuance of goodwill amortization.  In addition, the standard includes provisions for thereclassification of certain existing recognized intangibles as goodwill,reassessment of the useful lives of existing recognized intangibles,reclassification of certain intangibles out of previously reported goodwill andthe identification of reporting units for purposes of assessing potentialfuture impairments of goodwill.  Therewas no impact to the Company’s financial statements as a result of adoptingthis standard.

 

In June 2001, theFinancial Accounting Standards Board issued SFAS No. 143, “Accounting for AssetRetirement Obligations”.  This standardaddresses financial accounting and reporting for obligations related to theretirement of tangible long-lived assets and the related asset retirementcosts.  SFAS No. 143 is effective forfiscal years beginning after June 15, 2002. The Company does not expect its adoption of this standard to have asignificant impact on the consolidated financial statements.

 

In August 2001,the Financial Accounting Standards Board issued SFAS No. 144, “Accounting forthe Impairment or Disposal of Long-Lived Assets” which was effective January 1,2002.  This standard addresses financialaccounting and reporting for the impairment or disposal of certain long-livedassets. There was no impact to the Company’s financial statements as a resultof adopting this standard. 

 

6

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**Property and equipment held for sale — P**roperty and equipment held for sale iscarried at the lower of carrying amount or estimated net realizable value.

 

**Shareholders Equity —**In connection with the issuance of the convertiblenotes in December 2001, the Company issued 999,997 warrants to purchase commonstock of the Company at a per share warrant exercise price equal to the lowerof $9.00 or the lowest per common equivalent share price at which the Companysells equity after the date of the warrants. Each lender initially received warrants to purchase a number of sharesof common stock equal to 50% of the amount of notes held divided by the warrantexercise price.  Commencing with the90th day after the initial date of issuance of the warrants, the number ofshares of common stock into which the warrants are exercisable increases by anadditional 10% of the notes held divided by the warrant exercise price for each30-day period in which the notes continue to remain outstanding and notconverted, up to 100% of the outstanding notes divided by the warrant exerciseprice.  Pursuant to this provision, thenumber of shares of the Company’s common stock issuable under the warrantsincreased by 200,000 shares in each month of March, April, May and June 2002.As of June 30, 2002, the warrants issued in connection with the convertiblenotes in December 2001 entitle the holders to purchase 1799,997 shares ofcommon stock.

 

Holder redemption rightson Series F Preferred Stock expired on March 31, 2002.  In connection with the expiration of theserights, the Series F Preferred Stock has been reclassified to shareholders’equity as of March 31, 2002.

 

**Going Concern Considerations** — The Company, from inception, has experienced lossesfrom its activities in research and development and has had minimalrevenues.  This and the fact that theCompany is a development stage business create a substantial doubt as to itsability to continue as a going concern. The Independent Auditors’ Reportaccompanying the Company’s audited financial statements for the year endedDecember 31, 2001 contained a going concern opinion.

 

The Company’s ability toachieve profitability on substantial portions of its operations will also dependin large part on: obtaining additional financing through equity or debt issuesor development collaborations, as necessary; obtaining regulatory approvals ofits products and entering into satisfactory agreements for productcommercialization.

 

The financial statementsdo not include any adjustments relating to the recoverability andclassification of recorded asset amounts or the amounts and classification ofliabilities that might be necessary should the Company be unable to continue asa going concern. 

 

7

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(2)           **Corporate Restructuring**

 

On February 21, 2002, theCompany announced a consolidation of facilities and reduction in workforce from121 employees to 60 employees.  On May22, 2002, the Company announced a revised corporate strategy that will resultin the Company ceasing its non-strategic recombinant peptide productionoperations and closing its peptide production facilities. It is anticipatedthat third party contract manufacturers will source all future productionrequirements. ** **The May 2002announcement has resulted in the reduction of the workforce by an additional 55employees. A small number of these employees have been retained to completetransition activities.  Going forward,the Company is being operated by four full-time employees.

