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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(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, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-17521
ZILA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 86-0619668
(STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NO.)
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 30, 1997, the aggregate market value of common stock held by
non-affiliates of the Registrant was approximately $238,077,500.
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [ ] No [ ] N/A
APPLICABLE ONLY TO CORPORATE REGISTRANTS
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date.
At September 30, 1997, the number of shares of common stock outstanding was
32,790,849.
DOCUMENTS INCORPORATED BY REFERENCE
Materials from the Registrant's 1997 Proxy Statement have been incorporated
by reference into Part III, Items 10, 11, 12 and 13.
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TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business............................................................ 2
Item 2. Properties.......................................................... 13
Item 3. Legal Proceedings................................................... 14
Item 4. Submission of Matters to a Vote of Security Holders................. 15
Executive Officers of the Company................................... 15
PART II
Item 5. Market for the Company's Common Stock and Related Stockholder
Matters............................................................. 16
Item 6. Selected Financial Data............................................. 16
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................... 17
Item 8. Financial Statements and Supplementary Data......................... 20
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures............................................... 20
PART III
Item 10. Directors and Executive Officers of the Company..................... 21
Item 11. Executive Compensation.............................................. 21
Item 12. Security Ownership of Certain Beneficial Owners and Management...... 21
Item 13. Certain Relationships and Related Transactions...................... 21
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.... 22
SIGNATURES.............................................................................. 25
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PART I
ITEM 1. BUSINESS
GENERAL
Zila, Inc., a Delaware corporation, has three operating groups. Zila
Pharmaceuticals, a Nevada corporation ("Zila Pharmaceuticals"), markets a
growing line of non-prescription oral healthcare products, including
Zilactin(R), Zilactin(R)-B, Zilactin(R)-L, Zilactin(R)-Lip, new Zilactin(R) Baby
and Quik Floss(R). Cygnus Imaging, Inc., an Arizona corporation ("Cygnus"),
manufactures and markets domestically and internationally Stylus and
OralVision(TM) intraoral video camera systems, and Sens-A-Ray(TM) digital x-ray
systems. The third operating group, Bio-Dental Technologies Corporation, a
California corporation ("Bio-Dental"), consists of Practice Works(TM) dental
practice management software and Zila Dental Supply, a nationwide dental
products distributor, marketing 15,000 items to the dental office through
extensive direct mail, catalog sales and telemarketing. The Company's
subsidiaries consist of Zila Pharmaceuticals, Cygnus, Zila, Ltd., Zila
International, and Bio-Dental. Bio-Dental has two subsidiaries: Ryker Dental,
dba Zila Dental Supply, a Kentucky corporation and Integrated Dental
Technologies, a California corporation. Unless the context otherwise indicates,
the term "Zila" and "Company" as used herein refers to Zila, Inc. and each of
its subsidiaries.
The Company is incorporated in the State of Delaware. 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.
ZILA PHARMACEUTICALS
Products
Zilactin(R) Family of Products. The Company's primary emphasis has been
focused on the marketing of four over-the-counter, non-prescription products:
ZILACTIN(R), ZILACTIN(R)-L, ZILACTIN(R)-B AND ZILACTIN(R)-LIP. The Company's
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 -- a protective film with benzocaine for maximum pain relief
from mouth sores
ZILACTIN(R)-L -- a liquid for treating developing fever blisters and cold
sores
ZILACTIN(R)-LIP -- a lip balm for the prevention of sun blisters and the
treatment of cold sores and dry, chapped lips.
The ZILACTIN(R) treatment composition is covered by patents owned by the
Company. These patents cover the composition and the film-forming properties of
the product formula. See "Business -- Patents and Trademarks." ZILACTIN(R),
ZILACTIN(R)-B, AND ZILACTIN(R)-L formulas incorporate these proprietary
treatment compositions. ZILACTIN(R) and ZILACTIN(R)-B are packaged as gels in
.25 ounce plastic tubes. ZILACTIN(R)-L, a liquid, is packaged in a 10 cc 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 containing the
active ingredient form a thin, transparent, pliable film that holds the active
ingredient against the affected tissue and keeps the affected area clean. The
film can last up to six hours inside the mouth, a feature which makes the
formulation suitable for a variety of dental applications.
ZILACTIN(R) is being used by dentists to treat patients with canker sores
and other oral mucosal ulcers or lesions, and has been evaluated in dental
schools at selected major universities. ZILACTIN(R) was originally developed as
a treatment for herpes virus lesions. The most common form is Herpes Simplex
Type I, which is the cause of fever blisters and cold sores. Herpes Simplex Type
II is the cause of genital herpes. Other types of herpes infections include
chicken pox, shingles (herpes zoster), mononucleosis and the Epstein-Barr Virus.
Depending principally on the availability of resources, the Company may explore
the development of new products, including the addition of other medications
into the ZILACTIN(R) vehicle, and/or the approval of
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existing products as recognized treatments for such viruses. However, the
Company currently does not market ZILACTIN(R) as a treatment for genital herpes
or shingles.
ZILACTIN(R)-B is a medicated gel containing benzocaine with the
film-forming properties of ZILACTIN(R). ZILACTIN(R)-B has been formulated for a
segment of the market which prefers a film-forming application with a topical
anesthetic. ZILACTIN(R)-B quickly controls the pain associated with mouth sores
while shielding them from the environment of the mouth.
In July 1995, the Company began distributing a new lip balm in the Arizona
market. The product, called 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.
The products comprising the ZILACTIN(R) Family of Products represented 97.2
percent of Zila Pharmaceuticals' gross sales during the 1997 fiscal year.
Zila Pharmaceuticals also distributes QUIK FLOSS which is the only
clinically proven dental flosser on the market. The patented Y-shape allows for
one-handed flossing and provides superior access to even the toughest spots,
like back teeth. QUIK FLOSS is being marketed in a manner similar to the
successful strategy that is employed by ZILACTIN(R).
ORATEST(TM). The Company is currently seeking government approval from the
Food and Drug Administration (the "FDA") and the countries of the European Union
(the "EU") to distribute ORATEST(TM) (formerly known as OraScan), in the United
States and Europe. ORATEST(TM), a diagnostic for oral cancer and site
delineation device for biopsy and surgical excision, has been approved for
distribution in the United Kingdom, Canada, Australia, Hungary, Taiwan, Bermuda,
the Barbados and the Bahamas.
Published reports indicate that approximately 32,000 new cases of oral
cancer are diagnosed each year in the United States, and that there are over
8,000 oral cancer-related deaths annually. In most people, by the time it is
diagnosed, oral cancer has usually metastasized, resulting in a poor prognosis.
Those who do survive frequently undergo significantly disfiguring surgery. Data
published in 1994 by a major dental publication quotes a Harvard University
economist as stating that the annual cost of treating oral cancer in the United
States is $3.7 billion; far higher than the $665 million previously estimated.
The economist further states that ORATEST(TM) has the potential of reducing this
cost by approximately 60% because of the product's ability to identify oral
cancer lesions far earlier than they are being found today. The earlier these
lesions are identified, the greater the chances of reducing morbidity and
mortality. The Company's licensee, Block Drug Company, Inc., is marketing
ORATEST(TM) under the name ORASCREEN(TM) in the UK and it is being marketed as
ORASCAN(TM) in Canada. The Company has chosen to use the name "ORATEST(TM)" in
the United States and other countries. See also "Business -- Zila
Pharmaceuticals -- Government Regulations" and "Business -- Zila
Pharmaceuticals -- Patents and Trademarks" and "Business -- Zila
Pharmaceuticals -- Licensing."
Sales of ORATEST(TM) represented less than one percent of the Company's
gross sales during the 1997 fiscal year.
New Products. Zilactin Baby teething gel was introduced in June 1997. It
contains a higher level of benzocaine and a cool grape flavor. Unlike other
teething gels, it does not contain sacharin or coloring dyes.
Government Regulations
General. The development, manufacture and sale of pharmaceutical products
are subject to comprehensive and increasing governmental regulation in the areas
of practice, safety and efficacy, testing, advertising and promotion, labeling
and other matters. To be marketed over-the-counter, a new drug must either be
approved by the FDA in response to a New Drug Application ("NDA") or be the
subject of an applicable FDA monograph designating the product generally
recognized and effective or, if no monograph exists, be "grandfathered" as a
result of the use of the product prior to December 5, 1975. The process of
obtaining approval of an NDA for a new drug usually takes years and involves the
expenditure of substantial resources. This approval process includes laboratory
testing of the product in animals to determine safety, efficacy and
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potential toxicity, the filing with the FDA of a Notice of Claimed
Investigational Exemption for use of a New Drug prior to the initiation of a
double-blind clinical testing of new drugs, and testing of the new drug in
humans.
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 an 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.
ORATEST(TM). In 1994, the FDA approved an Investigational New Drug
application ("IND") for the ORATEST(TM) product. This approval is the first step
in securing a New Drug Application ("NDA") which will enable the Company to
market the ORATEST(TM) product in the United States. The IND approval also
allows the Company to manufacture the ORATEST(TM) product domestically for use
in clinical studies and to market it in 21 specific countries overseas. Based on
continuing communications with the FDA, the Company is in the process of
updating and resubmitting the application. The NDA will include updated clinical
information and refinements in manufacturing. See also "Business -- Zila
Pharmaceuticals -- Manufacturing and Distribution."
All ORATEST(TM) related patents that have been issued, those that will be
issued upon pending applications and those to which the Company has gained
exclusive rights will have their lives extended as a result of the NDA. These
include the patent owned by the National Technical Information Service ("NTIS"),
a patent recently issued covering a more stable formula and two other patents
that are expected to be issued upon pending applications.
The Company received regulatory approval to market the ORATEST(TM) product
in Australia in 1993. Approval to market ORATEST(TM) in certain Caribbean
countries, Hungary and Taiwan has also been received. The Medicine Control
Agency ("MCA"), which is the regulatory authority in the UK, has also granted
approval for the ORATEST(TM) product to be marketed in the UK under the name
ORASCREEN. The Company is proceeding with additional regulatory approval by the
European Union ("EU"). The EU has developed a procedure to allow more rapid
approval of pharmaceutical products in all member countries. The procedure
requires one EU country to approve a product and then act as the product's
advocate to the rest of the EU. The MCA of the UK will be the Company's advocate
to the EU for the approval of the ORATEST product. Before the EU approval
process can begin, MCA has requested updating and modification of selected
segments of the UK product license which MCA believes will facilitate acceptance
in the other countries. The Company has submitted the updated information to MCA
and is awaiting acceptance from them.
The Canadian production facility that is currently producing ORATEST(TM) is
regulated and approved by the Canadian government's Health Protection Branch
("HPB"). The HPB has a working agreement with MCA, which permits the ORATEST(TM)
produced in Canada to be distributed in Australia, the UK and other European
countries.
Patents and Trademarks
Patents. The Company currently holds three US patents and two Canadian
patents for ZILACTIN(R). The ZILACTIN(R) formula was granted a US patent on
August 25, 1981, a US patent covering extended applications of the basic
ZILACTIN(R) formula was granted on April 26, 1983, and a US patent covering the
film-forming properties of the ZILACTIN(R) formula containing an added medicinal
ingredient was issued on January 14, 1992. Such patents were granted for periods
of seventeen years from the grant dates and give the Company the right to
exclude others from making, using or selling the patent-protected products in
the United States. The Canadian patent, which covers the composition and
extended applications, was granted on December 3, 1985. Patent applications are
currently pending in numerous foreign countries and patents are expected to be
issued on these applications in the near future.
In 1992, the Company acquired an exclusive license to the rights of the
Department of Commerce's patent regarding a certain method of substantially
eliminating false positive tests when using ORATEST(TM) for the detection of
oral cancer. In 1994, the Company acquired the rights to a second patent which
described a stable form of the liquid used in the oral cancer test. A third and
fourth patent have been applied for in the US and in numerous foreign countries
covering still other applications for the oral cancer test.
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Trademarks. The Company registered the trademark ZILACTIN(R) with the
United States Patent and Trademark Office effective July 9, 1985. The Company
has also registered the trademarks "ZILA(R)", ZILACTIN(R)-B, and ZILACTIN(R)-L
in the United States. The Company believes that widespread use of the "ZILA(R)"
trademark as a dominant prefix to several product names will afford reasonable
protection for the "ZILA(R)" trademark as well as other marks in which "ZILA(R)"
is a dominant prefix. The Company is also taking steps under applicable
international treaties to register the "ZILA(R)" trademark. The names "ZILA(R)"
and ZILACTIN(R) are registered in Canada.
The Company is marketing ORATEST(TM) under the name ORASCREEN(TM) in the UK
and as a result has registered ORASCREEN(TM) as a trademark in the EU. The
Company has selected the name OraTest(TM) when the product is introduced in the
United States and other countries. It is in the process of being protected
through trademarks in all countries where the product is planned for
introduction.
Marketing
The Company employs three strategies to market its Over-the-Counter ("OTC")
oral care products. The primary strategy has been to 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. The second method is to
participate in retailer-driven activities designed to make the OTC products
available at more outlets and to offer value to consumers at the retail store
level. The third strategy is to build consumer awareness of the OTC products
through focused efforts like targeted advertising.
During fiscal year 1997, the Company participated in thirty-two 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. The Company believes that
superior efficacy and targeted marketing efforts are the reason that three
independently conducted pharmacist research studies reported that ZILACTIN(R) is
the number one OTC product pharmacists recommend for treating canker sores and
cold sores.
Throughout 1997, members of management met with key customers to present
two new products to get feedback on the Company's marketing programs. These
meetings resulted in retailer acceptance of the new products and the development
of sales building programs that have been implemented. Clear sales objectives
were agreed to and distributed to the retail broker network at the beginning of
the year. The broker network was strengthened in two markets positioning the
Company for continued sales growth.
The Company nationally introduced ZILACTIN(R) BABY during the fourth
quarter of fiscal 1997. Initial feedback has been positive with a large number
of drug/food chains and wholesalers stocking the product. A major objective of
the next fiscal year is to expand the number of retailers carrying ZILACTIN(R)
BABY.
Several effective and efficient programs designed to build consumer
awareness of the product line were implemented in the 1997 fiscal year. Among
the most notable were a heavily-funded trade advertising campaign geared to
various health professionals and a comprehensive couponing program that offered
purchase incentives to consumers. The trade advertising generated thousands of
requests for patient samples and patient pamphlets on the products.
The ORATEST(TM) product was introduced in Canada during the third quarter
of 1993. The demographics of Canada enabled the Company to test various
marketing strategies in connection with the introduction of ORATEST(TM). Through
test marketing, the Company acquired information regarding insurance coverage,
training tapes, advertising, public relations and the perspective of dentists
and other professionals. Although sales have been minimal the Company believes
that the knowledge gained in Canada will be invaluable as the Company prepares
for the introduction of the ORATEST(TM) product in the EU and the United States.
The marketing effort for ORATEST(TM) in Canada has been a multilevel
strategy designed to educate patients, dentists, specialists and staff on the
accuracy of the ORATEST(TM) product and the strong benefits of the early
detection of oral cancer. Health professionals have become aware of ORATEST(TM)
through a synergistic approach which includes medical conventions, direct mail,
journal advertising and some timely (indepen-
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dently authored) articles on the impact of oral cancer and the benefits of early
intervention. The Company has also been able to place educational advertisements
discussing the ORATEST(TM) product adjacent to oral cancer articles in leading
Canadian dental publications.
Manufacturing and Distribution
The Company employs outside manufacturers to produce and package all of its
products. Arizona Natural Resources of Phoenix, Arizona manufactures
ZILACTIN(R), ZILACTIN(R)-L, ZILACTIN(R)-B, ZILACTIN(R)-LIP and ZILACTIN(R)-Baby
and Clinipad Corporation ("Clinipad") of Charlotte, North Carolina manufactures
all sample packets. The Company places orders with each supplier based on its
anticipated needs for the products. Packaging components are supplied to each
manufacturer by the Company.
