Back to GetFilings.com
1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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, 2000
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 (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
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 29, 2000, the aggregate market value of common stock held
by non-affiliates of the registrant was $ 157,236,000.
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 29, 2000, the number of shares of common stock outstanding
was 43,512,520
DOCUMENTS INCORPORATED BY REFERENCE
Materials from the Registrant's 2000 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....................... 17
PART II .................................................................................... 17
Item 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS....................................................... 17
Item 6. SELECTED FINANCIAL DATA................................................... 18
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS..................................................... 18
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............................... 24
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURES................................................. 24
PART III ................................................................................... 24
PART IV .................................................................................... 24
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8K.......... 24
SIGNATURES.................................................................................. 26
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 12 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 nutraceutical 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 the OraTest(R) oral cancer detection
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 Zila Technologies, Inc., formerly 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 ("ZDS") and is a national distributor of
professional dental supplies, and Integrated Dental Technologies, Inc. ("IDT"),
a California corporation that distributed PracticeWorks(TM) dental practice
management software.
On October 28, 1999, Cygnus Imaging, Inc. ("Cygnus"), a manufacturer
and marketer of dental imaging products including digital x-ray systems and
intraoral cameras, 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.
On December 20, 1999, IDT completed the sale of substantially
all of it's assets and liabilities related to its PracticeWorks division located
in Gold River, California to InfoCure Corporation ("InfoCure"), of Atlanta,
Georgia for approximately $4.65 million. InfoCure is a national provider of
healthcare practice management software products and services to targeted
healthcare practice specialties and is listed on the NASDAQ under the symbol
INCX. Under the terms of the agreement, 10% of the sales price will be held in
escrow for one year in order to secure the representations, warranties, and
covenants made by the Company to InfoCure.
The Nutraceuticals Group includes Oxycal Laboratories, Inc., an Arizona
corporation ("Oxycal"), and its two subsidiaries, Inter-Cal Corporation, Inc,
("Inter-Cal"), 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) and a line
of botanical ingredients that includes the Palmettx(TM) saw palmetto product.
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 Company's principal executive offices are located at 5227 North
Seventh Street, Phoenix, Arizona 85014-2800, and its telephone number is (602)
266-6700.
1
4
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
patented 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 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. 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 that 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 that 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.
2
5
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.
- - OraTest(R) The OraTest(R) product, a diagnostic adjunct for oral
cancer and site delineation for biopsy and surgical
excision, is an easy-to-use, five minute chair-side oral
rinse or swab that can be administered by either a
medical practitioner or dentist. OraTest(R) contains the
active ingredient Zila(R) Tolonium Chloride, a staining
agent, that will adhere to specific cell types within
the mouth that are abnormal and that are not visible to
physicians or dentists. The product has been approved
for distribution in the United Kingdom, Australia,
Taiwan, Belgium, Holland, Luxembourg, Finland, Greece,
Portugal, China, Bermuda and the Bahamas. The Company is
currently moving forward with a Phase III clinical study
in order to receive government approval from the Food
and Drug Administration (the "FDA") to distribute the
OraTest(R) product in the United States. Currently,
OraTest(R) is marketed in the U.K., China and Taiwan.
According to the American Cancer Society, 30,200 new
oral, nasopharyngeal and laryngeal cancers will be
diagnosed and approximately 7,800 oral cancer related
deaths will occur in the U.S. in 2000. Worldwide, nearly
900,000 new cases of oral cancer occurred in 1996. Oral
cancer remains one of the most debilitating and
disfiguring of all malignancies. In most people
diagnosed with oral cancer, the disease has
metastasized, resulting in a poor prognosis because the
usual method of detecting the disease is a visual
examination. Those who do survive frequently undergo
significantly disfiguring surgery. When oral cancer is
detected early, survival rates are as high as 80%;
detected late the survival rate plummets to 18%.
OraTest(R) has been shown to identify even early-stage
oral cancer cells that are asymptomatic and clinically
unobservable.
PROFESSIONAL PRODUCTS GROUP
-Dental Supplies Zila Dental Supply is a national distributor of
professional dental supplies and equipment, 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.
3
6
Zila Dental Supply distributes over 27,000 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
and expand its e-commerce business development via its
Ole' on-line order entry system.
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). Inter-Cal Corporation, an Oxycal
subsidiary, distributes its products. Products
manufactured with Ester-C(R) nutritional ingredients are
sold throughout the U.S. and in over 41 countries
worldwide. Inter-Cal requires its customers to display
the federally-registered Ester-C(R) logo on their
packaging. 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 of 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 does not last long enough
for the skin to reap the benefits of Vitamin C.
Ester-C(R) Topical Concentrate is non-acidic and free of
chemical esters. Ester-C(R) Chelated Mineral Blend
provides the benefits of supplemental Vitamin C for
animals. EsterC(R) Beverage Grade mineral ascorbate is
characterized by a uniform particle size and shape that
blends easily into formulations for vitamin and sports
drinks, chewable tablets and other products where
delivery and dispersibility are important.
In November 1999, Inter-Cal introduced Palmettx(TM), a
standardized extract of the saw palmetto plant that
retains high concentrations of the active phytosterol
components and is extracted without chemicals, toxic
solvents or excessive heat. Saw Palmetto extract is used
to reduce the symptoms associated with glandular
swelling in patients with Benign Prostatic Hyperplasia
(BPH), a problem that affects as much as 50% of the male
population by the age of 60 years. Inter-Cal produces
Palmettx(TM) using a proprietary supercritical carbon
dioxide (CO2) fluid bioprocessing method, PureXtrax(TM),
which extracts botanicals naturally, without solvents
such as hexane and alcohol. The process is non-hazardous
to the environment, and the Company believes it assures
the highest product integrity, superior storage
stability and virtual elimination of all enzymes,
microorganisms, viruses, molds and spores.
4
7
MARKETING
PHARMACEUTICALS GROUP
-Strategy for The Company's Pharmaceuticals Group employs three
OTC Products strategies 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 2000, 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) During fiscal year 2000, Peridex(R) was marketed to
healthcare professionals and pharmacists with extensive
support from OnCall, Ltd., a national contract detailing
organization. On August 4, 2000, Omnii Products became
the exclusive dental profession sales and distribution
organization for Peridex(R). Omnii Products has an
extensive and growing national network of field sales
representatives with excellent coverage of dental
professionals. Additionally, Omnii Products
representatives 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) During the first half of fiscal 2000, OraTest(R) was
marketed in the U.K. by Zila's U.K. licensee,
Stafford-Miller Ltd. (a division of Block Drug Company),
under the name OraScreen(TM) to general practitioners.
The marketing effort for OraScreen(TM) in the U.K. was 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. The license agreement
with Stafford-Miller expired on December 31, 1999 and
was not renewed.
In January 2000, the Company, through it's wholly owned
subsidiary Zila Ltd U.K., contracted with Quedos Dental
(Sales) Ltd. to provide a six person sales force plus a
field sales manager to sell OraTest(R) products under
the OraTest(R) name in the U.K. Additionally, Zila Ltd.
has contracted with CPG Holdings Ltd, a third party
fulfillment organization, to warehouse and ship
OraTest(R) products throughout the European Union and
other selected countries.
PROFESSIONAL PRODUCTS GROUP
Zila Dental Supply markets its products directly to the
end user primarily by direct mail, an outside sales
force, trade shows, telemarketing and its award-winning
website. Zila Dental Supply believes it delivers their
customers the best value in the dental supply business
by providing competitive prices on dental supplies while
providing excellent customer service. Its award-winning
catalog provides a comprehensive reference of the
top-selling products available to the professional
dentist. Every month customers receive a special sale
flyer that offers significant savings and highlights
many manufacturers' specials. Zila Dental Supply offers
a 110% low price guarantee and free ground shipping on
all orders over $50.00.
5
8
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 and in 2000 added
Palmettx(TM), a branded saw palmetto utilizing patented
PureXtrax(TM) CO2 extraction process, to its product
offerings. 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. With the help of the advertising, Ester-C(R) is
transitioning from being a product sold primarily in
natural food outlets to one with more broad-based
availability in mass market and chain stores.
International sales activities are managed by local
distributors and are encouraged by advertising
assistance programs. Additionally, the Company has
sponsored public relations and advertising support 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 Ivers
Lee Corporation, dba Sharp of West Caldwell, New Jersey
manufactures all Zilactin(R) sample packets. National
Healthcare Manufacturing Corporation of Antioch,
Illinois manufactures the Zilactin(R) Toothache Swabs.
The Company places orders with each supplier based on
its anticipated needs for the products. The Company
supplies packaging components to each manufacturer.
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). 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 for distribution in the U.K. and for sale to
other selected countries. The Company has also
identified a U.S.-based company with the capacity to
manufacture the OraTest(R) rinse kits and swabs.
No GMP producer of toluidine blue existed worldwide. In
order to ensure an available and stable supply of
Zila(R) Tolonium Chloride, the world's only
pharmaceutical grade toluidine blue and the active
ingredient in the OraTest(R) product, the Company
established its own manufacturing facility. The facility
was certified as an approved facility for the
manufacturing of Zila(R) Tolonium Chloride under
federally regulated Good Manufacturing Practices (GMP)
standards, assuring pharmaceutical-grade quality.