 

The following is asummary of restructuring charges related to the staff reduction, consolidationof facilities and discontinuance of peptide production resulting from therevised corporate strategy. 

 
|                                                          |   | **Quarter ended  March 31, 2002** | ** ** | **Quarter ended  June 30, 2002** | ** ** | **Six months  June 30, 2002** | ** ** |
|---------------------------------------------------------------|--------|-----------------------------------|------------|----------------------------------|------------|-------------------------------|------------|
| Employee compensation & benefits:                         |   |                              |       |                             |       |                          |       |
| Severance pay & benefits                                  |   | $                                 | 923,249    |                             | $          | 1,222,879                     |       | $ | 2,146,128 |   |
| Occupancy & equipment costs:                              |   |                              |       |                             |       |                          |       |
| Non-cancelable lease costs, net of Estimated  sublease income |   | $                                 | 115,350    |                             | $          | 626,217                       |       | $ | 741,567 |   |
| Loss on impairment and abandonment of property and  Equipment |   | $                                 | 142,505    |                             | $          | 4,192,771                     |       | $ | 4,335,276 |   |
| Write down of patents                                         |   | —                            |       | $                                | 641,932    |                          | $          | 641,932 |   |
| Other                                                         |   | —                            |       | $                                | 221,757    |                          | $          | 221,757 |   |
| Total corporate restructuring Charges                         |   | $                                 | 1,181,104  |                             | $          | 6,905,556                     |       | $ | 8,086,660 |   |

The Company expects the majority of employeecompensation costs associated with the restructuring to be paid during 2002.The Company expects to pay liabilities established relating to non-cancelableleases over the respective lease periods, through fiscal 2005. Absent theability to sell the production facilities as a going concern, the Company willseek to sell the peptide production assets. The Company has written down thevalue of the production equipment to reflect anticipated net proceeds from saleand has written down to zero the building and

 

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leasehold improvements. The majority of thepatents issued to the Company have historically been in respect of productionprocesses or for medical applications which are no longer being pursued by theCompany in its revised strategy. The Company has written down to zero allpreviously capitalized patent expenses.  

The following is a summary of activityrelating to the restructuring charges during 2002: 
|                                 |   | **Restructuring  Charges** |      | **Cash  Payments** |   | **Non-cash  Charges(1)** |   | **June 30, 2002  Balance** |      |
|--------------------------------------|--------|----------------------------|-----------|--------------------|--------|--------------------------|--------|----------------------------|-----------|
| Employee compensation & benefits |   | $                          | 2,146,128 |               | $      | 1,139,352                |   | —                     |      | $ | 1,006,776 |   |
| Occupancy & equipment costs      |   | $                          | 5,076,843 |               | $      | 40,853                   |   | $                          | 4,335,276 |   | $ | 700,714 |   |
| Patents                              |   | $                          | 641,932   |               | — |                     | $      | 641,932                    |      | — |   |
| Other                                |   | $                          | 221,757   |               | 43,734 |                     | $      | 18,569                     |      | $ | 159,454 |   |
| Total                                |   | $                          | 8,086,660 |               | $      | 1,223,939                |   | $                          | 4,995,777 |   | $ | 1,866,944 |   |

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(1) Non-cash charges consist of impairmentand abandonment charges

 

The June 30, 2002 restructuring liabilitybalance is included in accrued expenses in the consolidated condensed balancesheet.

 

**Item 2.    MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

  **             **Following is adiscussion and analysis of the Company’s consolidated condensed financialcondition and results of operations for the three and six months ended June 30,2002 and 2001.  The section should beread in conjunction with the Company’s audited financial statements for theyear ended December 31, 2001, and Management’s Discussion and Analysis ofFinancial Condition and Results of Operations contained in the Company’s Form10-K for the year ended December 31, 2001, as filed with the Securities andExchange Commission.

 

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**Cautionary Statement About Forward-LookingStatements**

                This Form 10-Q contains, in addition to historical information,forward-looking statements that are based on the Company’s currentexpectations, beliefs, intentions or future strategies.  Such forward looking statements involveknown and unknown risks, uncertainties and other factors which may cause theactual results, performance or achievements of the Company to be materiallydifferent from any future results, performance or achievements, expressed orimplied by such forward-looking statements. The words “believe,” “expect,”“anticipate,” “plan,” “seek” and similar expressions identify forward-lookingstatements.  Readers are cautioned notto place undue reliance on these forward-looking statements that speak only asof the date the statement was made. These statements are subject to risks and uncertainties that could causeactual results to differ materially from the statements, including thedependence of the Company on obtaining future financing and its ability tocontinue operations, uncertainties involved in the additional development ofthe Company’s new pharmaceutical products, including securing strategic partnersto fund further development, the outcomes of clinical trials, obtainingregulatory approvals or clearances, the ability of the Company’s products to bemanufactured in commercial quantities, availability of commercial productioncapacity, the development of partnerships for distribution and marketing,protection of the Company’s patent and proprietary rights, avoidinginfringement of competitor’s proprietary rights, potential competition and theextent to which reimbursement for the costs of the products and treatments willbe available from government health administration authorities, private healthinsurers and other organizations.  Theserisks are further described in the Company’s Form 10-K for the year endedDecember 31, 2001 under the heading, “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations — Additional Factors That MayAffect Future Performance”.  The Companydoes not undertake responsibility to update such forward-looking statements toreflect events that arise after the date of this report.