In March 1993, the Company entered into an agreement with the Germiphene
Corporation ("Germiphene") of Brantford, Ontario, Canada, for the manufacture
and sale of the ORATEST(TM) product (called OraScan(TM) in Canada). Germiphene
produces and packages the ORATEST(TM) product at its facility and handles the
marketing to Canadian dentists and physicians. Fleet Laboratories of Watford,
Herts., United Kingdom, produces and packages the ORATEST(TM) product under the
ORASCREEN(TM) name for distribution in the UK by the Company's licensee, Block
Drug Company, Inc. ("Block"). The Company has also identified a US-based company
with the capacity to manufacture the ORATEST(TM) kits.
In order to ensure an available and stable supply of toluidine blue, the
active ingredient in the ORATEST(TM) product, the Company established its own
manufacturing facility. In 1995, the Company leased a facility and hired a
chemist to oversee the project. The FDA has visited the facility and will return
prior to final approval of ORATEST(TM). Several test batches of toluidine blue
have already been manufactured at the Company's facility and all have met the
specifications given the FDA with regard to the finished active ingredient.
With respect to the ingredients for the Company's products other than
ORATEST(TM), the Company does not anticipate any difficulty in obtaining the
ingredients necessary for the manufacture of such products because such
ingredients are readily available from numerous sources. In the event that any
vendor is unable to continue the manufacture of the Company's products, the
Company has other qualified manufacturers who are prepared to assist the Company
with its manufacturing needs.
In general, all the Company's products are shipped by the respective
manufacturers to the Company's facilities in Phoenix, Arizona where they are
warehoused and distributed to pharmaceutical wholesalers, drug and food store
chains, dentists and other customers. Because the Company maintains an inventory
of the products from which the Company fills orders, the Company does not have
and has not had a backlog of customer orders.
The Company has engaged the services of twenty-two independent sales
representatives to handle the solicitation of orders for its products primarily
from pharmaceutical wholesalers and chains, food wholesalers and chains, rack
jobbers and convenience stores. These representatives are compensated solely on
a commission basis, receiving a 7 1/2% commission on their sales of the products
as compensation for their sales efforts. Company personnel periodically
accompany these representatives on calls to key accounts. The Company has a
salaried Director of Sales to manage and coordinate the independent sales
representatives.
Competition
The pharmaceutical industry is highly competitive. A number of companies,
almost all of which have greater financial resources, marketing capabilities and
research and development capacities than the Company, are actively engaged in
the development of products that may compete with the Company's products. The
pharmaceutical industry is characterized by extensive and ongoing research
efforts, which may result in development by other companies of products
comparable or superior to any that are now on the market including those sold by
the Company.
The Company is unaware of any products currently on the market that provide
treatment as effective as ZILACTIN(R), ZILACTIN(R)-B and ZILACTIN(R)-L for the
treatment of their indicated uses. Although there can be no assurance in this
regard, management of the Company believes that there is a substantial potential
demand for
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products that are effective in the treatment of these conditions. 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.
Numerous products exist for treatment of HSV I symptoms (i.e., cold sores,
fever blisters), including the following products: Orajel and Tanac by Commerce
Drug Company, Herpicin-L by Campbell Laboratories, Inc., Proxigel by Reed and
Carnrick, and Carmex by Carma Lab, Inc. The Company does not believe that any of
these treatments have achieved a dominant market share. Based upon clinical
studies and clinical observations, the Company believes that ZILACTIN(R),
ZILACTIN(R)-B and ZILACTIN(R)-L will provide more effective symptomatic relief
of HSV I infections than the treatments of the Company's competitors.
ORATEST(TM), which the Company believes to be the world's first commercial
oral cancer detection system, was introduced in Canada in May 1993 and in
Australia in August 1993. During the 1995 fiscal year, the Company entered into
a license agreement for the distribution of the ORATEST(TM) product in the
United Kingdom (under the name ORASCREEN(TM)) and in other countries in the EU
plus Australia and New Zealand. The introduction of the ORATEST(TM) product in
the United States will begin as soon as FDA approval is obtained.
The Company relies on outside sources for its research and development
needs in much the same manner as its outside manufacturers. The research takes
one of two forms: clinical or laboratory development. Clinical studies currently
are under way at nine facilities on the use of the ORATEST(TM) product as an
oral cancer detection system and a site delineation stain for biopsy and
surgical excision. These studies are being conducted by universities and public
and Veteran Administration facilities.
Licensing
In certain instances the Company has expanded the distribution of its
products by licensing certain of its patents to other companies. In 1990, the
Company licensed Bausch & Lomb to distribute the Company's entire oral care line
(except for ORATEST(TM)) in markets outside of the United States with the right
to use the same names, formulas and packaging used by the Company. ZILACTIN(R)
was introduced by Bausch & Lomb in Canada in January 1991 and, under the terms
of the licensing agreement, the Company receives royalty payments based upon a
percentage of the licensed products' net sales. Since 1990, the Company and
Bausch & Lomb have amended this agreement in a manner that limits Bausch &
Lomb's distribution rights to Canada. The Company and Bausch & Lomb have agreed
to terminate this agreement effective December 31, 1997.
In 1991, the Company acquired ownership of certain exclusive rights to the
patents, technology and processes embodying the formulation and the application
of the ORATEST(TM) product. The Company is obligated to pay royalties to the
NTIS based upon certain usages of the ORATEST(TM) product. During the 1995
fiscal year, the Company entered into a licensing agreement with Block pursuant
to which Block was given the right to manufacture and sell ORATEST(TM) in
certain markets not previously pursued by the Company. The Company receives from
Block royalties equal to a set percentage of the net sales of ORATEST(TM) by
Block. Although sales to date in the United Kingdom have been minimal, the
Company has presented marketing strategies to Block which the Company believes
will have a positive impact on Block's sales of ORASCREEN(TM) in the United
Kingdom.
On January 18, 1996, the Company entered into an agreement in which The
Procter & Gamble Company ("P&G") agreed to market and distribute ORATEST(TM) in
the United States and 55 other countries worldwide, pending needed regulatory
approvals. On April 3, 1996, P&G informed the Company that it was exercising its
rights to terminate such agreement. Such termination was effective on July 1,
1996. P&G informed the Company that its decision to terminate the agreement was
based upon P&G's decision to refocus its resources on its core product line.
BIO-DENTAL
Operations -- Zila Dental Supply. Ryker Dental of Kentucky, one of
Bio-Dental's operating subsidiaries, operates under the trade name "Zila Dental
Supply". Zila Dental Supply is a national distributor of professional dental
supplies, carrying brand names such as Eastman Kodak, Dentsply, Hu-Friedy,
Premier and 3M. Most of Zila Dental Supply's sales are through telemarketing and
direct mail, as opposed to deploying the
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more traditional outside sales force. As a result, Zila Dental Supply believes
it can operate more efficiently than its major competitors.
Currently, Zila Dental Supply represents the products of over 400 dental
manufacturers. It is believed 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.
Zila Dental Supply distributes consumable supplies and very 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.
Traditionally, dentists have purchased their supplies from local
full-service supply companies, or from mail-order firms. Zila Dental Supply is
attempting to combine the level of service typically associated with the local
dealer with the convenience and competitive prices found with most mail-order
firms. Zila Dental Supply can do this partially as a result of the increased
efficiencies brought about by telemarketing. Where a traditional outside sales
person might call on 10 to 15 accounts per day, a telemarketer can reach 50 to
70 offices. Additionally, telemarketing has been shown to significantly increase
the response to direct mail pieces (like catalogs). Zila Dental Supply believes
that this gives it an advantage over mail order firms which do not follow-up by
phone.
Competition -- Zila Dental Supply. There are 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 market for dental supplies.
Zila Dental Supply's position with respect to its competitors is difficult to
determine since most of the companies are privately-held and do not disclose
financial information. However, the Company believes that approximately 50
percent of the market is dominated by three public companies: Patterson Dental
Company, Sullivan Dental, and Henry Schein, Inc. Two of these companies, Henry
Schein, Inc. and Sullivan Dental are scheduled to merge as of November 1, 1997,
indicative of the consolidation currently taking place within the industry.
Integrated Dental Technologies, Inc. ("IDT") is Bio-Dental's other
wholly-owned operating subsidiary. IDT was made up of two distinct product
lines; PracticeWorks(TM) dental practice management software and OralVision(TM)
intra-oral cameras. With the Company's acquisition of Cygnus in April 1997,
IDT's Oral Vision product line was transferred from Rancho Cordova, California
to Cygnus' facility in Scottsdale, Arizona (see "Cygnus" below)
IDT's other product line, PracticeWorks(TM), continues to be operated out
of the Company's Rancho Cordova, California facility. The Company believes that
Practice Works is one of the most advanced dental practice management software
systems on the market. Written to be compatible with the popular Windows and
Windows 95 formats, PracticeWorks helps dental practices improve their operating
efficiency in areas such as patient scheduling, treatment planning, insurance
processing, accounts receivable management, patient charting, and marketing
communications.
The Company believes that PracticeWorks' main competitors are Dentrix(TM),
sold by Henry Schein, Inc., and EagleSoft(TM), now owned by Patterson Dental
Company. Both of these companies possess greater financial resources than the
Company. However, the Company believes that PracticeWorks' unique product
features, expanded selling organization and increasingly experienced support
staff make it well positioned to compete with these larger competitors.
CYGNUS
On April 4, 1997, the Company acquired Cygnus, a privately held company
located in Scottsdale, Arizona that manufactures and distributes intra-oral
camera systems and other dental imaging products to
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domestic and international markets. The acquisition was accounted for as a
purchase and resulted in the issuance of approximately 260,000 shares of Zila
common stock.
Cygnus' products include the STYLUS 2000 and ORALVISION 6000 intra-oral
camera systems and the GEMINI, a video digitizer. In addition, Cygnus markets,
through an OEM license, SENS-A-RAY, a digital x-ray system. The products are
distributed and marketed through a network of domestic and international dental
dealers, and at trade shows and seminars. The Company believes that Cygnus' main
competitors are the AcuCam(TM), Insight(TM), Ultracam(TM), Reveal(TM) and
VistaCam(TM) intra-oral cameras. Several of these companies possess greater
financial resources than the Company. However, the Company believes that with
the unique features of Cygnus' products, its manufacturing expertise and
commitment to product development, Cygnus is well positioned to compete with
these larger competitors.
EMPLOYEES
As of July 31, 1997, the Company and its operating subsidiaries employed
one hundred and thirty-eight (138) people. Of these employees, six (6) are
executive officers and fifty-three (53) employees are involved in sales
functions. The accounting and administration departments employ thirty-eight
(38) people, with twenty-eight (28) employees in the purchasing and distribution
departments. There are thirteen (13) employees in manufacturing functions. 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 are good.
RISKS AND UNCERTAINTIES
No Assurance of Profitable Operations. For the fiscal years ended July 31,
1997, 1996, 1995, 1994 and 1993, the Company had net income (loss) of
($6,458,377), $1,217,298, ($1,282,357), $558,748, and $1,338,826, respectively.
The Company has had profitable operations in three of its last five fiscal
years. There can be no assurance that the Company will, in the future, return to
profitability or that the Company's plan for expanded operations will be
successful.
Introduction of OraTest(TM) In the United States; Uncertainties of
Regulatory Approval. Zila has not yet received Food and Drug Administration
("FDA") approval for OraTest(TM), a detection system for oral cancer and site
delineation stain for biopsy and surgical excision. The production and marketing
of the Company's OraTest(TM) and related products are subject to regulation by
numerous governmental authorities in the United States and other countries.
Prior to marketing, any drug developed by the Company must undertake rigorous
clinical testing and an extensive regulatory approval process mandated by the
FDA and equivalent foreign authorities. These processes can take a number of
years and require the expenditure of substantial resources. Obtaining such
approvals and completing such testing is a costly and timeconsuming 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.
If the FDA does not approve OraTest(TM) for the United States market, it could
have a material adverse effect on the business of Zila, and the market price for
Common Stock would likely be materially adversely affected as well. As of July
31, 1997, Zila has invested approximately $3,200,000 in the development of
OraTest(TM) and has also made a significant financial investment to secure FDA
approval of OraTest(TM) and to prepare for the introduction of OraTest(TM) to
the United States market. The failure of the FDA to approve OraTest(TM) would
make it impossible for Zila to recoup this investment through sales of
OraTest(TM) in the United States. Management of the Company believes that the
necessary approvals for the sale of OraTest(TM) in the United States will be
received; however, there can be no assurances in this regard. If regulatory
approval of a product 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
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reporting, and may require surveillance programs to monitor the usage or side
effects of each drug product. A marketed product, its manufacturer and its
manufacturing facilities are 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.
Potential Difficulty in Implementing Marketing Strategy. If FDA approval
of OraTest(TM) 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 can be no assurance that the Company may do this or be successful
in gaining market acceptance of OraTest(TM).
Competition; Research and Development. The pharmaceutical industry is
highly competitive. A number of companies, many of which have greater 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 Company relies on
outside sources for its ongoing research and development needs in much the same
manner as the Company relies on outside sources for manufacturing. 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, Bio-Dental, a
wholly-owned subsidiary of Zila, faces significant competition, primarily from a
various number of dental supply dealers and mail order supply houses in the
United States. Bio-Dental and Cygnus also face significant competition from
providers of dental practice management software and intra-oral camera systems.
Many of the competing providers of these products have significantly greater
market share and financial resources than Bio-Dental and Cygnus. In addition,
new competitors may enter into Bio-Dental's markets from time to time. It may be
difficult for Bio-Dental and Cygnus to maintain or increase sales volume and
market share due to such competition.
Dependence on Proprietary Rights. Zila relies on a combination of patent,
copyright, trademark and trade secret protection, nondisclosure agreements and
licensing arrangements to establish and protect its proprietary rights. Zila
owns and has exclusive licenses to a number of United States and foreign patents
and patent applications, and intends to seek additional patent applications as
it deems appropriate. There can be no assurance that 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. In addition, there can be no assurance that any
patents that may be issued to Zila will not be challenged, invalidated or
circumvented, or that any rights granted thereunder would provide proprietary
protection to, or effectively limit competition against, Zila. Zila also has a
number of trademarks. There can be no assurance that litigation with respect to
trademarks will not result from the use of registered or common law marks, or
that, if litigation against Zila were successful, any resulting loss of the
right to use a trademark would not reduce sales of Zila's products in addition
to the possibility of a significant damages award. Although Zila intends to
defend the proprietary rights, policing unauthorized use of proprietary
technology and products is difficult, and there can be no assurance that Zila's
efforts will be successful. In addition, the laws of certain foreign countries
may not protect the proprietary rights of Zila to the same extent as do the laws
of the United States.
Government Regulation. The approval and sale of pharmaceutical products is
heavily regulated by the FDA and other federal and state regulatory agencies.
Such regulation encompasses pricing, safety and efficacy, testing, advertising
and promotion, labeling of pharmaceutical products and other matters. Compliance
with such regulations is both costly and time consuming. In order to be legally
marketed over-the-counter ("OTC"), a product must either be the subject of a New
Drug Application ("NDA") approved by the FDA, be the subject of an applicable
FDA monograph designating the product generally recognized as safe and effective
or, if no FDA monograph exists, the FDA may designate a product as
"grandfathered" (i.e., the sale of such product is permissible because of the
safe use of such product or similar products prior to December 5, 1975).
ZILACTIN(R) and its family of products have been "grandfathered" and a letter
has been received by the Company from the FDA confirming that status.
ZILACTIN(R) is currently being marketed for the
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symptomatic relief of canker sores (oral mucosal ulcers or lesions), cold sores,
and fever blisters. ZILACTIN(R)-L (for the treatment of fever blisters and cold
sores before they erupt) is also marketed as a "grandfathered" product. Neither
of these products may be marketed as a treatment for genital herpes or herpes
zoster (commonly known as "shingles") without an effective new drug application.
