1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JULY 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-17521
ZILA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 86-0619668
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
5227 NORTH 7TH STREET, PHOENIX, ARIZONA 85014-2800
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (602) 266-6700
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
NONE N/A
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
At September 30, 1999, the aggregate market value of common stock held
by non-affiliates of the registrant was $129,528,641.
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [ ] No [ ] N/A
APPLICABLE ONLY TO CORPORATE REGISTRANTS
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
At September 30, 1999, the number of shares of common stock outstanding
was 40,863,895.
DOCUMENTS INCORPORATED BY REFERENCE
Materials from the Registrant's 1999 Proxy Statement have been
incorporated by reference into Part III, Items 10, 11, 12 and 13.
2
TABLE OF CONTENTS
PAGE
----
PART I ....................................................................................................... 1
Item 1. BUSINESS.................................................................................... 1
Item 2. PROPERTIES.................................................................................. 15
Item 3. LEGAL PROCEEDINGS........................................................................... 16
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......................................... 16
PART II ...................................................................................................... 17
Item 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS......................................................................... 17
Item 6. SELECTED FINANCIAL DATA..................................................................... 17
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS....................................................................... 18
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................................................. 23
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURES................................................................... 23
PART III ..................................................................................................... 24
PART IV ...................................................................................................... 25
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8............................. 25
SIGNATURES.................................................................................................... 27
3
This Form 10-K contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. The Company's actual results could differ materially from those set
forth in the forward-looking statements. Certain factors that might cause such a
difference are discussed in the section entitled "Cautionary Factors that May
Affect Future Results" on page 11 of this Form 10-K.
PART I
ITEM 1. BUSINESS
GENERAL
Zila, Inc., a Delaware corporation, is an international manufacturer
and marketer of pharmaceutical, biomedical, dental, and nutritional products.
The Company's business is organized into three major product groups:
Pharmaceuticals, Professional Products and Nutraceuticals. Unless the context
otherwise indicates, the terms "Zila" and "Company" as used herein refer to
Zila, Inc. and each of its subsidiaries.
The Pharmaceuticals Group consists of over-the-counter and prescription
products, including the Zilactin(R) family of over-the-counter products,
Peridex(R) prescription mouth rinse and OraTest(R), an oral cancer diagnostic
system. The Pharmaceuticals Group operates under the wholly owned
subsidiary of the Company, Zila Pharmaceuticals, Inc., a Nevada corporation.
The Professional Products Group operates through the Company's wholly
owned subsidiaries Bio-Dental Technologies Corporation, a California
corporation, and Cygnus Imaging, Inc., an Arizona corporation. Bio-Dental
Technologies Corporation has two subsidiaries, Ryker Dental of Kentucky, Inc. a
Kentucky corporation, which does business under the name Zila Dental Supply and
is a national distributor of professional dental supplies, and Integrated Dental
Technologies, Inc.("IDT"), a California corporation which distributes
PracticeWorks(TM), the Company's dental practice management software. Cygnus
Imaging, Inc. ("Cygnus") is a manufacturer and marketer of dental imaging
products including digital x-ray systems and intraoral cameras.
On October 28, 1999, Cygnus completed the sale of substantially all of
its assets and certain of its liabilities to Procare Laboratories, Inc.
("Procare"), of Scottsdale, Arizona for approximately $4.0 million. Procare is
controlled by the former owner and President of Cygnus, Egidio Cianciosi. The
purchase price was paid through the issuance of a note receivable which is
collateralized by the assets of Procare and matures November 10, 1999.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Company Overview" for the Company's acquisition
history.
Financial information for each group or segment for each of the last
three fiscal years is included in the Audited Consolidated Financial Statements.
The Nutraceuticals Group includes Oxycal Laboratories, Inc., an Arizona
corporation, ("Oxycal") and its two subsidiaries Inter-Cal Corporation, Inc, an
Arizona corporation, and Oxycal Export, Inc. a U.S. Virgin Islands corporation.
Oxycal and its subsidiaries manufacture and distribute a patented and unique
form of vitamin C under the trademark Ester-C(R).
The Company's principal executive offices are located at 5227 North
Seventh Street, Phoenix, Arizona 85014-2800, and its telephone number is (602)
266-6700.
PRODUCTS
PHARMACEUTICALS GROUP
- - Zilactin(R) The Zilactin(R) line includes six over-the-counter ("OTC"),
non-prescription products: Zilactin(R), Zilactin(R)-B,
Zilactin(R)-L, Zilactin(R)-Lip, Zilactin(R) Baby and
Zilactin(R) Toothache Swabs. The Zilactin(R) products are used
topically for the purposes described below:
- ZILACTIN(R) -- a protective film for canker sores,
cold sores and fever blisters.
- ZILACTIN(R)-B -- Zilactin(R)-B is a medicated gel
containing benzocaine with the film-forming
properties of Zilactin(R). Zilactin(R)-B has been
formulated for a segment of the market which prefers
a film-forming application with a topical anesthetic.
Zilactin(R)-B quickly controls the pain associated
with mouth sores while shielding them from the
environment of the mouth.
- ZILACTIN(R)-L -- a liquid for treating developing
fever blisters and cold sores.
- ZILACTIN(R)-Lip -- Zilactin(R)-Lip is positioned to
be a premium-priced, effective alternative to
existing lip balms. Zilactin(R)-Lip prevents sun
blisters and treats cold sores
-1-
4
and dry, chapped lips. Most other competing products
only perform one or two of such applications.
- ZILACTIN(R)-Baby -- Zilactin(R)-Baby is a medication
for teething pain. Zilactin(R)-Baby contains a higher
level of benzocaine than competing products, and has
a cool grape flavor. Unlike other teething gels, it
does not contain saccharin or coloring dyes.
ZILACTIN(R) TOOTHACHE SWABS - Zilactin(R) Toothache
Swabs is a new medication for aching teeth, sore gums
and pain from dentures and braces which the Company
began distributing in June of 1999. Each single use
dry handle swab applicator is saturated with a unique
Zilactin Toothache formula with 20 percent benzocaine
and is packaged 8 swabs to a box.
The Zilactin(R) treatment composition is covered by a patent
owned by the Company. This patent covers the composition and
the film-forming properties of the product formula. See
"Business --Patents and Trademarks." Zilactin(R) and
Zilactin(R)-B formulas incorporate these proprietary treatment
compositions.
Zilactin(R) and Zilactin(R)-B are packaged as gels in .25
ounce plastic tubes. Zilactin(R)-L, is a liquid packaged in a
7.4 ml plastic bottle. The products are applied directly to
affected areas in quantities large enough to cover the lesion
with the gel or liquid. The gels contain an active ingredient
which forms a thin, transparent, pliable film that holds the
active ingredient against the affected tissue and keeps the
affected area clean. The film can last up to six hours inside
the mouth, a feature which makes the formulation suitable for
a variety of dental applications.
In addition to its over-the-counter applications, Zilactin(R)
is being used by dentists to treat patients with canker sores
and other oral mucosal ulcers or lesions, and has been
evaluated in dental schools at selected major universities.
Zilactin(R) was originally developed as a treatment for herpes
virus lesions. The most common form is Herpes Simplex Type I,
which is the cause of fever blisters and cold sores. Herpes
Simplex Type II is the cause of genital herpes. Other types of
herpes infections include chicken pox, shingles (herpes
zoster), mononucleosis and the Epstein-Barr Virus. Depending
principally on the availability of resources, the Company may
explore the development of new products, including the
addition of other medications into the Zilactin(R) vehicle,
and/or the approval of existing products as recognized
treatments for Type II herpes and such other viruses. However,
the Company currently does not market Zilactin(R) as a
treatment for genital herpes or shingles.
The Company believes that superior efficacy and targeted
marketing efforts are the reason that three independent
pharmacist research studies reported that Zilactin(R) is the
number one OTC product pharmacists recommend for treating
canker sores and cold sores.
- - Peridex(R) Peridex(R) is a prescription antibacterial oral rinse used
between dental visits as part of a professional program for
the treatment of gingivitis. The active ingredient in
Peridex(R) is 0.12% chlorhexidine gluconate. Peridex(R) was
the first rinse to receive the American Dental Association
seal for reduction of plaque and gingivitis. Peridex(R)
effectively controls the oral bacteria associated with
periodontal disease, particularly in the first and only
completely reversible stage, gingivitis. Controlling gum
disease at its earliest stage is important because, if left
untreated, gingivitis can progress to periodontitis, resulting
in destruction of the periodontal structure and supporting
bone. The Company acquired the Peridex(R) product line from
Procter & Gamble on November 5, 1997 for $12.0 million plus
the value of acquired inventory.
- - OraTest(R) The OraTest(R)product, a diagnostic adjunct for oral cancer
and site delineation for biopsy and surgical excision, has
been approved for distribution in the United Kingdom, Canada,
Australia, Taiwan, Belgium, Holland, Luxembourg, Finland,
Greece, Portugal, China, Bermuda and the Bahamas. The Company
is currently seeking government approval from the Food and
Drug Administration (the "FDA") to distribute the OraTest(R)
product in the United States. The OraTest(R) product continues
to be marketed under the name OraScreen(R) in the U.K. by the
-2-
5
Company's licensee, Stafford-Miller (a division of Block Drug
Company, Inc.) and under the name OraScan in Canada by the
Germiphene Corporation. The Company will market the product
under the OraTest(R) name in the U.S. and other countries.
According to the American Cancer Society, 40,400 new oral,
nasopharyngeal and laryngeal cancers will be diagnosed and
12,300 oral cancer related deaths will occur in the U.S. in
1999. Worldwide, nearly 900,000 new cases of oral cancer
occurred in 1996, and incidence and mortality rates are
rising. In most people, by the time it is diagnosed, oral
cancer has usually metastasized, resulting in a poor
prognosis. Those who do survive frequently undergo
significantly disfiguring surgery. Data published in 1994 by a
major dental publication quotes a Harvard University economist
as stating that the annual cost of treating oral cancer in the
United States is $3.7 billion. The economist estimates
that OraTest(R) could have the potential of reducing this cost
by approximately 60% if it successfully identifies oral cancer
lesions far earlier than they are being found today. The
earlier these lesions are identified, the greater the chances
of reducing morbidity and mortality.
PROFESSIONAL PRODUCTS GROUP
- - Dental Zila Dental Supply is a national distributor of professional
Supplies dental supplies, carrying brand names such as Eastman Kodak,
Dentsply, Sybron/Kerr and 3M. Most of Zila Dental Supply's
sales are through direct mail, outside sales force,
telemarketing and the internet.
Zila Dental Supply distributes consumable supplies and small
equipment as well as a select group of large items of dental
equipment, such as compressors, sterilizers, dental lights and
chairs in limited geographical markets and represents the
products of over 500 dental manufacturers. The Company
believes that these products constitute the vast majority of
supplies used in the day-to-day operations of a dental
practice. For example, Zila Dental Supply carries a broad line
of dental alloys, x-ray film, composite filling materials,
impression materials, latex gloves, diamond and carbide
cutting instruments, anesthetics, asepsis and infection
control products, operative, hygiene and surgical instruments,
and a variety of other widely used items.
Dentists have traditionally purchased their supplies from
local full-service supply companies, or from mail-order firms.
Historically, Zila Dental Supply has operated primarily as a
direct mail distributor with full-service operations in
certain geographical markets. The mail order operation uses
the efficiencies of direct mail and telemarketing to provide
service, convenience and competitive prices. The full service
operation combines competitive prices with an even higher
level of service to the dental customer, usually resulting in
a higher level of sales per customer. Zila Dental Supply will
continue to provide the benefits of a mail order company
while, at the same time, seeking to expand its full-service
operations to other geographical markets.
- - Dental Cygnus manufacturers and markets intraoral cameras and digital
Imaging x-ray systems in domestic and international markets. Cygnus'
intraoral camera products include the OralVision 1000(TM) (for
U.S. and Canadian markets), Stylus 1000(TM) (featuring PAL
video format for export), and the Stylus 1500(TM). The Stylus
1500(TM) features mirror image, x-ray gray scale, quad freeze
frame and image stabilization for tremble-free images.
Rounding out the Cygnus camera line are the Stylus 2000(TM) ,
a fully self-contained system, and the Gemini(TM) video
management device, which turns any camera into a hands-free,
multi-functional diagnostic system.
During fiscal year 1998, Cygnus entered into an agreement with
Panasonic Medical and Industrial Video Company ("Panasonic"),
the U.S. division of Japan's Matsushita Industrial Equipment
Co., Ltd., which gives Cygnus exclusive U.S. rights for
Panasonic x-ray sensors for filmless digital x-ray technology.
Cygnus Ray2(TM), was introduced in February 1998. The system's
Panasonic sensors are available in pediatric, standard and
bite-wing sizes.
- - Dental Integrated Dental Technologies, Inc., located in Gold River,
Software California, develops and markets
-3-
6
PracticeWorks(TM), proprietary, state-of-the-art dental office
software. Written to be compatible with the popular Windows NT
and Windows 95 formats, PracticeWorks(TM) helps in improving
the operating efficiency of dental practices in areas such as
patient scheduling, treatment planning, insurance processing,
accounts receivable management, patient charting, and
marketing communications. PracticeWorks(TM) is a true 32 bit
Windows(R)-based software, and is Year 2000 ready.
NUTRACEUTICALS GROUP
- - Ester-C(R) Oxycal, located in Prescott, Arizona, manufactures a patented
and unique form of Vitamin C under the trademark Ester-C(R).
Its products are distributed by Inter-Cal Corporation, an
Oxycal subsidiary. Products manufactured with Ester-C(R)
nutritional ingredients are sold throughout the U.S. and in 41
countries worldwide. Inter-Cal requires its customers to
display the federally-registered Ester-C(R)logo on their
packaging. Exciting opportunities for Ester-C(R) nutritional
ingredients exist among topical applications (such as skin
creams), chewable vitamins, nutrition bars, sport drinks and
food fortification. Oxycal holds two patents on the use of
Vitamin C metabolites and their impact on pharmaceutical
products as well as nutritional supplements. Ester-C(R)Topical
Concentrate, a liquid formulation for skin care products,
provides a stable form vitamin C that penetrates to the
collagen-producing layers of the skin without chemicals.
Ordinary vitamin C is quite unstable in most health and beauty
care products and thus cannot provide the benefit of vitamin C
to the skin. Ester-C(R) Topical Concentrate is non-acidic and
free of chemical esters.
MARKETING
PHARMACEUTICALS GROUP
- - Strategy for The Company's Pharmaceuticals Group employs three strategies
OTC Products to market its OTC products:
- Education - educate several key groups of health
professionals on the uniqueness and effectiveness of each of
the products. Targeted efforts to build awareness of the
product line are made by direct mailings and attending medical
conventions. During fiscal year 1999, the Company participated
in over thirty meetings geared to dental, pharmacy and medical
professionals. At these meetings, Company representatives have
an opportunity to interact with and distribute information to
thousands of interested health professionals.
- Participation - participate in retailer-driven activities
designed to make its OTC products available at more outlets
and to offer value to consumers at the retail store level.
- Awareness - build consumer awareness of the OTC products
through focused efforts like targeted advertising and direct
mail sampling.
- - Peridex(R) Peridex(R) is marketed to healthcare professionals and
pharmacists with extensive support from ICS, Ltd., a national
contract detailing organization. Additionally, detailers call
upon the nation's 54 dental and 200 hygiene schools, as well
as managed care organizations, pharmacists and wholesalers, to
reinforce support for Peridex(R) and Zila's other brands.
- - OraTest(R) After two years of market preparation, Zila's U.K. licensee,
Stafford-Miller Ltd. (a division of Block Drug Company),
formally introduced OraTest(R) under the name OraScreen(TM) to
general practitioners in the U.K. in April 1998. The marketing
effort for OraScreen(TM) in the U.K. has been a multilevel
strategy designed to educate dentists, specialists and staff
on the accuracy of the OraScreen(TM) product and the strong
benefits of the early detection of oral cancer. Health
professionals have become aware of OraScreen(TM) through
journal advertising and some timely (independently authored)
articles on the impact of oral cancer and the benefits of
early intervention. The OraTest(R) product continues to be
marketed under the OraScan(R) name by the Germiphene
Corporation in Canada.
-4-
7
The Company is continuing to make extensive preparations for
the U.S. introduction of the OraTest(R) product once its
approved. One of the nation's leading dental advertising and
marketing firms has already prepared professional advertising
and training materials, and consumer education tools. A
national detailing force is being developed, and Zila Dental
Supply is well equipped to handle national OraTest(R)
distribution, direct mail promotion, sophisticated
telemarketing, outside sales force, and Internet selling.
PROFESSIONAL PRODUCTS GROUP
Both Cygnus and PracticeWorks(TM) expend considerable effort
educating their distributors about the quality, reliability
and features of its products. They both advertise their
products through industry publications and direct mail and
exhibit their products at industry trade shows. In addition,
Cygnus and PracticeWorks(TM) seek to stimulate interest in
their products by providing information and marketing
materials to influential and prominent experts and consultants
in the dental industry. Zila Dental Supply markets its
products directly to the end user primarily by direct mail,
outside sales force, trade shows and telemarketing.
NUTRACEUTICALS GROUP
Oxycal's manufacturing and marketing division, Inter-Cal
Corporation, supports education and sales of its value-added
vitamin C products with a multi-million dollar advertising
program. Inter-Cal promotes the patented Ester-C(R) ingredient
on behalf of more than one hundred manufacturers and marketers
of finished Ester-C(R) products. National radio advertising
with targeted print advertising is utilized in both the United
States and Canada. The advertising is assisting the transition
as an industry leading product in natural food outlets to more
broad-based availability in mass market and chain stores.