 

**Overview**

 

                Restoragen, Inc. is a development stage biotechnology company focusedon the development of peptide therapeutics. The Company’s principalpharmaceutical product currently under development is recombinant human GLP-1(rGLP-1). GLP-1 is believed to be an important insulinotropic peptide thatregulates metabolism and has been shown to reduce high blood glucose levels andto improve insulin secretion and action in type II diabetics. Since 1997, theCompany has focused its drug development efforts on rGLP-1 for the treatment oftype II diabetes and is currently completing phase 2 (b) clinical trials fortype II diabetes patients who are failing oral therapy.

 

                As a result of its research in type II diabetes, the Company believesthat GLP-1 has the potential to decrease insulin resistance. While virtuallyall type II diabetic patients have insulin resistance, most people who haveinsulin resistance do not develop diabetes. They do, however, frequentlypresent with other serious disorders. In particular, it appears that insulinresistance is a major risk factor for most serious and common cardiovasculardiseases. Restoragen has filed patent applications for uses of rGLP-1 and itsanalogs in various cardiovascular diseases. In May 2002 

 

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the Company announced its revised corporate strategyto focus on the clinical development of rGLP-1 in cardiovascular diseaseindications. The Company’s strategy is to establish partnerships withmarket leading pharmaceutical companies and medical device companies to developand commercialize rGLP-1 for certain niche cardiovascular diseases in whichinsulin resistance is an underlying factor. The Company anticipates that thedevelopment of rGLP-1 for the management of severe heart failure in patientswho are transplant ineligible will begin with a phase 2 (a) proof of conceptstudy in the third quarter of 2002.

 

                The Company also intends to establish partnerships with market leadingpharmaceutical and drug delivery companies to develop and commercializesustained release formulations of rGLP-1 for type II diabetes and othermetabolic diseases and cardiovascular disorders in which insulin resistance isan underlying factor.

 

                As a result of the refocused strategy, the Company ceased itsnon-strategic recombinant peptide production operations. The Company hasactively sought to license or sell the production technology and facilitiesassociated with its peptide production. Despite its best efforts, the Companyhas been unable to identify a buyer for the production technology orfacilities. The Company has begun the process of closing down the productionfacilities and will seek to sell all production equipment.

 

                Since inception, the Company has financed itsoperations through the sale of equity securities and issuance of debt. From Maythrough September 2001, the Company undertook a private placement of preferredstock through a national investment banking firm with the goal of raising approximately$30 million to fund operations. Despite significant efforts, including roadshows and individual investor meetings throughout the United States and Europe,the Company was not successful in placing those securities.

 

                In December 2001, Restoragen entered into a bridge loan agreement withseveral current shareholders and their affiliates, including Medtronic, Inc.,Rocky Mountain Associates, S.A. and Equity Four Life (Bahamas) Ltd. Restoragenreceived loans in an aggregate principal amount of $18 million, which bearinterest at prime plus three percent per annum. The loans are due and payablein December 2003. The loans are secured by a first priority security interestin the Company’s intellectual property and all proceeds from licensing of the intellectualproperty.

 

                The Company is continuing efforts to raiseadditional working capital to fund operations, and is holding discussions withexisting note holders. If the Company is unable to raise additional workingcapital, its ability to meet obligations in the ordinary course will beimpaired.

** **

**Results of Operations**

                The Company recorded revenues of $0.2 million in the second quarter of2002. The revenues related to third party proof of concept productionarrangements.

                Research and development expenses include those costs associated withthe research, development, production and testing of our pharmaceuticalproducts, including all direct costs 

 

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incurred in conducting our clinical trials and all costsrelated to the protection of proprietary rights.  These costs have aggregated $71.7 million since ourinception.  Research and developmentcosts were $2.3 million and $6.0 million for the three and six month periodsended June 30, 2002, as compared to $3.7 million and $6.7 million for the sameperiods in the prior fiscal year. Research and development activities have beenscaled back significantly following the corporate restructuring initiativesannounced in February and May of this year. General and administrative expenseswere $0.7 million and $1.5 million for the three and six-month periods endedJune 30, 2002, as compared to $0.8 million and $1.6 million for the sameperiods in 2001. Administrative costs have also decreased as a result of therestructuring initiatives.