Depending principally on the time and expense involved, NDAs seeking approval
for marketing ZILACTIN(R) and/or ZILACTIN(R)-L as topical applications for the
treatment of shingles and genital herpes may be filed by the Company. There can
be no assurance that any NDA will be filed with/or approved by the FDA. Any
challenge by the FDA of the Company's sale of or claims for ZILACTIN(R) would
materially adversely affect the business and prospects of the Company. The
Company is also seeking FDA and EU approval of OraTest(TM), an oral cancer
diagnostic. There can be no assurance that FDA or EU approval of OraTest(TM)
will be obtained.
Dependence on Key Personnel. The operations of the Company depend to a
great extent on the technical expertise and management efforts of Mr. Joseph
Hines, President of the Company, Mr. Clarence Baudhuin, Executive Vice President
of the Company, Mr. Edwin Pomerantz, Vice President of Regulatory and Technical
Affairs, Ms. Janice Backus, Vice President and Corporate Secretary, Mr. Bradley
C. Anderson, Vice President and Treasurer, Mr. Rocco Anselmo, President of Zila
Pharmaceuticals, and Curtis M. Rocca, III, President of Bio-Dental. The loss of
Messrs. Hines, Baudhuin, Anderson, Anselmo, Rocca or Pomerantz or Ms. Backus
could materially adversely affect the Company's business. The Company maintains
key person life insurance coverage on Messrs. Hines, Baudhuin, and Pomerantz.
Litigation. In July 1995, one of Zila's subsidiaries, Bio-Dental, was
named as a defendant, along with Bio-Dental's transfer agent and a shareholder
of Bio-Dental ("Shareholder"), in a lawsuit. The lawsuit alleges that Bio-Dental
wrongfully failed to register 200,000 Bio-Dental shares in the name of the
plaintiffs which were pledged as security by the Shareholder for a debt owed by
the Shareholder to the plaintiffs. Bio-Dental denied all of the material
allegations of the lawsuit against it and has asserted various affirmative
defenses. Bio-Dental accrued a liability of $450,000 in September 1996 because
it believed a loss was probable at that time. This amount was Bio-Dental's best
estimate of the loss in the event the outcome of the litigation was unfavorable
to Bio-Dental. In November 1996, Bio-Dental was granted a summary judgment in
which the court ruled in favor of Bio-Dental. The plaintiffs filed a motion to
reconsider the summary judgment ruling, which was denied by the court in January
1997. Having lost the summary judgment ruling and later having this ruling
upheld, the plaintiffs have now filed an appeal. Bio-Dental will continue to
vigorously defend against the claims set forth in the lawsuit. If the appeal is
successful, it could have an adverse impact on the Company.
Upon consummation of the Company's merger with Bio-Dental, each of the
outstanding shares of Bio-Dental common stock was converted into .825 shares of
the Company's Common Stock. Subsequent to the merger with Bio-Dental, the
Company's stock transfer agent was presented with a certificate purporting to
represent 220,000 shares of Bio-Dental common stock which did not appear on the
records of Bio-Dental's stock transfer agent as of the closing date. The Company
is currently investigating this matter and has not determined whether any shares
of the Company's common stock are required to be issued in exchange for the
shares purportedly represented by this certificate.
Possible Claims Relating to Products. The Company could be exposed to
possible claims for personal injury resulting from allegedly defective products
manufactured by third parties with which it has entered into manufacturing
agreements. The Company maintains product liability insurance coverage for
claims arising from the use of all its products. However, there can be no
assurance that the Company will not 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.
No Cash Dividends. Although the Company is not restricted in its ability
to pay cash dividends, the Company has never paid cash dividends on its Common
Stock and does not contemplate paying cash dividends in the foreseeable future.
Charter and Bylaw Provisions. The Company's Certificate of Incorporation,
as amended, and Bylaws contain provisions that limit or eliminate director
liability for certain actions. These provisions could, in some instances,
prevent redress by stockholders for certain actions taken by the Company's
directors.
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Warrants and Options. As of July 31, 1997, 3,182,357 shares of Common
Stock are issuable upon the exercise of outstanding options and warrants to
purchase shares of Common Stock. For the life of such options and warrants, the
option and warrant holders will have the opportunity to profit from a rise in
the price of the Common Stock, with a resulting dilution in the interest of
other holders of the Common Stock. The existence of such options and warrants
may adversely affect the terms on which the Company can obtain additional
financing. Further, the warrant and option holders can be expected to exercise
their warrants and options at a time when the Company would, in all likelihood,
be able to obtain additional capital by an offering of its unissued Common Stock
on terms more favorable to the Company than those provided by such options and
warrants.
Shares Eligible for Future Sale. As of July 31, 1997, the Company had
32,326,581 shares of Common Stock outstanding. An additional 3,182,357 shares of
Common Stock are issuable upon exercise of outstanding options and warrants to
purchase Common Stock. Such shares, subject to certain limitations, may be
available in the future for resale in the open market pursuant to Rule 144
promulgated under the Securities Act, as amended or pursuant to registration of
such shares under the Securities Act. The foregoing resales, if any, may have an
adverse effect on the market price of the Common Stock.
Possible Volatility of Common Stock Price. The market price for Common
Stock has fluctuated significantly in the past. Management of Zila believes that
such fluctuations may have been caused by announcements of new products,
quarterly fluctuations in the results of operations and other factors, including
changes in conditions of the pharmaceutical industry in general. Stock markets
have experienced extreme price volatility in recent years. This volatility has
had a substantial effect on the market prices of securities issued by Zila and
other pharmaceutical and health care companies, often for reasons unrelated to
the operating performance of the specific companies. Zila anticipates that the
market price for Common Stock may continue to be volatile.
Future Capital Requirements and Uncertainty of Future Funding; Dilutive and
Other Effects of Equity Line Agreement. The development of the Company's
products will require the commitment of substantial resources to conduct the
time-consuming research and development, clinical studies and regulatory
activities necessary to bring any potential product to market and to establish
production, marketing and sales capabilities. The Company may need to raise
substantial additional funds for these purposes. The Company may seek such
additional funding through collaborative arrangements and through public or
private financings, including equity financings. Under the terms of the Equity
Line Agreement, the Company has secured an equity line that allows the Company
to raise up to $22 million from investors over a 13-month period beginning
August 20, 1997. Other than this equity line, however, the Company currently has
no commitments for any additional financings, and there can be no assurance that
any such financings will be available to the Company or that adequate funds for
the Company's operations, whether from financial markets, collaborative or other
arrangements with corporate partners or from other sources, will be available
when needed or on terms attractive to the Company. 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.
While the equity line arrangement discussed above will help provide the
Company with additional future financing, the sale of Common Stock thereunder
will have a dilutive impact on other stockholders of the Company. As a result,
the Company's net income (loss) per share could be materially decreased in
future periods, and the market price of the Common Stock could be materially and
adversely affected. In addition, the Common Stock to be issued under the Equity
Line Agreement will be issued at a discount to the then-prevailing market price
of the Common Stock. These discounted sales could have an immediate adverse
effect on the market price of the Common Stock.
Issuance of Preferred Stock. The Company's Board of Directors has the
authority, 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
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rights, voting rights, rights and terms of redemption, redemption price and
liquidation preference. On October 17, 1997, the Company issued, into escrow,
30,000 shares of its Series A Convertible Preferred Stock as well as warrants to
purchase 360,000 shares of common stock. Such securities will be released from
escrow, as well as the purchase price of such securities, upon the completion of
the Company's acquisition of Oxycal Laboratories, Inc.
Environment and Controlled Use of Hazardous Materials. The Company is
subject to federal, state and local laws and regulations governing the use,
generation, manufacture, storage, discharge, handling and disposal of certain
materials and wastes used in its operations, some of which are classified as
"hazardous." There can be no assurance that the Company will not be required to
incur significant costs to comply with environmental laws and regulations as its
research activities are increased or that the operations, business and future
profitability of the Company will not 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.
ADDITIONAL INFORMATION
On October 17, 1997, the Company entered into an agreement pursuant to
which the Company agreed to issue 30,000 share of Series A Convertible Preferred
Stock (the "Series A Preferred Stock") and warrants to purchase 360,000 shares
of the Company's Common Stock (the "Warrants") for $30,000,000 (the "Preferred
Stock Proceeds"). The shares of Series A Preferred Stock, the Warrants and the
Preferred Stock Proceeds were deposited into escrow. The Warrants expire on
October 17, 2000 and have a per-share exercise price of $9.915. Concurrent with
the completion of the merger (the "Oxycal Merger") between a subsidiary of the
Company and Oxycal Laboratories, Inc. ("Oxycal"), the Preferred Stock Proceeds,
the Series A Preferred Stock and the Warrants will be released from escrow. In
the event the merger with Oxycal is not completed prior to November 13, 1997,
the escrow will terminate and the Series A Preferred Stock will be returned to
Zila and the Preferred Stock Proceeds will be returned to the investors along
with Warrants to purchase 210,000 shares of the Company's Common Stock. The
balance of the Warrants will be returned to the Company. The parties have
reserved the right to extend the escrow termination date beyond November 13,
1997. Zila intends to use a significant portion of the Preferred Stock Proceeds
to consummate the Oxycal Merger, the balance of the Preferred Stock Proceeds
will be used by the Company for working capital and to pay the fees and expenses
associated with the sale of the Series A Preferred Stock.
By an agreement dated October 28, 1997, the Company and Oxycal have agreed
to a merger whereby Oxycal will be merged into a wholly owned subsidiary of
Zila, with Oxycal being the surviving corporation. Upon the consummation of the
Oxycal Merger, Oxycal will become a wholly-owned subsidiary of Zila. Under the
terms of the Merger Agreement, Oxycal shareholders will receive cash
consideration for their shares of Oxycal capital stock. The Oxycal Merger is
subject to approval of the Oxycal shareholders.
There can be no assurance that the Oxycal shareholders will approve the
Oxycal Merger or, if the Oxycal Merger is approved, that the merger will be
consummated. Subsequent to year end, Zila has deposited $1,000,000 into escrow,
which amount will be delivered to Oxycal in the event the Oxycal Merger is not
consummated and reason for the failure is due to the actions or inactions of
Zila, Inc.
ITEM 2. PROPERTIES
On January 4, 1991, the Company purchased a 16,000 square foot building
located at 5227 North Seventh Street, Phoenix, Arizona 85014-2800. The Company
moved its corporate headquarters to this location on February 8, 1991. The
purchase price of the building was approximately $600,000. The Company paid 25%
of the purchase price in cash and obtained a loan for the balance of the
purchase price. The Company has refinanced the mortgage which matured April 1,
1996 with Bank One, Arizona (the "Bank"). The terms of the refinancing include
interest to be payable monthly on the unpaid balance at the Bank's prime
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rate plus two and one quarter percent (2.25%), to move with prime on a daily
basis. The refinanced mortgage loan is amortized over 20 years and is due on
April 1, 2001.
The Company also leases 3,502 square feet for a manufacturing facility in
Phoenix, Arizona. This facility will produce toluidine blue which will be used
in the manufacture of ORATEST(TM). The facility is leased under a three year
agreement which expires April 30, 1999, 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 $1,922. The Company does not currently
intend to invest in any other plants or manufacturing facilities. The Company's
products are currently manufactured by Clinipad, Arizona Natural Resources and
Germiphene. Together with the Company's laboratory facilities, the Company
believes that these manufacturers are capable of performing all necessary
production functions. See "Item 1. Business -- Manufacturing and Distribution."
The Company's subsidiaries holds additional leases on four separate
facilities. Bio-Dental leases 25,000 square feet of office/warehouse space in a
concrete building located at 11291 Sunrise Park Drive, Rancho Cordova,
California. The current lease rate for the Rancho Cordova facility is $9,837 per
month, and is constant for the duration of the lease. The lease for the Rancho
Cordova facility expires on November 30, 2001, however Bio-Dental has an option
to renew the lease for two subsequent five-year terms. Bio-Dental's
administrative offices are located in the Rancho Cordova facility. Zila Dental
Supply leases 19,200 square feet in an office/warehouse complex at 172 Lisle
Industrial Avenue, Lexington, Kentucky. The current lease rate is $2,800 per
month, and expires on October 31, 1998. On May 31, 1996, IDT entered into a
three year lease for 2,000 square feet beginning July 15, 1996 in an office
complex at 6021-A West 71st Street, Indianapolis, Indiana. The current lease
rate is $1,783 per month, and expires on July 14, 1999. Bio-Dental is a
guarantor of this lease. On April 1, 1997, Cygnus entered into a five year lease
for 6,042 square feet of office/warehouse space located at 8240 E. Gelding Suite
101, Scottsdale, Arizona. The current lease rate is $3,927 per month and
increases every twelve months with the monthly lease payment to be $4,350 in the
final year.
ITEM 3. LEGAL PROCEEDINGS
In July 1995, one of Zila's subsidiaries, Bio-Dental, was named as a
defendant, along with Bio-Dental's transfer agent and a shareholder of
Bio-Dental ("Shareholder"), in a lawsuit. The lawsuit alleges that Bio-Dental
wrongfully failed to register 200,000 Bio-Dental shares in the name of the
plaintiffs which were pledged as security by the Shareholder for a debt owed by
the Shareholder to the plaintiffs. Bio-Dental denied all of the material
allegations of the lawsuit against it and has asserted various affirmative
defenses. Bio-Dental accrued a liability of $450,000 in September 1996 because
it believed a loss was probable at that time. This amount was Bio-Dental's best
estimate of the loss in the event the outcome of the litigation was unfavorable
to Bio-Dental. In November 1996, Bio-Dental was granted a summary judgment in
which the court ruled in favor of Bio-Dental. The plaintiffs filed a motion to
reconsider the summary judgment ruling, which was denied by the court in January
1997. Having lost the summary judgment ruling and later having this ruling
upheld, the plaintiffs have now filed an appeal. Bio-Dental will continue to
vigorously defend against the claims set forth in the lawsuit. If the appeal is
successful, it could have an adverse impact on the Company.
Upon consummation of the Company's merger with Bio-Dental, each of the
outstanding shares of Bio-Dental common stock was converted into .825 shares of
the Company's Common Stock. Subsequent to the merger with Bio-Dental, the
Company's stock transfer agent was presented with a certificate purporting to
represent 220,000 shares of Bio-Dental common stock which did not appear on the
records of Bio-Dental's stock transfer agent as of the closing date. The Company
is currently investigating this matter and has not determined whether any shares
of the Company's common stock are required to be issued in exchange for the
shares purportedly represented by this certificate.
Colgate-Palmolive. On April 13, 1994, Zila filed a complaint in the United
States District Court for the District of Arizona, titled Zila Pharmaceuticals,
Inc. v. Colgate-Palmolive Company ("Colgate"), CIV No. 94-0756 PHX-EHC. The
complaint was served on Colgate on May 10, 1994. The complaint alleges that
Colgate's Orabase Gel product infringes the Company's U.S. Patent No. 5,081,158
(the "'158 Patent") which covers Zila's non-prescription, film-forming,
bioadhesive medications sold in food and drug stores nationwide. The complaint
sought to enjoin Colgate's manufacture and distribution of Orabase Gel and
requested an
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award of damages in an appropriate amount. The case was settled on March 6, 1997
and had no material impact on the Company's financial statements.
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.
EXECUTIVE OFFICERS OF THE COMPANY
The following sets forth the information regarding the executive officers
of the Company that are not otherwise disclosed in the Company's definitive
Proxy Statement for the Annual Meeting of Shareholders on December 11, 1997.
Edwin Pomerantz joined the Company in March 1984 as Vice President of
Marketing. In 1995, his title was changed to Vice President -- Regulatory &
Technical Affairs in order to better describe the duties performed by Mr.