Education and promotion to the trade is primarily accomplished
through several national trade shows in the U.S. and Canada.
Print advertising in trade journals is also used.
International sales activities are managed by local
distributors and are encouraged by advertising assistance and
rebate programs. Some corporate sponsored public relations and
advertising is done in the U.K.
MANUFACTURING AND SUPPLY
PHARMACEUTICALS GROUP
The Company employs a network of outside manufacturers to
produce and package all of its products within the
Pharmaceuticals Group. The following is a breakdown by product
line.
- - Zilactin(R) Arizona Natural Resources of Phoenix, Arizona manufactures the
Zilactin(R) line of products, and Clinipad Corporation
("Clinipad") of Charlotte, North Carolina manufactures all
Zilactin(R) sample packets. National Health Care of Antioch,
Illinois manufactures the Zilactin(R) Toothache Swabs. The
Company places orders with each supplier based on its
anticipated needs for the products. Packaging components are
supplied to each manufacturer by the Company. Secondary
suppliers are maintained as alternate supply sources, and are
an integral part of the Company's strategy to maintain its
product pipeline.
- - Peridex(R) Xttrium of Chicago, Illinois is the primary manufacturer of
Peridex(R). Accupac of Mainland, Pennsylvania is the Company's
secondary manufacturer of Peridex(R). Peridex(R) was
manufactured by Procter & Gamble through June 1998.
- - OraTest(R) Fleet Laboratories Ltd. of Watford, Herts, United Kingdom,
("Fleet") produces and packages the OraTest(R) product under
the name OraScreen(TM) for distribution in the U.K. by the
Company's licensee, Stafford-Miller Ltd. (a division of Block
Drug Company, Inc.). Fleet also manufactures the OraTest(R)
product for sale to other countries including Taiwan and
Australia.
-5-
8
Germiphene Corporation of Brantford, Ontario, Canada,
continues to produce and package the OraScan(R) product at its
facility. The Company has also identified a U.S.-based company
with the capacity to manufacture the OraTest(R) kits.
In order to ensure an available and stable supply of Zila(R)
Tolonium Chloride, the world's only pharmaceutical grade
toluidine blue, the active ingredient in the OraTest(R)
product, the Company established its own manufacturing
facility. In February 1999, the FDA performed a Pre-Approval
Inspection and no deficiencies or "required corrective
actions" were identified by FDA personnel. Several test
batches of Zila(R) Tolonium Chloride have already been
manufactured at the Company's facility and all have met
specifications. In preparation for the U.S. marketing of the
OraTest(R) product and increasing global sales, the Company
has expanded its Phoenix manufacturing facility with the
addition of a second production line.
PROFESSIONAL PRODUCTS GROUP
Products distributed by Zila Dental Supply are manufactured by
over 500 dental manufacturers. The Company's intraoral cameras
are manufactured by Cygnus at its Scottsdale, Arizona facility
and the CygnusRay2(TM) is manufactured by Panasonic.
NUTRACEUTICALS GROUP
All products within the Nutraceuticals Group are manufactured
at Oxycal's Prescott, Arizona location.
COMPETITION
PHARMACEUTICALS GROUP
All industries in which the Company sells its products are
highly competitive. A number of companies, almost all of which
have greater financial resources, marketing capabilities and
research and development capacities than the Company, are
actively engaged in the development of products that may
compete with the Company's products. The pharmaceutical
industry is characterized by extensive and ongoing research
efforts which may result in development by other companies of
products comparable or superior to any that are now on the
market, including those sold by the Company.
- - Zilactin(R) Numerous products exist for treatment of herpes simplex virus
I ("HSV I") symptoms (i.e., cold sores, fever blisters),
including the following products: Orajel and Tanac by Del
Pharmaceuticals, Inc., Herpecin-L by Anthem, Inc., and Carmex
by Carma Lab, Inc. Although there can be no assurance in this
regard, management of the Company believes that there is a
substantial potential demand for products that are effective
in the treatment of these conditions. The Company does not
believe that any of these treatments have achieved a dominant
market share. Based upon clinical studies and comments
received by the Company from physicians and dentists,
management believes that its products will be able to meet
much of that demand and that Zilactin(R), Zilactin(R)-B and
Zilactin(R)-L will provide more effective symptomatic relief
of HSV I infections than the treatments of the Company's
competitors.
- - Peridex(R) Peridex(R)competitors include generic versions and name brands
such as Periogard, made by Colgate Oral Pharmaceuticals. Many
of the competitors possess greater financial resources than
the Company. However, the Company believes that Peridex's(R)
reputation as the "gold standard" of prescription
antibacterial oral rinse and the detailing sales force will
allow the Company to compete effectively in the marketplace.
- - OraTest(R) OraTest(R), was introduced in Canada in May 1993, in Australia
in 1993 and in the U.K. in April 1998. In April 1998,
regulatory approvals were obtained in Portugal, Belgium,
Luxembourg, Holland, Finland and Greece. Regulatory approval
was obtained in China during the 1999 fiscal year. The Company
intends to distribute the OraTest(R) product in those
countries not covered in
-6-
9
the license agreement with Stafford-Miller.
Zila(R) Tolonium Chloride is the active ingredient in the
Company's oral cancer detection system, OraTest(R). Zila(R)
Tolonium Chloride is the world's only pharmaceutical grade
toluidine blue, produced in compliance with stringent FDA
current Good Manufacturing Practices ("GMP") regulations.
Zila(R) Tolonium Chloride and its technology are protected by
issued and pending patents. See also "Business -- Patents and
Trademarks."
PROFESSIONAL PRODUCTS GROUP
- - Dental Zila Dental Supply competes with approximately 200 dental
Supplies supply dealers and mail order supply houses in the United
States, some of which have significantly greater financial
resources than the Company. Zila Dental Supply's sales make up
less than 2% of the total domestic market for dental supplies.
Zila Dental Supply's position with respect to its competitors
is difficult to determine since most of the companies are
privately-held and do not disclose financial information.
However, the Company believes that approximately 50 percent of
the market is dominated by two public companies: Patterson
Dental Company and Henry Schein, Inc., both of which are very
active in the acquisition market in an effort to gain market
share.
- - Dental There are many companies marketing dental practice management
Software software with the major competitors to PracticeWorks(TM) being
Dentrix, sold by Henry Schein, Inc., EagleSoft, owned by
Patterson Dental Company and SoftDent, purchased by Dentsply
New Image. All of these companies possess greater financial
resources than the Company. However, the Company believes that
PracticeWorks(TM)' unique product features, expanded selling
organization and increasingly experienced support staff make
it well positioned to compete with these larger competitors.
- - Dental Cygnus' competitors in both the intraoral camera and digital
Imaging x-ray markets include Dentsply New Image, Schick Technologies,
Henry Schein, Inc., Trophy Radiology, and Welch Allyn Dental
Systems. Many of these companies possess greater financial
resources than the Company.
NUTRACEUTICALS GROUP
- - Ester-C Within the vitamin C market, the Company's competitors include
all other vitamin C manufacturers, such as Roche and Takeda.
Many of the Company's competitors, particularly those in
markets other than the health food and vitamin store market,
have substantially greater financial resources than the
Company. The Company believes that the growing number of
health food and vitamin distributors and retailers are
increasingly likely to align themselves with producers that
offer a wide variety of high quality products, have a loyal
customer base, support their brands with strong marketing and
advertising programs and provide consistently high levels of
customer service. The Company believes that it competes
favorably with other producers of vitamin C because of the
positive attributes of its Ester-C(R)product, high
customer-order fill rate, strong distribution network, and
advertising and promotional support.
LICENSING
PHARMACEUTICALS GROUP
In certain instances the Company has expanded the distribution
of its products by licensing certain of its patents to other
companies.
In 1991, the Company acquired ownership of certain exclusive
rights to the patents, technology and process embodying the
formulation and the application of the OraTest(R) product. The
Company is obligated to pay royalties to the National
Technical Information Service based upon certain usages of the
OraTest(R) product. During the 1995 fiscal year, the Company
entered into a licensing agreement pursuant to which
Stafford-Miller Ltd. (a division of Block Drug Company, Inc.)
("Block") was given the right to distribute the OraTest(R)
product under the name
-7-
10
OraScreen(TM) in certain markets not previously pursued by the
Company. The Company receives royalties from Block equal to a
set percentage of the net sales of OraScreen(TM) by Block. In
April 1998, OraScreen(TM) was launched at the British Dental
Association ("BDA") meeting held in Harrogate in the United
Kingdom. Following this meeting the BDA created and
distributed a booklet titled "Guidelines for Early Detection."
This booklet outlined the education and application of
OraScreen(TM) in the dental office head and neck examination.
In August 1998, the Company entered into a license agreement
with Nippon Shoji Kaishi, Ltd. (now known as Azwell, Inc.) to
obtain regulatory approval and market the OraTest(R) product
in Japan.
GOVERNMENT REGULATIONS
General The Company's operations are subject to extensive regulation
by governmental authorities in the United States and other
countries with respect to the testing, approval, manufacture,
labeling, marketing, distribution and sale of its products.
The Company devotes significant time, effort and expense
addressing the extensive government regulations applicable to
its business, and in general, the trend is towards more
stringent regulation.
On an ongoing basis, the FDA reviews the safety and efficacy
of marketed pharmaceutical products and monitors labeling,
advertising and other matters related to the promotion of such
products. The FDA also regulates the facilities and procedures
used to manufacture pharmaceutical products in the United
States or for sale in the United States. Such facilities must
be registered with the FDA and all products made in such
facilities must be manufactured in accordance with "good
manufacturing practices" established by the FDA. Compliance
with good manufacturing practices guidelines requires the
dedication of substantial resources and requires significant
costs. The FDA periodically inspects the Company's contract
manufacturing facilities and procedures to assure compliance.
The FDA may cause a recall or withdraw product approvals if
regulatory standards are not maintained. FDA approval to
manufacture a drug is site specific. In the event an approved
manufacturing facility for a particular drug becomes
inoperable, obtaining the required FDA approval to manufacture
such drug at a different manufacturing site could result in
production delays, which could adversely affect the Company's
business and results of operations.
In connection with its activities outside the United States,
the Company is also subject to regulatory requirements
governing the testing, approval, manufacture, labeling,
marketing, distribution and sale of its products, which
requirements vary from country to country. Whether or not FDA
approval has been obtained for a product, approval of the
product by comparable regulatory authorities of foreign
countries may need to be obtained prior to marketing the
product in those countries. The approval process may be more
or less rigorous from country to country, and the time
required for approval may be longer or shorter than that
required in the United States. No assurance can be given that
clinical studies conducted outside of any country will be
accepted by such country, and the approval of any
pharmaceutical product in one country does not assure that
such product will be approved in another country. The Company
is also subject to worldwide governmental regulations and
controls relating to product safety, efficacy, packaging,
labeling and distribution. While not all of the products which
the Company plans to introduce into the market are "new drugs"
or "new devices," those fitting the regulatory definitions are
subject to a stringent premarket approval process in most
countries. Submission of a substantial amount of preclinical
and clinical information prior to market introduction
significantly increases the amount of time and related costs
incurred for preparing such products for market.
The federal and state governments in the United States, as
well as many foreign governments, from time to time explore
ways to reduce medical care costs through health care reform.
These efforts have resulted in, among other things, government
policies that encourage the use of generic drugs rather than
brand name drugs to reduce drug reimbursement costs. Virtually
every state in the United States has a generic substitution
law which permits the dispensing pharmacist to substitute a
generic drug for the prescribed brand name product. The debate
to reform the
-8-
11
United States' health care system is expected to be protracted
and intense.
The Company submits data to the FDA as necessary in response
to the ongoing monograph review of the safety and efficacy of
all OTC drug products marketed in the United States. As a
responsible manufacturer, the Company is alert to the
possibility that the final monographs to be issued in the
foreseeable future may require formula modifications of
certain of its products to maintain compliance with these
regulations, a possibility facing competitive products as
well.
Manufacturing companies, especially those engaged in health
care related fields, are subject to a wide range of federal,
state and local laws and regulations. Concern for maintaining
compliance with federal, state, local and foreign regulations
on environmental protection, hazardous waste management,
occupational safety and industrial hygiene has also increased
substantially. The Company cannot predict what additional
legislation or governmental action, if any, will be enacted or
taken with respect to the above matters and what its effect,
if any, will be on the Company's consolidated financial
position, results of operations or cash flows.
- - Zilactin(R) Zilactin(R)is marketed by the Company as a treatment for the
symptomatic relief of canker sores (oral mucosal ulcers and
lesions), cold sores and fever blisters. The Company is not
required to file a New Drug Application ("NDA") covering these
uses of Zilactin(R); however, the Company may not market
Zilactin(R) as a treatment of genital herpes or shingles
unless NDAs for such purposes are filed and approved.
The FDA's regulation of most of the OTC drug products in the
United States (such as Zila's Zilactin(R) family of products)
has not been finalized. In addition, the FTC continually
monitors the advertising practices of consumer products
companies with respect to claims made relating to product
functionality and efficacy.
- - OraTest(R) In 1994, the FDA approved an Investigational New Drug
Application ("IND") for the Company's OraTest(R)product. This
approval is the first step in securing the data required to
support an NDA which will enable the Company to market
Oratest(R)in the United States and allow the Company to
manufacture the product domestically for use in clinical
studies and to market it in 21 countries overseas. In November
1998, the FDA notified the Company that the OraTest(R)NDA was
being given "priority review," which targeted agency review
within six months from September 3, 1998, the date when the
Company provided additional data to the FDA. On January 13,
1999, the FDA's Oncologic Drugs Advisory Committee (the
"Committee") met to review the OraTest(R)NDA and recommended,
among other things, that the FDA not approve the NDA as
submitted. Subsequent to the Committee meeting, Company
representatives engaged in a dialog with the FDA, culminating
in a meeting at the agency on March 1, 1999.
On March 3, 1999, the Company received an action letter from
the FDA outlining certain deficiencies in the OraTest(R) NDA
that prevented the FDA from approving the product at that
time. The FDA's letter detailed a procedure for amending the
NDA to rectify those matters. Following the March 1, 1999
meeting with the FDA, a new clinical research group was
engaged and a protocol for a supplemental clinical study was
prepared and submitted to the FDA for review. The FDA has
provided the Company with comments on the protocol and an
action plan is being developed. The Company intends to use the
data from this study to amend its present NDA. Also, as a
result of the March 1st meeting, the Company terminated the
12-site clinical study which began in 1995, and all the data
from this study will be submitted to the FDA as supplemental
information.
The Company received regulatory approval to market the
OraTest(R) product in Australia in 1993. Approval to market
the OraTest(R) product in certain Caribbean countries, Hungary
and Taiwan has also been received. The Medicines Control
Agency ("MCA"), which is the regulatory authority in the U.K.,
has also granted approval for the OraTest(R) product to be
marketed in the U.K. under the name OraScreen(R).
In January 1998, Zila submitted a Mutual Recognition Procedure
("MRP") application through the MCA for regulatory approval of
OraScreen(R) in the European Union ("EU"). In April 1998,
Belgium, the Netherlands, Luxembourg, Portugal, Finland and
Greece gave their regulatory
-9-
12
approval through this application. Zila has also received
licenses to sell in Greece, Luxembourg, Finland, Belgium,
Portugal and the Netherlands and is finalizing the license
procedure for the remaining EU member nations. The Company is
following up as the procedure warrants with all of the
remaining countries.
PATENTS AND TRADEMARKS
- - Zilactin(R) A comprehensive U.S. patent covering present film-forming
Zilactin(R)products was issued on January 14, 1992. The patent
was granted for a period of seventeen years from the grant
date and gives the Company the right to exclude others from
making, using or selling the patent-protected products in the
United States. A Canadian patent, which covers the composition
and extended applications, was granted on December 3, 1985.
Patent applications were filed in numerous foreign countries
and patents have issued or are expected to be issued on these
applications in the near future.
The Company has registered the trademarks Zila(R) and
Zilactin(R) in the United States, Canada and in several
important foreign countries and has applications pending to
register these trademarks in others. The Company believes that
widespread use of the Zila(R) and Zilactin(R) trademark alone
and as the dominant features of other marks, e.g.,
Zilactin(R)-B, Zilactin(R)-L, etc., affords reasonable
protection for the family of trademarks in which Zila(R) is
the dominant feature.
- - Peridex(R) Peridex(R)as a brand name has become the gold standard within
the dental industry for prescription oral rinses in both the
U.S. and Canada. Concurrent with the purchase of the
Peridex(R)brand from Procter & Gamble, Zila Pharmaceuticals
purchased the trademark rights to Peridex(R). Accordingly,
Procter & Gamble has assigned the Peridex(R)trademark to the
Company for each country where it has been previously
registered, except for certain countries in Western Europe.
The Company recorded its trademark assignment for
Peridex(R)with the U.S. Patent and Trademark office on June
26, 1998 and with the Canadian Registrar of Trademarks on July
3, 1998. Additionally, the Company is in the process of
recording trademark assignments in other countries where the
Peridex(R)trademark had been previously registered by Procter
& Gamble. As international sales opportunities continue to
develop, the Company intends to register the
Peridex(R)trademark in countries where it has not been
previously registered.
- - OraTest(R) The Company has issued patents in the United States and either
has patent applications or issued patents in major foreign
countries protecting the basic OraTest(R)oral diagnostic
product. The Company is the exclusive licensee of the National
Institutes of Health under its U.S. and Canadian patents
covering the use of toluidine blue for detection of oral
cancer. In addition, the Company has filed patent applications
in the United States and many foreign countries covering the
process the Company developed for manufacturing its
Zila(R)Tolonium Chloride drug substance and covering other
dyes which are chemically related to toluidine blue for use in
detecting epitheleal cancer.