 

                In February 2002, Restoragen announced a restructuring and a reductionof total workforce from 121 to 60 employees. In May 2002, the Company announceda revised corporate strategy that would result in the Company ceasing itsnon-strategic recombinant peptide production operations and closing its peptideproduction facilities. The May 2002 announcement has resulted in the reductionof the workforce by an additional 55 employees. A small number of theseemployees have been retained to complete transition activities. Going forward,the Company is being operated by four full time employees.

 

                In connection with the restructuring, the Company recordedrestructuring costs of approximately $1.2 million during the first quarter of2002 and $6.9 million during the second quarter of 2002.  The second quarter charge included anon-cash charge of $4.9 million related to the write down of tangible andintangible assets. The Company has written down production equipment to reflectanticipated net proceeds from sale and has written down to zero the buildingand leasehold improvements. The majority of the patents issued to the Companyhave historically been in respect of production processes or for medicalapplications  which are no longer beingpursued by the Company in its revised strategy. It is anticipated that theCompany’s ongoing net cash outflow for the second half of the year will beapproximately $1.1 million per month.

                Interest income decreased to $0.04 million and $0.07 million for thethree and six month periods ended June 30, 2002, as compared to $0.1 millionand $0.2 million for the same periods in 2001, reflecting lower interest ratesand lower interest earning assets. We incurred interest expense of $0.5 millionand $1.0 million for the three and six-month periods ended June 30, 2002compared to $0.2 million and $0.4 million for the same period in 2001.  The increase reflects interest chargesassociated with the bridge loan financing secured in December 2001.

 

**Liquidity and Capital Resources**  

                Working capital was $0.5 million as of June 30, 2002, compared to $10.7million as of December 31, 2001.  Cashand cash equivalents were $4.4 million as of June 30, 2002.  

                During the six months ended June 30, 2002, the Company usedapproximately $9.9 million of cash for operating activities and $0.1 millionfor asset acquisitions.  Cash paymentsfor financing activities totaled $0.6 million for the six-month period.  Based on its anticipated revised operatingplan, the Company believes that existing cash and cash equivalents will besufficient to fund operations until the beginning of the fourth quarter of2002.

                The Company continues to seek financing from existing noteholders.  Additional 

 

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financing may require a restructuring orre-capitalization. The restructuring or re-capitalization could take one ofseveral forms, including conversion of all or a portion of the notes to equity,refinancing the indebtedness using new funds from third party sources, orvoluntary or involuntary bankruptcy or re-capitalization under Chapter 11 ofthe United States Bankruptcy Code. In any form of restructuring orre-capitalization involving conversion of the indebtedness to equity, theinterests of existing shareholders could be substantially diluted. The ultimatesuccess of the financing will depend upon the Company’s ability to successfullynegotiate and implement a restructuring plan with the note holders. If theCompany is unable to restructure or obtain financing from another source, theCompany will be required to discontinue all of its operations.

 

                As of June 30, 2002, the Company had a negative shareholders equity of$19.9 million and shareholders’ deficit accumulated during the developmentstage of $101.3 million. Historically the auditors’ reports on the Company’sfinancial statements have contained an explanatory paragraph concerning theCompany’s ability to continue as a going concern and its status as adevelopment stage company. The Company will incur additional losses as itcontinues to operate.

 

**New Accounting Pronouncements**

                In July 2001, the FASB issued Statement of Financial AccountingStandards No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets”, whichwas effective January 1, 2002.  SFAS 142requires, among other things, the discontinuance of goodwill amortization.  In addition, the standard includesprovisions for the reclassification of certain existing recognized intangiblesas goodwill, reassessment of the useful lives of existing recognizedintangibles, reclassification of certain intangibles out of previously reportedgoodwill and the identification of reporting units for purposes of assessingpotential future impairments of goodwill. There was no impact to the Company’s financial statements as a result ofadopting this standard.

 

                In June 2001, the Financial Accounting Standards Board issued SFAS No.143, “Accounting for Asset Retirement Obligations”.  This standard addresses financial accounting and reporting forobligations related to the retirement of tangible long-lived assets and therelated asset retirement costs.  SFASNo. 143 is effective for fiscal years beginning after June 15, 2002. TheCompany does not expect its adoption of this standard to have a significantimpact on the consolidated financial statements.