PROFESSIONAL PRODUCTS GROUP
Zila Dental Supply distributes products from over 500
manufacturers.
NUTRACEUTICALS GROUP
All products within the Nutraceuticals Group are
manufactured at Oxycal's Prescott, Arizona location.
6
9
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
that 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., Anbesol by Whitehall
Labs, 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 current
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
within the dental profession and the change in
distribution strategies should allow the Company to
compete more 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. In 1999, regulatory approval was obtained in
China.
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 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 Supplies Zila Dental Supply competes with approximately 200
dental 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 60 percent of the market is dominated by
two public companies: Patterson Dental Company and Henry
Schein, Inc.
7
10
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 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. This agreement was
terminated in December 1999.
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 both
the Company's manufacturing facilities and its contract
manufacturing plants 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.
8
11
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 any
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.
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.
9
12
- - OraTest(R) In 1994, the FDA approved an Investigational New Drug
Application ("IND") for the Company's OraTest(R)
product. 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 several meetings at
the agency in 1999 and 2000.
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.
In November 1999, the Company contracted with ILEX(TM)
Oncology Services, Inc. ("ILEX"), a wholly-owned
subsidiary of ILEX(TM) Oncology, Inc. of San Antonio,
Texas, for management of clinical research and liaison
with the FDA related to the Company's pursuit of
regulatory approval for the OraTest(R) product. In
August 2000, the Company received FDA approval to
proceed with a new clinical study.
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.
In January 1998, Zila submitted a Mutual Recognition
Procedure ("MRP") application through the MCA for
regulatory approval of OraTest(R) in the European Union
("EU"). In April 1998, Belgium, the Netherlands,
Luxembourg, Portugal, Finland and Greece gave their
regulatory 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 pursuing approvals 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.
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.
10
13
- - 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 a protocol for the
use of toluidine blue for detection of oral cancer. In
addition, the Company has been granted a patent in the
United States and filed applications in 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
epithelial 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 applications and the
remainders 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.
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
11
14
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, 2000, the Company and its operating subsidiaries had 241
employees in the following categories:
Categories Number of Employees
------------------------------ -------------------
Executive Officers 4
Sales and Service 79
Accounting and Administration 80
Purchasing and Distribution 50
Manufacturing 28
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 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.
12
15
- - Uncertainties of The rigorous clinical testing and an extensive
Regulatory regulatory approval process mandated by the FDA and
Approval equivalent foreign authorities before the Company can
market any new 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 of Zila has not received final FDA approval for OraTest(R)
OraTest(R) in the and is in the process of initiating additional studies
United States to include in an amended NDA. As of July 31, 2000, Zila
expensed approximately $17.7 million for 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 from
Key Products 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, 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 whom 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.
13
16
- - 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. It
may be difficult for the Company 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 products' 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 trademark and trade secret protection, nondisclosure
Rights 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.
- - Future Capital The development of the Company's products will require
Requirements the commitment of substantial resources to conduct the
and Uncertainty time-consuming research and development, clinical
of Future studies and regulatory activities necessary to bring any
Funding 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.
14
17
- - Possible The market price for the Company's common stock has
Volatility of fluctuated significantly in the past. Management of Zila
Common Stock believes that such fluctuations may have been caused by
Price 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 of The Company's Board of Directors has the authority,
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, 2000, all
of the shares of the Series A Preferred Stock have been
converted into shares of the Company's common stock.
- - Environmental The Company is subject to federal, state and local laws
and Controlled and regulations governing the use, generation,
Use of manufacture, storage, discharge, handling and disposal
Hazardous of certain materials and wastes used in its operations,
Materials 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.
Foreign Currency The Company transacts business in various foreign
countries. Foreign currency exposures are primarily, but
not limited to, vendor and customer payments and
inter-company balances in currencies other than the
functional currency. Fluctuations in foreign currencies
could have a material adverse effect on the Company's
results of operations.
ITEM 2. PROPERTIES
- - Corporate On January 4, 1991, the Company purchased a 16,000
Headquarters 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.
15
18
- - Manufacturing The Company leases 7,040 square feet for a manufacturing
Facilities facility in Phoenix, Arizona. This facility produces
Zila(R) Tolonium Chloride, which is the active
ingredient in 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.
Together with the Company's laboratory facilities, the
Company believes that its current manufacturers are
capable of performing all necessary production
functions. See "Item 1. Business -- Manufacturing and
Distribution."
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. The property is
free of liens. This facility manufactures and
distributes a patented and enhanced form of Vitamin C
under the trademark Ester-C(R). In November 1999, Oxycal
broke ground on a new 65,000 square-foot production and
product development facility in Prescott, Arizona's
Prescott Airpark which is financed by Yavapai County
Industrial Development Authority Bond proceeds. 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 fall of 2000. Additionally, 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 that expired on April
30, 2000 but continued on a month-to-month basis
beginning May 1, 2000. Monthly lease payments are
$7,055.
- - 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. 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 December 31, 2000. Zila Dental
Supply leases 7,500 square feet in an office building at
125 Lisle Industrial Avenue, Lexington, Kentucky. The
current lease rate is $9,603 per month, and expires on
December 31, 2004. 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 November 19, 1999, Zila Dental
Supply entered into a five-year lease for 4,761 square
feet at 555 Menlo Drive, Suite B, Rocklin, California
for their Rocklin branch office. The current lease rate
is $4,047 per month.
ITEM 3. LEGAL PROCEEDINGS
The Company and certain officers of the Company have
been named as defendants in a consolidated First Amended
Class Action Complaint 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 Complaint
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 common
stock in violation of the federal securities laws. The
Company and the individual defendants deny all
allegations of wrongdoing and are defending themselves
vigorously. In September 2000, the Court denied the
defendants' motion to dismiss the First Amended Class
Action Complaint and ordered that the matter proceed to
trial on the issue of liability commencing on February
26, 2001.
16
19
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.
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, 2000
First Quarter 3.688 3.000
Second Quarter 5.375 2.625
Third Quarter 8.000 3.094
Fourth Quarter 4.938 3.125
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
The number of stockholders of record of the Common Stock as of July 31,
2000 and September 29, 2000 were approximately 3,239 and 3,270, respectively. As
of July 31, 2000 there are no shares of the Company's Preferred Stock
outstanding.
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.
On March 23, 2000, the Company issued a warrant to purchase 10,000
shares of the Company's common stock, $0.001 par value per share, to a financial
advisor. The warrant was issued pursuant to the terms of an engagement
agreement, and the exercise price is $4.906 per share. The warrant was issued
pursuant to the exemption set forth in Section 4(2) of the Securities Act of
1933, as amended.
17
20
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: 2000 1999 1998(1) 1997 1996
------------ ------------ ------------ ------------ -----------
Net Sales $ 77,491,741 $ 71,159,241 $ 61,942,765 $ 38,592,252 $37,479,546
Licensing Fees and Royalty Revenue 89,167 135,510 164,345 72,640 2,100,484
Net Income (Loss) 2,932,027 (1,966,982) 2,301,068 (6,458,377) 1,217,298
Net Income (Loss) Attributable to Common
Shareholders 2,932,027 (1,966,982) (5,013,532) (6,458,377) 1,217,298
Net Income (Loss) Per Share Attributable To
Common Shareholders 0.07 (0.05) (0.15) (0.20) 0.04
AT JULY 31
------------------------------------------------------------------------------
BALANCE SHEET DATA: 2000 1999 1998(1) 1997 1996
------------ ------------ ------------ ------------ -----------
Current Assets $ 31,380,071 $ 30,750,624 $ 27,992,138 $ 10,779,049 $13,251,960
Current Liabilities 11,050,668 8,704,760 8,777,242 5,804,965 6,672,497
Total Assets 77,711,459 76,555,933 69,863,877 23,604,032 25,309,781
Long-Term Debt 4,548,953 9,577,755 1,355,547 375,908 382,006
Total Liabilities 15,599,621 18,282,515 10,132,789 6,180,873 7,054,503
Series A Convertible Redeemable Preferred
Stock 8,787,191 33,801,930
Shareholders' Equity 62,111,838 49,486,227 25,929,158 17,423,159 18,255,278
(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.
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 words "believe," "expect," "anticipate," "intend,"
"estimate" and other expressions, which are predictions of or indicate future
events and trends and which do not relate to historical matters, identify
forward-looking statements. These forward-looking statements are based largely
on the Company's expectations or forecasts of future events, can be affected by
inaccurate assumptions and are subject to various business risks and known and
unknown uncertainties, a number of which are beyond the Company's control.
Therefore, actual results could differ materially from the forward-looking
statements contained in this document, and readers are cautioned not to place
undue reliance on such forward-looking statements. The Company undertakes no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise. There can be no
assurance that the forward-looking statements contained in this document will,
in fact, transpire or prove to be accurate.
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 worldwide 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
18
21
Zila Dental Supply, a national distributor of professional dental supplies, Zila
Technologies, Inc., formerly Cygnus Imaging Inc. ("Cygnus") and Integrated
Dental Technologies, Inc. ("IDT"). The Nutraceuticals Group is presently
comprised of Oxycal Laboratories, Inc. ("Oxycal") and its Inter-Cal subsidiary
("Inter-Cal"), a manufacturer and distributor of mineral and botanical products
including a patented and unique form of Vitamin C under the trademark Ester-C(R)
and the Palmettx botanical line of products.