The Company has registered the OraTest(R) trademark in the
United States and has either pending applications for
registration or issued registrations of this trademark in
major foreign countries in which this mark is being used or in
which it will be used. The Company licensed the use of the
trademark OraScreen(TM) in Europe and certain other foreign
countries and has obtained registrations of the OraScreen(TM)
trademark in all major European countries and in important
Pacific Rim countries.
- - Ester-C(R) Three U.S. patents were issued in connection with
Ester-C(R)nutritional ingredients, in 1989, 1990 and 1992. All
three patents expire in the year 2007. The first patent covers
compositions for administering vitamin C that contains
theonate or other vitamin C metabolites. The second and third
patents cover the metabolite technology which improved the
absorption of vitamin C from the Ester-C(R)formulation and is
applicable to a wide variety of other non-prescription and
prescription drugs. Oxycal has filed and is currently pursuing
corresponding patent applications in all major foreign
countries. Most patents have already been issued on these
foreign
-10-
13
applications and the remainder are being diligently
pursued.
Recently Oxycal developed Ester-C(R) Topical
Concentrate, a stable form of vitamin C that
penetrates the skin to help produce collagen and
supporting structures. Oxycal has filed U.S and
international patent applications for the Ester-C(R)
Topical Concentrate product and method of
manufacturing.
The Company has three major and several other
trademarks issued by the United States Patent and
Trademark office in the United States. The Ester-C(R)
trademark was issued in August 1985; the EC(R) logo
trademark was issued in August 1990; and the
CV-Flex(R) trademark was issued in August 1990. The
Company also has trademarks issued in 36 foreign
countries with trademarks pending in other countries.
- - PracticeWorks(TM) PracticeWorks(TM) is a registered trademark of
Integrated Dental Technologies, Inc.
PRODUCT LIABILITY INSURANCE
The Company faces an inherent risk of exposure to product liability
claims in the event that the use of one or more of its products is alleged to
have resulted in adverse effects. Such risk exists even with respect to those
products that are manufactured in licensed and regulated facilities or that
otherwise received regulatory approval for commercial sale. There can be no
assurance that the Company will not be subject to significant product liability
claims. Many of the Company's customers require the Company to maintain product
liability insurance coverage as a condition to their conducting business with
the Company. As the loss of such insurance coverage could result in a loss of
such customers, the Company intends to take all reasonable steps necessary to
maintain such insurance coverage. There can be no assurance that insurance
coverage will be available in the future on commercially reasonable terms, or at
all, or that such insurance will be adequate to cover potential product
liability claims. The loss of insurance coverage or the assertion of a product
liability claim or claims could have a material adverse effect on the Company's
business, financial condition and results of operations.
EMPLOYEES
As of July 31, 1999, the Company and its operating subsidiaries had 286
employees in the following categories:
Categories Number of Employees
------------------------------ -------------------
Executive Officers 8
Sales 113
Accounting and Administration 79
Purchasing and Distribution 41
Manufacturing 45
No employees are represented by a labor union, nor are there any
current labor relations complaints on file with any agency. The Company believes
its relationship with its employees is good.
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
The disclosure and analysis in this report and in the
Company's other reports, press releases and public
statements of our officers contain some
forward-looking statements. Forward-looking
statements give the Company's current expectations or
forecasts of future events, and may be identified by
the fact that they do not relate strictly to
historical or current facts. In particular,
forward-looking statements include statements
relating to future actions, prospective products or
product approvals, future performance or results of
current and anticipated products, sales efforts,
expenses, the outcome of contingencies such as legal
proceedings, and financial results. Many factors
discussed in Part I of this report, for example
government
-11-
14
regulation, competition, and the supply of raw
materials, will be important in determining future
results.
Any or all forward-looking statements in this report,
any other report, and in any other public statements
may turn out to be wrong. They can be affected by
inaccurate assumptions or by known or unknown
uncertainties. No forward-looking statement can be
guaranteed, and actual results may differ materially.
The Company undertakes no obligation to publicly
update forward-looking statements. Shareholders are
advised to consult further disclosures on related
subjects in the Company's other reports to the
Securities and Exchange Commission. The following
cautionary discussion of risks, uncertainties and
possible inaccurate assumptions are factors that the
Company's management believes could cause actual
results to differ materially from expected and
historical results. Factors other than those included
below could also adversely affect the Company's
business results. The following discussion is
provided pursuant to the Private Securities
Litigation Reform Act of 1995.
- - Uncertainties of The rigorous clinical testing and an extensive
Regulatory Approval regulatory approval process mandated by the FDA and
equivalent foreign authorities before the Company can
market any drug can take a number of years and
require the expenditure of substantial resources.
Obtaining such approvals and completing such testing
is a costly and time consuming process, and approval
may not be ultimately obtained. The length of the FDA
review period varies considerably, as does the amount
of clinical data required to demonstrate the safety
and efficacy of a specific product. The Company may
also decide to replace the compounds in testing with
modified or optimized compounds, thus extending the
testing process. In addition, delays or rejections
may be encountered based upon changes in FDA policy
during the period of product development and FDA
regulatory review of each submitted new drug
application or product license application. Similar
delays may also be encountered in other countries.
There can be no assurance that even after such time
and expenditures, regulatory approval will be
obtained for any products developed by the Company.
A marketed product, its manufacturer and its
manufacturing facilities are also subject to
continual review and periodic inspections, and later
discovery of previously unknown problems with a
product, manufacturer or facility may result in
restrictions on such product or manufacturer,
potentially including withdrawal of the product from
the market.
- - Introduction Zila has not received final FDA approval for
of OraTest(R) in OraTest(R) and is in the process of initiating
the United States additional studies to include an amended NDA. As of
July 31, 1999, Zila expensed approximately $11.8
million in OraTest(R) including a significant
financial investment towards obtaining FDA approval
of OraTest(R) and to prepare for the introduction of
OraTest(R) to the United States market. There can be
no assurance that the FDA will issue a final approval
of OraTest(R), and the failure of the FDA to approve
OraTest(R) would make it impossible for Zila to
recoup its investment through sales of OraTest(R) in
the United States. The failure of the FDA to finally
approve OraTest(R) will have a material adverse
effect on the Company's results of operations. If
regulatory approval is granted, such approval may
entail limitations on the indicated uses for which
the product may be marketed. Further, even if such
regulatory approval is obtained, the FDA will require
post-marketing reporting, and may require
surveillance programs to monitor the usage or side
effects of OraTest(R).
If FDA approval of OraTest(R) is received, the
Company must establish a marketing and sales force
with technical expertise to market directly to the
dental professional or it must obtain the assistance
of a pharmaceutical company with a large sales force.
There is no assurance that the Company will be
successful in gaining market acceptance of
OraTest(R).
- - Dependence on A large percentage of the Company's revenues result
Key Products from sales of Ester-C, Peridex(R), and the
Zilactin(R) family of products. If any of these major
products were to become subject to a problem such as
loss of patent protection, unexpected side effects,
regulatory proceedings,
-12-
15
publicity affecting user confidence, or pressure from
competing products, or if a new, more effective
treatment should be introduced, the impact on the
Company's revenues could be significant.
- - Possible Claims The Company could be exposed to possible claims for
Relating to personal injury resulting from allegedly defective
Products products manufactured by third parties with which it
has entered into manufacturing agreements. The
Company maintains product liability insurance
coverage for claims arising from the use of all its
products. However, the Company could be subject to
product liability claims in excess of its insurance
coverage. Any significant product liability claims
not within the scope of the Company's insurance
coverage could have a material adverse effect on the
Company.
- - Competition; The pharmaceutical industry is highly competitive. A
Research and number of companies, many of which have greater
Development financial resources, marketing capabilities and
research and development capacities than the Company,
are actively engaged in the development of products
similar to those products produced and marketed by
the Company. The pharmaceutical industry is
characterized by extensive and ongoing research
efforts. Other companies may succeed in developing
products superior to those marketed by the Company.
Such companies may even succeed in developing a cure
for herpes simplex virus, which would substantially
reduce the potential market for symptomatic
treatments such as Zilactin(R). In addition, Zila
Dental Supply faces significant competition,
primarily from a various number of dental supply
dealers and mail order supply houses in the United
States. PracticeWorks(TM) and Cygnus also face
significant competition from providers of dental
practice management software and intra-oral camera
systems. Many of the competing providers of these
products have significantly greater market share and
financial resources than PracticeWorks(TM) and
Cygnus. In addition, new competitors may enter into
Cygnus' and PracticeWorks(TM)' markets from time to
time. It may be difficult for PracticeWorks(TM) and
Cygnus to maintain or increase sales volume and
market share due to such competition.
- - Generic In the U.S., competition with producers of generic
Competition products is a major challenge. The Company's loss of
any of its product's patent protection could lead to
a dramatic loss in sales of the product in the U.S.
market.
- - Dependence on Zila relies on a combination of patent, copyright,
Proprietary Rights trademark and trade secret protection, nondisclosure
agreements and licensing arrangements to establish
and protect its proprietary rights. Zila owns and has
exclusive licenses to a number of United States and
foreign patents and patent applications, and intends
to seek additional patent applications as it deems
appropriate. Whether patents will issue from any of
these pending applications or, if patents do issue,
that any claims allowed will be sufficiently broad to
cover Zila's products or to effectively limit
competition against Zila is uncertain. Furthermore,
any patents that may be issued to Zila may be
challenged, invalidated or circumvented. Litigation
may result from the Company's use of registered
trademarks or common law marks and, if litigation
against Zila were successful, a resulting loss of the
right to use a trademark could reduce sales of Zila's
products and could result in a significant damages
award. Although Zila intends to defend the
proprietary rights, policing unauthorized use of
proprietary technology and products is difficult.
International operations may be affected by changes
in intellectual property legal protections and
remedies in foreign countries in which in the Company
does business.
- - Raw Materials Raw materials essential to the Company's business are
generally readily available. However, certain raw
materials and components used in the manufacture of
the pharmaceutical products are available from
limited sources, and in some cases, a single source.
Any curtailment in the availability of such raw
materials could be accompanied by production delays,
and in the case of products for which only one raw
material supplier exists, could result in a material
loss of sales. In addition, because raw material
sources for pharmaceutical products must generally be
approved by regulatory authorities, changes in raw
material suppliers could result in production delays,
higher raw material costs and loss of sales and
customers.
-13-
16
- - Future Capital The development of the Company's products will
Requirements and require the commitment of substantial resources to
Uncertainty of conduct the time-consuming research and development,
Future Funding clinical studies and regulatory activities necessary
to bring any potential product to market and to
establish production, marketing and sales
capabilities. The Company may need to raise
substantial additional funds for these purposes. The
Company may seek such additional funding through
collaborative arrangements and through public or
private financings. The inability to obtain
sufficient funds may require the Company to delay,
scale back or eliminate some or all of its research
and product development programs, to limit the
marketing of its products or to license third parties
the rights to commercialize products or technologies
that the Company would otherwise seek to develop and
market itself.
- - Possible Volatility The market price for the Company's common stock has
of Common Stock fluctuated significantly in the past. Management of
Price Zila believes that such fluctuations may have been
caused by announcements of new products, quarterly
fluctuations in the results of operations and other
factors, including changes in conditions of the
pharmaceutical industry in general. Stock markets
have experienced extreme price volatility in recent
years. This volatility has had a substantial effect
on the market prices of securities issued by Zila and
other pharmaceutical and health care companies, often
for reasons unrelated to the operating performance of
the specific companies. Zila anticipates that the
market price for its common stock may continue to be
volatile.
- - Issuance The Company's Board of Directors has the authority,
of Preferred Stock without any further vote by the Company's
stockholders, to issue up to 2,500,000 shares of
Preferred Stock in one or more series and to
determine the designations, powers, preferences and
relative, participating, optional or other rights
thereof, including without limitation, the dividend
rate (and whether dividends are cumulative),
conversion rights, voting rights, rights and terms of
redemption, redemption price and liquidation
preference. On October 17, 1997, the Company issued
30,000 shares of its Series A Convertible Preferred
Stock as well as warrants to purchase 360,000 shares
of common stock to various investors for
consideration of $30.0 million. As of July 31, 1999,
22,518 shares of the Series A Preferred Stock have
been converted into shares of the Company's common
stock.
The Preferred Stock is convertible into shares of the
Company's common stock at a conversion rate based on
the price of such common stock at the date of
issuance. However, if the market price of the
Company's common stock does not appreciate by a fixed
percentage at various measurement dates, the holders
of the Preferred Stock have the right to receive
additional shares of the Company's common stock upon
conversion, based on a repricing formula. Per
guidance from the Emerging Issues Task Force, the
intrinsic value of the beneficial conversion feature
of the Preferred Stock has been measured and
recognized as an embedded dividend in fiscal year
1998 and such non-cash embedded dividend has been
deducted from net income in the accompanying
consolidated statement of operations to arrive at the
amount of net income attributable to common
shareholders. Additionally, because the Preferred
Stock has conditions for redemption that are not
solely within the control of the Company, it has been
classified outside of permanent equity in the
accompanying consolidated balance sheet and has been
accreted to its redemption value.
- - Environmental The Company is subject to federal, state and local
and Controlled laws and regulations governing the use, generation,
Use of Hazardous manufacture, storage, discharge, handling and
Materials disposal of certain materials and wastes used in its
operations, some of which are classified as
"hazardous." The Company could be required to incur
significant costs to comply with environmental laws
and regulations as its research activities are
increased, and the operations, business and future
profitability of the Company could be adversely
affected by current or future environmental laws and
regulations. Although the Company believes that its
safety procedures for handling and disposing
materials comply with such laws and regulations, the
risk of accidental contamination or injury from these
materials cannot be eliminated. In the event of such
an accident, the Company could be held liable for any
damages that result and any such liability could
exceed the resources of the Company.
-14-
17
- - Year 2000 The Company is currently working to evaluate and
Compliance mitigate the extent of any "Year 2000" problems that
may exist at the Company or that may have an effect
on its business, but it has not yet completed this
evaluation and there can be no assurance that such
evaluation will be timely completed. While the
Company does not expect the costs to address the
problem will be material, and it does not expect that
the consequences of incomplete or untimely resolution
of the problem will materially impact the operation
of its business, there can be no assurance that the
costs and liabilities associated with Year 2000
issues will not have a material impact on its
business, prospects, revenues or financial position.
The Company has not incurred, and does not expect to
incur, any specific quantifiable cost that can be
directly and solely related to the Year 2000 issue.
The Company does not yet have a contingency plan to
handle a worst case scenario.
ITEM 2. PROPERTIES For further discussion of Year 2000 Impact see
Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations.
- - Corporate Headquarters On January 4, 1991, the Company purchased a 16,000
square foot building located at 5227 North Seventh
Street, Phoenix, Arizona 85014-2800. The Company
moved its corporate headquarters to this location on
February 8, 1991. The purchase price of the building
was approximately $600,000. The Company paid 25% of
the purchase price in cash and obtained a loan for
the balance of the purchase price. The Company has
refinanced the mortgage with Bank One, Arizona (the
"Bank"). The terms of the refinancing include
interest to be payable monthly on the unpaid balance
at an interest rate of nine percent (9.00%). The
refinanced mortgage loan is amortized over 20 years
and is due on April 1, 2001.
- - Manufacturing Facility The Company leases 7,040 square feet for a
manufacturing facility in Phoenix, Arizona. This
facility produces toluidine blue which will be used
in the manufacture of OraTest(R). The facility is
leased under a three year agreement which expires
September 30, 2002, and is located in an area with
property available for expansion. The agreement has
an option to renew for an additional five years.
Monthly lease payments are $4,640. The Company does
not currently intend to invest in any other plants or
manufacturing facilities. The Company's products are
currently manufactured by Clinipad, Arizona Natural
Resources and Germiphene. Together with the Company's
laboratory facilities, the Company believes that
these manufacturers are capable of performing all
necessary production functions. See "Item 1. Business
-- Manufacturing and Distribution."
- - Oxycal The Company's Oxycal subsidiary, owns 2.79 acres and
occupies a 27,440 square foot facility located at 533
Madison Avenue, Prescott, Arizona 86301. There are no
liens on this property. This facility manufactures
and distributes a patented and enhanced form of
Vitamin C under the trademark Ester-C(R). In April
1999, a five acre lot was purchased slated to
accommodate a new 65,000 square-foot building. The
new building will feature larger production,
laboratory, packaging, storage and shipping areas as
well as a controlled environment. The construction is
scheduled for completion in the summer of 2000.
- - Other The Company's subsidiaries hold additional leases on
seven separate facilities. Bio-Dental leases 25,000
square feet of office/warehouse space in a concrete
building located at 11291 Sunrise Park Drive, Rancho
Cordova, California. The current lease rate for the
Rancho Cordova facility is $9,837 per month, and is
constant for the duration of the lease. The lease for
the Rancho Cordova facility expires on November 30,
2001, however Bio-Dental has an option to renew the
lease for two subsequent five-year terms.
Bio-Dental's administrative offices are located in
the Rancho Cordova facility. Zila Dental Supply
leases 19,200 square feet in an office/warehouse
complex at 172 Lisle Industrial Avenue, Lexington,
Kentucky. The current lease rate is $3,124 per month,
and expires on October 31, 2000. On December 1, 1998,
Zila Dental Supply entered into a three-year lease
for 3,915 square feet at 4544 South Pinemont, Suite
204, Houston, Texas for their Houston branch office.