 

                In August 2001, the Financial Accounting Standards Board issued SFASNo. 144, “Accounting for the Impairment or Disposal of Long Lived Assets” whichwas effective January 1, 2002.  Thisstandard addresses financial accounting and reporting for the impairment ordisposal of certain long-lived assets. There was no impact to the Company’s financial statements as a result ofadopting this standard.

 

**Critical Accounting Policies**

 

                The Company recorded restructuring charges totaling $8.1 million duringthe six months 

 

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ended June 30, 2002. Estimates were utilized in determining these restructuring chargesincluding estimates of fair values for property and equipment held forsale, estimated costs to maintain vacated facilities, and estimated length oftime necessary to sublease the Company’s vacated facilities.  The Company will adjust such estimates asadditional information is available or as circumstances change.

 

                The Company reviews long-lived assets and certain intangibles forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable.  An evaluation of recoverability is performed by comparing theundiscounted cash flows associated with the asset to the asset’s carryingamount to determine if a write down is required.

 

                As permitted by SFAS No. 123, “Accounting for Stock-basedCompensation”, the Company accounts for its stock-based awards to employees underthe intrinsic value method in accordance with Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees” and relatedinterpretations.  All stock-based awardsto independent consultants are accounted for under the fair value method asrequired by SFAS No. 123 and related interpretations.

 

**ContractualObligations and Commitments**

                Our contractual obligations and commitments, consisting of capital andoperating lease obligations, notes payable and convertible notes payable have notchanged significantly during the six month period ended June 30, 2002.

**Market Risk**

**               **Weare exposed to market risk related to changes in interest rates. The Companydoes not use derivative financial instruments for speculative or tradingpurposes.  Due to the nature of cash andcash equivalents, we believe that there is no material market risk exposure.

**Item 3.    QUALITATIVEAND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK****.**

See Item 2, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations — Market Risk”. 

 

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**PART II**

**OTHER INFORMATION**

** **

**Item 1.**    **LEGAL PROCEEDINGS****.**

                None

**Item 2.**    **CHANGES IN SECURITIES****.**

                In connection with the issuance of the convertible notes in December2001, the Company issued 999,997 warrants to purchase common stock of theCompany at a per share warrant exercise price equal to the lower of $9.00 orthe lowest per common equivalent share price at which the Company sells equityafter the date of the warrants.  Each lenderinitially received warrants to purchase a number of shares of common stockequal to 50% of the amount of notes held divided by the warrant exerciseprice.  Commencing with the 90th dayafter the initial date of issuance of the warrants, the number of shares ofcommon stock into which the warrants are exercisable increases by an additional10% of the notes held divided by the warrant exercise price for each 30-dayperiod in which the notes continue to remain outstanding and not converted, upto 100% of the outstanding notes divided by the warrant exercise price.Pursuant to this provision, the number of shares of the Company’s common stockissuable under the warrants increased by 200,000 shares in each month of March,April, May and June 2002. As of June 30, 2002, the warrants issued inconnection with the convertible notes in December 2001 entitle the holders topurchase 1,799,997 shares of common stock

**Item 3.    DEFAULTSUPON SENIOR SECURITIES****.**

                None  

**Item 4.    SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS****.**

                None

**Item 5.    OTHERINFORMATION****.**

On July 15, 2002 Peter Tattle resigned from the Board of Directors forpersonal reasons. On July 22, 2002 Richard de Souza resigned from the Board ofDirectors for personal reasons.

**Item 6.    EXHIBITSAND REPORTS ON FORM 8-K****.**

(a)                                  Exhibits

None

(b)                                 Reportson Form 8-K. The Company filed a Form 8-K on May 30, 2002, attaching a pressrelease that announced the Company’s revised corporate strategy and workforcereduction.  No financial statements wererequired to be filed with the report. 

 

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**SIGNATURES**

                Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                        |   | RESTORAGEN,  INC.             |   |
|-----------------------------|--------|-------------------------------|--------|
|                        |   |                          |   |
|                        |   |                          |   |
|                        |   |                          |   |
| Dated:   July 25, 2002 |   | /s/ Ashleigh  W. Palmer       |   |
|                        |   | Ashleigh W. Palmer            |   |
|                        |   | Chief Executive Officer       |   |
|                        |   | (Duly Authorized Officer)     |   |
|                        |   |                          |   |
|                        |   | /s/ David S. Walker           |   |
|                        |   | David S. Walker               |   |
|                        |   | Chief Financial Officer       |   |
|                        |   | (Principal Financial Officer) |   |

 

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