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.
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.
On October 28, 1999, Cygnus completed the sale of substantially all of
its assets and certain 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.
On December 20, 1999, IDT completed the sale of substantially all of
its assets and liabilities related to its PracticeWorks division located in Gold
River, California to InfoCure Corporation ("InfoCure"), of Atlanta, Georgia for
approximately $4.65 million. InfoCure is a national provider of healthcare
practice management software products and services to targeted healthcare
practice specialties and is listed on NASDAQ under the symbol INCX. Under the
terms of the agreement, 10% of the sales price will be held in escrow for one
year in order to secure the representations, warranties, and covenants made by
the Company to InfoCure.
OPERATING RESULTS
Fiscal year ended July 31, 2000. Total net revenues grew 8.8% to $77.6
million for the 2000 fiscal year, compared to revenues of $71.3 million for the
prior fiscal year.
Net revenues in 2000 for Zila Dental Supply increased 26.3% to $39.8
million compared to $31.5 million for the previous fiscal year. This increase
was primarily attributable to an increase in full-service operations due to the
contribution of the two additional branch offices opened in fiscal 1999 and
increases in internet sales. Zila Pharmaceuticals had net revenues of $16.8
million for the 2000 fiscal year, a 7.6% decrease from the $18.1 million
recorded during the corresponding period last year. The decrease was due
primarily to a 44.1% decline in sales of Peridex(R) due to increased pricing
pressures from generic equivalents. In order to increase sales of Peridex, Zila
Pharmaceuticals has signed a distribution agreement with Omnii Products. Omnii
is a national marketer and detailer of dental products that targets dispensing
dentist professionals in the United States. Over-the-counter product sales of
the Zilactin(R) family of products increased 28.4% when compared to the
corresponding period last year, primarily due to increased sales of the
Zilactin(R) Toothache Swab and Zilactin-L product lines. Net revenues for
Inter-Cal for fiscal year 2000 were $19.1 million, a 27.5% increase when
compared to $15.0 million for fiscal year 1999. Inter-Cal's international sales
increased 104% to $6.1 million during the current fiscal year as compared to the
previous year due to improved economic conditions in foreign markets, primarily
in the Pacific Rim region. In addition, Inter-Cal had increased demand for all
of its major domestic product lines in fiscal 2000 when compared to the fiscal
1999 year.
Cost of products sold were $40.0 million for the fiscal year ended July
31, 2000, a 16.5% increase from $34.3 million for the previous fiscal year. Cost
of products sold as a percentage of net revenues increased to 51.6% in fiscal
year 2000 from 48.2% in the corresponding 1999 period. The increase for the
period reflects the growth of Zila Dental Supply as a percentage of total
revenues, 51.3% for fiscal 2000 compared to 44.2% for same period of the
previous fiscal year. The gross profit
19
22
margin for Zila Dental Supply is lower as compared to the other operating groups
resulting in a higher cost of products sold as a percentage of revenues.
Cost of products sold as a percentage of net revenues for Zila Dental
Supply decreased slightly to 74.3% in fiscal year 2000 from 74.6% in fiscal year
1999 primarily due to an increase in vendor rebate programs in the first quarter
of fiscal 2000. Cost of products sold as a percentage of net revenues for Zila
Pharmaceuticals increased to 23.2% in fiscal year 2000, compared to 17.9% for
the corresponding period in fiscal 1999. The increase for the period is a result
of a change in the mix of products sold as well as a promotional program for
Peridex(R) that offered the product at reduced pricing during the second half of
the year. Cost of products sold as a percentage of net revenues for Inter-Cal
decreased slightly to 27.2% for the current fiscal year from 27.9% due primarily
to favorable raw material contracts in effect for fiscal year 2000 as compared
to fiscal year 1999.
The Company incurred selling, general and administrative expenses of
$32.4 million, or 41.8% of net revenues during the fiscal year ended July 31,
2000 compared to $31.9 million, or 44.7% of net revenue in fiscal year 1999. The
decrease in selling, general and administrative expenses as a percentage of
revenue is attributable to a reduction in costs related to the Cygnus and
PracticeWorks businesses partially offset by increased costs related to the
expansion of the sales force and service department at Zila Dental Supply's full
service branches, increased selling and administrative costs related to the
OraTest(R) international product launches, increased marketing and selling
expenses at Inter-Cal and increased corporate legal, professional and insurance
expenses.
Research and development expenses decreased $2.4 million or 59.2%, from
$4.0 million incurred in fiscal year 1999 to $1.6 million for the same period in
fiscal year 2000. The decrease was primarily due to reduced expenses related to
research and clinical activities associated with the OraTest(R) product, and
reduced expenses related to seeking international approval of OraTest(R) and a
reduction of costs incurred in the Cygnus and PracticeWorks businesses which
were sold in fiscal year 2000.
Depreciation and amortization expenses decreased $104,000 from $3.6
million in fiscal year 1999 to $3.5 million in fiscal year 2000. The decrease
was mainly related to the sale of the Cygnus and PracticeWorks businesses.
The Company recorded interest expense of $212,000 for the year ended
July 31, 2000 compared to $393,000 in the prior fiscal year, a decrease of
$181,000. The decrease was attributable to decreases in debt obligations
incurred during fiscal year 2000 as compared to the previous year period.
In the year ended July 31, 2000, the Company recorded income tax
expense of $1.8 million which is net of $2.9 million in income tax benefit
resulting from the reversal of a valuation allowance ($1 million of which was
attributable to the exercise of common stock options and therefore credited to
capital in excess of par value) as compared to an income tax benefit of $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. The reversal of the valuation allowance was based on the
Company's estimate that it is more likely than not that certain net operating
losses of prior years will be realized. Excluding the effects of the reversal of
the valuation allowance, the Company's effective tax rate for the current fiscal
year is higher than the statutory rate due primarily to the amortization of
intangible assets that is not deductible for tax purposes and the
non-deductibility of the Company's foreign operating losses. Additionally,
approximately $1.7 million of goodwill related to the sale of Cygnus was not
deductible for tax purposes.
For the fiscal year ended July 31, 2000, the Company had net income of
$2.9 million compared to a net loss of $2.0 for 1999. The increase in
profitability is due primarily to the increased profitability in the
Nutraceuticals Group, the sale of the PracticeWorks business and the elimination
of losses associated with the Cygnus business.
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 was 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
20
23
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 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 reflect nine months of revenues
whereas the twelve months ended July 31, 1999 reflect a full twelve months of
Oxycal revenues. PracticeWorks 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 was 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 was 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 was a result of favorable raw materials
purchase contracts in effect for fiscal year 1999 as compared to fiscal year
1998. PracticeWorks 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 was 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
was 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.
21
24
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 was 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 shareholders. 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.
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, 2000, the Company had cash and cash equivalents of $5.6
million compared to $5.8 million at July 31, 1999. Excess cash and cash
equivalents are invested primarily in money market accounts. The Company's
working capital was $20.3 million at July 31, 2000 as compared to $22.0 million
at July 31, 1999. Working capital decreased primarily due to a reduction in
deferred income taxes related to the use of tax loss carryforwards in fiscal
2000. The Company's current ratio was 2.8 at July 31, 2000, compared to 3.5 at
July 31, 1999.
During the year ended July 31, 2000, cash provided by operating
activities totaled $1.1 million primarily related to net income of $2.9 million
plus non-cash depreciation and amortization of $3.5 million and deferred taxes
of $1.5 million, reduced by the gain on sale of assets of $4.7 million.
Significant changes in operating assets and liabilities were comprised of (i) an
increase in accounts receivable of $2.0 million due to increased sales at Zila
Dental Supply and Inter-Cal during the current fiscal year, (ii) an increase in
inventories of $2.9 million primarily because of new product introductions at
Inter-Cal and increased purchases of dental supplies and equipment to support
the growing sales at Zila Dental Supply and (iii) an increase in prepaid
expenses of $1.0 million primarily related to the deposit paid to ILEX(TM), all
of which was partially offset by an increase in accounts payable and accrued
expenses of $3.6 million related to the increase in inventory purchases.
The Company generated cash from investing activities of $2.4 million
during the year ended July 31, 2000, primarily due to the $7.7 million net
proceeds from the sale of the Cygnus and PracticeWorks assets. Part of these
proceeds were used to purchase property and equipment of $5.2 million,
consisting of manufacturing additions for the Oxycal and OraTest(R) businesses.
Additionally, $3.7 million was used in financing activities during the 2000
fiscal year. The Company retired outstanding debt of $5.4 million, comprised of
the final payment of $1.0 million made to P & G related to the acquisition of
the Peridex product line and $4.2 million to repay in full its line of credit
with Bank One. The Company used $409,750 to repurchase 135,000 shares of Zila
common stock on the open market.
At July 31, 2000, the Company had federal income tax net operating loss
carryforwards of approximately $9.8 million, which expire in years 2007 through
2019.
In February 1999, the Company increased its line of credit with Bank
One to $9.0 million and extended the commitment period to December 1, 2000.
Interest is payable monthly on the unpaid balance outstanding at the bank's
prime rate (9.5% at July 31, 2000) plus .25%. At July 31, 2000, the Company had
no borrowings under the line of credit. Under the line of credit, the Company is
required to comply with financial covenants based on certain financial ratios.