The current lease rate is $2,145 per month. On June
1, 1999, IDT entered into a five year lease for 5,600
square feet at 11344 Coloma Road, Suite 650, Gold
River, California. The current lease rate is $7,320
per month and increases every twelve months with the
monthly lease payment to be $8,109 in the final year.
-15-
18
On February 1, 2000 the lease will include an
additional 1,635 square feet at a rate of $2,126 per
month increasing every twelve months beginning August
1, 2000 with the monthly lease payment to be $2,354
per month in the final year. IDT also occupies an
office complex at 6021-A West 71st Street,
Indianapolis, Indiana on a month-to-month basis at a
rate of $3,566. On April 1, 1997, Cygnus entered into
a five year lease for 6,042 square feet of
office/warehouse space located at 8240 E. Gelding
Suite 101, Scottsdale, Arizona. The current lease
rate is $4,048 per month and increases every twelve
months with the monthly lease payment to be $4,350 in
the final year. Oxycal leases 14,400 square feet of
warehouse space located at 1066 Spire Drive,
Prescott, Arizona. The facility is leased under a
one-year agreement which expires April 30, 2000.
Monthly lease payments are $7,055 and will continue
on a month-to-month basis beginning May 1, 2000.
ITEM 3. LEGAL PROCEEDINGS
The Company and certain officers of the Company have been named as
defendants in a consolidated First Amended Class Action Compliant filed July 6,
1999 in the United States District Court for the District of Arizona, under the
caption In re Zila Securities Litigation, No. CIV 99 0115 PHX EHC. The First
Amended Class Action Compliant seeks damages in an unspecified amount on behalf
of a class consisting of purchasers of the Company's securities from November
14, 1996 through January 13, 1999 for alleged violations of the federal
securities laws. Specifically, the plaintiffs allege that in certain public
statements and filings with the Securities and Exchange Commission the
defendants made false or misleading statements and concealed material adverse
information related to OraTest(R) that artificially inflated the price of the
Company's securities. The Company and the individual defendants deny all
allegations of wrongdoing and are defending themselves vigorously. On September
10, 1999, the Company and the individual defendants filed with the Court a
motion to dismiss the First Amended Class Action Complaint in its entirety. It
is not possible to predict with any degree of certainty when the Court will rule
on the defendants' motion to dismiss.
In July 1995, one of Zila's subsidiaries, Bio-Dental, was named as a
defendant, along with Bio-Dental's transfer agent and a shareholder of
Bio-Dental ("Shareholder"), in a lawsuit. The lawsuit alleges that Bio-Dental
wrongfully failed to register 200,000 Bio-Dental shares in the name of the
plaintiffs which were pledged as security by the Shareholder for a debt owed by
the Shareholder to the plaintiffs. Bio-Dental denied all of the material
allegations of the lawsuit against it and has asserted various affirmative
defenses. Bio-Dental accrued a liability of $450,000 in September 1996 because
it believed a loss was probable at that time. This amount was Bio-Dental's best
estimate of the loss in the event the outcome of the litigation was unfavorable
to Bio-Dental. In November 1996, Bio-Dental was granted a summary judgment in
which the court ruled in favor of Bio-Dental. In February 1997, the plaintiffs
started the process to appeal the judgment. Subsequently, the appellate court
upheld the lower court's summary judgment in favor of Bio-Dental. Accordingly,
in fiscal year 1998, Bio-Dental reversed the amount of the accrued liability.
On September 8, 1999, the Securities and Exchange Commission (the
"Commission") entered an order directing investigation entitled "In the Matter
of Zila, Inc." The Commission is investigating whether (i) there were purchases
or sales of securities of the Company by persons while in possession of material
non-public information concerning the prospects that the Oncologic Drugs
Advisory Committee for the FDA would recommend approval of the OraTest(R) NDA
and whether the FDA would subsequently approve the NDA; (ii) such persons
conveyed information regarding these matters to other persons who effected
transactions in securities of the Company without disclosing the information;
and (iii) there were false and misleading statements in press releases, filings
with the Commission, or elsewhere concerning these matters. The Company does not
believe it has violated any of the federal securities laws and is cooperating
fully with the Commission in its investigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matter to a vote of its security holders
during the fourth quarter of the fiscal year covered by this report.
-16-
19
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Information regarding the market for Zila's Common Stock and related
stockholder matters is set forth below. The following table sets forth, for the
fiscal periods shown, the high and low quotations in dollars per share for the
Common Stock as reported by the National Association of Securities Dealers
Automated Quotation System ("NASDAQ").
HIGH LOW
---- ---
FISCAL YEAR ENDED JULY 31, 1999
First Quarter 6.625 3.875
Second Quarter 12.063 4.125
Third Quarter 5.000 3.250
Fourth Quarter 4.000 2.750
FISCAL YEAR ENDED JULY 31, 1998
First Quarter 8.875 6.000
Second Quarter 8.000 5.625
Third Quarter 8.375 7.000
Fourth Quarter 8.250 6.250
The number of stockholders of record of the Common Stock as of July 31,
1999 and September 30, 1999 were approximately 3,369 and 3,356, respectively. As
of July 31, 1999 there are 7,482 shares of the Company's Preferred Stock
outstanding (See "Item 1 -- Additional Information").
The Company has not paid dividends on the Common Stock. It is the
present policy of the Company's Board of Directors to retain future earnings to
finance the growth and development of the Company's business. Any future
dividends will be at the discretion of the Company's Board of Directors and will
depend upon the financial condition, capital requirements, earnings and
liquidity of the Company as well as other factors the Company's Board of
Directors may deem relevant.
ITEM 6. SELECTED FINANCIAL DATA
The following tables summarize selected financial information derived
from the Company's audited financial statements. The information set forth below
is not necessarily indicative of results of future operations and should be read
in conjunction with the Company's Consolidated Financial Statements and related
Notes and with "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in this Form 10-K.
FISCAL YEAR ENDED JULY 31
---------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA: 1999 1998(1) 1997 1996 1995
------------ ------------ ------------ ------------ ------------
Net Sales $ 71,159,241 $ 61,972,765 $ 38,592,252 $ 37,479,546 $ 35,064,245
Licensing Fees and Royalty Revenue 135,510 164,345 72,640 2,100,484 1,956,654
Net Income (Loss) (1,966,982) 2,301,068 (6,458,377) 1,217,298 (1,282,357)
Net Income (Loss) Attributable
to Common Shareholder (1,966,982) (5,013,532) (6,458,377) 1,217,298 (1,282,357)
Net Income (Loss) Per Share
Attributable To Common Shareholder (0.05) (0.15) (0.20) 0.04 (0.04)
AT JULY 31
-------------------------------------------------------------------
BALANCE SHEET DATA: 1999 1998(1) 1997 1996 1995
----------- ----------- ----------- ----------- -----------
Current Assets $30,750,624 $27,992,138 $10,779,049 $13,251,960 $12,010,497
Current Liabilities 8,704,760 8,777,242 5,804,965 6,672,497 6,401,072
Total Assets 76,555,933 69,863,877 23,604,032 25,309,781 16,691,859
Long-Term Debt 9,577,755 1,355,547 375,908 382,006 1,136,239
Total Liabilities 18,282,515 10,132,789 6,180,873 7,054,503 7,537,311
Series A Convertible Redeemable
Preferred Stock 8,787,191 33,801,930
Shareholders' Equity 49,486,227 25,929,158 17,423,159 18,255,278 9,154,548
(1) The increase in the amounts above between 1997 and 1998 is primarily
the result of the acquisitions discussed in Note 2 to the financial
statements.
-17-
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Form 10-K contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The Company's actual results could differ materially from
those set forth in the forward-looking statements. Certain factors that might
cause such a difference include the following: prospective products and
regulatory approval of such products, approval or disapproval of OraTest(R) by
the FDA, future performance or results of current and anticipated products,
product liability claims, unavailability of raw materials, Year 2000 issues,
sales efforts, expenses, the outcome of contingencies such as legal proceedings,
financial results and competition.
COMPANY OVERVIEW
The following discussion and analysis should be read in conjunction
with "Selected Financial Data" and the audited Consolidated Financial Statements
and Notes thereto.
Zila is a world-wide manufacturer and marketer of pharmaceutical,
biomedical, dental and nutritional products. The Company has three major
operating groups: Pharmaceuticals, Professional Products and Nutraceuticals. The
Pharmaceuticals Group consists of over-the-counter and prescription products,
including the Zilactin(R) family of over-the-counter products, Peridex(R)
prescription mouth rinse, and OraTest(R), an oral cancer detection system. The
Professional Products Group includes Zila Dental Supply, a national distributor
of professional dental supplies, Cygnus Imaging ("Cygnus"), a manufacturer and
marketer of digital x-ray systems and intraoral cameras, and Integrated Dental
Technologies, Inc., which distributes PracticeWorks(TM), a dental practice
management software product. The Nutraceuticals Group is comprised of Oxycal
Laboratories, Inc. ("Oxycal") and its Inter-Cal Subsidiary, which are
manufacturers and distributors of a patented and unique form of vitamin C under
the trademark Ester-C(R).
On November 5, 1997, the Company's Zila Pharmaceuticals, Inc. ("Zila
Pharmaceuticals") subsidiary completed its acquisition of the Peridex(R) product
line, a prescription anti-bacterial oral rinse from The Procter & Gamble Company
("P&G"). The purchase price was $12.0 million plus the value of acquired
inventory. The Company has paid $11.0 million as of July 31, 1999 and final
payment of $1.0 million is due November 1999.
On November 10, 1997, the Company acquired Oxycal, paying $28.0 million
for all outstanding shares of Oxycal. The Company raised the funds to consummate
the merger through a private placement of 30,000 shares of the Company's Series
A Convertible Redeemable Preferred Stock ("Preferred Stock") and warrants to
purchase 360,000 shares of the Company's Common Stock for $30.0 million.
The Peridex(R) and Oxycal acquisitions were accounted for using the
purchase method of accounting for business combinations. In connection with the
Oxycal acquisition, the excess of assets over liabilities assumed relate
principally to trademarks and goodwill, which are amortized over 25 and 20
years, respectively. In connection with the Peridex(R) acquisition, the excess
has been allocated to goodwill and is being amortized over 12 years. Results of
operations of Peridex(R) and Oxycal have been included in the Company's
statement of operations from their respective acquisition dates.
OPERATING RESULTS
Fiscal year ended July 31, 1999. Net revenues during the 1999 fiscal
year totaled $71.3 million compared to net revenues of $62.1 million for the
prior fiscal year, an increase of 14.8%. Net revenues in 1999 for Zila Dental
Supply were $31.5 million compared to $28.1 million for the previous fiscal
year, an increase of 12.4%. The increase is mainly due to improved mail order
sales, expansion of the sales force in conjunction with the opening of two
additional branch offices and increased internet sales. Zila Pharmaceuticals,
marketer of Peridex(R)and the Zilactin(R) family of products had net revenues of
$18.1 million for the fiscal year ended July 31, 1999, an increase of 17.5% over
fiscal year 1998 sales of $15.4 million. The main increase in net revenues was
due to the acquisition of Peridex(R) in the second quarter of fiscal year 1998.
As a result, the twelve months ended July 31, 1998 reflect nine months of
Peridex(R) revenues whereas the twelve months ended July 31, 1999 reflect a full
twelve months of Peridex(R) revenues. Also contributing to the increased
revenues was the addition of the Zilactin(R) Toothache Swab product launched
during fiscal year 1999, increased revenues in the Zilactin(R)-L, Zilactin(R)
Baby and Zilactin(R)-B product
-18-
21
lines. Net revenues in 1999 for Oxycal were $15.0 million compared to $12.2
million for the previous fiscal year, an increase of 22.6%. Oxycal was acquired
during the second quarter of fiscal year 1998 and therefore the net revenues for
fiscal year 1998 reflects nine months of revenues whereas the twelve months
ended July 31, 1999 reflect a full twelve months of Oxycal revenues.
PracticeWorks(TM) had net revenues of $4.5 million for fiscal year 1999, an
increase of 32.1% over net revenues of $3.4 million in fiscal year 1998. The
increase was primarily due to expansion of its dealer network and increased
demand for Windows based and Year 2000 ready dental software systems. Net
revenues in 1999 for Cygnus were $1.8 million compared to $2.7 million for the
previous fiscal year, a decrease of 34.4%. Technical difficulties with the
digital x-ray systems were the primary reason for the decrease in sales as
compared to the previous year.
Cost of products sold were $34.3 million for the fiscal year ended July
31, 1999, an increase of 11.9% as compared to $30.7 million for the previous
fiscal year. Cost of products sold as a percentage of net revenues decreased to
48.2% compared to 49.4% in fiscal year 1998. Cost of products sold as a
percentage of net revenues for Zila Dental Supply decreased to 74.6% in fiscal
year 1999 from 75.8% in fiscal year 1998. This decrease is mainly due to reduced
costs resulting from vendor rebate programs. Cost of products sold as a
percentage of net revenues for Zila Pharmaceuticals increased to 17.9% in
fiscal year 1999 as compared to 16.7% in fiscal year 1998. This increase is due
mainly to the introduction and market expansion of newer products, which have
higher costs as compared to the existing products. Also contributing to the
increase in 1999, were promotions for Peridex(R), which offered the product at
reduced pricing throughout fiscal year 1999. Cost of products sold as a
percentage of net revenues for Oxycal decreased to 27.9% in fiscal year 1999 as
compared to 29.7% in fiscal year 1998. The decrease is a result of favorable raw
materials purchase contracts in effect for fiscal year 1999 as compared to
fiscal year 1998. PracticeWorks(TM) had a decrease in cost of products sold as a
percentage of net revenues from 10.3% in fiscal year 1998 to 6.2% in fiscal year
1999. The decrease is mainly due to an increase in higher software and support
revenue and lower training costs. Cygnus had an increase in cost of sales as a
percentage of net revenues from 76.9% in fiscal year 1998 to 98.8% in fiscal
year 1999. The increase is primarily related to the technical difficulties with
the digital x-ray systems and related inventory write-offs.
The Company incurred selling, general and administrative expenses of
$31.9 million or 44.7% of net revenues during the fiscal year ended July 31,
1999 compared to $25.5 million or 41.0% of net revenues in the fiscal year ended
July 31, 1998. This increase is mainly attributable to selling, general and
administrative expenses resulting from the Oxycal and Peridex(R) acquisitions in
the second quarter of fiscal year 1998, corporate regulatory affairs, legal,
public relations and professional services as well as increased selling expense
at Zila Dental Supply. Costs associated with resolving technical problems with
the CygnusRay2(TM), Cygnus's digital x-ray system, also contributed to the
increase.
Research and development expenses increased $1.3 million, or 49.9%,
from $2.7 million in fiscal year 1998 to $4.0 million in fiscal year 1999. The
increase was mainly related to research and clinical activities associated with
OraTest(R) and Ester-C(R), as well as product development expenses related to
the digital x-ray systems and dental practice management software.
Depreciation and amortization expenses increased $800,000 from $2.8
million in fiscal year 1998 to $3.6 million in fiscal year 1999. The increase is
mainly due to the additional amortization of intangibles and goodwill from the
Oxycal and Peridex(R) acquisitions, which occurred during the second quarter of
fiscal year 1998.
Interest income decreased $31,000 from $320,000 in the prior fiscal
year to $289,000 during the fiscal year 1999 due to decreased bank balances.
Interest expense increased from $335,000 in fiscal year 1998 to $393,000 in
fiscal year 1999. The increase was attributable to additional debt obligations
during fiscal year 1999 related to the funding of a new manufacturing and
laboratory facility for Oxycal and additional financing to support OraTest(R)
clinical, regulatory, manufacturing and marketing costs.
The benefit for income taxes was $846,000 ($250,000 of which was
attributable to the exercise of common stock options and therefore credited to
capital in excess of par value) for the fiscal year ended July 31, 1999 compared
to an income tax benefit of $2.6 million ($800,000 of which was attributable to
the exercise of common stock options and therefore credited to capital in excess
of par value) during the year ended July 31, 1998. In the past, the Company had
offset its net deferred tax asset with valuation allowance due to the Company's
lack of earnings history.
-19-
22
For the fiscal year ended July 31, 1999, the Company had a net loss of
$2.0 million compared to net income of $2.3 million for 1998. The decrease in
profitability is primarily due to increased spending in OraTest(R), increased
losses at Cygnus resulting from the technical difficulties with the digital
x-ray system and lower tax benefit recognized in 1999 compared to 1998. In
fiscal year 1998, net income has been reduced in the amount of $7.3 million by
the accretion of an embedded dividend on the Series A Preferred Stock issued in
November 1997 to arrive at net loss attributable to common shareholder. As a
result, for the fiscal year 1998, the Company had a net loss attributable to
common shareholders of $5.0 million after taking into account the embedded
dividend.
Fiscal year ended July 31, 1998. Net revenues during the 1998 fiscal
year totaled $62.1 million compared to net revenues of $38.7 million for the
prior fiscal year, an increase of 60.6%. Net revenues in 1998 for Zila Dental
Supply were $28.1 million compared to $26.5 million in fiscal year 1997, a 5.7%
increase. The increase is due primarily to increased sales overall in the dental
supply market. Zila Pharmaceuticals net revenues in 1998 were $15.4 million
compared to $6.7 million in 1997, a 129.8% increase. The increase is primarily
due to the acquisition in the second quarter of 1998 of Peridex(R) and continued
growth in the Zilactin(R) line of products. Net revenues in 1998 for Oxycal were
$12.2 million and are directly attributable to the acquisition of Oxycal in the
second fiscal quarter of 1998. PracticeWorks(TM) had net revenues of $3.4
million in 1998, an increase of 55.8% when compared to the net revenues of $2.2
million in 1997 due primarily to an expansion of the sales force. Net revenues
in 1998 for Cygnus were $2.7 million, a 15.1% decrease over the $3.2 million of
net revenues in 1997 due primarily to decreased camera sales.