Pomerantz. From 1982 until 1984, Mr. Pomerantz was a partner and half-owner of
Golden Memories, Inc., a company engaged in the photographic business. From 1975
to 1982, Mr. Pomerantz was Vice President for Family Record Plan, Inc., a
photography business. Prior to 1975, Mr. Pomerantz held senior marketing
management positions at Viviane Woodward Cosmetics, Chas. Pfizer & Company,
Inc., Avon Products, Inc., and Rexall Drug and Chemical Company.
Janice L. Backus has served as Secretary of the Company since April 1989
and in 1993 she was named a Vice President of the Company. From 1983 until April
1989, Ms. Backus served as Assistant Secretary of the Company. Ms. Backus has
also served as the Assistant to the President since 1983. Prior to joining the
Company, Ms. Backus held administrative and secretarial positions with the
American Heart Association, Arizona Division, BX International and Century
Capital Corporation.
Bradley C. Anderson joined the Company as Vice President and Treasurer in
November 1996. Prior to joining the Company, from 1985 to 1996, Mr. Anderson was
employed by Deloitte & Touche LLP, most recently as an Audit Senior Manager, in
which capacity Mr. Anderson provided auditing, planning, and other assistance
and consulting to numerous privately and publicly held companies, including the
Company. Mr. Anderson received his B.S. in Accountancy from Brigham Young
University. Mr. Anderson is a Certified Public Accountant.
Rocco Anselmo joined the Company as the Executive Vice President and
General Manager of Zila Pharmaceuticals since 1993 and in 1997 became President
of Zila Pharmaceuticals. From 1983 to 1993, Mr. Anselmo held various positions
with Oral-B Laboratories, Inc., most recently as General Manager of Oral-B Labs
International from 1991 to 1993. From 1972 to 1983, Mr. Anselmo held various
sales and marketing positions with S.C. Johnson and Sterling Drug Company.
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PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Information regarding the market for Zila, Inc.'s common stock (the "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, 1997
First Quarter.......................................................... 7 7/8 6 1/4
Second Quarter......................................................... 8 3/8 6 3/8
Third Quarter.......................................................... 9 3/8 6 7/16
Fourth Quarter......................................................... 8 1/8 6 7/16
FISCAL YEAR ENDED JULY 31, 1996
First Quarter.......................................................... 4 1/2 3 3/4
Second Quarter......................................................... 5 7/8 3 3/4
Third Quarter.......................................................... 10 1/4 3 5/8
Fourth Quarter......................................................... 9 1/8 6 3/8
The number of stockholders of record of the Common Stock as of July 31,
1997 and September 30, 1997 were approximately 3,565 and 3,504, respectively. As
of July 31, 1997 there are no shares of the Company's preferred stock
outstanding (See "Item 1 -- Additional Information").
The Company has not paid dividends on the Common Stock. It is the present
policy of the Company's Board of Directors to retain future earnings to finance
the growth and development of the Company's business. Any future dividends will
be at the discretion of the Company's Board of Directors and will depend upon
the financial condition, capital requirements, earnings and liquidity of the
Company as well as other factors the Company's Board of Directors may deem
relevant.
ITEM 6. SELECTED FINANCIAL DATA
The following tables summarize selected financial information derived from
the Company's audited financial statements. The information set forth below is
not necessarily indicative of results of future operations and should be read in
conjunction with the Company's Consolidated Financial Statements and related
Notes and with "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in this Form 10-K.
FISCAL YEAR ENDED JULY 31
---------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA 1997 1996 1995 1994 1993
- ------------------------------ ------------ ------------ ----------- ----------- -----------
Net Sales..................... $ 38,592,252 $ 37,479,546 $35,064,245 $22,474,672 $13,445,944
Licensing Fees and Royalty
Revenue..................... 72,640 2,100,484 1,956,654 1,732,277 1,846,492
Net Income (Loss)............. (6,458,377) 1,217,298 (1,282,357) 558,748 1,338,826
Net Income (Loss) Per Share... (0.20) 0.04 (0.04) 0.02 0.05
AT JULY 31
---------------------------------------------------------------------
BALANCE SHEET DATA 1997 1996 1995 1994 1993
- ------------------------------ ------------ ------------ ----------- ----------- -----------
Current Assets................ $ 10,779,049 $ 13,251,960 $12,010,497 $11,011,202 $ 7,055,906
Current Liabilities........... 5,804,965 6,672,497 6,401,072 5,557,594 1,885,012
Total Assets.................. 23,604,032 25,309,781 16,691,859 15,085,434 9,833,481
Long-Term Debt................ 375,908 382,006 1,136,239 437,586 469,959
Total Liabilities............. 6,180,873 7,054,503 7,537,311 5,995,180 2,354,971
Shareholders' Equity.......... 17,423,159 18,255,278 9,154,548 9,090,254 7,478,510
16
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward Looking Statements. The following discussion contains
forward-looking statements which involve risks and uncertainties. The Company's
actual results may differ materially from the results discussed in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to those items described below and those described in Item 1
of this Annual Report on Form 10-K under the heading "Risks and Uncertainties,"
"Additional Information" and in Item 3 "Legal Proceedings."
The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes thereto.
On January 8, 1997, the Company completed a merger with Bio-Dental. On
December 30, 1996, Bio-Dental's shareholders approved the all-stock transaction
which provided for a per share exchange of .825 shares of the Company's common
stock for each share of Bio-Dental common stock outstanding. As of January 8,
1997, Bio-Dental had 6,565,300 shares of common stock outstanding.
The merger has been accounted for as a pooling of interests, and
accordingly, the consolidated financial statements give retroactive effect to
the Bio-Dental merger and include the combined operations of Zila and Bio-Dental
for all periods presented. Prior to the combination, Bio-Dental's year-end was
March 31. Effective August 1, 1995, Bio-Dental's results are reported on a July
31, 1996 basis along with the results of Zila, Inc. Bio-Dental's net loss for
the four-month period ended July 31, 1995 is reflected as an adjustment to the
deficit during the year ended July 31, 1996. For the four-month period ended
July 31, 1995, Bio-Dental had revenues of $11,056,774, operating costs and
expenses of $11,631,735, and a net loss of $416,817. Certain adjustments and
reclassifications have been made to conform previously issued Bio-Dental
financial statements to classifications and accounting policies used by Zila.
On April 4, 1997, the Company acquired Cygnus Imaging, Inc., a privately
held company located in Scottsdale, Arizona that manufactures and distributes
intra-oral camera systems and other dental imaging products. The acquisition was
accounted for as a purchase and resulted in the issuance of approximately
260,000 shares of Zila common stock and the recording of approximately
$2,101,000 of goodwill.
COMPANY OVERVIEW
Zila has three operating groups. Zila Pharmaceuticals markets a growing
line of non-prescription oral healthcare products, including Zilactin,
Zilactin-B, Zilactin-L, Zilactin-Lip, new Zilactin Baby and Quik Floss. Cygnus
Imaging manufactures and markets internationally CygnaScope and OralVision
intraoral video camera systems, and Sens-A-Ray digital x-ray systems. The third
operating group, Bio-Dental Technologies, consists of Practice Works dental
practice management software and Zila Dental Supply, a nationwide dental
products distributor, marketing 15,000 items to the dental office through
extensive direct mail, catalog sales and telemarketing.
OPERATING RESULTS
Fiscal year ended July 31, 1997. For the fiscal year ended July 31, 1997,
the Company had a net loss of $6,458,377 compared to net income of $1,217,298
for 1996.
Net sales during the 1997 fiscal year totaled $38,592,252 compared to net
sales of $37,479,546 for the prior fiscal year, an increase of 3.0%. The growth
in net sales was attributable mainly to the Company's distribution subsidiary,
Zila Dental Supply. Sales for Zila Dental Supply rose to $26,531,761, up 5.8%
from $25,077,638 in the prior year. Additional growth came from one of the
Company's other subsidiaries, Zila Pharmaceuticals, which had net sales of
$6,719,228 in fiscal year 1997 compared to $5,978,131 in 1996, a 12.4% increase.
The increase at Zila Pharmaceuticals was primarily due to the sales of
ZILACTIN-B(R) which have continued to increase since its introduction in the
first quarter of fiscal year 1995. These increases were partially offset by
decreased sales in certain discontinued product lines associated with the
restructuring of Bio-Dental's IDT subsidiary, which occurred in prior periods.
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19
Licensing fees and royalty revenues were $72,640 for fiscal year 1997
compared to $2,100,484 for the prior fiscal year. Approximately $1,235,000 in
royalty revenues earned in fiscal 1996 were related to the licensing agreement
between Bio-Dental and Denticator International, Inc. ("DII"). In July 1996,
Bio-Dental disposed of its rights to receive future royalty payments from DII in
exchange for a lump sum payment of approximately $7,500,000. In addition,
amounts were recorded in fiscal 1996 attributable to the licensing of OraTest
for markets in the United Kingdom and the United States by the Stafford-Miller
Company and The Procter & Gamble Company, respectively. Of these amounts,
$625,000 was paid by Procter & Gamble as a one-time licensing fee required in
connection with the termination of its licensing agreement with the Company.
Cost of products sold were $23,542,342 for the fiscal year ended July 31,
1997, a 5.0% decrease from $24,771,193 for the fiscal year ended July 31, 1996.
Cost of sales as a percentage of net sales decreased to 61.0% during fiscal year
1997 as compared to 66.1% in fiscal 1996. These decreases are primarily due to
lower costs resulting from the restructuring of IDT.
The Company incurred $20,161,319 of selling, general and administrative
expenses during the fiscal year ended July 31, 1997, an increase of $1,672,080
over the fiscal year ended July 31, 1996. Approximately $1,423,000 of the
increases were attributable to costs associated with the funding of OraTest
research, start-up manufacturing costs and staffing. The Company also incurred
approximately $364,000 of additional amortization costs related to purchased
technology rights as compared to the previous fiscal year. The Company also
incurred increased legal, shareholder, audit, salary, and insurance expenses as
compared to the previous fiscal year. These increases were partially offset by
decreases in marketing, selling, product development and administrative expenses
at Bio-Dental resulting from the restructuring of IDT, which occurred in prior
periods.
Merger related expenses increased $225,190 from $146,675 in the prior
fiscal year to $371,865 and are directly related to the Bio-Dental merger.
Impairment charges during fiscal year 1997 of $587,659 relate to an impairment
loss recognized to reduce the carrying value of IDT's long-lived assets which
include goodwill and software rights. Restructuring charges of $271,631 during
fiscal year 1996, are directly attributable to the restructuring of IDT.
Litigation costs, related to the Colgate and the Shareholder suits,
increased $807,785 to $1,147,363 from the same period in the prior fiscal year.
These increases were due to the accrual of a liability in the event that the
outcome of the Shareholder litigation would be unfavorable to Bio-Dental and
also due to legal expenses arising out of the Company's efforts to prevent
infringements on the Zilactin patents (See "Part I -- 3 -- Legal Proceedings").
Interest and other income increased $53,782 from $147,848 in the prior
fiscal year to $201,630 during fiscal 1997. Interest expense decreased from
$471,607 in fiscal year 1996 to $79,450 in fiscal year 1997. The decrease was
attributable to lower debt obligations during fiscal year 1997 as compared to
fiscal year 1996.
Fiscal year ended July 31, 1996. For the fiscal year ended July 31, 1996,
the Company had net income of $1,217,298 compared to a net loss of $1,282,357
for 1995.
Net sales during the 1996 fiscal year totaled $37,479,546 compared to net
sales of $35,064,245 for the prior fiscal year, an increase of 6.9%. The growth
in net sales was attributable mainly to the Company's distribution subsidiary,
Zila Dental Supply which was able to increase its average volume per customer.
Sales for Zila Dental Supply rose to $25,077,638, up 22.0% from $20,551,803 in
fiscal year 1995. Additional growth came from one of the Company's other
subsidiaries, Zila Pharmaceuticals, which had net sales of $5,978,131 in fiscal
year 1996 compared to $5,147,667 in 1995, a 16.1% increase. The increase at Zila
Pharmaceuticals was primarily due to the sales of ZILACTIN(R)-B which have
continued to increase since its introduction in the first quarter of fiscal year
1995. These increases were partially offset by a decline in net sales at
Integrated Dental Technologies (IDT), a wholly owned subsidiary of Bio-Dental.
The decline at IDT resulted mainly as a result of IDT's launch of the
"paperless" dental office which was met with little initial demand. Previously,
IDT had sold only dental practice management software systems and intra-oral
cameras on a stand-alone basis. When the Company began focusing on these larger,
"integrated" systems, sales of the individual
18
20
components declined. In December 1995, IDT announced that it was discontinuing
its "paperless" dental office offering, and returning to its previous strategy
of selling just intra-oral cameras and practice management software. In
connection with this restructuring, the Company recorded $271,631 in
restructuring charges in fiscal year 1996. There were no such charges in fiscal
year 1995.
Licensing fees and royalty revenues were $2,100,484 for fiscal year 1996
compared to $1,956,654 for the prior fiscal year. This increase was attributable
to licensing of OraTest in the United States to The Procter & Gamble Company
("P&G"). Included in such amounts for the fiscal year ended July 31, 1996, are
$750,000 of non-refundable licensing fees that the Company received from P&G in
connection with a licensing agreement between P&G and the Company, which
agreement was terminated on April 3, 1996. The increase was partially offset by
a decrease in royalty revenues from Denticator International, Inc. (DII), a
wholly owned subsidiary of Bio-Dental. This reduction came mainly as a result of
lower levels of profitability at DII, which had a resulting effect on royalties
payable to Bio-Dental. On July 22, 1996, Young Innovations, Inc. (Young)
acquired substantially all of the assets and certain liabilities of DII.
Bio-Dental received approximately $7.5 million in lieu of future royalties that
Bio-Dental was entitled to receive in connection with its licensing agreement
with DII. In addition, Young issued Bio-Dental a "product credit" against future
purchases from Young equal to the amounts due Bio-Dental at the time of closing.
Included in other receivables and other assets at July 31, 1996 is $600,249 and
$355,103, respectively, of product credits due from Young.
Cost of products sold were $24,771,193 for the fiscal year ended July 31,
1996, a 12.1% increase from $22,093,228 for the fiscal year ended July 31, 1995.
This increase is primarily due to increased sales volume during fiscal year 1996
as compared to fiscal year 1995. Cost of sales as a percentage of net sales
increased to 66.1% during fiscal year 1996 as compared to 63.0% in fiscal 1995.
The increase is attributable primarily to the write-off of inventory associated
with the IDT restructuring program and reserves established in recognition of a
degradation of inventory value of older model intra-oral camera inventory, as
IDT released its newer model camera. The inventory write down and the reserves
were not included as "restructuring charges," but rather were taken against cost
of products sold.
The Company incurred $18,489,239 of selling, general and administrative
expenses during the fiscal year ended July 31, 1996, an increase of $2,295,160
over the fiscal year ended July 31, 1995. The bulk of this increase related to
the higher than expected costs of marketing, selling and supporting the various
products of IDT, including IDT's filmless x-ray and computer hardware products.
Additionally, administrative expenses during the fiscal year ended July 31, 1996
increased primarily due to travel and business expense, legal, shareholder
expense, and amortization of purchased technology rights. The Company also had
increases in internal funding of product development during the fiscal year
ended July 31, 1996 as compared to the previous fiscal year. Product development
increases were mainly due to start-up manufacturing costs related to OraTest,
and staffing and legal expenses arising out of the Company's efforts to prevent
infringement of the ZILACTIN patents.
Interest and other income for the fiscal year ended July 31, 1996 decreased
$104,824 from $252,672 in the prior fiscal year due primarily to the scheduled
termination of lease revenues from DII in March 1995. Interest expense increased
from $211,544 in fiscal year 1995 to $471,607 in fiscal year 1996. In April
1996, Bio-Dental borrowed $1.25 million by issuing term notes to provide
additional working capital. Amortization of issuance costs and note discounts
(associated with warrants issued to the lenders) are included in interest
expense. These term notes were repaid in July 1996 and the remaining unamortized
issuance costs were written off to interest expense at that time.