At July 31, 2000, the Company was in compliance with such covenants.
During the second quarter of fiscal year 2000, Inter-Cal began
construction of a new manufacturing and laboratory facility that is expected to
be completed by October 2000. In April 1999, Inter-Cal 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
Inter-Cal for the construction of the facility. The trustee, Bank One, Arizona,
is holding the Bond proceeds but released $1.9 million during fiscal year 2000
to pay for construction costs and equipment. The Bonds consist of $3.9 million
Series A and $1.1 million Taxable Series B which, as of July 31, 2000, carried
interest rates of 4.5% and 6.7%, 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
22
25
Inter-Cal obtain, for the benefit of the Bondholders, an irrevocable direct-pay
letter of credit to secure payment of principal and interest. The letter of
credit is guaranteed by Zila.
On December 20, 1999, IDT completed the sale of substantially all of
its assets and liabilities related to its PracticeWorks division located in Gold
River, California to InfoCure of Atlanta, Georgia for approximately $4.65
million. InfoCure is a national provider of healthcare practice management
software products and services to targeted healthcare practice specialties and
is listed on NASDAQ under the symbol INCX. Under the terms of the agreement, 10%
of the sales price will be held in escrow for one year in order to secure the
representations, warranties, and covenants made by the Company to InfoCure.
In November 1999, the Company contracted with ILEX(TM) Oncology
Services, Inc. ("ILEX"), a wholly owned subsidiary of ILEX(TM) Oncology, Inc. of
San Antonio, Texas, for management of clinical research and liaison with the
U.S. Food and Drug Administration ("FDA") related to the Company's pursuit of
regulatory approval for the OraTest(R) oral cancer detection product. In March
2000, the Company paid approximately $792,000 to ILEX as a deposit on estimated
expenses related to an FDA-required clinical study associated with the Company's
ongoing efforts to obtain FDA approval of OraTest(R). Current commitments under
the ILEX agreement include a monthly installment payment of $76,000 plus
reimbursement for out of pocket expenses as they occur during the course of the
study. The contract or any workplan may be terminated at any time by Zila upon
not less than 90 days prior written notice of termination to ILEX. If the
agreement is so terminated, Zila shall pay ILEX any amount owed, but not yet
paid, for work performed prior to the date of termination.
On November 10, 1999, the Company announced that the Company's Board of
Directors authorized the repurchase of up to one million shares of Zila common
stock. Purchases will be made on the open market depending on market conditions
and other factors. As of July 31, 2000, 135,000 shares had been repurchased for
$409,750.
The Company believes that cash generated from its operations, its
investing activities and the availability of cash under its line of credit are
sufficient to finance its level of operations, anticipated capital expenditures
and stock repurchase program 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 assurances that such funds will be
available on terms acceptable to the Company.
NEW ACCOUNTING PRONOUNCEMENTS
The Securities and Exchange Commission released Staff Accounting
Bulletin ("SAB") No. 101 Revenue Recognition in Financial Statements on December
3, 1999, SAB No. 101A on March 24, 2000 and SAB No. 101B on June 26, 2000. SAB
No. 101 sets forth revenue recognition issues, including conceptual issues as
well as certain industry specific guidance. The Company is required to report
the impact of SAB No. 101, as amended by SAB No. 101A and SAB No. 101B, no later
than the fourth quarter of the fiscal year 2001. The effect of the change, if
any, would be recognized as a cumulative effect of a change in accounting
principle as of August 1, 2000. Prior year financial statements will not be
restated. The Company has not yet made an evaluation of the impact of adopting
these statements on the Company's financial position or operating results.
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities ("SFAS No. 133"), establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. SFAS No. 133 requires that an
enterprise recognize all derivatives as either assets or liabilities in the
balance sheet and measure those instruments at fair value. If certain
conditions are met, a derivative may be specifically designated as a hedge. The
accounting for changes in the fair value of a derivative instrument depends on
the intended use of the derivative and resulting designation. The Company
adopted SFAS No. 133 effective August 1, 2000 and the adoption did not have a
material impact on the Company's results of operations as the Company has no
significant derivative financial instruments or hedging activities.
23
26
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.
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 7, 2000, which will be filed
with the SEC not later than 120 days after July 31, 2000.
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, 2000 and
1999 and related Consolidated Statements of Operations and
Comprehensive Income, Convertible Redeemable Preferred Stock and
Shareholders' Equity, and Cash Flows for each of the years in the
three-year period ended July 31, 2000 Filed herewith
(b) Reports on Form 8-K for the quarter ended July 31, 2000.
None.
(c) Exhibits.
EXHIBIT
NUMBER DESCRIPTION METHOD OF FILING
- ------ ----------- ----------------
3-A Certificate of Incorporation, as amended A
3-B Bylaws A
3-C Certificate of Designations, Preferences and Rights of Series A
Convertible Preferred Stock E
4-A Specimen Stock Certificate A
4-B Form Stock Purchase Warrant re Series A Preferred Stock E
4-C Deere Park Capital Management Warrant D
4-D Bartholomew Investment, L.P. Warrant D
10-A Revolving Line of Credit Loan Agreement dated February 1, 1999 between
Zila, Inc. and Bank One, Arizona A
10-B# Stock Option Award Plan (as amended through April 10, 1991) B
10-C# Non-Employee Directors Stock Option Plan (as amended through April 10, 1991) B
10-D# 1997 Stock Option Award Plan E
10-E Agreement dated November 26, 1996 between Cheseborough Ponds USA Co
and Zila Pharmaceuticals, Inc C
24
27
10-F Private Equity Line of Credit between Deere Park Capital Management
and Zila, Inc. Dated as of April 30, 1997 D
10-G Amendment to Private Equity Line of Credit Agreement D
10-H Registration Rights Agreement dated as of May 9, 1997 between Zila,
Inc. and Deere Park Capital Management D
10-I Registration Rights Agreement dated as of May 9, 1997 between Zila,
Inc. and Bartholomew Investment, L.P D
10-J Securities Purchase Agreement dated as of October 17, 1997 by and
among Zila, Inc. and certain investors E
10-K Registration Rights Agreement dated October 17, 1997 by and among
Zila, Inc. and certain investors E
10-L Asset Purchase Agreement dated October 28, 1999 between Zila, Inc., Cygnus
Imaging, Inc. and Procare Laboratories, Inc. A
10-M Secured Note dated October 28, 1999 between Zila, Inc. and Procare Laboratories, Inc. A
10-N Asset Purchase agreement dated as of November 30, 1999 by and among Zila, Inc.,
Integrated Dental Technologies, Inc., InfoCure Systems, Inc., and InfoCure Corporation G
21 Subsidiaries of Registrant F
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 Michael S. Lesser *
24-E Power of Attorney of Curtis M. Rocca *
24-F Power of Attorney of Christopher D. Johnson
24-G Power of Attorney of Kevin J. Tourek *
27 Financial Data Schedule *
* Filed herewith
A Incorporated by reference to the Company's Annual Report on Form 10-K
for fiscal Year ended July 31, 1999
B Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended January 31, 1996, as amended
C Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended October 31, 1996, as amended
D Incorporated by reference to the Company's Form S-3 Registration
Statement No. 333-31651
E Incorporated by reference to the Company's Annual Report on Form 10-K
for fiscal year ended July 31, 1997
F Incorporated by reference to the Company's Annual Report on Form 10-K
for fiscal Year ended July 31, 1998
G Incorporated by reference to the Company's Annual Report on Form 8-K
dated January 3, 2000
25
28
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 27th
day of October 2000.
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 27, 2000
- ------------------------------------ President, Chief Executive
Joseph Hines Officer
/s/ BRADLEY C. ANDERSON Vice President and Chief October 27, 2000
- ------------------------------------ Financial Officer
Bradley C. Anderson
* Director October 27, 2000
- ------------------------------------
Carl A. Schroeder
* Director October 27, 2000
- ------------------------------------
Michael S. Lesser
* Director October 27, 2000
- ------------------------------------
Curtis M. Rocca III
* Director October 27, 2000
- ------------------------------------
Christopher D. Johnson
* Director October 27, 2000
- ------------------------------------
Kevin J. Tourek
*By /s/ BRADLEY C. ANDERSON October 27, 2000
- ------------------------------------
Bradley C. Anderson
Attorney-in-Fact
26
29
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, 2000 and 1999, and the related consolidated
statements of operations and comprehensive income, convertible redeemable
preferred stock and shareholders' equity, and of cash flows for each of the
three years in the period ended July 31, 2000. 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.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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, 2000 and 1999, and the results of their operations and their cash flows for
each of the three years in the period ended July 31, 2000 in conformity with
accounting principles generally accepted in the United States of America.