Cost of products sold were $30.7 million for the fiscal year ended July
31, 1998, a 30.3% increase from $23.5 million for the fiscal year ended July 31,
1997 due to increased sales resulting primarily from the acquisitions of Oxycal
and Peridex(R). Cost of sales as a percentage of net revenues decreased to 49.4%
during fiscal year 1998 compared to 60.9% in fiscal year 1997. This decrease is
primarily due to lower costs as a percentage of net revenues relating to the
Oxycal and Peridex(R) product lines. Cost of products sold as a percentage of
net revenues for Zila Dental Supply increased slightly to 75.8% in 1998 from
74.0% in 1997 primarily due to the inability to pass on price increases from
suppliers to customers. Cost of products sold as a percentage of net revenues
for Zila Pharmaceuticals decreased slightly to 16.7% in 1998 from 17.9% in 1997
primarily due to the increased costs associated with the launch of the
Zilactin(R)-Baby in 1998. Cost of products sold as a percentage of net revenues
for PracticeWorks(TM) decreased to 10.3% in 1998 from 24.9% in 1997 primarily
due to the discontinuation in 1997 of hardware sales which carried a higher
percentage of cost of products sold. Cost of products sold as a percentage of
net revenues for Cygnus increased to 76.9% in 1998 from 71.4% in 1997 primarily
due to pricing pressures and the phase-out of a line of cameras.
The Company incurred selling, general and administrative expenses of
$25.5 million or 41.0% of net revenues during the fiscal year ended July 31,
1998, compared to $20.1 million or 52.1% of net revenues, an increase of $5.4
million over the prior fiscal year. This increase reflects primarily an increase
in the marketing and administrative personnel and other selling and
administrative costs necessary to support the consolidated businesses of the
acquired companies. The decrease in selling, general and administrative expenses
as a percentage of net revenues reflects the Company's ability to take advantage
of economies of scale resulting from the larger installed customer base and a
higher base of revenue realized from the Oxycal and Peridex(R) acquisitions.
Research and development expenses increased $1.7 million from $972,000
in fiscal 1997 to $2.7 million in fiscal 1998. The increase is mainly associated
to research and clinical activities associated with OraTest(R) and the addition
of Oxycal research expenses.
Depreciation and amortization expenses increased $1.6 million from $1.2
million in the prior fiscal year to $2.8 million in fiscal year 1998. The
increases are mainly due to the additional amortization of intangibles and
goodwill associated with the Oxycal and Peridex(R) acquisitions.
Interest income increased $118,000 from $202,000 in the prior fiscal
year to $320,000 during fiscal year 1998 due to higher cash balances. Interest
expense increased from $79,000 in fiscal year 1997 to $335,000 in fiscal year
1998. The increase was attributable to additional debt obligations during fiscal
year 1998 related to the Peridex(R) acquisition.
During the year ended July 31, 1998, the Company recorded an income tax
benefit of $2.6 million ($800,000 of which was attributable to the exercise of
common stock options and therefore was credited to capital in
-20-
23
excess of par value). In the past, the Company had offset its net deferred tax
asset with valuation allowance due to the Company's lack of earnings history.
For the fiscal year ended July 31, 1998, the Company had net income of
$2.3 million compared to net loss of $6.5 million for 1997. Net income
attributable to common shareholders has been reduced in the amount of $7.3
million by the accretion of an embedded dividend on the Series A Preferred Stock
issued in November 1997. As a result, for the fiscal year 1998, the Company had
a net loss attributable to common shareholders of $5.0 million after the
reduction for the non-cash embedded dividend.
INFLATION AND SEASONALITY
Inflation has had no material effect on the operations or financial
condition of the Company. The Company's operations are not considered seasonal
in nature.
LIQUIDITY AND CAPITAL RESOURCES
At July 31, 1999, the Company held cash and cash equivalents of $5.8
million compared to $5.2 million at July 31, 1998. The Company's working capital
was $22.0 million at July 31, 1999 as compared to $19.2 million at July 31, 1998
representing an increase of $2.8 million. The increase in working capital is due
primarily to an increase in accounts receivable - net of $1.6 million.
Net cash used in operating activities was $792,000 during 1999 and was
attributable to the net loss of $2.0 million as adjusted for the effects of
non-cash items of $3.0 million and changes in operating assets and liabilities
totaling $1.9 million. Significant changes in operating assets and liabilities
were comprised of an increase in accounts receivable of $1.6 million related to
higher fourth quarter sales in 1999 than in 1998, and an increase in deferred
revenue of $414,000 related to software support.
Net cash used in investing activities was approximately $2.5 million
consisting of $1.8 million in capital expenditures for the OraTest(R) and Oxycal
product lines and $686,000 of capitalized patent and license costs.
The net cash of $3.8 million provided in financing activities for the
year ended July 1999 was comprised of net borrowings of $8.3 million partially
offset by the proceeds from the Oxycal bond transaction, which are held by the
trustee of $4.8 million. In addition, the Company received $259,000 from the
issuance of common stock related to the exercise of stock options.
At July 31, 1999, the Company had income tax net operating loss
carryforwards of approximately $24.0 million which expire in years 2000 through
2019.
In February 1999, the Company increased its line of credit with Bank
One Corporation to $9 million and extended the commitment period to December 1,
2000. Additionally, the interest rate was reduced to the prime rate (8.0% at
July 31, 1999) plus .25%. At July 31, 1999, the Company had borrowings of $4.2
million against the line of credit. The loan covenants remain essentially
unchanged from the prior commitment.
In April 1999, Oxycal entered into a transaction with The Industrial
Development Authority of the County of Yavapai (the "Authority") in which the
Authority issued $5.0 million in Industrial Development Revenue Bonds
(the"Bonds"), the proceeds of which were loaned to Oxycal for the construction
of a new manufacturing and laboratory facility. The Bond proceeds are being held
by the trustee, Bank One, Arizona until such time as construction costs are
incurred. The Bonds consist of $3.9 million Series A and $1.1 million Taxable
Series B which, as of April 30, 1999, carried interest rates of 3.6% and 5.0%,
respectively. The Bonds were marketed and sold by Banc One Capital Markets and
carry a maturity of 20 years. In connection with the issuance of the Bonds, the
Authority required that Oxycal obtain, for the benefit of the Bond holders, an
irrevocable direct-pay letter of credit to secure payment of principal and
interest. The letter of credit is guaranteed by the Company.
On November 10, 1997, the Company completed a $30.0 million financing
involving the private placement of Series A Convertible Redeemable Preferred
Stock. Proceeds from the sale were used primarily to acquire all the outstanding
shares of Oxycal.
-21-
24
The Company believes that cash generated from its operations and the
availability of cash under its line of credit as of July 31, 1999 are sufficient
to finance its level of operations and currently anticipated capital
expenditures through the next 12 months. The Company may require additional
financing to support the production and future OraTest(R) clinical, regulatory,
manufacturing and marketing costs or to make any significant acquisitions. There
can be no assurance that such funds would be available on terms acceptable to
the Company.
YEAR 2000 IMPACT. The Year 2000 issue is the result of computer
programs being written using two digits rather than four to define the
applicable year. The Company recognizes that the impact of the Year 2000 issue
extends beyond traditional computer hardware and software to automated plant
systems and instrumentation, as well as third parties. The Year 2000 issue has
been addressed within the Company by its individual business units, and progress
is reported periodically to management. The Company has contracted with
independent experts as considered necessary.
The Company has substantially completed the process of evaluating the
capabilities of its internal computer systems, software and equipment to process
the Year 2000 correctly. The Company believes that most vendor developed
software which it utilizes in its internal operations has been made Year 2000
compliant through vendor provided updates. Additionally, the Company has tested
its internally developed software and hardware, which are included in the
products sold to its customers. Those systems and applications identified as
needing remediation will be modified and tested prior to December 31, 1999.
In addition to risks associated with the Company's own computer
systems, software and equipment, the Company's business may be adversely
affected by any third party with whom it transacts business that have not
resolved the Year 2000 issue. These include financial institutions, suppliers,
vendors and governmental agencies. The Company is reviewing the efforts of its
vendors and customers to become Year 2000 compliant. Letters and questionnaires
have been sent to most critical entities with which the Company does business to
assess their Year 2000 readiness. Responses to the questionnaires arrive
periodically and are helping the Company evaluate the extent to which it maybe
vulnerable to its vendors' own Year 2000 issues. As of July 31, 1999, the
Company's individual business units have reported that a majority of the
responses have been received and the Company has not discovered any significant
negative third party Year 2000 compliance issues. Although this review is
continuing, the Company is not currently aware of any vendor or customer
circumstances that may have a material adverse impact on the Company. The
Company can provide no assurance that Year 2000 compliance plans will be
successfully completed by suppliers and customers in a timely manner. If a
significant number of the Company's suppliers and customers were to experience
business disruptions as a result of their lack of Year 2000 readiness, their
problems could have a material adverse effect on the financial position and
results of operations of the Company.
Costs
The total cost of Year 2000 activities is not expected to be material
to the Company's operations, liquidity or capital resources. Costs are managed
within each business unit. The total estimated cost for the Company's Year 2000
work is approximately $200,000, of which approximately $175,000 has been
incurred as of July 31, 1999; however, such costs are subject to change as a
result of ongoing evaluation of the extent of the Year 2000 problem at the
Company. The total costs of the Year 2000 systems upgrades and assessments are
currently funded through cash flow from operating activities.
Risks
The Company believes that the Year 2000 issue will not pose significant
operational problems for the Company. However, there can be no assurances that
the Year 2000 compliance activities performed by the Company will adequately
identify and test all of the Company's critical internal and external systems to
ensure Year 2000 compliance. Additionally, due to the general uncertainty
inherent in the Year 2000 issue, there can be no assurance that the Year 2000
issues of other entities will not have a material adverse impact on the
Company's systems or results of operations.
Contingency Plan
The Company believes that its most significant risk with respect to
Year 2000 issues relates to the performance and readiness status of third
parties. Such risks include the inability to process and deliver customer
-22-
25
orders and payments, procure salable merchandise and perform other critical
business functions which could have a material impact on the financial
performance of the Company. Currently, the Company is formulating plans to
assure adequate inventory to meet customer needs, identifying and securing
alternate sources of critical services, materials and utilities when possible
and establishing crisis teams to address unexpected problems. Due diligence and
monitoring with respect to third parties is scheduled to be performed on a
continuous basis until the end of 1999. A formal plan will be adopted if it
becomes evident that there will be an area of non-compliance in the Company's
systems or at a critical third party which will impact its operations.
New Accounting Pronouncements. In June 1998, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities.
SFAS No. 133 requires that an enterprise recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. The statement is effective for the Company's fiscal
quarters and fiscal years beginning after June 15, 2000. The Company has not
completed evaluating the impact of implementing the provisions of SFAS No. 133.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Consolidated financial statements, together with the related notes and
the report of Deloitte & Touche LLP, independent certified public accountants,
are set forth hereafter. Other required financial information and schedules are
set forth herein, as more fully described in Item 14 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
-23-
26
PART III
The information called for by this Part III is, in accordance with
General Instruction G(3) to Form 10-K, incorporated herein by reference to the
information contained in the Company's definitive proxy statement for the annual
meeting of stockholders of Zila to be held December 9, 1999, which will be filed
with the SEC not later than 120 days after July 31, 1999.
-24-
27
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES, AND REPORTS ON FORM 8-K
METHOD OF FILING
----------------
(a) Financial Statements
(1) Report of Deloitte & Touche LLP Filed herewith
(2) Consolidated Financial Statements and Notes thereto of the
Company including Consolidated Balance Sheets as of July 31, 1999 and
1998 and related Consolidated Statements of Operations, Shareholders'
Equity, and Cash Flows for each of the years in
the three-year period ended July 31, 1999 Filed herewith
(b) Reports on Form 8-K for the quarter ended July 31, 1999.
None.
(c) Exhibits.
EXHIBIT
NUMBER DESCRIPTION METHOD OF FILING
- ------- ----------- ----------------
3-A Certificate of Incorporation, as amended *
3-B Bylaws *
3-C Certificate of Designations, Preferences and Rights of Series A
Convertible Preferred Stock D
4-A Specimen Stock Certificate *
4-B Form Stock Purchase Warrant re Series A Preferred Stock D
4-C Deere Park Capital Management Warrant C
4-D Bartholomew Investment, L.P. Warrant C
10-A Revolving Line of Credit Loan Agreement dated February 1, 1999 between
Zila, Inc. and Bank One, Arizona *
10-B# Stock Option Award Plan (as amended through April 10, 1991) A
10-C# Non-Employee Directors Stock Option Plan (as amended through April 10, 1991) A
10-D# 1997 Stock Option Award Plan D
10-E Agreement dated November 26, 1996 between Cheseborough Ponds USA Co
and Zila Pharmaceuticals, Inc B
10-F Private Equity Line of Credit between Deere Park Capital Management
and Zila, Inc. Dated as of April 30, 1997 C
10-G Amendment to Private Equity Line of Credit Agreement C
10-H Registration Rights Agreement dated as of May 9, 1997 between Zila,
Inc. and Deere Park Capital Management C
10-I Registration Rights Agreement dated as of May 9, 1997 between Zila,
Inc. and Bartholomew Investment, L.P C
10-J Securities Purchase Agreement dated as of October 17, 1997 by and
among Zila, Inc. and certain investors D
10-K Registration Rights Agreement dated October 17, 1997 by and among
Zila, Inc. and certain investors D
10-L Asset Purchase Agreement dated October 28, 1999 between Zila, Inc.,
Cygnus Imaging, Inc. and Procare Laboratories, Inc. *
10-M Promissory Note dated October 28, 1999 between Zila, Inc. and
Procare Laboratories, Inc. *
21 Subsidiaries of Registrant E
23 Consent of Deloitte & Touche LLP (regarding Form S-8 and Form S-3
Registration Statements) *
-25-
28
24-A Power of Attorney of Joseph Hines *
24-B Power of Attorney of Bradley C. Anderson *
24-C Power of Attorney of Carl A. Schroeder *
24-D Power of Attorney of Patrick M. Lonergan *
24-E Power of Attorney of Michael S. Lesser *
24-F Power of Attorney of Curtis M. Rocca *
24-G Power of Attorney of Christopher D. Johnson
24-H Power of Attorney of Kevin J. Tourek *
27 Financial Data Schedule *
* Filed herewith
A Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended January 31, 1996, as amended
B Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended October 31, 1996, as amended
C Incorporated by reference to the Company's Form S-3 Registration
Statement No. 333-31651
D Incorporated by reference to the Company's Annual Report on Form 10-K
for fiscal year ended July 31, 1997
E Incorporated by reference to the Company's Annual Report on Form 10-K
for fiscal year ended July 31, 1998.
-26-
29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized, this 29th
day of October, 1999.
ZILA, INC., a Delaware corporation
By /s/ BRADLEY C. ANDERSON
--------------------------------------
Bradley C. Anderson
Vice President
and Chief Financial Officer (Principal
Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report on Form 10-K has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ JOSEPH HINES Chairman of the Board, October 29, 1999
- -------------------------------------- President, Chief Executive
Joseph Hines Officer
/s/ BRADLEY C. ANDERSON Vice President and Chief October 29, 1999
- -------------------------------------- Financial Officer
Bradley C. Anderson
* Director October 29, 1999
- --------------------------------------
Carl A. Schroeder
* Director October 29, 1999
- --------------------------------------
Patrick M. Lonergan
* Director October 29, 1999
- --------------------------------------
Michael S. Lesser
* Director October 29, 1999
- --------------------------------------
Curtis M. Rocca III
* Director October 29, 1999
- --------------------------------------
Christopher D. Johnson
* Director October 29, 1999
- --------------------------------------
Kevin J. Tourek
*By /s/ BRADLEY C. ANDERSON October 29, 1999
--------------------------------------
Bradley C. Anderson
Attorney-in-Fact
-27-
30
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Zila, Inc.