INFLATION
Inflation has had no material effect on the operations or financial
condition of the Company.
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21
LIQUIDITY AND CAPITAL RESOURCES
At July 31, 1997, the Company had net working capital of $4,974,084, and
its current ratio (the ratio of current assets to current liabilities) was 1.86
to 1. At July 31, 1996, the Company had net working capital of $6,579,463 and
its current ratio was 2.0 to 1.
Trade accounts receivable at July 31, 1997 were $2,822,687 compared to
trade accounts receivable at July 31, 1996 of $2,821,440. Trade accounts
receivable as a percentage of quarterly net sales of $9,712,162 were 29.1% at
July 1997 as compared to 31.2% at July 31, 1996 which had quarterly net sales of
$9,043,556.
At July 31, 1997, the Company had inventories of $4,286,627, an increase of
$86,185 from inventories at July 31, 1996. The Company believes current
inventories are at levels necessary to support market expansion and to maintain
adequate liquidity.
Management believes that continued growth in the Company's sales of its
products will provide sufficient funding for the Company's current operating
divisions for the next twelve months. However, the Company will require
additional financing to fund future OraTest manufacturing and marketing costs.
In anticipation of these potential requirements, effective April 30, 1997, Zila
entered into an investment agreement (the "Investment Agreement") with Deere
Park Capital Management (the "Investor") which allows the Company to sell up to
$25 million of Zila's common stock with the proceeds to be used to fund OraTest
marketing and general corporate purposes. The option to sell stock to the
Investor will remain available for a period of twelve months following the
effective date of the registration statement discussed below (the "Twelve Month
Period"). As part of the Investment Agreement, Zila sold $3 million of stock on
April 30, 1997, and has committed to sell an additional $10 million of common
stock to the Investor over the Twelve Month Period.
The Investment Agreement provides that Zila can obtain up to $2,000,000 at
any one time through the sale of the Company's common stock. All shares sold
will be at a 7% discount to the average low trading price of the Company's
common stock over a specified period of time, subject to a maximum purchase
price calculation. Sales under the Investment Agreement are subject to the
satisfaction of certain conditions, including registration of the shares, a
minimum market volume, and certain limitations on the number of shares of the
Company's common stock outstanding.
As a commitment fee for keeping the equity line available for the Twelve
Month Period, the Company has issued warrants dated May 7, 1997 (the "Warrants")
to the Investor exercisable for 300,000 shares of common stock at an exercise
price of $8.6125 per share. The Warrants are exercisable for a three-year period
commencing October 31, 1997. A registration statement pertaining to the shares
issued and to be issued under the Investment Agreement and the warrants was
filed and became effective in August 1997. During October 1997, the Company sold
$8,000,000 of the Company's common stock under the Investment Agreement to the
Investor. The proceeds from the sale are intended for potential acquisitions and
general corporate purposes.
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.
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22
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
Information respecting the directors of the Company is incorporated herein
by reference to the "Election of Directors" and the "Section 16(a) Beneficial
Ownership Reporting Compliance" sections of the Company's definitive Proxy
Statement for the Annual Meeting of Stockholders on December 11, 1997.
Information respecting the executive officers of the Company is set forth at
Part I of this Form 10-K Report.
ITEM 11. EXECUTIVE COMPENSATION
Information responsive to this Item is incorporated herein by reference to
the "Executive Compensation" section of the Company's definitive Proxy Statement
for the Annual Meeting of Stockholders on December 11, 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning the Common Stock beneficially owned by each director
of the Company, by all officers and directors of the Company as a group, and by
each shareholder known by the Company to be the beneficial owner of more than 5%
of the outstanding Common Stock is incorporated herein by reference to the
"Principal Stockholders and Stockholdings of Management" section of the
Company's definitive Proxy Statement for the Annual Meeting of Stockholders on
December 11, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information responsive to this Item is incorporated herein by reference to
the "Certain Transactions" section of the Company's definitive Proxy Statement
for the Annual Meeting of Stockholders on December 11, 1997.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
PAGE OR
METHOD OF FILING
----------------
Financial Statements
(a)
(1) Report of Deloitte & Touche LLP................................ Filed herewith
(2) Report of Grant Thorton LLP.................................... Filed herewith
(3) Consolidated Financial Statements and Notes thereto of the
Company including Consolidated Balance Sheets as of July 31,
1997 and 1996 and related Consolidated Statements of Operations,
Shareholders' Equity, and Cash Flows for each of the years in
the three-year period ended July 31, 1997...................... Filed herewith
(1) Report of Deloitte & Touche LLP as to Financial Statement
Schedules for fiscal years ended July 31, 1997, 1996, and 1995..... Filed herewith
(2) Schedule II -- Valuation and Qualifying Accounts............... Filed herewith
Exhibits. The following exhibits are filed as part of this Report.
(c)
EXHIBIT PAGE OR
NUMBER DESCRIPTION METHOD OF FILING
- ------- ------------------------------------------------------------------- ----------------
2 Merger Agreement dated August 8, 1996 among Zila, Inc. Bio-Dental
Technologies Corporation and Zila Merger Corporation............... A
3-A Certificate of Incorporation, as amended........................... B
3-B Bylaws............................................................. B
4-A Specimen Stock Certificate......................................... B
4-B Certificate of Designations, Preferences and Rights of Series A
Convertible Preferred Stock........................................ *
4-C Specimen Warrant Certificate....................................... C
4-D Form Stock Purchase Warrant re Series A Preferred Stock............ *
4-E Deere Park Capital Management Warrant.............................. J
4-F Bartholomew Investment, L.P. Warrant............................... J
10-A Revolving Line of Credit Loan Agreement dated April 8, 1991 between
Zila, Inc. and Banc One, Arizona................................... D
10-B# Stock Option Award Plan (as amended through April 10, 1991)........ E
10-C# Non-Employee Directors Stock Option Plan (as amended through April
10, 1991).......................................................... E
10-D# Bio-Dental Technologies Corporate Stock Option Plan................ I
10-E# 1997 Stock Option Award Plan....................................... *
10-F License Agreement dated February 5, 1990 between Zila
Pharmaceuticals, Inc. and Bausch and Lomb Ireland.................. F
10-G Manufacturing and Distribution Agreement dated March 12, 1993
between Zila, Inc. and Germiphene Corporation...................... G
10-H Agreement dated November 26, 1996 between Cheseborough Ponds USA Co
and Zila Pharmaceuticals, Inc...................................... H
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24
EXHIBIT PAGE OR
NUMBER DESCRIPTION METHOD OF FILING
- ------- ------------------------------------------------------------------- ----------------
10-I Private Equity Line of Credit between Deere Park Capital Management
and Zila, Inc. Dated as of April 30, 1997.......................... J
10-J Amendment to Private Equity Line of Credit Agreement............... J
10-K Registration Rights Agreement dated as of May 9, 1997 between Zila,
Inc. and Deere Park Capital Management............................. J
10-L Registration Rights Agreement dated as of May 9, 1997 between Zila,
Inc. and Bartholomew Investment, L.P............................... J
10-M Merger Agreement dated as of April 3, 1997 among Zila, Inc., Cygnus
Imaging, Inc., Cygnus Merger Corporation, and Egidio Cianciosi,
James Jenson and Kenneth Kirk...................................... J
10-N Securities Purchase Agreement dated as of October 17, 1997 by and
among Zila, Inc. and certain investors............................. *
10-O Registration Rights Agreement dated October 17, 1997 by and among
Zila, Inc. and certain investors................................... *
11 Statement re: Computation of Net Income (Loss) Per Common Share.... *
21 Subsidiaries of Registrant......................................... *
23-A Consent of Deloitte & Touche LLP (regarding Form S-8 and Form S-3
Registration Statements)........................................... *
23-B Consent of Grant Thornton (regarding Form S-8 and Form S-3
Registration Statements)........................................... *
24-A Power of Attorney of Joseph Hines.................................. *
24-B Power of Attorney of Clarence J. Baudhuin.......................... *
24-C Power of Attorney of Douglas Ayer.................................. *
24-D Power of Attorney of Patrick M. Lonergan........................... *
24-E Power of Attorney of Michael S. Lesser............................. *
24-F Power of Attorney of Carl A. Schroeder............................. *
24-G Power of Attorney of Curtis M. Rocca............................... *
27 Financial Data Schedule............................................ *
99 The Company's 1997 Proxy Statement for the Annual Meeting of
Stockholders to be held on December 11, 1997....................... K
- ---------------
# Management contract or compensation plan or arrangement
* Filed herewith
A Incorporated by reference to Exhibit 2 to the Company's Form S-4 Registration Statement
No. 333-10107, as amended
B Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal
year ended July 31, 1988, as amended
C Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal
year ended July 31, 1994, as amended
D Incorporated by reference to the Company's Form S-3 Registration Statement No. 33-46239
E Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended January 31, 1996, as amended
F Incorporated by reference to Exhibit 10-C to Post-Effective Amendment No. 3 to Form S-1
Registration Statement No. 33-27739
23
25
G Incorporated by reference to Exhibit 10-L to the Company's Annual Report on Form 10-K
for the fiscal year ended July 31, 1993, as amended
H Incorporated by reference to the Company's Quarterly Report for the quarterly period
ended October 31, 1996, as amended
I Incorporated by reference to the Company's Current Report dated February 11, 1997
J Incorporated by reference to the Company's Form S-3 Registration Statement No.
333-31651
K Filed by amendment
(d) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K dated July 21, 1997, to
report certain information regarding the effect of the merger with Bio-Dental,
including financial statements that gave retroactive effect to the Bio-Dental
merger and include the combined operations of Zila and Bio-Dental.
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26
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 28th
day of October, 1997.
ZILA, INC., a Delaware corporation
By /s/ CLARENCE J. BAUDHUIN
------------------------------------
Clarence J. Baudhuin
Executive Vice President of
Administration
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 28, 1997
- ------------------------------------------ President, Chief Executive
Joseph Hines Officer
/s/ CLARENCE J. BAUDHUIN Executive Vice President of October 28, 1997
- ------------------------------------------ Finance and Administration,
Clarence J. Baudhuin Treasurer and Director
* Director October 28, 1997
- ------------------------------------------
Douglas Ayer
* Director October 28, 1997
- ------------------------------------------
Patrick M. Lonergan
* Director October 28, 1997
- ------------------------------------------
Carl A. Schroeder
* Director October 28, 1997
- ------------------------------------------
Curtis M Rocca III
* Director October 28, 1997
- ------------------------------------------
Michael S. Lesser
*By /s/ CLARENCE J. BAUDHUIN October 28, 1997
- ------------------------------------------
Clarence J. Baudhuin
Attorney-in-Fact
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27
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, 1997 and 1996, and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended July 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. The consolidated financial statements give retroactive effect to the
merger of the Company and Bio-Dental Technologies Corporation ("Bio-Dental") on
January 8, 1997, which has been accounted for as a pooling of interests as
described in Note 1 to the consolidated financial statements. We did not audit
the consolidated statements of operations, shareholders' equity and cash flows
of Bio-Dental for the eight months ended March 31, 1996 and for the years ended
March 31, 1996 and 1995, which statements reflect total revenues of $22,034,442
for the eight months ended March 31, 1996 and $33,091,216 and $31,582,277 for
the years ended March 31, 1996 and 1995, respectively. Those financial
statements were audited by other auditors whose report has been furnished to us,
and our opinion, insofar as it relates to the amounts included for Bio-Dental as
of such dates and for such periods, is based solely on the report of such other
auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of the other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Zila, Inc. and subsidiaries at July
31, 1997 and 1996, and the results of their operations and their cash flows for
each of the three years in the period ended July 31, 1997 in conformity with
generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Phoenix, Arizona
October 28, 1997
F-1
28
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
BIO-DENTAL TECHNOLOGIES CORPORATION
AND SUBSIDIARIES
We have audited the consolidated statements of operations, stockholders'
equity and cash flows of BIO-DENTAL TECHNOLOGIES CORPORATION AND SUBSIDIARIES
for the eight months ended March 31, 1996 and for each of the two years ended
March 31, 1996 (not presented separately herein). 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements of BIO-DENTAL TECHNOLOGIES
CORPORATION AND SUBSIDIARIES referred to above present fairly, in all material
respects, the consolidated results of their operations and their consolidated
cash flows for the eight months ended March 31, 1996 and for each of the two
years ended March 31, 1996 in conformity with generally accepted accounting
principles.
As discussed in note A, the Company merged with Zila, Inc. on January 8,
1997.
GRANT THORNTON LLP
Sacramento, California
April 11, 1997
F-2
29
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JULY 31, 1997 AND 1996
1997 1996
------------ -----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents...................................... $ 2,071,563 $ 3,491,904
Short-term investments......................................... 711,470
Trade accounts receivable -- less allowance for doubtful
accounts of $349,021 (1997) and $183,877 (1996)............. 2,822,687 2,821,440
Other receivables.............................................. 319,127 620,378
Income tax receivable.......................................... 494,757
Inventories.................................................... 4,286,627 4,200,442
Prepaid expenses and other current assets...................... 538,360 444,913
Deferred income taxes.......................................... 245,928 961,413
----------- -----------
Total current assets................................... 10,779,049 13,251,960
PROPERTY AND EQUIPMENT -- Net.................................... 1,865,385 1,928,778
PURCHASED TECHNOLOGY RIGHTS -- Net............................... 6,910,293 7,346,733
GOODWILL -- Net.................................................. 2,693,139 836,729
OTHER INTANGIBLE ASSETS -- Net................................... 1,228,542 1,449,492
OTHER ASSETS..................................................... 127,624 496,089
----------- -----------
TOTAL.................................................. $ 23,604,032 $25,309,781
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable............................................... $ 3,262,904 $ 2,934,123
Accrued liabilities............................................ 2,106,572 1,546,662
Deferred revenue............................................... 395,594 187,561
Income taxes payable........................................... 1,976,369
Current portion of long-term debt.............................. 39,895 27,782
----------- -----------
Total current liabilities.............................. 5,804,965 6,672,497
LONG-TERM DEBT -- Net of current portion......................... 375,908 382,006
----------- -----------
Total liabilities...................................... 6,180,873 7,054,503
----------- -----------
COMMITMENTS AND CONTINGENCIES (Notes 10, 12, 13, 16 and 18)
SHAREHOLDERS' EQUITY:
Preferred stock, $.001 par value -- authorized, 2,500,000
shares; none issued.........................................
Common stock, $.001 par value -- authorized, 50,000,000 shares;
issued, 32,326,581 shares (1997) and 31,077,329 shares
(1996)...................................................... 32,327 31,078
Capital in excess of par value................................. 30,360,446 24,760,269
Unrealized loss on securities available-for-sale............... (24,832)
Deficit........................................................ (12,969,189) (6,510,812)
----------- -----------
Total.................................................. 17,423,584 18,255,703
----------- -----------
Less common stock held by wholly-owned subsidiary -- 42,546
shares (at cost)............................................ (425) (425)
----------- -----------
Total shareholders' equity............................. 17,423,159 18,255,278
----------- -----------
TOTAL.................................................. $ 23,604,032 $25,309,781
=========== ===========
See notes to consolidated financial statements.