DELOITTE & TOUCHE LLP
Phoenix, Arizona
September 29, 2000
F-1
30
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JULY 31, 2000 AND 1999
- --------------------------------------------------------------------------------
ASSETS 2000 1999
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents $ 5,558,487 $ 5,770,970
Trade receivables, less allowance for doubtful accounts
of $345,857 (2000)and $459,083 (1999) 9,893,587 8,741,283
Inventories - net 13,204,137 11,405,883
Prepaid expenses and other current assets 2,479,072 1,126,773
Deferred income taxes 244,788 3,705,715
------------ ------------
Total current assets 31,380,071 30,750,624
------------ ------------
PROPERTY AND EQUIPMENT - net 9,442,278 5,680,281
PURCHASED TECHNOLOGY RIGHTS - net 5,600,975 6,037,415
GOODWILL - net 12,725,978 15,679,969
TRADEMARKS and OTHER INTANGIBLE ASSETS- net 12,423,632 13,214,636
CASH HELD BY TRUSTEE 2,928,001 4,834,755
OTHER ASSETS 3,210,524 358,253
------------ ------------
TOTAL $ 77,711,459 $ 76,555,933
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 6,599,702 $ 3,724,820
Accrued liabilities 3,622,330 2,760,735
Deferred revenue 982,037
Short-term borrowings 51,770 72,769
Current portion of long-term debt 776,866 1,164,399
------------ ------------
Total current liabilities 11,050,668 8,704,760
LONG-TERM DEBT - Net of current portion 4,548,953 9,577,755
------------ ------------
Total liabilities 15,599,621 18,282,515
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 12 and 13)
SERIES A CONVERTIBLE REDEEMABLE PREFERRED STOCK:
Issued and outstanding 0 shares (2000) and 7,482 shares (1999) 8,787,191
------------ ------------
SHAREHOLDERS' EQUITY:
Preferred stock, $.001 par value - authorized 2,500,000 shares; none
issued other than Series A Convertible Redeemable Preferred
Stock shown above
Common stock, $.001 par value - authorized, 65,000,000 shares;
issued 43,362,658 shares (2000) and 40,378,588 shares (1999) 43,363 40,379
Capital in excess of par value 79,424,235 69,395,551
Accumulated other comprehensive income 71,666
Deficit (17,017,676) (19,949,703)
Less: 135,000 shares of common stock in treasury, at cost (409,750)
------------ ------------
Total shareholders' equity 62,111,838 49,486,227
------------ ------------
TOTAL $ 77,711,459 $ 76,555,933
============ ============
See notes to consolidated financial statements.
F-2
31
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
YEARS ENDED JULY 31, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
2000 1999 1998
------------ ------------ ------------
NET REVENUES $ 77,580,908 $ 71,294,751 $ 62,107,110
------------ ------------ ------------
OPERATING COSTS AND EXPENSES:
Cost of products sold 40,004,391 34,335,344 30,676,673
Selling, general and administrative 32,449,161 31,853,421 25,469,787
Research and development 1,628,580 3,988,028 2,660,135
Depreciation and amortization 3,478,120 3,581,768 2,769,956
------------ ------------ ------------
77,560,252 73,758,561 61,576,551
------------ ------------ ------------
INCOME (LOSS) FROM OPERATIONS 20,656 (2,463,810) 530,559
------------ ------------ ------------
OTHER INCOME (EXPENSES):
Interest income 388,773 288,918 319,774
Interest expense (212,671) (392,805) (334,646)
Other income (expense) (182,921) 4,715 (14,619)
Gain on sale of assets 4,677,860
------------ ------------ ------------
4,671,041 (99,172) (29,491)
------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES 4,691,697 (2,562,982) 501,068
INCOME TAX (EXPENSE) BENEFIT (1,759,670) 596,000 1,800,000
------------ ------------ ------------
NET INCOME (LOSS) 2,932,027 (1,966,982) 2,301,068
PREFERRED STOCK DIVIDEND REQUIREMENT:
SERIES A EMBEDDED DIVIDEND 7,314,600
------------ ------------ ------------
NET INCOME (LOSS) ATTRIBUTABLE TO
COMMON SHAREHOLDERS $ 2,932,027 $ (1,966,982) $ (5,013,532)
============ ============ ============
NET INCOME (LOSS) PER SHARE:
BASIC $ 0.07 $ (0.05) $ (0.15)
------------ ------------ ------------
DILUTED $ 0.07 $ (0.05) $ (0.15)
------------ ------------ ------------
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING
BASIC 42,180,236 38,013,058 33,990,947
DILUTED 43,576,180 38,013,058 33,990,947
NET INCOME $ 2,932,027
Other comprehensive income (loss), net of tax
Foreign currency translation adjustment 75,166
Net unrealized loss on available-for-sale-securities (3,500)
------------
Other comprehensive income 71,666
------------
COMPREHENSIVE INCOME $ 3,003,693
============
See notes to consolidated financial statements.
F-3
32
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONVERTIBLE REDEEMABLE PREFERRED STOCK AND
SHAREHOLDERS' EQUITY
Years Ended July 31, 2000, 1999 and 1998
SHAREHOLDERS' EQUITY
--------------------------------------------------
CONVERTIBLE REDEEMABLE
PREFERRED STOCK COMMON STOCK
------------------------ ---------------------- CAPITAL IN
PAR EXCESS OF
SHARES AMOUNT SHARES VALUE PAR VALUE DEFICIT
-------- ------------- ---------- -------- ----------- ------------
BALANCE, AUGUST 1, 1997 - - 32,326,581 $ 32,327 $30,360,021 ($12,969,189)
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 2,301,068
Series A embedded dividend (7,314,600)
-------- ------------- ---------- -------- ----------- ------------
BALANCE, JULY 31, 1998 28,800 33,801,930 34,743,575 34,744 43,877,135 (17,982,721)
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 (1,966,982)
-------- ------------- ---------- -------- ----------- ------------
BALANCE, JULY 31, 1999 7,482 8,787,191 40,378,588 40,379 69,395,551 (19,949,703)
Conversion of preferred stock into
common stock (7,482) (8,787,191) 2,904,472 2,904 8,784,287
Warrants issued for services provided 30,000
Purchase of common stock for treasury
Exercise of common stock warrants 49,074 49 76,280
Exercise of common stock options 30,524 31 148,117
Income tax benefit - stock options 990,000
Foreign currency translation
Net unrealized loss on available-for-sale securities
Net income 2,932,027
-------- ------------- ---------- -------- ----------- ------------
BALANCE, JULY 31, 2000 - $ - 43,362,658 $ 43,363 $79,424,235 $(17,017,676)
======== ============== ========== ======== =========== ============
----------------------------------------------
ACCUMULATED TOTAL
OTHER COMMON
TREASURY COMPREHENSIVE SHAREHOLDERS'
STOCK INCOME (LOSS) EQUITY
---------- ------------- ------------
BALANCE, AUGUST 1, 1997 - - $ 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
Series A embedded dividend (7,314,600)
---------- -------- ------------
BALANCE, JULY 31, 1998 - - 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)
---------- -------- ------------
BALANCE, JULY 31, 1999 - - 49,486,227
Conversion of preferred stock into
common stock 8,787,191
Warrants issued for services provided 30,000
Purchase of common stock for treasury (409,750) (409,750)
Exercise of common stock warrants 76,329
Exercise of common stock options 148,148
Income tax benefit - stock options 990,000
Foreign currency translation 75,166 75,166
Net unrealized loss on available-for-sale securities (3,500) (3,500)
Net income 2,932,027
---------- -------- ------------
BALANCE, JULY 31, 2000 $ (409,750) $ 71,666 $ 62,111,838
========== ======== ============
See notes to consolidated financial statements.
F-4
33
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JULY 31, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
2000 1999 1998
------------ ----------- ------------
OPERATING ACTIVITIES:
Net income (loss) $ 2,932,027 $(1,966,982) $ 2,301,068
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Depreciation and amortization 3,478,120 3,581,768 2,769,956
Gain on sale of assets (4,677,860)
Discount on contractual obligation and other 122,189 117,046 288,365
Warrants issued for services 30,000
Deferred income taxes 1,545,378 (670,285) (1,800,000)
Change in assets and liabilities:
Receivables - net (1,983,531) (1,580,043) 1,766,866
Inventories (2,871,820) 144,126 (3,010,557)
Prepaid expenses and other assets (1,140,726) (103,935) (418,875)
Accounts payable and accrued liabilities 3,618,248 (727,357) 585,526
Deferred revenue 83,281 414,081 172,362
------------ ----------- ------------
Net cash provided by (used in) operating activities 1,135,306 (791,581) 2,654,711
------------ ----------- ------------
INVESTING ACTIVITIES:
Net proceeds from sale of assets 7,749,927
Purchases of property and equipment (5,198,064) (1,762,927) (1,276,262)
Acquisitions, net of cash acquired (33,595,322)
Purchases of intangible assets (159,210) (686,236) (942,284)
------------ ----------- ------------
Net cash provided by (used in) investing activities 2,392,653 (2,449,163) (35,813,868)
------------ ----------- ------------
FINANCING ACTIVITIES:
Net (repayments) proceeds from short-term borrowings (20,999) 29,352 87,598
Net proceeds from issuance of common stock 224,477 259,312 10,559,611
Net proceeds from issuance of preferred stock 28,647,250
Net proceeds from issuance of long-term debt 9,209,486 93,753
Cash released (held) by trustee 1,906,754 (4,834,755)
Purchase of common stock for treasury (409,750)
Principal payments on long-term debt (5,440,924) (892,882) (3,059,417)
------------ ----------- ------------
Net cash (used in) provided by financing activities (3,740,442) 3,770,513 36,328,795
------------ ----------- ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (212,483) 529,769 3,169,638
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 5,770,970 5,241,201 2,071,563
------------ ----------- ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 5,558,487 $ 5,770,970 $ 5,241,201
============ =========== ============
CASH PAID FOR INTEREST $ 172,813 $ 229,318 $ 46,029
============ =========== ============
CASH PAID FOR INCOME TAXES $ 128,074 $ $ 23,000
============ =========== ============
(continued)
F-5
34
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
YEARS ENDED JULY 31, 2000, 1999 AND 1998
- --------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND
FINANCING ACTIVITIES: 2000 1999 1998
------------ ----------- ------------
Income tax benefit attributable to exercise of common stock options $ 990,000 $ 250,000 $ 800,000
============ =========== =============
Conversion of Series A Convertible Redeemable Preferred stock
to common stock $ 8,787,191 $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
=============
See notes to consolidated financial statements. (Concluded)
F-6
35
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JULY 31, 2000, 1999 AND 1998
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 worldwide 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
diagnostic system. The Professional Products Group includes Zila Dental Supply
("Zila Dental"), a national distributor of professional dental supplies, Zila
Technologies, Inc, formerly known as Cygnus Imaging Inc. ("Cygnus"), a
manufacturer and marketer of digital x-ray systems and intraoral cameras, and
Integrated Dental Technologies, Inc. ("IDT"), which distributed PracticeWorks, a
dental practice management software product. The Nutraceuticals Group is
presently comprised of Oxycal Laboratories, Inc. ("Oxycal") and its Inter-Cal
subsidiary, a manufacturer and distributor of mineral and botanical products
including a patented and unique form of vitamin C under the trademark Ester-C(R)
and the Palmettex(TM) botanical line of products.