Phoenix, Arizona
We have audited the consolidated balance sheets of Zila, Inc. and subsidiaries
(the "Company") as of July 31, 1999 and 1998, and the related consolidated
statements of operations, convertible redeemable preferred stock and
shareholders' equity, and of cash flows for each of the three years in the
period ended July 31, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits. The consolidated financial statements
give retroactive effect to the merger of the Company and Bio-Dental Technologies
Corporation ("Bio-Dental") on January 8, 1997, which has been accounted for as a
pooling of interests as described in Note 1 to the consolidated financial
statements.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Zila, Inc. and subsidiaries at July
31, 1999 and 1998, and the results of their operations and their cash flows for
each of the three years in the period ended July 31, 1999 in conformity with
generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Phoenix, Arizona
October 29, 1999
F-1
31
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JULY 31, 1999 AND 1998
ASSETS 1999 1998
---------------------- ----------------------
CURRENT ASSETS:
Cash and cash equivalents $ 5,770,970 $ 5,241,201
Trade receivables, less allowance for doubtful accounts
of $459,083 (1999) and $493,520 (1998) 8,741,283 7,161,240
Inventories - Net 11,405,883 11,550,009
Prepaid expenses and other current assets 1,126,773 1,254,258
Deferred income taxes 3,705,715 2,785,430
---------------------- ----------------------
Total current assets 30,750,624 27,992,138
---------------------- ----------------------
PROPERTY AND EQUIPMENT - Net 5,680,281 4,955,861
PURCHASED TECHNOLOGY RIGHTS - Net 6,037,415 6,473,854
GOODWILL - Net 15,679,969 17,009,914
TRADEMARKS - Net 10,782,029 11,131,925
OTHER INTANGIBLE ASSETS - Net 2,432,607 2,173,352
CASH HELD BY TRUSTEE 4,834,755
OTHER ASSETS 358,253 126,833
---------------------- ----------------------
TOTAL $ 76,555,933 $ 69,863,877
====================== ======================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,680,639 $ 4,917,626
Accrued liabilities 2,760,735 2,251,105
Deferred revenue 982,037 567,956
Short-term borrowings 116,950 87,598
Current portion of long-term debt 1,164,399 952,957
---------------------- ----------------------
Total current liabilities 8,704,760 8,777,242
LONG-TERM DEBT - Net of current portion 9,577,755 1,355,547
---------------------- ----------------------
Total liabilities 18,282,515 10,132,789
---------------------- ----------------------
COMMITMENTS AND CONTINGENCIES
SERIES A CONVERTIBLE REDEEMABLE PREFERRED STOCK:
Issued 30,000; outstanding 7,482 shares (1999) and
28,800 shares (1998); liquidation preference value:
$1,220 per share 8,787,191 33,801,930
---------------------- ----------------------
SHAREHOLDERS' EQUITY:
Preferred stock, $.001 par value - authorized
2,500,000 shares; issued 30,000 shares of Series A
Preferred Stock
Common stock, $.001 par value - authorized,
65,000,000 shares; issued 40,378,588 shares
(1999) and 34,743,575 shares (1998) 40,379 34,744
Capital in excess of par value 69,395,976 43,877,560
Deficit (19,949,703) (17,982,721)
---------------------- ----------------------
49,486,652 25,929,583
Less 42,546 shares of common stock held by wholly-owned
subsidiary (at cost) (425) (425)
---------------------- ----------------------
Total shareholders' equity 49,486,227 25,929,158
---------------------- ----------------------
TOTAL $ 76,555,933 $ 69,863,877
====================== ======================
See notes to consolidated financial statements.
F-2
32
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JULY 31, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
1999 1998 1997
------------ ------------ ------------
NET REVENUES $ 71,294,751 $ 62,107,110 $ 38,664,892
------------ ------------ ------------
OPERATING COSTS AND EXPENSES:
Cost of products sold 34,335,344 30,676,673 23,542,342
Selling, general and administrative 31,853,421 25,469,787 20,141,557
Research and development 3,988,028 2,660,135 972,221
Depreciation and amortization 3,581,768 2,769,956 1,154,428
------------ ------------ ------------
73,758,561 61,576,551 45,810,548
------------ ------------ ------------
(LOSS) INCOME FROM OPERATIONS (2,463,810) 530,559 (7,145,656)
------------ ------------ ------------
OTHER INCOME (EXPENSES):
Interest income 288,918 319,774 201,630
Interest expense (392,805) (334,646) (79,450)
Other expense 4,715 (14,619) (24,832)
------------ ------------ ------------
(99,172) (29,491) 97,348
------------ ------------ ------------
(LOSS) INCOME BEFORE INCOME
TAX BENEFIT (2,562,982) 501,068 (7,048,308)
INCOME TAX BENEFIT 596,000 1,800,000 589,931
------------ ------------ ------------
NET (LOSS) INCOME (1,966,982) 2,301,068 (6,458,377)
PREFERRED STOCK DIVIDEND REQUIREMENT:
SERIES A EMBEDDED DIVIDEND (NOTE 9) 7,314,600
------------ ------------ ------------
NET LOSS ATTRIBUTABLE TO COMMON
SHAREHOLDERS $ (1,966,982) $ (5,013,532) $ (6,458,377)
============ ============ ============
BASIC AND DILUTED LOSS PER SHARE $ (0.05) $ (0.15) $ (0.20)
============ ============ ============
BASIC AND DILUTED SHARES OUTSTANDING 38,013,058 33,990,947 31,530,096
============ ============ ============
See notes to consolidated financial statements.
F-3
33
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONVERTIBLE REDEEMABLE
PREFERRED STOCK AND SHAREHOLDERS' EQUITY
YEARS ENDED JULY 31, 1999, 1998 AND 1997
SHAREHOLDERS' EQUITY
-------------------------------------------------
CONVERTIBLE REDEEMABLE
PREFERRED STOCK COMMON STOCK
-------------------------- -----------------------------
CAPITAL IN
PAR EXCESS OF
SHARES AMOUNT SHARES VALUE PAR VALUE
------ ---------- ---------- ------ ----------
BALANCE, JULY 31, 1996 -- -- 31,077,329 $ 31,078 $ 24,760,269
Issuance of common stock 810,094 810 4,550,171
Exercise of common stock warrants 153,665 154 478,211
Exercise of common stock options 285,493 285 571,795
Change in unrealized loss on
securities available-for-sale
Net loss
------ ---------- ---------- ------ ----------
BALANCE, JULY 31, 1997 -- -- 32,326,581 32,327 30,360,446
Issuance of preferred stock 30,000 $ 36,555,000
Preferred stock issuance fees (1,352,750)
Conversion of preferred stock into
common stock (1,200) (1,400,320) 190,543 190 1,400,130
Issuance of common stock 1,588,869 1,589 10,177,534
Exercise of common stock warrants 214,609 215 609,862
Exercise of common stock options 422,973 423 529,588
Income tax benefit - stock options 800,000
Net income
Series A Embedded dividend
------ ---------- ---------- ------ ----------
BALANCE, JULY 31, 1998 28,800 33,801,930 34,743,575 34,744 43,877,560
Conversion of preferred stock into
common stock (21,318) (25,014,739) 5,483,371 5,483 25,009,256
Exercise of common stock warrants 35,975 36 107,889
Exercise of common stock options 115,667 116 151,271
Income tax benefit - stock options 250,000
Net loss
----- ------------ ---------- ------------ ------------
BALANCE, JULY 31, 1999 7,482 $ 8,787,191 40,378,588 $ 40,379 $ 69,395,976
===== ============ ========== ============ ============
SHAREHOLDERS' EQUITY
------------------------------------------------------------------------
COMMON STOCK UNREALIZED
HELD BY LOSS ON TOTAL
WHOLLY-OWNED SECURITIES COMMON
SUBSIDIARY AVAILABLE- SHAREHOLDERS'
DEFICIT (AT COST) FOR-SALE EQUITY
------------ ------------ ------------ ------------
BALANCE, JULY 31, 1996 $ (6,510,812) $ (425) $ (24,832) $ 18,255,278
Issuance of common stock 4,550,981
Exercise of common stock warrants 478,365
Exercise of common stock options 572,080
Change in unrealized loss on
securities available-for-sale 24,832 24,832
Net loss (6,458,377) (6,458,377)
------------ ------------ ------------ ------------
BALANCE, JULY 31, 1997 (12,969,189) (425) -- 17,423,159
Issuance of preferred stock
Preferred stock issuance fees
Conversion of preferred stock into
common stock 1,400,320
Issuance of common stock 10,179,123
Exercise of common stock warrants 610,077
Exercise of common stock options 530,011
Income tax benefit - stock options 800,000
Net income 2,301,068 2,301,068
Series A Embedded dividend (7,314,600) (7,314,600)
------------ ------------ ------------ ------------
BALANCE, JULY 31, 1998 (17,982,721) (425) -- 25,929,158
Conversion of preferred stock into
common stock 25,014,739
Exercise of common stock warrants 107,925
Exercise of common stock options 151,387
Income tax benefit - stock options 250,000
Net loss (1,966,982) (1,966,982)
------------ ------------ ------------ ------------
BALANCE, JULY 31, 1999 $(19,949,703) $ (425) $ -- $ 49,486,227
============ ============ ============ ============
See notes to consolidated financial statements.
F-4
34
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JULY 31, 1999, 1998 AND 1997
1999 1998 1997
------------ ------------ ------------
OPERATING ACTIVITIES:
Net (loss) income $ (1,966,982) $ 2,301,068 $ (6,458,377)
Adjustments to reconcile net (loss) income to
net cash (used in) provided by operating activities:
Depreciation and amortization 3,581,768 2,769,956 1,154,428
Impairment of assets -- -- 587,659
Other -- -- 47,381
Discount on contractual obligation 117,046 288,365 --
Deferred income taxes (670,285) (1,800,000) 715,485
Change in assets and liabilities:
Receivables - net (1,580,043) 1,766,866 353,713
Inventories 144,126 (3,010,557) 129,965
Prepaid expenses and other assets (103,935) (418,875) 288,086
Accounts payable and accrued liabilities (727,357) 585,526 593,105
Income taxes payable -- -- (2,471,126)
Deferred revenue 414,081 172,362 208,033
------------ ------------ ------------
Net cash (used in) provided by operating activities (791,581) 2,654,711 (4,851,648)
------------ ------------ ------------
INVESTING ACTIVITIES:
Purchases of short-term investments -- -- (222,615)
Proceeds from sales of short-term investments -- -- 934,085
Purchases of property and equipment (1,762,927) (1,276,262) (601,172)
Acquisitions, net of cash acquired -- (33,595,322) 18,142
Purchases of intangible assets (686,236) (942,284) (118,465)
------------ ------------ ------------
Net cash (used in) provided by investing activities (2,449,163) (35,813,868) 9,975
------------ ------------ ------------
FINANCING ACTIVITIES:
Net proceeds from short-term borrowings 29,352 87,598 41,298
Net proceeds from issuance of common stock 259,312 10,559,611 3,833,755
Net proceeds from issuance of preferred stock -- 28,647,250 --
Net proceeds from issuance of long-term debt 9,209,486 93,753 --
Cash held by trustee (4,834,755) -- --
Principal payments on long-term debt (892,882) (3,059,417) (453,721)
------------ ------------ ------------
Net cash provided by financing activities 3,770,513 36,328,795 3,421,332
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 529,769 3,169,638 (1,420,341)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD $ 5,241,201 $ 2,071,563 $ 3,491,904
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 5,770,970 $ 5,241,201 $ 2,071,563
============ ============ ============
CASH PAID FOR INTEREST $ 229,318 $ 46,029 $ 79,450
============ ============ ============
CASH PAID FOR INCOME TAXES $ -- $ 23,000 $ 1,165,710
============ ============ ============
(continued)
F-5
35
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
YEARS ENDED JULY 31, 1999, 1998 AND 1997
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND
FINANCING ACTIVITIES FOR 1999, 1998 and 1997: 1999 1998 1997
----------- ----------- -----------
Income tax benefit attributable to exercise of common stock options $ 250,000 $ 800,000
=========== ===========
Conversion of Series A Convertible Redeemable Preferred stock $25,014,739 $ 1,400,320
=========== ===========
Non-cash aspects of Oxycal acquisition:
Fair value of assets acquired other than cash and cash
equivalents $12,787,836
===========
Liabilities assumed $ 1,213,729
===========
Intangible assets recorded in connection with acquisition of Oxycal $14,795,040
===========
Non-cash aspects of Peridex acquisition:
Fair value of assets acquired other than cash and cash
equivalents $ 220,000
===========
Contractual obligation recorded in connection with the acquisition
of Peridex $ 5,570,000
===========
Goodwill recorded in connection with the acquisition of Peridex $11,570,637
===========
Embedded dividend recorded in connection with issuance of
Series A Convertible Redeemable Preferred Stock $ 7,314,600
===========
Non-cash aspects of Cygnus acquisition:
Stock issued $ 1,725,000
===========
Fair value of assets acquired other than cash and cash
equivalents $ 342,567
===========
Liabilities assumed $ 737,200
===========
Goodwill recorded in connection with the acquisition of Cygnus $ 2,101,491
===========
See notes to consolidated financial statements. (Concluded)
F-6
36
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JULY 31, 1999, 1998 AND 1997
1. NATURE OF BUSINESS ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business Activities -- Zila, Inc. ("Zila" or the "Company"), a
Delaware corporation, is a manufacturer and marketer of pharmaceutical,
biomedical, dental and nutritional products. The Company has three major
operating groups: Pharmaceuticals, Professional Products and Nutraceuticals. The
Pharmaceuticals Group consists of over-the-counter and prescription products,
including the Zilactin(R) family of over-the-counter products, Peridex(R)
prescription mouth rinse, and OraTest(R), an oral cancer detection system. The
Professional Products Group includes Zila Dental Supply, a national distributor
of professional dental supplies, Cygnus Imaging ("Cygnus"), a manufacturer and
marketer of digital x-ray systems and intra-oral cameras, and Integrated Dental
Technologies, Inc., which distributes PracticeWorks(TM), a dental practice
management software product. The Nutraceuticals Group is presently comprised of
Oxycal Laboratories, Inc. ("Oxycal") and its Inter-Cal subsidiary, which are
manufacturers and distributors of a patented and unique form of Vitamin C
under the trademark Ester-C(R).
Principles of Consolidation -- The consolidated financial statements include
the accounts of Zila, Inc. and its wholly-owned subsidiaries, Zila
Pharmaceuticals, Inc., Zila International Inc., Zila Ltd., Bio-Dental
Technologies Corporation ("Bio-Dental"), Cygnus, and Oxycal. Zila International
Inc. has no operations and its assets at July 31, 1999 and 1998 consist of
42,546 shares of common stock of the Company. All significant intercompany
balances and transactions are eliminated in consolidation.
On January 8, 1997, the Company completed a merger with Bio-Dental. On
December 30, 1996, Bio-Dental's shareholders approved the all-stock transaction
which provided for a per share exchange of .825 shares of the Company's common
stock for each share of Bio-Dental common stock outstanding. As of January 8,
1997, Bio-Dental had 6,565,300 shares of common stock outstanding. The merger
has been accounted for as a pooling of interests, and accordingly, the fiscal
1997 consolidated financial statements give retroactive effect to the Bio-Dental
merger and include the combined operations of the Company and Bio-Dental for the
entire fiscal year.
Use of Estimates -- The preparation of financial statements in conformity
with generally accepted accounting principles necessarily requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
Cash Equivalents -- The Company considers highly liquid investments
purchased with original maturities of three months or less to be cash
equivalents.
Inventories, which consist of finished goods and raw materials, are stated
at the lower of cost (first-in, first-out method) or market.
F-7
37
Property and equipment are stated at cost and are depreciated using
straight-line methods over their respective estimated useful lives, ranging from
2 to 40 years. Leasehold improvements are depreciated over the lease term or the
estimated useful life, whichever is shorter.
Goodwill and Trademarks are being amortized on a straight-line basis over 12
to 40 years.
Other intangible assets consist of deferred patent and licensing costs,
software rights, and covenants not to compete. Deferred patent and licensing
costs incurred in connection with the acquisition of patent rights, obtaining
Food and Drug Administration ("FDA") regulatory approvals and obtaining other
licensing rights for treatment compositions are capitalized and amortized over
the estimated benefit period not exceeding 17 years. Covenants not to compete
are amortized over the term of the agreement. Research and development costs
totaling approximately $3,988,028, $2,660,135 and $972,221 in 1999, 1998 and
1997, respectively, were expensed as incurred.
Net (loss) income per common share - Basic net (loss) income per common
share is computed by dividing net (loss) income attributable to common
shareholders by the weighted average number of common shares outstanding during
the year before giving effect to stock options considered to be dilutive common
stock equivalents. Diluted net (loss) income per common share is computed by
dividing net (loss) income attributable to common shareholders by the weighted
average number of common shares outstanding during the year after giving effect
to stock options and warrants considered to be dilutive common stock
equivalents. For the years ended July 31, 1999, 1998 and 1997, options and
warrants that would otherwise qualify as common stock equivalents are excluded
because their inclusion would have the effect of decreasing the loss per share.
New Accounting Pronouncements -- In June 1998, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities.
SFAS No. 133 requires that an enterprise recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. The statement is effective for the Company's fiscal
quarters and fiscal years beginning after June 15, 2000. The Company has not
completed evaluating the impact of implementing the provisions of SFAS No. 133.
Financial Instruments -- The carrying amounts and estimated fair value of
the Company's financial instruments are as follows:
The carrying values of cash and cash equivalents, receivables, accounts
payable and accrued expenses approximate fair values due to the short-term
maturities of these instruments.
The carrying amount of long-term debt and short-term borrowings are
estimated to approximate fair value as the actual interest rate is
consistent with the rate estimated to be currently available for debt of
similar term and remaining maturity.
Financial instruments which potentially subject the Company to credit risk
consist principally of trade receivables. The Company provides credit, in the
normal course of business, to pharmaceutical wholesalers and chains, food
wholesalers and chains, rack jobbers, convenience stores, and dentists. The
Company performs ongoing credit evaluations of its customers and maintains an
allowance for credit losses.
F-8
38
Certain reclassifications have been made to the 1998 and 1997 financial
statements to conform to the classifications used in 1999.
2. ACQUISITIONS
On November 5, 1997, the Company's Zila Pharmaceuticals, Inc. subsidiary
completed its acquisition of the Peridex(R) product line ("Peridex"), a
prescription anti-bacterial oral rinse from The Procter & Gamble Company
("P&G"). The purchase price was $12.0 million plus the value of acquired
inventory. The Company has paid $11.0 million as of July 31, 1999 and final
payment of $1.0 million is due in November 1999.