F-3
30
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JULY 31, 1997, 1996 AND 1995
1997 1996 1995
----------- ----------- -----------
REVENUES:
Net sales......................................... $38,592,252 $37,479,546 $35,064,245
Licensing fees and royalty revenue................ 72,640 2,100,484 1,956,654
----------- ----------- -----------
Total revenues............................ 38,664,892 39,580,030 37,020,899
----------- ----------- -----------
OPERATING COSTS AND EXPENSES:
Cost of products sold............................. 23,542,342 24,771,193 22,093,228
Selling, general and administrative............... 20,161,319 18,489,239 16,194,079
Merger-related expenses........................... 371,865 146,675
Impairment charges................................ 587,659
Litigation expenses............................... 1,147,363 339,578 276,633
Restructuring charges............................. 271,631
----------- ----------- -----------
Total operating costs and expenses........ 45,810,548 44,018,316 38,563,940
----------- ----------- -----------
LOSS FROM OPERATIONS................................ (7,145,656) (4,438,286) (1,543,041)
----------- ----------- -----------
OTHER INCOME (EXPENSES):
Interest income................................... 201,630 147,848 252,672
Interest expense.................................. (79,450) (471,607) (211,544)
Gain on disposition of royalty rights............. 7,519,529
Realized (loss) gain on short-term investments.... (24,832) (1,668) 9,611
----------- ----------- -----------
Total other income........................ 97,348 7,194,102 50,739
----------- ----------- -----------
(LOSS) INCOME BEFORE BENEFIT (PROVISION) FOR INCOME
TAXES AND CUMULATIVE EFFECT OF ACCOUNTING
CHANGE............................................ (7,048,308) 2,755,816 (1,492,302)
BENEFIT (PROVISION) FOR INCOME TAXES................ 589,931 (1,538,518) 180,000
----------- ----------- -----------
(LOSS) INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING
CHANGE............................................ (6,458,377) 1,217,298 (1,312,302)
CUMULATIVE EFFECT OF ACCOUNTING CHANGE.............. 29,945
----------- ----------- -----------
NET (LOSS) INCOME................................... $(6,458,377) $ 1,217,298 $(1,282,357)
=========== =========== ===========
(LOSS) INCOME PER COMMON SHARE:
(Loss) income before cumulative effect of
accounting change.............................. $ (.20) $ .04 $ (.04)
Cumulative effect of accounting change............
----------- ----------- -----------
NET (LOSS) INCOME PER COMMON SHARE.................. $ (.20) $ .04 $ (.04)
=========== =========== ===========
WEIGHTED AVERAGE NUMBER OF COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING..................... 31,530,096 30,401,236 29,134,901
=========== =========== ===========
See notes to consolidated financial statements.
F-4
31
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED JULY 31, 1997, 1996 AND 1995
COMMON STOCK UNREALIZED
COMMON STOCK HELD BY LOSS ON TOTAL
-------------------- CAPITAL IN WHOLLY-OWNED SECURITIES COMMON
PAR EXCESS OF SUBSIDIARY AVAILABLE- SHAREHOLDERS'
SHARES VALUE PAR VALUE DEFICIT (AT COST) FOR-SALE EQUITY
----------- ------- ----------- ------------ ------------ ---------- -------------
BALANCE, AUGUST 1, 1994........ 28,915,859 $28,916 $15,090,699 $ (6,028,936) $ (425) $ 9,090,254
Private placement of common
stock -- net of expenses of
$30,000.................... 316,875 317 1,115,487 1,115,804
Exercise of common stock
warrants................... 98,775 99 37,310 37,409
Exercise of common stock
options.................... 71,819 72 120,113 120,185
Issuance of stock............ 43,213 43 101,171 101,214
Unrealized loss on securities
available-for-sale......... $(27,961) (27,961)
Net loss..................... (1,282,357) (1,282,357)
---------- ------- ----------- ----------- ----- -------- -----------
BALANCE, JULY 31, 1995......... 29,446,541 29,447 16,464,780 (7,311,293) (425) (27,961) 9,154,548
Issuance of common stock..... 1,076,299 1,076 7,227,975 7,229,051
Exercise of common stock
warrants................... 140,138 141 179,368 179,509
Exercise of common stock
options.................... 414,351 414 753,146 753,560
Common stock warrants issued
for debt discount.......... 135,000 135,000
Change in unrealized loss on
securities
available-for-sale......... 3,129 3,129
Adjustment to conform year-
end of Bio-Dental.......... (416,817) (416,817)
Net income................... 1,217,298 1,217,298
---------- ------- ----------- ----------- ----- -------- -----------
BALANCE, JULY 31, 1996......... 31,077,329 31,078 24,760,269 (6,510,812) (425) (24,832) 18,255,278
Issuance of common stock..... 810,094 810 4,550,171 4,550,981
Exercise of common stock
warrants................... 153,665 154 478,211 478,365
Exercise of common stock
options.................... 285,493 285 571,795 572,080
Change in unrealized loss on
securities
available-for-sale......... 24,832 24,832
Net loss..................... (6,458,377) (6,458,377)
---------- ------- ----------- ----------- ----- -------- -----------
BALANCE, JULY 31, 1997......... 32,326,581 $32,327 $30,360,446 $(12,969,189) $ (425) $ -- $17,423,159
========== ======= =========== =========== ===== ======== ===========
See notes to consolidated financial statements.
F-5
32
ZILA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JULY 31, 1997, 1996 AND 1995
1997 1996 1995
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income....................................................... $(6,458,377) $ 1,217,298 $(1,282,357)
Cumulative effect of accounting change.................................. (29,945)
Adjustments to reconcile net (loss) income to net cash used in operating
activities:
Depreciation and amortization......................................... 1,154,428 763,664 520,681
Loss on disposals of property and equipment........................... 3,055 33,084 1,955
Gain on disposition of royalty rights................................. (7,519,529)
Compensation paid in stock............................................ 19,494 18,573 30,642
Note discount paid with stock warrants................................ 135,000
Realized loss (gain) on short-term investments........................ 24,832 1,668 (9,611)
Impairment of assets.................................................. 587,659
Change in assets and liabilities:
Trade accounts receivable............................................. 52,462 100,122 49,238
Other receivables..................................................... 301,251 (72,147) (44,304)
Inventories........................................................... 129,965 1,621,034 (267,507)
Prepaid expenses and other current assets............................. (80,379) 319,813 (223,060)
Deferred income taxes................................................. 715,485 (283,831) (180,000)
Other assets.......................................................... 368,465 (438,760) 3,652
Accounts payable and accrued expenses................................. 593,105 (346,575) 380,883
Income taxes receivable/payable....................................... (2,471,126) 2,543,689 (718,741)
Deferred revenue...................................................... 208,033 12,404 (9,431)
---------- ---------- ----------
Net cash used in operating activities............................. (4,851,648) (1,894,493) (1,777,905)
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments..................................... (222,615) (214,150) (270,985)
Proceeds from sale of short-term investments............................ 934,085 197,878 564,761
Purchases of property and equipment..................................... (601,172) (880,024) (557,095)
Proceeds from sale of property and equipment............................ 8,916 474
Proceeds from disposition of royalty rights............................. 7,890,047
Purchases of intangible assets.......................................... (118,465) (226,117) (254,196)
Acquisitions............................................................ 18,142 (125,000)
Loans to related parties................................................ (8,836)
Collections of notes receivable......................................... 32,801 131,956
---------- ---------- ----------
Net cash provided by (used in) investing activities............... 9,975 6,684,351 (393,921)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from borrowings............................................ 41,298 1,000,000
Net (payments) proceeds on short-term borrowings........................ (2,727,460) 207,383
Net proceeds from issuance of common stock.............................. 3,833,755 933,068 1,273,398
Principal payments on long-term debt.................................... (453,721) (12,509) (51,507)
---------- ---------- ----------
Net cash provided by (used in) financing activities............... 3,421,332 (1,806,901) 2,429,274
---------- ---------- ----------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS...................... (1,420,341) 2,982,957 257,448
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR.............................. 3,491,904 508,947 524,414
---------- ---------- ----------
CASH AND CASH EQUIVALENTS, END OF YEAR.................................... $ 2,071,563 $ 3,491,904 $ 781,862
========== ========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest.................................................. $ 79,450 $ 483,297 $ 211,544
========== ========== ==========
Cash paid for income taxes.............................................. $ 1,165,710 $ 3,000 $ 691,000
========== ========== ==========
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Issuance of 259,398 shares of common stock in connection with the
acquisition of Cygnus................................................. $ 1,725,000
==========
Assumption of liabilities in connection with the acquisition of
Cygnus................................................................ $ 737,200
==========
Fair value of Cygnus assets acquired other than cash and cash
equivalents........................................................... $ 342,567
==========
Goodwill recorded in connection with the acquisition of Cygnus.......... $ 2,101,491
==========
Issuance of 869,118 shares of common stock in connection with the
acquisition of CTM.................................................... $ 7,170,223
==========
Assumption of liabilities in connection with the acquisition of CTM..... $ 70,000
==========
Fair value of assets acquired other than cash and cash equivalents...... $ 273,399
==========
Assumption of liabilities in connection with the acquisition of Oral
Vision................................................................ $ 202,827
==========
Issuance of 39,189 shares of common stock in connection with the
acquisition of Crown.................................................. $ 70,572
==========
See notes to consolidated financial statements.
F-6
33
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JULY 31, 1997, 1996 AND 1995
1. NATURE OF BUSINESS ACTIVITIES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business Activities -- Zila, Inc. and subsidiaries (the
"Company") is involved in the acquisition, development and marketing of
over-the-counter, non-prescription products. In addition, through its
wholly-owned subsidiaries, the Company sells professional dental products
domestically and internationally. It markets consumable dental merchandise and
supplies and equipment via telemarketing and catalog sales and markets
high-technology dental products such as intra-oral cameras and practice software
to dentists.
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") and Cygnus Imaging, Inc. ("Cygnus").
Zila International Inc. has no operations and its assets at July 31, 1997 and
1996 consist of 42,546 shares of common stock of the Company. All significant
intercompany balances and transactions are eliminated in consolidation.
On January 8, 1997, the Company completed a merger with Bio-Dental. On
December 30, 1996, Bio-Dental's shareholders approved the all-stock transaction
which provided for a per share exchange of .825 shares of the Company's common
stock for each share of Bio-Dental common stock outstanding. As of January 8,
1997, Bio-Dental had 6,565,300 shares of common stock outstanding.
The merger has been accounted for as a pooling of interests, and
accordingly, the accompanying consolidated financial statements give retroactive
effect to the Bio-Dental merger and include the combined operations of the
Company and Bio-Dental for all periods presented. Prior to the combination,
Bio-Dental's year-end was March 31. Effective August 1, 1995, Bio-Dental's
results are reported on a July 31, 1996 basis along with the results of Zila,
Inc. Bio-Dental's net loss of $416,817 for the four-month period ended July 31,
1995 is reflected as an adjustment to the deficit during the year ended July 31,
1996. For the four-month period ended July 31, 1995, Bio-Dental had revenues of
$11,056,774, operating costs and expenses of $11,631,735, and a net loss of
$416,817. Certain adjustments and reclassifications have been made to conform
previously issued Bio-Dental financial statements to classifications and
accounting policies used by the Company.
The following table shows the effect on the results of operations as
restated for the periods prior to the combination of Bio-Dental.
1997 1996 1995
----------- ----------- -----------
Sales:
Zila, Inc................................. $ 3,153,812 $ 5,978,131 $ 5,147,667
Bio-Dental................................ 16,944,215 31,501,415 29,916,578
----------- ----------- -----------
Combined sales.............................. $20,098,027 $$37,479,546 $35,064,245
=========== =========== ===========
Net income (loss):
Zila, Inc................................. $ (135,528) $ (827,337) $ (862,920)
Bio-Dental................................ (976,356) 2,044,635 (419,437)
----------- ----------- -----------
Combined net income (loss).................. $(1,111,894) $ 1,217,298 $(1,282,357)
=========== =========== ===========
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.
F-7
34
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Cash Equivalents -- The Company considers highly liquid investments
purchased with original maturities of three months or less to be cash
equivalents.
Short-Term Investments -- The Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in
Debt and Equity Securities, on August 1, 1994. SFAS No. 115 requires the
classification of securities at acquisition into one of three categories:
available-for-sale, held to maturity or trading. All the Company's investments
are classified as available-for-sale.
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 20 years. Leasehold improvements are depreciated over the lease term or the
estimated useful life, whichever is shorter.
Goodwill is being amortized on a straight-line basis over 15 to 40 years.
The Company assesses the recoverability of goodwill based on undiscounted
projections of future cash flows.
Other intangible assets consist of deferred patent and licensing costs,
software rights, organizational costs, 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 $2,270,000, $626,000 and $711,000 in
1997, 1996 and 1995, respectively, were expensed. The Company assesses the
recoverability of its intangible assets based on undiscounted projections of
future cash flows.
Net (loss) income per common share is computed based on the weighted
average number of common shares outstanding during each period after giving
effect for any dilutive stock options, warrants and convertible preferred stock,
all of which are considered to be common stock equivalents. For the years ended
July 31, 1997 and 1995, 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. Fully diluted net (loss) income per
common share is not materially different from primary net (loss) income per
common share.
New Accounting Pronouncements -- In March 1995, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 121, Accounting for Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. This Statement
establishes accounting standards for the impairment of long-lived assets,
certain identifiable intangibles and goodwill related to those assets to be held
and used and long-lived assets and certain identifiable intangibles to be
disposed of. The Statement requires that long-lived assets and certain
identifiable intangibles to be held and used by an entity be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. In addition, the Statement
requires that certain long-lived assets and intangibles to be disposed of be
reported at the lower of carrying amount or fair value less costs to sell. The
Company adopted this accounting standard effective August 1, 1996, as required
and adoption of this Statement had no material impact on the financial
Statements.
In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based
Compensation. As permitted by SFAS No. 123, the Company uses the intrinsic
value-based method prescribed by the Accounting Principles Board ("APB") Opinion
No. 25, Accounting for Stock Issued to Employees, and related interpretations in
accounting for its stock-based employee compensation plans. Accordingly, no
compensation expense has been recognized for such plans. A summary of the pro
forma effects on reported income (loss) from continuing operations and income
(loss) per share for fiscal 1997 and 1996 as if the fair
F-8
35
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
value-based method of accounting defined in SFAS No. 123 had been applied is
included in Note 9 to these consolidated financial statements.
Beginning the second quarter of fiscal 1998, the Company will be required
to implement SFAS No. 128, Earnings per Share, which requires, among other
matters, presentation of basic earnings per share, which is calculated utilizing
only weighted average common shares outstanding. SFAS No. 128 is not expected to
materially impact previously reported earnings (loss) per share.
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income,
and SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information. SFAS No. 130 requires that an enterprise (a) classify items of
other comprehensive income by their nature in a financial statement and (b)
display the accumulated balance of other comprehensive income separately from
retained earnings and additional capital in the equity section of a statement of
financial position. SFAS No. 131 establishes standards for the way that public
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports to shareholders. It also
establishes standards for disclosures about products and services, geographic
areas and major customers. Both statements are effective for fiscal years
beginning after December 15, 1997. The Company has not completed evaluating the
impact of implementing the provisions of SFAS Nos. 130 and 131.
Financial Instruments -- The following disclosure of the estimated fair
value of financial instruments is made in accordance with the requirements of
SFAS No. 107, Disclosures About Fair Value of 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 is 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.
Certain reclassifications have been made to the 1996 and 1995 financial
statements to conform to the classifications used in 1997.
2. ACQUISITIONS
On April 4, 1997, the Company acquired Cygnus, a privately-held company
located in Scottsdale, Arizona that manufactures and distributes intra-oral
camera systems and other dental imaging products. The acquisition was accounted
for as a purchase and resulted in the issuance of 259,398 shares of the
Company's common stock with a market value of $1,725,000 and the recording of
approximately $2,101,000 of goodwill. The goodwill will be amortized on a
straight-line basis over 15 years.