On October 28, 1999, Cygnus completed the sale of substantially all of its
assets and certain 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.
On December 20, 1999, the Company, through IDT, completed the sale of
substantially all of IDT's assets and liabilities related to its PracticeWorks
division located in Gold River, California to InfoCure Corporation ("InfoCure"),
of Atlanta, Georgia for approximately $4.65 million. InfoCure is a national
provider of healthcare practice management software products and services to
targeted healthcare practice specialties and is listed on the NASDAQ under the
symbol INCX. Under the terms of the agreement, 10% of the sales price will be
held in escrow for one year in order to secure the representations, warranties,
and covenants made by the Company to InfoCure.
The Company prepares its financial statements in accordance with accounting
principles generally accepted in the United States of America. Significant
accounting policies are as follows:
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"), Zila Technologies, Inc, and Oxycal
Laboratories, Inc. Zila International Inc. has no operations. All significant
intercompany balances and transactions are eliminated in consolidation.
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.
F-7
36
Inventories, which consist of finished goods and raw materials, are stated
at the lower of cost (first-in, first-out method) or market.
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
15 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 $1,629,000, $3,988,000 and $2,660,000 in 2000, 1999 and
1998, respectively, were expensed.
Net income (loss) per common share - Basic net income (loss) per common
share is computed by dividing net income (loss) available 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 income per common share is computed by dividing net
income (loss) available to common shareholders by the weighted average number of
common shares outstanding during the year after giving effect to convertible
preferred stock, stock options and warrants considered to be dilutive common
stock equivalents. For the years ended July 31, 1999 and 1998, convertible
preferred stock, 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.
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. Amounts included in selling, general and
administrative expenses related to increases in the allowance for doubtful
accounts receivable during fiscal 2000, 1999 and 1998 were $178,000, $371,000
and $90,000, respectively.
Comprehensive income consists of net income and other gains and losses
affecting shareholders' equity that, under generally accepted accounting
principles are excluded from net income. For the Company, such items consist
primarily of unrealized gains and losses on marketable equity investments and
foreign currency translation gains and losses.
F-8
37
Certain reclassifications have been made to the 1999 and 1998 financial
statements to conform to the classifications used in 2000.
Accounting for Derivative Instruments and Hedging Activities -- SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No.
133") establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. SFAS No. 133 requires that an enterprise recognize all
derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. If certain conditions are met, a derivative may
be specifically designated as a hedge. The accounting for changes in the fair
value of a derivative instrument depends on the intended use of the derivative
and resulting designation. The Company adopted SFAS No. 133 effective August 1,
2000, and the adoption did not have a material impact on the Company's results
of operations as the Company has no significant derivative financial
instruments or hedging activities.
New Accounting Pronouncements -- The Securities and Exchange Commission
released Staff Accounting Bulletin ("SAB") No. 101 Revenue Recognition in
Financial Statements on December 3, 1999, SAB No. 101A on March 24, 2000 and SAB
No. 101B on June 26, 2000. SAB No. 101 sets forth revenue recognition issues,
including conceptual issues as well as certain industry specific guidance. The
Company is required to report the impact of SAB No. 101, as amended by SAB No.
101A and SAB No. 101B, no later than the fourth quarter of the fiscal year 2001.
The effect of the change, if any, would be recognized as a cumulative effect of
a change in accounting principle as of August 1, 2000. Prior year financial
statements will not be restated. The Company has not yet made an evaluation of
the impact of adopting these statements on the Company's financial position or
operating results.
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 $12,000,000 plus the value of acquired
inventory.
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 the
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,
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
F-9
38
for the year ended July 31, 1998 represents 270 days of accretion and is based
on the assumption that the Preferred Stock had been issued at the beginning of
the period.
1998
----
Revenues $68,329,759
Net income $4,991,556
Series A Preferred Stock embedded dividend $7,314,600
Net loss available to common shareholders $(2,323,044)
Basic loss per share $(0.07)
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.
3. SALE OF ASSETS
As described in Note 1, on October 28, 1999, Cygnus completed the sale
of substantially all of its assets and certain liabilities and on December 20,
1999, the Company completed the sale of substantially all of IDT's assets and
liabilities related to its PracticeWorks division.
The following unaudited pro forma condensed statement of operations
data for the year ended July 31, 2000, present historical statement of
operations data for the Company, Cygnus and IDT as if the Cygnus and IDT
transactions had occurred as of August 1, 1999. The pro forma data are not
necessarily indicative of the results of operations that would actually have
been reported had the transactions been consummated at the date mentioned above
or which may be reported in the future.
Unaudited Pro Forma Condensed Statement of Operations
Year ended July 31, 2000 Historical
---------------------------------------
(in thousands except per share data) Zila Pro forma
Consolidated Cygnus(a) IDT(a) Adjustments(b) Pro Forma
Net revenues $77,581 $193 $1,515 $75,873
Cost of products sold 40,004 110 69 39,825
Selling, general and administrative expenses 32,449 491 1,188 30,770
Research and development expenses 1,629 155 120 1,354
Depreciation and amortization 3,478 110 35 3,333
Income (loss) from operations 21 (673) 103 591
Other income (expense) 4,671 (4,678) (7)
Income tax (expense) benefit (1,760) (2,761) 1,001
Net income (loss) 2,932 (673) 103 (1,917) 1,585
Net income per share (basic) $0.07 $0.04
Basic shares outstanding 42,180 42,180
Net income per share (diluted) $0.07 $0.04
Diluted shares outstanding 43,576 43,576
F-10
39
(a) Represents Cygnus and IDT balances for the year ended July 31, 2000.
These amounts are removed to reflect the sale of assets and the
corresponding revenue and expenses thereby reducing the consolidated
balances for pro forma purposes.
(b) The Company believes that no pro forma adjustments are required other
than the elimination of the gain on the sale of the assets and the
resulting income tax effect recorded in the consolidated statement of
operations.
4. INVENTORIES
Inventories consist of the following at July 31:
2000 1999
---- ----
Finished goods $ 9,219,343 $ 7,531,175
Raw materials 4,168,834 4,174,321
Inventory reserves (184,040) (299,613)
------------ ------------
Total inventories $ 13,204,137 $ 11,405,883
============ ============
Amounts included in cost of products sold related to increases in inventory
reserves during fiscal 2000, 1999 and 1998 were $ 33,040, $-0- and $129,880,
respectively.
5. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at July 31:
2000 1999
---- ----
Land $ 1,221,097 $ 1,221,097
Construction in progress 3,618,340
Building and improvements 2,174,869 2,112,065
Furniture and equipment 2,995,821 2,989,752
Leasehold improvements and other assets 475,941 526,828
Production and warehouse equipment 3,470,101 2,715,507
----------- -----------
Total property and equipment 13,956,169 9,565,249
Less accumulated depreciation and amortization 4,513,891 3,884,968
----------- -----------
Property and equipment -- net $ 9,442,278 $ 5,680,281
=========== ===========
Depreciation and amortization expense related to property and equipment
for 2000, 1999 and 1998 was $1,112,995, $1,038,507 and $769,866, respectively.