On November 10, 1997, the Company acquired, by merger, Oxycal. Oxycal
develops, manufactures and markets a patented, unique form of Vitamin C under
the trademark Ester-C(R). The Company paid $28,000,000 for all outstanding
shares of Oxycal. The Company raised the funds to consummate the merger in a
private placement of 30,000 shares of the Company's Series A Convertible
Redeemable Preferred Stock ("Preferred Stock") and warrants to purchase 360,000
shares of the Company's common stock for $30,000,000.
The Peridex and Oxycal acquisitions were accounted for using the purchase
method of accounting for business combinations. In connection with the Oxycal
acquisition, trademarks and goodwill of $11,096,280 and $3,698,760,
respectively, were recorded and are amortized on a straight-line basis over 25
and 20 years. In connection with the Peridex acquisition, goodwill of
$11,570,637 was recorded and is amortized on a straight-line basis over 12
years. Results of operations of Peridex and Oxycal have been included in the
Company's statement of operations from their respective acquisition dates.
The following unaudited pro forma summary presents the consolidated results
of operations as if the acquisitions had occurred as of the beginning of each
period presented and do not purport to be indicative of what would have occurred
had the acquisitions been made as of those dates or of results which may occur
in the future. The unaudited pro forma summary data for the year ended July 31,
1997 combines historical financial information of the Company for the year ended
July 31, 1997 and Peridex and Oxycal for the year ended June 30, 1997. The
unaudited pro forma summary data for the year ended July 31, 1998 combines
actual financial results of the Company for the year ended July 31, 1998, which
includes Peridex and Oxycal results for the nine months ended July 31, 1998, and
Peridex and Oxycal for the three months ended September 30, 1997. The embedded
dividend for the year ended July 31, 1998 and 1997 represents 270 days of
accretion and is based on the assumption that the Preferred Stock had been
issued at the beginning of each period.
1998 1997
------------ ------------
Revenues $ 68,329,759 $ 65,757,902
Net income $ 4,991,556 $ 3,942,566
Series A Preferred Stock embedded dividend $ 7,314,600 $ 7,314,600
Net loss attributable to common shareholders $ (2,323,044) $ (3,372,034)
Basic loss per share $ (0.07) $ (0.11)
F-9
39
These pro forma results have been prepared for comparative purposes only and
include certain adjustments such as the increase in amortization expense
associated with goodwill as a result of applying the purchase method of
accounting for the acquisitions.
On April 4, 1997, the Company acquired Cygnus, a privately-held company
located in Scottsdale, Arizona that manufactures and distributes intra-oral
camera systems and other dental imaging products. The acquisition was accounted
for as a purchase and resulted in the issuance of 259,398 shares of the
Company's common stock with a market value of $1,725,000 and the recording of
approximately $2,101,000 of goodwill. The goodwill is amortized on a
straight-line basis over 15 years.
3. INVENTORIES
Inventories consist of the following at July 31:
1999 1998
------------ ------------
Finished goods $ 7,531,175 $ 7,048,539
Raw materials 4,174,321 4,807,214
Inventory reserves (299,613) (305,744)
------------ ------------
Total inventories $ 11,405,883 $ 11,550,009
============ ============
Amounts reflected in cost of products sold related to inventory reserves during
fiscal 1999, 1998 and 1997 were $-0-, $129,880 and $396,996, respectively.
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at July 31:
1999 1998
---------- ----------
Land $1,221,097 $ 817,911
Building and improvements 2,112,065 2,069,626
Furniture and equipment 2,989,752 2,700,739
Leasehold improvements and other assets 526,828 374,229
Production and warehouse equipment 2,715,507 1,912,037
---------- ----------
Total property and equipment 9,565,249 7,874,542
Less accumulated depreciation 3,884,968 2,918,681
---------- ----------
Property and equipment -- net $5,680,281 $4,955,861
========== ==========
Depreciation expense for 1999, 1998, and 1997 was $1,038,507, $769,866,
and $498,342, respectively.
F-10
40
5. INTANGIBLE ASSETS
Intangible assets consist of the following at July 31:
1999 1998
----------- -----------
Purchased technology rights -- net of accumulated
amortization of $1,382,058 (1999) and $945,619 $ 6,037,415 $ 6,473,854
(1998) =========== ===========
Goodwill -- net of accumulated amortization of
$2,535,283 (1999) and $1,205,338 (1998) $15,679,969 $17,009,914
=========== ===========
Trademarks - net of accumulated amortization of
$765,936 (1999) and $427,193 (1998) $10,782,029 $11,131,925
=========== ===========
Other intangible assets:
Patents $ 1,370,300 $ 1,110,644
Licensing costs 1,648,133 1,692,853
Other 748,299 265,844
----------- -----------
Total other intangible assets 3,766,732 3,069,341
Less accumulated amortization 1,334,125 895,989
----------- -----------
Other intangible assets -- net $ 2,432,607 $ 2,173,352
=========== ===========
Licensing costs consist primarily of professional fees associated with
obtaining FDA approval for a new product, OraTest(R). The recoverability of the
deferred licensing costs and purchased technology rights is dependent upon both
FDA approval and sufficient revenues generated from sales of OraTest(R) (see
Note 11). Purchased technology rights relate to the acquisition of CTM, Inc in
fiscal year 1996.
Amortization of the Company's intangible assets during fiscal 1999, 1998 and
1997, was $2,543,261, $2,000,090 and $656,086, respectively.
6. SHORT-TERM BORROWINGS AND LONG-TERM DEBT
Short-term borrowings consisted of $116,950 at July 31, 1999 and $87,598 at
July 31, 1998, for installments due on the Company's various insurance policies.
Long-term debt consisted of the following at July 31: 1999 1998
----------- ------------
Revolving line of credit, (1) $ 4,200,000 --
IDA Bond Payable, Series A, (2) 3,900,000 --
IDA Bond Payable, Series B, (2) 1,100,000 --
Mortgage note payable, interest rate 9%, monthly payments of
$2,315 with a balloon due April 1, 2001 326,440 $ 354,223
Note payable, P&G, final payment due November 1999, net of
unamortized discount (see Note 2) 975,411 1,858,365
Notes payable for equipment with interest rates between 3.06%
and 9.44% with maturities no later than 2001 240,303 95,916
----------- -----------
10,742,154 2,308,504
Less current portion 1,164,399 952,957
----------- -----------
Long term portion $ 9,577,755 $ 1,355,547
----------- -----------
F-11
41
(1) The Company obtained a $9,000,000 bank line of credit in February 1999,
which is collateralized by trade accounts receivable, inventories and rights to
payment. This line of credit expires December 1, 2000. Interest is payable
monthly on the unpaid balance outstanding at the bank's prime rate (8.00% at
July 31, 1999) plus .25%. At July 31, 1999, the Company had borrowings of
$4,200,000 against this line. All borrowings are secured by Zila, Inc. corporate
assets and guarantees of its subsidiaries.
(2) In April 1999, Oxycal entered into a transaction with The Industrial
Development Authority of the County of Yavapai (the "Authority") in which the
Authority issued $5.0 million in Industrial Development Revenue Bonds (the
"Bonds"), the proceeds of which were loaned to Oxycal for the construction of a
new manufacturing and laboratory facility. The Bond proceeds are being held by
the trustee, Bank One, Arizona until which time construction costs are incurred.
The Bonds consist of $3.9 million Series A and $1.1 million Taxable Series B
which, as of April 30, 1999, carried interest rates of 3.60% and 5.00%,
respectively. The Bonds were marketed and sold by Banc One Capital Markets and
carry a maturity of 20 years. In connection with the issuance of the Bonds, the
Authority required that Oxycal obtain, for the benefit of the Bond holders, an
irrevocable direct-pay letter of credit to secure payment of principal and
interest. The letter of credit is guaranteed by the Company.
Aggregate annual maturities of long-term debt for the years ending July 31
are as follows:
2000 $ 1,164,399
2001 4,926,854
2002 436,589
2003 457,203
2004 453,469
2005 and beyond 3,303,640
-----------
Total $10,742,154
Less current portion 1,164,399
-----------
Long-term portion $ 9,577,755
===========
Under the mortgage note and line of credit, the Company is required to
comply with financial covenants based on certain financial ratios. At July 31,
1999, the Company was not in compliance with one of these covenants. The Company
has received a waiver from the bank with respect to this covenant at July 31,
1999 and the covenant has been modified for measurement dates subsequent to July
31, 1999.
7. STOCK OPTIONS AND WARRANTS
As a result of the merger with Bio-Dental, each Bio-Dental stock option or
stock purchase warrant that was outstanding at the merger date can be used to
purchase .825 shares of Zila, Inc. common stock. The exercise price of
outstanding Bio-Dental options and warrants was also adjusted at the merger
date. The new exercise prices are calculated by dividing the original exercise
price by .825. The summary of activity related to options and warrants below
includes Bio-Dental options and warrants adjusted for the terms of the merger.
a. Options -- The Company adopted the 1997 Stock Option Award Plan which
became effective on February 5, 1997, authorizing the Board of Directors to
grant options to employees and certain employee directors of the Company to
purchase up to 1,000,000 shares of the Company's common stock. The options are
issuable at an exercise price no less than market value at the date of grant.
Options may be exercised up to five to ten years from the date of grant. At July
31, 1999, 231,474 shares were available for grant under this plan.
F-12
42
The Company adopted a Stock Option Award Plan which became effective on
September 1, 1988, authorizing the Board of Directors to grant options to
employees and certain employee-directors of the Company to purchase up to
4,000,000 shares of the Company's common stock. The plan was amended December 8,
1995 to increase the authorized number of shares to 5,000,000. The options are
issuable at an exercise price no less than the market value at the date of
grant. Options may be exercised at any time up to five to ten years from the
date of grant. At July 31, 1999, no shares were available for grant under this
plan.
The Company adopted a Non-Employee Directors Stock Option Plan which became
effective October 20, 1989, authorizing the Board of Directors to grant options
to 100,000 shares to non-employee members of the Board of Directors in
increments of 2,500 shares per director each year. The plan was amended December
8, 1995 to increase the authorized number of shares to 200,000. The options are
issuable at exercise price equal to the market value at the date of grant. All
options may be exercised at any time up to five years from the date of grant. At
July 31, 1999, 57,500 shares were available for grant under this plan.
A summary of the status of the option plans as of July 31, 1999, 1998 and
1997 and changes during the years then ended is presented below:
1999 1998 1997
---------------------------- ---------------------------- -----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- ----------- --------- ----------- --------- -----------
Outstanding at beginning of year 2,195,918 $ 5.25 2,281,373 $ 4.03 2,036,002 $ 2.81
Granted 419,500 7.40 586,000 5.97 712,558 6.98
Exercised (115,667) 2.61 (422,973) 3.15 (285,493) 1.90
Forfeited (239,828) 6.34 (248,482) 3.87 (181,694) 3.93
--------- --------- ---------
Outstanding at end of year 2,259,923 5.38 2,195,918 5.26 2,281,373 4.03
========= ========= =========
Options exercisable at year-end 1,488,078 1,494,866 1,703,267
========= ========= =========
Weighted average fair value of
options granted during the year $ 5.98 $ 1.96 $ 2.54
========== ========== ==========
The following table summarizes information about fixed stock options
outstanding at July 31, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------------------- ----------------------------
NUMBER WEIGHTED WEIGHTED NUMBER WEIGHTED
OUTSTANDING AVERAGE AVERAGE EXERCISABLE AVERAGE
RANGE OF AT REMAINING EXERCISE AT EXERCISE
EXERCISE PRICES JULY 31, 1999 CONTRACTUAL LIFE PRICE JULY 31, 1999 PRICE
--------------- ------------- ---------------- -------- ------------- ----------
$ .12 - 1.31 249,752 1.43 $ 1.19 249,752 $ 1.19
2.42 - 4.00 511,076 5.05 3.21 411,076 3.16
4.24 - 6.13 664,137 7.12 5.52 457,337 5.48
6.50 - 8.19 580,958 5.13 6.97 252,578 6.97
9.88 254,000 9.37 9.88 117,335 9.88
---------- ---------
.12 - 9.88 2,259,923 5.76 5.38 1,488,078 4.72
========= =========
The Company applies APB Opinion No. 25 and related interpretations in
accounting for its stock-based employee compensation plans. Accordingly, no
compensation cost has been recognized for its stock-based employee compensation
plans. Had compensation cost been computed based on the fair value of awards on
the
F-13
43
date of grant, utilizing the Black-Scholes option-pricing model, consistent with
the method stipulated by SFAS No. 123, the Company's net loss attributable to
common shareholders and loss per share attributable to common shareholders for
the years ended July 31, 1999, 1998 and 1997 would have been reduced (increased)
to the pro forma amounts indicated below, followed by the model assumptions
used:
JULY 31,
-------------------------------------------------
1999 1998 1997
------------- ------------- -----------
Net loss attributable
to common shareholders:
As reported $(1,967,000) $(5,014,000) $(6,458,000)
Pro forma $(2,838,440) $(6,114,000) $(7,791,000)
Net loss attributable
to common shareholder per
basic shares outstanding:
As reported $ (.05) $ (.15) $ (.20)
Pro forma $ (.07) $ (.18) $ (.25)
Black-Scholes model assumptions:
Risk-free interest rate 4.4 - 4.5% 4.2 - 4.4% 5.5 - 6.0%
Expected volatility 82% 38% 39%
Expected term 3 - 6 years 2 - 6 years 2 - 6 years
Dividend yield 0% 0% 0%
b. Warrants -- The Company has issued warrants to various investors,
shareholders and other third parties in connection with services provided and
purchases of the Company's stock. Activity related to such warrants, which
expire at various dates through October 2000, is summarized as follows:
NUMBER OF WARRANT PRICE
SHARES PER SHARE
------ ---------
Outstanding, August 1, 1996 770,672 $.60 - 3.77
Issued 300,000 8.6125
Exercised (153,665) .60 - 3.00
Expired (14,992) .75 - 2.41
---------
Outstanding, July 31, 1997 902,015 .60 - 8.6125
Issued 456,000 7.625 - 9.92
Exercised (214,609) .60 - 3.00
----------
Outstanding, July 31, 1998 1,143,406 3.00 - 9.915
Exercised (35,975) 3.00
----------
Outstanding, July 31, 1999 1,107,431 $3.00 - 9.915
==========
F-14
44
8. INCOME TAXES
The consolidated income tax (benefit) provision consists of the following
for the years ended July 31:
1999 1998 1997
----------- ----------- -----------
Current:
Federal $ 63,000 $ (51,000) $ (312,000)
State 11,000 (9,000) --
----------- ----------- -----------
Total current 74,000 (60,000) (312,000)
----------- ----------- -----------
Deferred:
Federal (570,000) (1,479,000) (304,000)
State (100,000) (261,000) 26,000
----------- ----------- -----------
Total deferred (670,000) (1,740,000) (278,000)
----------- ----------- -----------
Total consolidated income tax
benefit $ (596,000) $(1,800,000) $ (590,000)
=========== =========== ===========
The reconciliation of the federal statutory rate to the effective income tax
rate for the years ended July 31 is as follows:
1999 1998 1997
---- ---- ----
Federal statutory rate (34)% 34% (34)%
Adjustments:
State income taxes -- net of federal
benefit (6) 6 (6)
Non-deductible meal and entertainment
expenses 4 7 2
Non-deductible acquisition expenses and
other 16 14
Non-deductible goodwill amortization 23 74
(Decrease) increase in valuation
allowance (26) (494) 30
---- ---- ----
Effective tax rate (23)% (359)% (8)%
==== ==== ====
The components of the Company's deferred income tax assets and liabilities
for the years ended July 31 are shown below:
1999 1998 1997
----------- ----------- -----------
Current deferred income tax assets:
Net operating loss carryforwards $ 6,635,000 $ 7,062,000 $ 6,810,000
Allowance for obsolete or
discontinued inventory 164,000 146,000 219,000
Book basis vs. tax basis differences 370,000 49,000 227,000
Reserve for litigation 29,000 27,000 180,000
Product warranty allowance 78,000 45,000 173,000
Allowance for doubtful accounts 151,000 112,000 140,000
Accrued vacation 78,000 79,000 40,000
Other 61,000 36,000 20,000
----------- ----------- -----------
Total current deferred income tax assets 7,566,000 7,556,000 7,809,000
Valuation allowance (3,860,000) (4,771,000) (7,563,000)
----------- ----------- -----------
Net deferred income tax asset $ 3,706,000 $ 2,785,000 $ 246,000
=========== =========== ===========
F-15
45
Approximately $2,063,000 of the deferred tax asset before valuation
allowance relates to deductions generated by the exercise of stock options,
which, if realized, will result in an increase in capital in excess of par
value. Management believes the valuation allowance reduces deferred tax assets
to an amount that represents management's best estimate of the amount of such
deferred tax assets that more likely than not will be realized.
Deferred income taxes reflect the tax effect of temporary differences
between the amounts of assets and liabilities recognized for financial reporting
and tax purposes. In the past, the Company had offset its net deferred tax asset
with a valuation allowance due to the Company's lack of earnings history. The
benefit for income taxes was $846,000 ($250,000 of which was attributable to the
exercise of common stock options and therefore credited to capital in excess of
par value) for the fiscal year ended July 31, 1999 compared to an income tax
benefit of $2.6 million ($800,000 of which was attributable to the exercise of
common stock options and therefore credited to capital in excess of par value)
during the year ended July 31, 1998.
At July 31, 1999, the Company had federal net operating loss carryforwards
totaling approximately $18,561,000 which expire, if not previously utilized,
from 2000 through 2019. Net operating loss carryforwards for state income tax
purposes, totaling approximately $5,411,000, must be utilized within five years
of the date of their origination, and expire from 2000 through 2004.