The accompanying consolidated statements of operations reflect the
operating results of Cygnus since the effective date of the acquisition. Pro
forma unaudited consolidated operating results of the Company and
F-9
36
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Cygnus for the years ended July 31, 1997 and 1996, assuming the acquisition had
been made at the beginning of the period presented, are summarized below:
1997 1996
----------- -----------
Total revenues.................................... $40,150,865 $40,598,224
=========== ===========
Net (loss) income................................. $(6,717,275) $ 1,124,910
=========== ===========
Net (loss) income per common share................ $ (0.20) $ 0.04
=========== ===========
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 acquisition. The pro forma financial information is not
necessarily indicative of the results of operations as they would have been had
the transaction been affected on the assumed date.
On March 7, 1996, the Company purchased one-third of the outstanding common
stock of CTM Associates, Inc. ("CTM") from one of the three directors and
shareholders of CTM. On June 3, 1996, the Company acquired the remaining
two-thirds of the outstanding shares of CTM. The only significant asset of CTM
was the technology rights it held related to OraTest (a diagnostic for oral
cancer and site delineation device for biopsy and surgical excision) and its
right to receive certain royalties from sales of OraTest from the Company.
Accordingly, the acquisition of CTM eliminates the Company's obligation to pay
royalties to CTM on revenues generated from sales of OraTest. As consideration
for the acquisition of all of the CTM common stock, the Company issued a total
of 869,118 shares of the Company's common stock with a value of $7,170,223, paid
$125,000, and assumed certain liabilities of approximately $70,000. The
acquisition was accounted for as an acquisition of assets and the purchase price
was recorded as purchased technology rights. The purchased technology rights are
being amortized on a straight-line basis over the expected period of benefit of
17 years which is based on the remaining life of the related patents.
On November 14, 1994, Bio-Dental signed an agreement and purchased the
assets and certain liabilities of Crown Systems, Inc. ("Crown"), effective
November 1, 1994. In connection with this purchase, Bio-Dental issued 29,858
shares of common stock to Crown. The assets acquired consisted primarily of
accounts receivable and dental practice management software rights. The assets
and liabilities are held in Integrated Dental Technologies, Inc. ("IDT"), a
wholly-owned subsidiary of Bio-Dental. As part of the transaction, Bio-Dental
retired approximately $205,000 of assumed liabilities. On October 25, 1995,
Bio-Dental issued an additional 9,331 shares of common stock to the previous
owners of Crown due to a change in the calculated purchase price. The
transaction was accounted for as a purchase. The software rights which were
acquired were being amortized over a period of five years. In October 1996,
Bio-Dental recorded an impairment write-down against all such software rights as
described in Note 15.
In 1994, Bio-Dental purchased the assets and certain liabilities of Oral
Vision, Inc. In connection with this purchase, the Company issued 225,000 shares
of restricted common stock. The transaction was accounted for as a purchase.
F-10
37
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. SHORT-TERM INVESTMENTS
Short-term investments consisted of the following at July 31, 1996:
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------- ------- ------- --------
Mutual and money market funds............. $449,718 $10,971 $24,702 $435,987
Corporate fixed income securities......... 111,186 284 3,506 107,964
Government fixed income securities........ 175,399 7,880 167,519
-------- ------- ------- --------
Total short-term investments.............. $736,303 $11,255 $36,088 $711,470
======== ======= ======= ========
All of the above short-term investments that are being held for indefinite
periods of time, including those which may be sold in response to needs for
liquidity or changes in interest rates, are accounted for as securities
available-for-sale and are carried at fair value, with the net, after-tax,
unrealized holding gain or loss reported as a separate component of
shareholders' equity with no effect on current results of operations. The change
in the unrealized loss on securities available-for-sale for the years ended July
31, 1997 and 1996 is as follows:
Unrealized loss on securities available-for-sale at August 1, 1995........ $(27,961)
Net decrease in unrealized loss, due principally to decrease in interest
rates................................................................... 3,129
--------
Unrealized loss on securities available-for-sale at July 31, 1996......... (24,832)
Realized loss............................................................. 24,832
--------
Unrealized loss on securities available-for-sale at July 31, 1997......... $ --
========
4. INVENTORIES
Inventories consist of the following at July 31:
1997 1996
---------- -----------
Finished goods..................................... $4,381,339 $ 5,168,486
Raw materials...................................... 451,563 290,771
Inventory reserves................................. (546,275) (1,258,815)
---------- ----------
Total inventories.................................. $4,286,627 $ 4,200,442
========== ==========
Amounts charged to cost of products sold to increase inventory reserves
during fiscal 1997, 1996 and 1995 were $396,996, $1,117,065 and $54,750,
respectively.
5. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at July 31:
1997 1996
---------- ----------
Land................................................ $ 216,731 $ 216,731
Building and improvements........................... 651,034 517,628
Furniture and equipment............................. 2,234,889 2,086,511
Leasehold improvements and other assets............. 387,631 390,302
Production and warehouse equipment.................. 118,553 111,339
---------- ----------
Total property and equipment 3,608,838 3,322,511
Less accumulated depreciation and amortization...... 1,743,453 1,393,733
---------- ----------
Property and equipment -- net....................... $1,865,385 $1,928,778
========== ==========
F-11
38
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. INTANGIBLE ASSETS
Intangible assets consist of the following at July 31:
1997 1996
---------- ----------
Purchased technology rights -- net of accumulated
amortization of $509,180 (1997) and $72,740
(1996)............................................ $6,910,293 $7,346,733
========== ==========
Goodwill -- net of accumulated amortization of
$162,070 (1997) and $132,908 (1996)............... $2,693,139 $ 836,729
========== ==========
Patents............................................. $ 570,494 $ 466,978
Licensing costs..................................... 1,086,509 1,063,636
Software rights..................................... 287,982
Organizational costs................................ 84,544 113,626
Covenants not to compete............................ 120,000 120,000
---------- ----------
Total other intangible assets....................... 1,861,547 2,052,222
Less accumulated amortization....................... 633,005 602,730
---------- ----------
Other intangible assets -- net...................... $1,228,542 $1,449,492
========== ==========
Deferred licensing costs consist primarily of certain costs associated with
obtaining FDA approval for a new product, OraTest (formerly OraScan). The
recoverability of the deferred licensing costs and purchased technology rights
is dependent upon both FDA approval and sufficient revenues generated from sales
of OraTest; management believes that they will receive FDA approval and generate
revenues sufficient to recover such costs. Purchased technology rights relate to
the acquisition of CTM (Note 2).
Amortization of the Company's intangible assets during fiscal 1997, 1996
and 1995, was $656,086, $335,214 and $153,463, respectively.
7. LONG-TERM DEBT
At July 31, 1997, long-term debt consists of a mortgage note bearing
interest at the bank's prime rate (8.25% at July 31, 1997) plus 2.25% per year
due in monthly principal installments of $2,315, through March 2001 with a
balloon payment due April 1, 2001. The Company has the option through March 1998
to convert to a fixed interest rate of 4.25% over the United States Treasury
rate. The note is collateralized by the Company's land and building.
Aggregate annual maturities of long-term debt for the years ending July 31
are as follows:
1998.............................................................. $ 39,895
1999.............................................................. 41,098
2000.............................................................. 36,151
2001.............................................................. 298,659
--------
Total............................................................. 415,803
Less current portion.............................................. 39,895
--------
Long-term portion................................................. $375,908
========
Under the mortgage note, the Company is required to comply with financial
covenants based on certain financial ratios. At July 31, 1997, the Company was
not in compliance with two of these covenants. The Company has received a waiver
from the bank with respect to these covenants at July 31, 1997 and the covenants
have been modified for measurement dates subsequent to July 31, 1997. Management
believes it
F-12
39
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
will comply with the modified covenants at future measurement dates.
Accordingly, the Company's mortgage note is classified as long-term.
8. LICENSING FEE INCOME AND ROYALTIES
The Company has entered into various licensing agreements (the
"Agreements"). Under the terms of the Agreements, the licensees acquire the
right to manufacture and sell the Company's products in markets previously not
pursued by the Company. In return, the Company will receive non-refundable
license fees and/or royalties equal to a fixed percentage of the net sales by
the licensees of the Company's products. One of the Agreements provides that the
royalty payments will meet certain minimum annual levels irrespective of the
volume of sales subject to the Agreement.
During the year ended July 31, 1996, the Company received $750,000 in
non-refundable licensing fees from The Procter & Gamble Company ("P&G") in
connection with a licensing agreement between P&G and the Company, which was
subsequently terminated on April 3, 1996. Additionally, under the licensing
agreement with P&G, the Company received $265,330 in reimbursements for costs
associated with obtaining FDA approval for OraTest. At July 31, 1996, the
Company had a receivable of approximately $130,000 from P&G which was received
after year-end.
In March 1991, Bio-Dental incorporated a wholly-owned subsidiary,
Denticator International, Inc. ("DII") and transferred Bio-Dental's
manufacturing operations into DII in exchange for the issuance of a $600,282
note to Bio-Dental with monthly principal payments of $10,005 plus interest at
150% of Bio-Dental's cost of funds from April 1, 1994 through March 31, 1999.
Interest only payments were made from March 1991 through March 31, 1994.
Effective with the date of incorporation, Bio-Dental entered into a licensing
agreement with DII for the manufacture and sale of certain dental products owned
by Bio-Dental. Under this agreement, DII paid Bio-Dental a monthly royalty equal
to the greater of $30,000 or 17% of net sales of DII. In addition, the agreement
provided for further royalties to be paid to Bio-Dental if DII achieved certain
levels of profitability. On March 31, 1991, Bio-Dental sold all of the
outstanding capital stock of DII to DII's former operations manager. The sales
agreement incorporated the licensing agreement described above.
During 1996 and 1995, Bio-Dental earned royalties under the DII licensing
agreement totaling $1,235,069 and $1,665,699, respectively, which are included
in licensing fees and royalty revenue and interest on the note receivable
totaling $66,739 and $69,418, respectively, which is included in interest
income.
On July 22, 1996, Young Innovations, Inc. ("Young") acquired substantially
all of the assets and certain liabilities of DII. Bio-Dental received
approximately $7,500,000 in lieu of future royalties that Bio-Dental was
entitled to receive in connection with its licensing agreement with DII. In
addition, Young issued Bio-Dental a product credit against future purchases from
Young equal to the amounts due Bio-Dental at the time of closing. Included in
other receivables at July 31, 1997 and 1996 is $319,127 and $600,249,
respectively, of product credits due from Young. Additionally, at July 31, 1996,
product credits due from Young of $355,103 are included in other assets.
Concurrent with the closing of the transaction, Bio-Dental canceled options to
purchase 50,000 shares of Bio-Dental's restricted common stock that were held by
DII.
9. STOCK OPTIONS AND WARRANTS
As a result of the merger described in Note 1, each Bio-Dental stock option
or stock purchase warrant that was outstanding at the merger date can be used to
purchase .825 shares of Zila, Inc. common stock. The exercise price of
outstanding Bio-Dental options and warrants was also adjusted at the merger
date. The new exercise prices are calculated by dividing the original exercise
price by .825. The summary of activity related to options and warrants below
includes Bio-Dental options and warrants adjusted for the terms of the merger.
a. Options -- The Company adopted the 1997 Stock Option Award Plan which
became effective on February 5, 1997, authorizing the Board of Directors to
grant options to employees and certain employee
F-13
40
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
directors of the Company to purchase up to 1,000,000 shares of the Company's
common stock. The options will be issued with an exercise price no less than
market value at the date of grant. Options may be exercised up to five to ten
years from the date of grant. At July 31, 1997, 872,519 shares were available
for grant under this plan.
The Company adopted a Stock Option Award Plan which became effective on
September 1, 1988, authorizing the Board of Directors to grant options to
employees and certain employee-directors of the Company to purchase up to
4,000,000 shares of the Company's common stock. The plan was amended December 8,
1995 to increase the authorized number of shares to 5,000,000. The options will
be issued with 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, 1997, 15,355 shares were available for grant under
this plan.
The Company adopted a Non-Employee Directors Stock Option Plan which became
effective October 20, 1989, authorizing the Board of Directors to grant options
to 100,000 shares to non-employee members of the Board of Directors in
increments of 2,500 shares per director each year. The plan was amended December
8, 1995 to increase the authorized number of shares to 200,000. The options will
be issued with 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, 1997, 80,000 shares were available for grant under this plan.
A summary of the status of the option plans as of July 31, 1997, 1996 and
1995 and changes during the years then ended is presented below:
1997 1996 1995
--------------------- --------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- -------- ---------- -------- --------- --------
Outstanding at beginning of year... 1,906,575 $ 2.81 2,040,936 $ 2.35 1,817,596 $ 2.26
Granted............................ 712,558 6.98 354,242 4.26 318,580 3.50
Exercised.......................... (285,493) 1.90 (414,351) 2.28 (71,819) 1.78
Forfeited.......................... (181,694) 3.93 (74,252) 3.51 (23,421) 3.06
---------- ---------- ----------
Outstanding at end of year......... 2,151,946 4.03 1,906,575 2.81 2,040,936 2.35
========== ========== ==========
Options exercisable at year-end.... 1,703,267 1,851,575
========== ==========
Weighted average fair value of
options granted during the
year............................. $ 2.54 $ 1.90
========== ==========
The following table summarizes information about fixed stock options
outstanding at July 31, 1997:
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, 1997 CONTRACTUAL LIFE PRICE JULY 31, 1997 PRICE
- ---------------- ------------- ---------------- -------- ------------- --------
$0.12 - $1.31 397,712 3.36 $ 1.25 397,712 $ 1.25
2.42 - 3.94 714,080 6.18 2.91 711,580 2.91
4.24 - 6.06 466,696 8.34 4.51 418,517 2.42
6.78 - 8.18 573,458 9.32 7.00 175,458 5.83
--------- ---------
0.12 - 8.18 2,151,946 1,703,267
========= =========
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
F-14
41
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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) and income (loss) per share for the years ended July
31, 1997 and 1996 would have been reduced (increased) to the pro forma amounts
indicated below, followed by the model assumptions used:
JULY 31,
---------------------------
1997 1996
----------- -----------
Net income (loss):
As reported..................................... $(6,458,000) $1,217,000
Pro forma....................................... $(7,791,000) $862,000
Net income (loss) per weighted average number of
common and common equivalent shares outstanding:
As reported..................................... $(.20) $.04
Pro forma....................................... $(.25) $.03
Black-Scholes model assumptions:
Risk-free interest rate......................... 5.5 - 6.0% 5.5 - 6.0%
Expected volatility............................. 39% 39%
Expected term................................... 2 - 6 years 3 - 6 years
Dividend yield.................................. 0% 0%
b. Warrants -- The Company has issued warrants to various investors,
shareholders and other third parties in connection with services provided and
purchases of the Company's stock. Activity related to such warrants, which
expire at various dates through October 2000, is summarized as follows:
NUMBER OF WARRANT PRICE
SHARES PER SHARE
--------- ------------------
Outstanding, August 1, 1994.................... 1,143,197 $ .60 - $ 3.77
Issued....................................... 50,000 2.50
Exercised.................................... (98,775) .60 - 2.41
Expired...................................... (137,520) 3.00
---------
Outstanding, July 31, 1995..................... 956,902 .60 - 3.77
Issued.......................................
Exercised.................................... (140,138) 2.41 -
Expired...................................... (46,092) 3.13
---------
Outstanding, July 31, 1996..................... 770,672 .60 - 3.77
Issued....................................... 300,000 8.6125
Exercised.................................... (153,665) .60 - 3.00
Expired...................................... (14,992) .75 - 2.41
---------
Outstanding, July 31, 1997................... 902,015 $ .60 - $8.6125
=========
10. RELATED PARTY TRANSACTIONS
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 and a director of the Company, a royalty of 5% of gross
sales of the treatment composition. Royalty expense to Dr. Tinnell for the years
ended July 31, 1997, 1996 and 1995 was $310,827, $300,078 and $263,311,
respectively.