6. INTANGIBLE ASSETS
Intangible assets consist of the following at July 31:
2000 1999
---- ----
Purchased technology rights -- net of accumulated amortization of
$1,818,498 (2000) and $1,382,058 (1999) $ 5,600,975 $ 6,037,415
============ ============
Goodwill -- net of accumulated amortization of $3,385,783 (2000) and
$2,535,283 (1999) $ 12,725,978 $ 15,679,969
============ ============
Trademarks and other intangible assets:
Trademarks $ 11,514,218 $ 11,547,965
Patents 1,494,021 1,370,300
F-11
40
Licensing costs 1,548,818 1,648,133
Other 472,736 748,299
------------ ------------
Total trademarks and other intangible assets 15,029,793 15,314,697
Less accumulated amortization 2,606,161 2,100,061
------------ ------------
Trademarks and other intangible assets -- net $ 12,423,632 $ 13,214,636
============ ============
Licensing costs consist primarily of professional fees associated with
seeking FDA approval for a new product, OraTest(R). Purchased technology
rights relate to the acquisition of CTM, Inc in fiscal year 1996. The
recoverability of the deferred licensing costs and purchased technology rights
is dependent upon obtaining FDA approval and generating sufficient revenues from
sales of OraTest(R) (see Note 12).
Amortization of the Company's intangible assets during fiscal 2000, 1999
and 1998 was $2,365,125, $2,543,261 and $2,000,090, respectively.
7. SHORT-TERM BORROWINGS AND LONG-TERM DEBT
Short-term borrowings consisted of $51,770 at 7.12% and $72,769 at 6.29% at
July 31, 2000 and 1999, respectively, for installments due on the Company's
various insurance policies.
Long-term debt consisted of the following at July 31: 2000 1999
---- ----
Revolving line of credit, (1) $ 4,200,000
IDA bond payable, Series A, (2) $ 3,789,296 3,900,000
IDA bond payable, Series B, (2) 1,068,776 1,100,000
Mortgage note payable, interest at 9%, monthly
payments of $2,315 with a balloon due April 1, 2001 298,659 326,440
Note payable, P&G, paid in 1999, net of unamortized
discount (see Note 2) 975,411
Notes payable for equipment with interest rates between
3.06% and 9.44% with maturities no later than 2001 169,088 240,303
----------- ------------
5,325,819 10,742,154
Less current portion 776,866 1,164,399
----------- ------------
Long-term portion $ 4,548,953 $ 9,577,755
----------- ------------
(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 (9.50% at
July 31, 2000) plus .25%. At July 31, 2000, the Company had no borrowings
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 trustee, Bank One, Arizona, is
holding the bond proceeds but released approximately $1.9 million during fiscal
year 2000 to pay for construction and equipment costs. The Bonds consist of $3.9
million Series A and $1.1 million Taxable Series B which, as of July 31, 2000,
carried interest rates of 4.5% and 6.7%, 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 Bondholders, an irrevocable direct-pay letter of
credit to secure payment of principal and interest. The letter of credit is
guaranteed by the Company.
F-12
41
Aggregate annual maturities of long-term debt for the years ending July 31
are as follows:
2001 $ 776,866
2002 469,836
2003 473,469
2004 450,711
2005 425,784
2006 and beyond 2,729,153
----------
Total 5,325,819
Less current portion 776,866
----------
Long-term portion $4,548,953
==========
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,
2000, the Company was in compliance with all of the covenants.
8. STOCK OPTIONS AND WARRANTS
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. In
fiscal 1997, 1998 and 1999 the Company granted 51,000, 74,900 and 285,000
options, respectively, to employees. These option grants will be effective under
the Plan only if the stockholders approve an amendment to the Plan at the
Company's 2000 annual meeting of stockholders to increase the number of shares
covered by it. At July 31, 2000, no shares were available for grant under this
plan and the Company had granted 410,900 more shares than authorized by the
plan.
The Company adopted a Stock Option Award Plan that 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, 2000, no shares were available for grant under this
plan.
The Company adopted a Non-Employee Directors Stock Option Plan that became
effective October 20, 1989, authorizing the Board of Directors to grant options
of 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 an 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, 2000, 137,500 shares were available for grant under this
plan.
F-13
42
A summary of the status of the option plans as of July 31, 2000, 1999 and
1998 and changes during the years then ended is presented below:
2000 1999 1998
------------------------- ------------------------- --------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
Outstanding at beginning of year 2,306,678 $ 5.41 2,275,918 $ 5.25 2,281,373 $ 4.03
Granted 513,000 3.25 419,500 7.40 666,000 5.97
Exercised (30,524) 4.85 (115,667) 2.61 (422,973) 3.15
Cancelled (212,800) 4.37 (273,073) 6.34 (248,482) 3.87
----------- ----------- -----------
Outstanding at end of year 2,576,354 5.07 2,306,678 5.41 2,275,918 5.26
=========== =========== ===========
Options exercisable at year-end 1,877,559 1,488,078 1,494,866
=========== =========== ===========
Weighted average fair value of
options granted during the year $ 2.22 $ 5.98 $ 1.96
=========== =========== ===========
The following table summarizes information regarding stock options
outstanding as of July 31, 2000:
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, 2000 CONTRACTUAL LIFE PRICE JULY 31, 2000 PRICE
--------------- ------------- ---------------- ------------ ------------- ------------
$ .12 - 1.50 249,752 0.4 $ 1.19 249,752 $ 1.19
1.51 - 3.00 211,710 1.1 2.94 211,710 2.94
3.01 - 4.50 704,471 7.8 3.37 206,471 3.64
4.51 - 6.00 498,218 6.9 5.60 418,751 5.56
6.01 - 8.00 675,203 6.1 6.87 648,535 6.86
8.01 - 9.92 237,000 8.4 9.88 142,340 9.88
------------- -------------
.12 - 9.92 2,576,354 6.00 5.06 1,877,559 5.25
============= =============
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 date of grant, utilizing the Black-Scholes option-pricing model, consistent
with the method stipulated by SFAS No. 123, the Company's net income (loss)
attributable to common shareholders and income (loss) per share attributable to
common shareholders for the years ended July 31, 2000, 1999 and 1998 would have
been reduced (increased) to the pro forma amounts indicated below, followed by
the model assumptions used:
JULY 31,
------------------------------------------------
2000 1999 1998
------------ ------------- -------------
Net income (loss) attributable to common shareholders:
As reported $ 2,932,000 $ (1,967,000) $ (5,014,000)
Pro forma $ 2,539,000 $ (2,838,000) $ (6,114,000)
Net income (loss) attributable to common shareholders
per basic share outstanding:
As reported $ .07 $ (.05) $ (.15)
Pro forma $ .06 $ (.07) $ (.18)
F-14
43
Black-Scholes model assumptions:
Risk-free interest rate 5.3% 4.4 - 4.5% 4.2 - 4.4%
Expected volatility 78% 82% 38%
Expected term 3 - 6 years 3 - 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 March 2005, is summarized as follows:
NUMBER OF WARRANT PRICE
SHARES PER SHARE
---------- --------------
Outstanding, August 1, 1997 902,015 $0.60 - 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
Issued 10,000 4.90
Exercised (49,074) 3.00
---------
Outstanding, July 31, 2000 1,068,357 $3.00 - 9.915
=========
9. INCOME TAXES
The consolidated income tax expense (benefit) consists of the following for
the years ended July 31:
2000 1999 1998
----------- ----------- -------------
Current:
Federal $ 154,000 $ 63,000 $ (51,000)
State 60,000 11,000 (9,000)
----------- ----------- -------------
Total current 214,000 74,000 (60,000)
----------- ----------- -------------
Deferred:
Federal 1,314,000 (570,000) (1,479,000)
State 232,000 (100,000) (261,000)
----------- ----------- -------------
Total deferred 1,546,000 (670,000) (1,740,000)
----------- ----------- -------------
Total consolidated income tax provision
(benefit) $ 1,760,000 $ (596,000) $ (1,800,000)
=========== =========== =============
The reconciliation of the federal statutory rate to the effective income
tax rate for the years ended July 31 is as follows:
2000 1999 1998
---------- ---------- ----------
Federal statutory rate 34% (34)% 34%
Adjustments:
State income taxes -- net of federal benefit 10 (6) 6
Effect of foreign tax rates 2
Non-deductible meal and entertainment expenses 1 4 7
Non-deductible acquisition expenses and other 16 14
Non-deductible intangible amortization 9 23 74
F-15
44
Non-deductible goodwill related to sale of assets 14
Decrease in valuation allowance (32) (26) (494)
---------- ---------- ----------
Effective tax rate 38% (23)% (359)%
========== ========== ==========
The components of the Company's deferred income tax assets and liabilities
for the years ended July 31 are shown below:
2000 1999 1998
----------- ----------- ------------
Deferred income tax assets:
Net operating loss carryforwards $ 3,767,000 $ 6,635,000 $ 7,062,000
Allowance for obsolete or discontinued
inventory 59,000 164,000 146,000
Alternative minimum tax credit 154,000
Book basis vs. tax basis differences (547,000) 370,000 49,000
Reserve for litigation 16,000 29,000 27,000
Product warranty allowance 78,000 45,000
Allowance for doubtful accounts 136,000 151,000 112,000
Accrued vacation 93,000 78,000 79,000
Accrued bonus 264,000 32,000
Other 156,000 29,000 36,000
----------- ----------- ------------
Total deferred income tax assets 4,098,000 7,566,000 7,556,000
Valuation allowance (948,000) (3,860,000) (4,771,000)
----------- ----------- ------------
Net deferred income tax assets $ 3,150,000 $ 3,706,000 $ 2,785,000
=========== =========== ============
Deferred income taxes reflect the tax effect of temporary differences
between the amounts of assets and liabilities recognized for financial reporting
and tax purposes. The Company had offset its net deferred tax assets with a
valuation allowance due to the Company's lack of earnings history. 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.