9. REDEEMABLE PREFERRED STOCK
On November 10, 1997, the Company completed a $30,000,000 financing
involving the private placement of Series A Convertible Redeemable Preferred
Stock. Proceeds from the sale were used primarily to acquire all the outstanding
shares of Oxycal. The Preferred Stock is convertible into shares of the
Company's common stock at a conversion rate based on the price of such common
stock at the date of issuance. However, if the market price of the Company's
common stock does not appreciate by a fixed percentage at various measurement
dates, the holders of the Preferred Stock have the right to receive additional
shares of the Company's common stock upon conversion, based on a repricing
formula. Per guidance from the Emerging Issues Task Force, the intrinsic value
of the beneficial conversion feature of the Preferred Stock has been measured
and recognized as an embedded dividend and such non-cash embedded dividend has
been deducted from net income in the accompanying fiscal 1998 consolidated
statement of operations to arrive at the amount of net loss attributable to
common shareholders. Additionally, because the Preferred Stock has conditions
for redemption that are not solely within the control of the Company, it has
been classified outside of permanent equity in the accompanying consolidated
balance sheet and has been accreted to its redemption value. During the year
ended July 31, 1999, 21,318 shares of the Preferred Stock were converted into
common stock.
10. COMMITMENTS AND CONTINGENCIES
In June 1992, the Company entered into an agreement with Daleco Capital
Corporation to form a limited partnership known as Daleco Zila Partners II, L.P.
(the "Partnership"). The Company and its officers have no partnership interest
in the Partnership. The purpose of the Partnership was to provide the Company
with a means to fund the marketing program for certain new products. The
original Partnership agreement provided for a minimum of $150,000 and a maximum
of $1,562,500 to be raised by the sale of partnership units. Under the original
agreement, the Partnership will expend up to 80% of the gross partnership
proceeds for marketing and sales-related expenditures on behalf of the Company.
In 1994, the Partnership agreement was amended to
F-16
46
increase the maximum amount of marketing funds potentially available to the
Company to be raised to $2,250,000.
At July 31, 1999, approximately $1,820,000 has been spent. The Company is
committed to pay the Partnership a commission equal to 5% to 10% of the gross
sales of certain of the Company's new products, until such time as three times
the amount of funds expended on the Company's marketing program by the
Partnership has been paid to the Partnership. The Company has paid commissions
to the Partnership of approximately $31,000, $16,000 and $64,000, for the years
ended July 31, 1999, 1998 and 1997, respectively.
In connection with the acquisition of patent rights in 1980, the Company
agreed to pay to Dr. James E. Tinnell, the inventor of one of the Company's
treatment compositions, a royalty of 5% of gross sales of the treatment
composition. Royalty expense to Dr. Tinnell for the years ended July 31, 1999,
1998 and 1997 was $390,170, $371,943 and $310,827, respectively.
The Company is pursuing approval of a New Drug Application ("NDA") pending
with the FDA for OraTest(R). The initiation of the marketing of OraTest(R) in
the United States is dependent upon the approval of the NDA by the FDA. During
1994, the FDA approved the Company's application for an Investigational New Drug
for OraTest, which allows the Company to manufacture the product in the United
States for clinical studies and export to certain foreign countries. In November
1998, the FDA notified the Company that the OraTest(R) NDA was being given
"priority review," which targeted agency review within six months from September
3, 1998, the date when the Company provided additional data to the FDA. On
January 13, 1999, the FDA's Oncologic Drugs Advisory Committee (the "Committee")
met to review the OraTest(R) NDA and recommended, among other things, that the
FDA not approve the NDA as submitted. Subsequent to the Committee meeting,
Company representatives engaged in a dialog with the FDA, culminating in a
meeting at the agency on March 1, 1999.
On March 3, 1999, the Company received an action letter from the FDA
outlining certain deficiencies in the OraTest(R) NDA that prevented the FDA from
approving the product at that time. The FDA's letter detailed a procedure for
amending the NDA to rectify those matters. Following the March 1, 1999 meeting
with the FDA, a new clinical research group was engaged and a protocol for a
supplemental clinical study was prepared and submitted to the FDA for review.
The FDA has provided the Company with comments on the protocol and an action
plan is being developed. The Company intends to use the data from this study to
amend its present NDA. Also, as a result of the March 1st meeting, the Company
has terminated the 12-site clinical study begun in 1995, and all the data from
this study will be submitted to the agency as supplemental information.
Management is committed to completing the FDA review process.
The Company leases a manufacturing facility in Phoenix, Arizona under a
three year agreement which expires September 30, 2002. The agreement has an
option to renew for an additional five years. Additionally, the Company leases
offices, warehouse facilities and certain equipment, under operating leases
which expire through 2004. Future minimum lease payments under these
non-cancelable leases are as follows:
2000 $393,939
2001 236,388
2002 154,316
2003 113,352
2004 104,630
----------
Total $1,002.625
==========
F-17
47
Rent expense for the years ended July 31, 1999, 1998 and 1997 totaled
$340,170, $270,297 and $209,110, respectively.
The Company and certain of its officers have been named as defendants in a
consolidated First Amended Class Action Compliant filed July 6, 1999 in the
United States District Court for the District of Arizona, under the caption In
re Zila Securities Litigation, No. CIV 99 0115 PHX EHC. The First Amended Class
Action Compliant seeks damages in an unspecified amount on behalf of a class
consisting of purchasers of the Company's securities from November 14, 1996
through January 13, 1999 for alleged violations of the federal securities laws.
Specifically, the plaintiffs allege that in certain public statements and
filings with the Securities and Exchange Commission the defendants made false or
misleading statements and concealed material adverse information related to
OraTest(R) that artificially inflated the price of the Company's securities. The
Company and the individual defendants deny all allegations of wrongdoing and are
defending themselves vigorously. On September 10, 1999, the Company and the
individual defendants filed with the Court a motion to dismiss the First Amended
Class Action Complaint in its entirety. It is not possible to predict with any
degree of certainty when the Court will rule on the defendants' motion to
dismiss.
In July 1995, one of Zila's subsidiaries, Bio-Dental, was named as a
defendant, along with Bio-Dental's transfer agent and a shareholder of
Bio-Dental ("Shareholder"), in a lawsuit. The lawsuit alleges that Bio-Dental
wrongfully failed to register 200,000 Bio-Dental shares in the name of the
plaintiffs which were pledged as security by the Shareholder for a debt owed by
the Shareholder to the plaintiffs. Bio-Dental denied all of the material
allegations of the lawsuit against it and has asserted various affirmative
defenses. Bio-Dental accrued a liability of $450,000 in September 1996 because
it believed a loss was probable at that time. This amount was Bio-Dental's best
estimate of the loss in the event the outcome of the litigation was unfavorable
to Bio-Dental. In November 1996, Bio-Dental was granted a summary judgment in
which the court ruled in favor of Bio-Dental. In February 1997, the plaintiffs
started the process to appeal the judgment. Subsequently, the appellate court
upheld the lower court's summary judgment in favor of Bio-Dental. Accordingly,
Bio-Dental reversed the amount of accrued liability.
On September 8, 1999, the Securities and Exchange Commission (the
"Commission") entered an order directing an investigation entitled "In the
Matter of Zila, Inc." The Commission is investigating whether (i) there were
purchases or sales of securities of the Company by persons while in possession
of material non-public information concerning the prospects that the Oncologic
Drugs Advisory Committee for the FDA would recommend approval of the OraTest(R)
NDA and whether the FDA would subsequently approve the NDA; (ii) such persons
conveyed information regarding these matters to other persons who effected
transactions in securities of the Company without disclosing the information;
and (iii) there were false and misleading statements in press releases, filings
with the Commission, or elsewhere concerning these matters. The Company does not
believe it has violated any of the federal securities laws and is cooperating
fully with the Commission in its investigation.
The Company is subject to other legal proceedings and claims, which arise in
the ordinary course of business. In the opinion of management, the amount of
ultimate liability with respect to these actions will not materially affect the
financial position or results of operations of the Company.
F-18
48
11. EMPLOYEE BENEFIT PLAN
The Company, except for Oxycal, has adopted the Zila, Inc. 401(k) Savings
and Retirement Plan (the "Zila Plan") for the benefit of eligible employees.
Participants may contribute, through payroll deductions, up to 15% of their
basic compensation not to exceed Internal Revenue Code limitations. The Company
may make matching or profit sharing contributions to the Zila Plan. During 1999,
1998, and 1997, the Company contributed approximately $62,000, $39,600 and
$19,000, respectively, to the Zila Plan. Oxycal adopted a 401(k) defined
contribution plan (the "Oxycal Plan") effective November 1, 1995 for all
eligible employees. An employee may contribute up to a certain maximum amount
each year. During 1999 and 1998, Oxycal contributed approximately $60,488 and
$40,653, respectively to the Oxycal Plan. Effective July 1, 1999, the Oxycal
Plan was merged into the Zila Plan.
F-19
49
12. IMPAIRMENT OF ASSETS
In connection with assessing the recoverability of goodwill and other
intangible assets in the first quarter of fiscal 1997, the Company determined
that such assets that are associated with Integrated Dental Technologies, Inc.
("IDT"), a wholly-owned subsidiary of Bio-Dental, would not likely be
recoverable. This determination was the result of IDT failing to achieve
original projections of operating results subsequent to the restructuring of IDT
in early 1996. As a result, a $587,659 impairment loss was recognized to reduce
the carrying value of these long-lived assets to fair value. Fair value was
estimated based on management's best estimate of discounted future cash flows.
13. EQUITY LINE INVESTMENT AGREEMENT
In April 1997, the Company entered into an investment agreement (the
"Investment Agreement") with Deere Park Capital Management (the "Investor")
which allowed the Company to sell up to $25,000,000 of the Company's common
stock with the proceeds to be used to fund OraTest(R) marketing and general
corporate purposes. Under the Investment Agreement the Company sold $13,000,000
of common stock. The option to sell stock to the Investor expired in September
1998.
As a commitment fee for keeping the equity line available for the 12 Month
Period, the Company issued warrants dated May 7, 1997 (the "Warrants") to the
Investor exercisable for 300,000 shares of common stock at an exercise price of
$8.6125 per share. The Warrants are exercisable for a three year period
commencing October 31, 1997.
14. SUBSEQUENT EVENT
On October 28, 1999, Cygnus completed the sale of substantially all of its
assets and certain of its liabilities to Procare Laboratories, Inc. ("Procare"),
of Scottsdale, Arizona for approximately $4.0 million. Procare is controlled by
the former owner and President of Cygnus, Egidio Cianciosi. The purchase price
was paid through the issuance of a note receivable which is collateralized by
the assets of Procare and matures November 10, 1999.
15. SEGMENT INFORMATION
In fiscal 1999, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information". SFAS No. 131 supersedes FAS
No. 14, "Financial Reporting for Segments of a Business Enterprise", replacing
the "industry segment" approach with the "management" approach. The management
approach designates the internal organization that is used by management for
making operating decisions and assessing performance as the source of the
Company's reportable segments.
The Company is organized into three major product groups and further
organized into six segments, all of which have distinct product lines, brand
names and are managed as autonomous business units. The Company has identified
the following segments for purposes of applying SFAS No. 131: Pharmaceuticals
which includes Zila Pharmaceuticals, Inc., OraTest products, Dental Supply which
includes Bio-Dental Technologies Corporation and Ryker Dental of Kentucky, Inc.
which does business under the name Zila Dental Supply, Dental Software, which
includes Integrated Dental Technologies, Inc., the distributor for
PracticeWorks, Dental Imaging which includes Cygnus Imaging, Inc. and
Nutraceuticals which includes Oxycal Laboratories, Inc. The Company evaluates
performance and allocates resources to segments based on operating results.
Corporate overhead expenses have been combined with the OraTest segment.
F-20
50
The table below presents information about reported segments for the three years
ended July 31 (in thousands):
DENTAL DENTAL DENTAL
PHARMACEUTICALS ORATEST SUPPLY SOFTWARE IMAGING NUTRACEUTICALS TOTAL
Net Revenues:
1999 .......................... $ 18,148 $ 311 $ 31,534 $ 4,516 $ 1,781 $ 15,005 $ 71,295
1998 .......................... 15,439 237 28,055 3,418 2,716 12,242 62,107
1997 .......................... 6,719 20 26,532 2,194 3,200 -- 38,665
Income (loss) before income taxes:
1999 .......................... 5,801 (8,872) 658 509 (3,662) 3,003 (2,563)
1998 .......................... 5,046 (5,727) 854 (273) (1,573) 2,174 501
1997 .......................... 1,699 (6,624) 678 (2,091) (710) -- (7,048)
Identifiable assets:
1999 .......................... 13,157 18,861 10,136 871 3,734 29,797 76,556
1998 .......................... 15,223 12,888 7,962 618 4,973 28,200 69,864
1997 .......................... 6,598 5,586 7,883 534 3,003 -- 23,604
Capital expenditures:
1999 .......................... 13 681 115 85 79 790 1,763
1998 .......................... 57 399 70 76 230 444 1,276
1997 .......................... 43 296 178 73 11 -- 601
Depreciation and amortization:
1999 .......................... 1,011 920 293 103 422 833 3,582
1998 .......................... 760 830 274 61 237 608 2,770
1997 .......................... 54 720 224 27 129 -- 1,154
F-21
51
16. QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly financial information is presented in the following summary:
1998
------------------------------------------------------------------------
Quarters Ended
------------------------------------------------------------------------
October 31 January 31 April 30 July 31
----------- ----------- ----------- -----------
Net Revenues $ 10,800,182 $ 16,940,983 $ 17,723,721 $ 16,642,224
Gross Profit 4,222,924 8,822,177 9,799,328 8,586,008
Net income (loss) (429,790) 1,281,999 220,661 1,228,198
Net loss attributable to common
shareholders (429,790) (1,872,693) (2,667,430) (43,619)
Net loss attributable to common
shareholders - basic (0.01) (0.05) (0.08) (0.00)
Net loss attributable to common
shareholder - diluted (0.01) (0.05) (0.08) (0.00)
1999
------------------------------------------------------------------------
Quarters Ended
------------------------------------------------------------------------
October 31 January 31 April 30 July 31
----------- ----------- ----------- -----------
Net Revenues $ 16,502,808 $ 18,121,619 $ 16,916,658 $ 19,753,666
Gross Profit 8,644,162 9,496,567 8,481,157 10,337,521
Net income (loss) 755,508 (1,147,298) (2,420,984) 845,792
Net income (loss) attributable to
common shareholders 755,508 (1,147,298) (2,420,984) 845,792
Net income (loss) attributable to
common shareholders - basic .02 (0.03) (0.06) 0.02
Net income (loss) attributable to
common shareholder - diluted .02 (0.03) (0.06) 0.02
F-22
52
Exhibits Index
EXHIBIT
NUMBER DESCRIPTION METHOD OF FILING
- ------ ----------- ----------------
3-A Certificate of Incorporation, as amended *
3-B Bylaws *
3-C Certificate of Designations, Preferences and Rights of Series A
Convertible Preferred Stock D
4-A Specimen Stock Certificate *
4-B Form Stock Purchase Warrant re Series A Preferred Stock D
4-C Deere Park Capital Management Warrant C
4-D Bartholomew Investment, L.P. Warrant C
10-A Revolving Line of Credit Loan Agreement dated February 1, 1999 between
Zila, Inc. and Bank One, Arizona *
10-B# Stock Option Award Plan (as amended through April 10, 1991) A
10-C# Non-Employee Directors Stock Option Plan (as amended through April 10, 1991) A
10-D# 1997 Stock Option Award Plan D
10-E Agreement dated November 26, 1996 between Cheseborough Ponds USA Co
and Zila Pharmaceuticals, Inc B
10-F Private Equity Line of Credit between Deere Park Capital Management
and Zila, Inc. Dated as of April 30, 1997 C
10-G Amendment to Private Equity Line of Credit Agreement C
10-H Registration Rights Agreement dated as of May 9, 1997 between Zila,
Inc. and Deere Park Capital Management C
10-I Registration Rights Agreement dated as of May 9, 1997 between Zila,
Inc. and Bartholomew Investment, L.P C
10-J Securities Purchase Agreement dated as of October 17, 1997 by and
among Zila, Inc. and certain investors D
10-K Registration Rights Agreement dated October 17, 1997 by and among
Zila, Inc. and certain investors D
10-L Asset Purchase Agreement dated October 28, 1999 between Zila, Inc., Cygnus
Imaging Inc. and Procare Laboratories, Inc. *
10-M Secured Note dated October 28, 1999 between Zila, Inc. and Procare
Laboratories, Inc. *
21 Subsidiaries of Registrant E
23 Consent of Deloitte & Touche LLP (regarding Form S-8 and Form S-3
Registration Statements) *
24-A Power of Attorney of Joseph Hines
24-B Power of Attorney of Bradley C. Anderson
24-C Power of Attorney of Carl A. Schroeder
24-D Power of Attorney of Patrick M. Lonergan
24-E Power of Attorney of Michael S. Lesser
24-F Power of Attorney of Curtis M. Rocca
24-G Power of Attorney of Christopher D. Johnson
24-H Power of Attorney of Kevin J. Tourek
27 Financial Data Schedule
* Filed herewith
A Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended January 31, 1996, as amended
B Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended October 31, 1996, as amended
C Incorporated by reference to the Company's Form S-3 Registration
Statement No. 333-31651
D Incorporated by reference to the Company's Annual Report on Form 10-K
for fiscal year ended July 31, 1997
E Incorporated by reference to the Company's Annual Report on Form 10-K
for fiscal year ended July 31, 1998.