F-15
42
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company advanced $129,338 in fiscal year 1994 to certain of its
officers for withholding taxes due upon exercise of common stock options. The
outstanding advances were $16,167 at July 31, 1996. The notes bore interest at
4.16% per year and were payable in full on December 31, 1996. During fiscal year
1997, the note balance was paid down to $11,167 and the remaining amount was
forgiven. Included in interest income is $962 and $1,609 for the years ended
July 31, 1996 and 1995, respectively, related to these notes.
11. INCOME TAXES
The consolidated income tax (benefit) provision consists of the following
for the years ended July 31:
1997 1996 1995
--------- ---------- ---------
Current:
Federal............................... $(312,000) $1,524,000
State................................. -- 455,000
--------- ----------
Total current........................... (312,000) 1,979,000
--------- ----------
Deferred:
Federal............................... (304,000) (245,000) $(124,200)
State................................. (26,000) (195,000) (55,800)
--------- ---------- ---------
Total deferred.......................... (278,000) (440,000) (180,000)
--------- ---------- ---------
Total consolidated income tax (benefit)
provision............................. $(590,000) $1,539,000 $(180,000)
========= ========== =========
The reconciliation of the federal statutory rate to the effective income
tax rate for the years ended July 31 is as follows:
1997 1996 1995
---- ---- ----
Federal statutory rate................................ (34)% 34% (34)%
Adjustments:
State income taxes -- net of federal benefit........ (6) 6 (6)
Non-deductible meal, entertainment and other
expenses......................................... 2 2 3
Increase in valuation allowance..................... 30 14 25
--
--- ---
Effective tax rate.................................... (8)% 56% (12)%
=== == ===
F-16
43
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the Company's deferred income tax assets and liabilities
for the years ended July 31 are shown below:
1997 1996
----------- -----------
Current deferred income tax assets:
Net operating loss carryforwards........................ $ 6,810,000 $ 5,840,400
Allowance for obsolete or discontinued inventory........ 219,000 404,000
Impairment of assets.................................... 235,000
Reserve for litigation.................................. 180,000
Product warranty allowance.............................. 173,000 114,000
Allowance for doubtful accounts......................... 140,000 70,000
Accrued vacation........................................ 40,000 28,000
Other................................................... 20,000 15,000
----------- -----------
Total current deferred income tax assets.................. 7,817,000 6,471,400
Non-current deferred income tax liabilities:
Federal depreciation.................................... (8,000) (8,000)
Valuation allowance....................................... (7,563,000) (5,502,000)
----------- -----------
Net deferred income tax asset............................. $ 246,000 $ 961,400
=========== ===========
As a result of applying SFAS No. 109, previously unrecorded deferred tax
benefits from operating loss carryforwards incurred by the Company were
recognized at August 1, 1993, as part of the cumulative effect of adopting the
Statement. Also recognized at that date was a valuation allowance for the same
amount. Approximately $1,966,000 of the deferred tax asset before valuation
allowance relates to deductions generated by the exercise of stock options,
which, if realized, will result in an increase in capital in excess of par
value. Management believes the valuation allowance reduces deferred tax assets
to an amount that represents management's best estimate of the amount of such
deferred tax assets that more likely than not will be realized.
At July 31, 1997, the Company had federal net operating loss carryforwards
totaling approximately $18,346,000 which expire, if not previously utilized,
from 1998 through 2012. Net operating loss carryforwards for state income tax
purposes, totaling approximately $9,534,000, must be utilized within five years
of the date of their origination, and expire from 1999 through 2003.
12. DALECO ZILA PARTNERS II, L.P.
In June 1992, the Company entered into an agreement with Daleco Capital
Corporation to form a limited partnership known as Daleco Zila Partners II, L.P.
(the "Partnership"). The Company and its officers have no partnership interest
in the Partnership. The purpose of the Partnership was to provide the Company
with a means to fund the marketing program for certain new products. The
original Partnership agreement provided for a minimum of $150,000 and a maximum
of $1,562,500 to be raised by the sale of partnership units. Under the original
agreement, the Partnership will expend up to 80% of the gross partnership
proceeds for marketing and sales-related expenditures on behalf of the Company.
In 1994, the Partnership agreement was amended to increase the maximum amount of
marketing funds potentially available to the Company to be raised to $2,250,000.
In addition, the Company issued to Daleco Capital Corporation and the
Partnership warrants to purchase 100,000 and 300,000 shares, respectively, of
the Company's common stock at $3.00 a share subject to a vesting schedule. As a
part of the amendment to the original agreement, Daleco Capital Corporation and
the Partnership were issued an additional 80,000 and 240,000 warrants,
respectively. The warrants vest at the rate at which the Partnership expends the
net partnership proceeds on the Company's marketing program.
F-17
44
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At July 31, 1997, approximately $1,820,000 has been spent. The Company is
committed to pay the Partnership a commission equal to 5% to 10% of the gross
sales of certain of the Company's new products, until such time as three times
the amount of funds expended on the Company's marketing program by the
Partnership has been paid to the Partnership.
Included in selling, general and administrative expense for the years ended
July 31, 1997, 1996 and 1995 is approximately $64,000, $15,000 and $25,000,
respectively, of commissions paid to the Partnership.
During the year ended July 31, 1995, the Partnership funded or accrued
approximately $10,500 in marketing costs. The Company had no funding of
marketing programs by the Partnership after July 31, 1995 and anticipates no
further funding. Accordingly, 137,520 warrants expired as a result of the
Partnership raising less than the maximum level of marketing funds.
13. COMMITMENTS AND CONTINGENCIES
The Company has a New Drug Application pending with the FDA for OraTest.
The initiation of the marketing of OraTest in the United States is dependent
upon the approval of the New Drug Application by the FDA. During 1994, the FDA
approved the Company's application for an Investigational New Drug for OraTest,
which allows the Company to manufacture the product in the United States for
clinical studies and export to certain foreign countries. The Company believes
that the FDA will approve the New Drug Application and the production and
marketing of OraTest (Note 6).
The Company leases a manufacturing facility in Phoenix, Arizona under a
three year agreement which expires April 30, 1999. The agreement has an option
to renew for an additional five years. Additionally, the Company leases offices,
warehouse facilities and certain equipment, under operating leases which expire
through 2002. Future minimum lease payments under these noncancellable leases
are as follows:
1998.............................................. $252,592
1999.............................................. 210,950
2000.............................................. 168,792
2001.............................................. 169,276
2002.............................................. 55,748
--------
Total............................................. $857,358
========
Rent expense for the years ended July 31, 1997, 1996 and 1995 totaled
$209,110, $171,096 and $170,936, respectively.
The Company filed a complaint against Colgate-Palmolive Company ("Colgate")
alleging that one of Colgate's products infringes upon one of the Company's
patents. Colgate answered the Company's complaint, denying the infringement and
asserting that the Company's patent is invalid and unenforceable. The case was
settled on March 6, 1997 and had no material impact on the Company's
consolidated financial statements.
In July 1995, Bio-Dental was named as a defendant, along with Bio-Dental's
transfer agent and a shareholder of Bio-Dental (the "Shareholder"), in a
lawsuit. The lawsuit alleges that Bio-Dental wrongfully failed to register
200,000 Bio-Dental shares of stock in the name of the plaintiffs which were
pledged as security by the Shareholder for a debt owed by the Shareholder to the
plaintiffs.
Bio-Dental denies all of the material allegations of the lawsuit against it
and asserts various affirmative defenses. Bio-Dental will vigorously defend
against the claims set forth in the lawsuit. In September 1996, Bio-Dental
accrued a liability of $450,000 because it decided to attempt a settlement of
this litigation. Bio-Dental's settlement attempt was not successful. In January
1997, a judgment by the court in favor of Bio-Dental and against the plaintiffs
was filed. In February 1997, the plaintiffs started the process to appeal the
judgment.
F-18
45
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Upon consummation of the Company's merger with Bio-Dental, each of the
outstanding shares of Bio-Dental common stock was converted into .825 shares of
the Company's common stock. Subsequent to the merger, the Company's stock
transfer agent was presented with a certificate purporting to represent 220,000
shares of Bio-Dental common stock which did not appear on the records of
Bio-Dental's stock transfer agent as of the closing date. The Company is
currently investigating this matter and has not determined whether any shares of
the Company's common stock are required to be issued in exchange for the shares
purportedly represented by this certificate.
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.
14. EMPLOYEE BENEFIT PLAN
The Company has adopted the Zila, Inc. 401(k) Savings and Retirement Plan
(the "Plan") for the benefit of eligible employees. Employees may elect to defer
receipt of a portion of their compensation to future years. The Company may make
matching or profit sharing contributions to the Plan. During 1997, 1996, and
1995, the Company contributed approximately $19,000, $14,000 and $11,000,
respectively, to the Plan.
Bio-Dental adopted an Employee Stock Ownership Plan ("ESOP") in fiscal year
1991. The benefits allocated to each participant are in direct proportion to
that person's annual compensation. All employees who meet the following criteria
are eligible for benefits: 1) must be 18 years of age or older; 2) must have
worked at least 1,000 hours in the given plan (fiscal) year; and 3) must be
employed on the last day of the plan year. All participants become fully vested
after 5 years of continuous employment with Bio-Dental.
Once vested, a person may receive benefits under the plan:
a. no later than six years from the date of termination of employment
with Bio-Dental; or
b. upon reaching the age of 60.
In June 1997, the assets of the plan were frozen.
15. RESTRUCTURING
During the year ended July 31, 1996, the Company recorded a charge of
$271,631 for the restructuring of IDT. As a result of the restructuring, IDT no
longer sells computer hardware or filmless x-ray systems. Costs included in the
restructuring charge include contract costs and other costs.
As a result of management's decision to restructure its operations, an
inventory valuation allowance of approximately $300,000 was recorded, and
management reserved approximately $250,000 for sales returns related to
discontinued items.
In connection with assessing the recoverability of goodwill and other
intangible assets in the first quarter of fiscal 1997, the Company determined
that such assets that are associated with IDT would not likely be recoverable as
defined by SFAS No. 121. This determination was the result of IDT failing to
achieve original projections of operating results subsequent to the
restructuring of IDT in early 1996. As a result, a $587,659 impairment loss was
recognized to reduce the carrying value of these long-lived assets to fair
value. Fair value was estimated based on management's best estimate of
discounted future cash flows.
16. EQUITY LINE INVESTMENT AGREEMENT
Effective April 30, 1997, the Company entered into an investment agreement
(the "Investment Agreement") with Deere Park Capital Management (the "Investor")
which allows the Company to sell up to $25,000,000 of the Company's common stock
with the proceeds to be used to fund OraTest marketing and
F-19
46
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
general corporate purposes. The option to sell stock to the Investor will remain
available for a period of 12 months beginning August , 1997 (the "12 Month
Period"). As part of the Investment Agreement, the Company sold $3,000,000 of
stock on April 30, 1997, and has committed to sell an additional $10,000,000 of
common stock to the Investor over the 12 Month Period.
The Investment Agreement provides that the Company can obtain up to
$2,000,000 at any one time through the sale of the Company's common stock. All
shares sold will be at a 7% discount to the average low trading price of the
Company's common stock over a specified period of time, subject to a maximum
purchase price calculation. Sales are subject to the satisfaction of certain
conditions, including registration of the shares, a minimum market volume, and
certain limitations on the number of shares of the Company's common stock
outstanding.
As a commitment fee for keeping the equity line available for the 12 Month
Period, the Company has issued warrants dated May 7, 1997 (the "Warrants") to
the Investor exercisable for 300,000 shares of common stock at an exercise price
of $8.6125 per share. The Warrants are exercisable for a three year period
commencing October 31, 1997.
During October 1997, the Company sold $8,000,000 of the Company's common
stock under the Investment Agreement to the Investor. The proceeds from the sale
are intended for potential acquisitions and general corporate purposes.
17. SEGMENTS OF BUSINESS
The Company aligns its business into two segments, Consumer and
Professional. The Consumer segment's principal products are over-the-counter,
non-prescription oral care products. Major brands include Zilactin(R),
Zilactin(R)-L, (formerly Zilactol(R)), Zilactin(R)-B and Zilactin(R)-Lip. These
products are distributed primarily through pharmaceutical wholesalers and
chains, food wholesalers and chains, rack jobbers and convenience stores. The
Professional segment includes dental supplies, dental equipment, dental practice
management software, digital x-ray devices, intra-oral cameras and OraTest
product development costs. These products are used principally in the
professional fields by dentists and other oral care health professionals and are
sold directly to the professional.
Intersegment sales are not significant.
CONSUMER PROFESSIONAL TOTAL
---------- ----------- -----------
Net sales:
1997....................................... $6,719,228 $31,873,024 $38,592,252
1996....................................... 5,978,131 31,501,415 37,479,546
1995....................................... 5,147,667 29,916,578 35,064,245
(Loss) income before income taxes:
1997....................................... (1,871,098) (5,177,210) (7,048,308)
1996....................................... (443,038) 3,198,854 2,755,816
1995....................................... (213,040) (1,279,262) (1,492,302)
Identifiable assets:
1997....................................... 3,834,527 19,769,504 23,604,031
1996....................................... 3,135,973 22,173,808 25,309,781
1995....................................... 3,353,565 13,338,294 16,691,859
Capital expenditures:
1997....................................... 168,299 432,873 601,172
1996....................................... 256,175 623,849 880,024
1995....................................... 51,364 505,731 557,095
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47
ZILA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONSUMER PROFESSIONAL TOTAL
----------- ----------- -----------
Depreciation and amortization:
1997....................................... 157,527 996,900 1,154,427
1996....................................... 136,925 626,739 763,664
1995....................................... 111,941 408,740 520,681
18. SUBSEQUENT EVENTS
On October 17, 1997, the Company entered into an agreement pursuant to
which the Company agreed to issue 30,000 shares of Series A Convertible
Preferred Stock (the "Series A Preferred Stock") and warrants to purchase
360,000 shares of the Company's Common Stock (the "Warrants") for $30,000,000
(the "Preferred Stock Proceeds"). The shares of Series A Preferred Stock, the
Warrants and the Preferred Stock Proceeds were deposited into escrow. The
Warrants expire on October 17, 2000 and have a per-share exercise price of
$9.915. Concurrent with the completion of the merger (the "Oxycal Merger")
between a subsidiary of the Company and Oxycal Laboratories, Incorporated
("Oxycal"), the Preferred Stock Proceeds, the Series A Preferred Stock and the
Warrants will be released from escrow. In the event the merger with Oxycal is
not completed prior to November 13, 1997, the escrow will terminate and the
Series A Preferred Stock will be returned to Zila and the Preferred Stock
Proceeds will be returned to the investors along with Warrants to purchase
210,000 shares of the Company's Common Stock. The balance of the Warrants will
be returned to the Company. The parties have reserved the right to extend the
escrow termination date beyond November 13, 1997. The Company intends to use a
significant portion of the Preferred Stock Proceeds to consummate the Oxycal
Merger, the balance of the Preferred Stock Proceeds will be used by the Company
for working capital and to pay the fees and expenses associated with the sale of
the Series A Preferred Stock.
By an agreement dated October 28, 1997, the Company and Oxycal have agreed
to a merger whereby Oxycal will be merged into a wholly-owned subsidiary of
Zila, Inc., with Oxycal being the surviving corporation. Upon the consummation
of the Oxycal Merger, Oxycal will become a wholly-owned subsidiary of the
Company. Oxycal develops, manufactures and markets a patented, enhanced form of
Vitamin C under the trademark Ester-C(R). Under the terms of the Merger
Agreement, Oxycal shareholders will receive cash consideration for their shares
of Oxycal capital stock. The Oxycal Merger is subject to approval of the Oxycal
shareholders. There can be no assurance that the Oxycal shareholders will
approve the Oxycal Merger, or, if the Oxycal Merger is approved, that the merger
will be consummated. The Company has deposited $1,000,000 into escrow, which
amount will be delivered to Oxycal in the event the Oxycal Merger is not
consummated due to the actions or inactions of Zila, Inc.
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