At July 31, 2000, approximately $1,117,000 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 and the Company recorded income tax expense of $1.8 million
which is net of $2.9 million in income tax benefit resulting from the reversal
of a valuation allowance ($1 million of which was attributable to the exercise
of common stock options and therefore credited to capital in excess of par
value). 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, 2000, the Company had federal net operating loss carryforwards
totaling approximately $9,832,000 that expire, if not previously utilized, from
2007 through 2019. Net operating loss carryforwards for state income tax
purposes, totaling approximately $948,000, must be utilized within five years of
the date of their origination, and expire from 2001 through 2004.
F-16
45
10. 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 was 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 did not appreciate by a fixed percentage at various measurement
dates, the holders of the Preferred Stock had the right to receive additional
shares of the Company's common stock upon conversion, based on a repricing
formula. 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 had conditions for redemption that were not solely within
the control of the Company, it was classified outside of permanent equity in the
accompanying consolidated balance sheet and was accreted to its redemption
value. During the year ended July 31, 2000, the remaining 7,482 shares of the
Preferred Stock were converted into common stock.
11. TREASURY STOCK
During the quarter ended January 31, 2000, the Company began acquiring
shares of its common stock in conjunction with a stock repurchase program
announced in November 1999. That program authorized the repurchase of up to one
million shares of Zila common stock from time to time on the open market
depending on market conditions and other factors. As of July 31, 2000, the
Company purchased 135,000 shares of common stock at an aggregate cost of
$409,750.
12. 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 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 increase the maximum amount of
marketing funds potentially available to the Company to be raised to $2,250,000.
At July 31, 2000, 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 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 $16,000, $31,000 and $16,000 for
the years ended July 31, 2000, 1999 and 1998, 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, 2000,
1999 and 1998 was $449,916, $390,170 and $371,943, respectively.
The Company is pursuing approval of a New Drug Application ("NDA") 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
F-17
46
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 meetings at the agency in 1999 and 2000.
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. In November 1999, the Company
contracted with ILEX(TM) Oncology Services, Inc. ("ILEX"), a wholly-owned
subsidiary of ILEX(TM) Oncology, Inc. of San Antonio, Texas, for management of
clinical research and liaison with the FDA related to the Company's pursuit of
regulatory approval for the OraTest(R) oral cancer detection product. In March
2000, the Company paid approximately $792,000 to ILEX as a deposit on estimated
expenses related to an FDA-required clinical study associated with the Company's
ongoing efforts to obtain FDA approval of OraTest(R). Current commitments under
the ILEX agreement include a monthly installment payment of $76,000 plus
reimbursement for out of pocket expenses as they occur during the course of the
study. The contract or any workplan may be terminated at any time by Zila upon
not less than 90 days prior written notice of termination to ILEX. If the
agreement is so terminated, Zila shall pay ILEX any amount owed, but not yet
paid, for work performed prior to the date of termination.
The Company leases offices, warehouse facilities and certain equipment,
under operating leases that expire through 2005. Future minimum lease payments
under these non-cancelable leases are as follows:
2001 $ 396,870
2002 300,066
2003 204,003
2004 199,560
2005 84,275
-----------
Total $ 1,184,774
===========
Rent expense for the years ended July 31, 2000, 1999 and 1998 totaled
$352,502, $340,170 and $270,297, respectively.
The Company and certain officers of the Company have been named as
defendants in a consolidated First Amended Class Action Complaint 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 Complaint 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
"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 common stock in violation of the federal securities
laws. The Company and the individual defendants deny all allegations of
wrongdoing and are defending themselves vigorously. In September 2000, the Court
denied the defendants' motion to dismiss the First Amended Class Action
Complaint and ordered that the matter proceed to trial on the issue of liability
commencing on February 26, 2001.
F-18
47
On September 8, 1999, 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.
13. EMPLOYEE BENEFIT PLAN
During fiscal year 2000, the Company has made available to all eligible
employees, the Zila, Inc. 401(k) Savings and Retirement Plan (the "Zila Plan").
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 2000,
1999 and 1998, the Company contributed approximately $293,000, $62,000 and
$39,600, respectively, to the Zila Plan. Prior to fiscal year 2000, eligible
Oxycal employees participated in a different 401(k) defined contribution plan
(the "Oxycal Plan") whereby an employee could contribute up to a certain maximum
amount each year. During the 1999 and 1998 fiscal years, 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.
14. SEGMENT INFORMATION
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. See
Note 3 regarding the disposition of the Dental Software and Dental Imaging
businesses.
F-19
48
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:
2000................................ $16,765 $153 $39,817 $1,515 $193 $19,138 $77,581
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
Income (loss) before income taxes:
2000................................ 4,758 (10,325) 290 4,855 (734) 5,848 4,692
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
Identifiable assets:
2000................................ 13,461 18,836 12,292 478 32,644 77,711
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
Capital expenditures:
2000................................ 195 441 237 109 16 4,200 5,198
1999................................ 13 681 115 85 79 790 1,763
1998................................ 57 399 70 76 230 444 1,276
Depreciation and amortization:
2000................................ 1,011 1,001 300 35 110 1,021 3,478
1999................................ 1,011 920 293 103 422 833 3,582
1998................................ 760 830 274 61 237 608 2,770
Revenues from customers attributed to all foreign countries from which
the Company derives revenue were $5,680,691, $2,933,610, and $4,135,420 for the
years ended July 31, 2000, 1999 and 1998, respectively.
F-20
49
15. QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly financial information is presented in the following summary:
2000
------------------------------------------------------------
Quarters Ended
------------------------------------------------------------
October 31 January 31 April 30 July 31
---------- ---------- -------- -------
Net revenues $19,171,593 $20,216,797 $19,422,777 $18,769,741
Gross profit 9,669,362 9,850,710 9,311,819 8,744,626
Net income (loss) (51,382) 1,964,252 16,413 1,002,744
Net income (loss) per share - basic 0.00 0.05 0.00 0.02
Net income (loss) per share - diluted 0.00 0.05 0.00 0.02
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) per share - basic 0.02 (0.03) (0.06) 0.02
Net income (loss) per share - diluted 0.02 (0.03) (0.06) 0.02
F-21
50
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION METHOD OF FILING
- ------ ----------- ----------------
3-A Certificate of Incorporation, as amended A
3-B Bylaws A
3-C Certificate of Designations, Preferences and Rights of Series A
Convertible Preferred Stock E
4-A Specimen Stock Certificate A
4-B Form Stock Purchase Warrant re Series A Preferred Stock E
4-C Deere Park Capital Management Warrant D
4-D Bartholomew Investment, L.P. Warrant D
10-A Revolving Line of Credit Loan Agreement dated February 1, 1999 between
Zila, Inc. and Bank One, Arizona A
10-B# Stock Option Award Plan (as amended through April 10, 1991) B
10-C# Non-Employee Directors Stock Option Plan (as amended through April 10, 1991) B
10-D# 1997 Stock Option Award Plan E
10-E Agreement dated November 26, 1996 between Cheseborough Ponds USA Co
and Zila Pharmaceuticals, Inc C
10-F Private Equity Line of Credit between Deere Park Capital Management
and Zila, Inc. Dated as of April 30, 1997 D
10-G Amendment to Private Equity Line of Credit Agreement D
10-H Registration Rights Agreement dated as of May 9, 1997 between Zila,
Inc. and Deere Park Capital Management D
10-I Registration Rights Agreement dated as of May 9, 1997 between Zila,
Inc. and Bartholomew Investment, L.P D
10-J Securities Purchase Agreement dated as of October 17, 1997 by and
among Zila, Inc. and certain investors E
10-K Registration Rights Agreement dated October 17, 1997 by and among
Zila, Inc. and certain investors E
10-L Asset Purchase Agreement dated October 28, 1999 between Zila, Inc., Cygnus
Imaging, Inc. and Procare Laboratories, Inc. A
10-M Secured Note dated October 28, 1999 between Zila, Inc. and Procare Laboratories, Inc. A
10-N Asset Purchase agreement dated as of November 30, 1999 by and among Zila, Inc.,
Integrated Dental Technologies, Inc., InfoCure Systems, Inc., and InfoCure Corporation G
21 Subsidiaries of Registrant F
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 Michael S. Lesser *
24-E Power of Attorney of Curtis M. Rocca *
24-F Power of Attorney of Christopher D. Johnson
24-G Power of Attorney of Kevin J. Tourek *
27 Financial Data Schedule *
* Filed herewith
A Incorporated by reference to the Company's Annual Report on Form 10-K
for fiscal Year ended July 31, 1999
B Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended January 31, 1996, as amended
C Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended October 31, 1996, as amended
D Incorporated by reference to the Company's Form S-3 Registration
Statement No. 333-31651
E Incorporated by reference to the Company's Annual Report on Form 10-K
for fiscal year ended July 31, 1997
F Incorporated by reference to the Company's Annual Report on Form 10-K
for fiscal Year ended July 31, 1998
G Incorporated by reference to the Company's Annual Report on Form 8-K
dated January 3, 2000