<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
/X/ Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended April 30,1996 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
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ZILA, INC.
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(Exact Name of registrant as specified in its charter)
Delaware No. 86-0619668
- ----------------------------- ------------------------------------
(State or Other Jurisdiction (IRS Employer Identification number)
corporation or organization)
5227 North 7th Street, Phoenix, Arizona 85014
- ---------------------------------------- --------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (602)266-6700
-------------
(former name, former address and former fiscal year, if changed since last
report)
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____.
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
The number of shares of the Company's common stock outstanding at April
30, 1996 was 25,038,960 shares.
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TABLE OF CONTENTS
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Page no.
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed consolidated balance sheets as of April 30, 1996
(unaudited) and July 31, 1995 3
Condensed consolidated statements of operations (unaudited)
for quarters and nine months ended April 30, 1996 and 1995 4
Condensed consolidated statements of cash flows (unaudited)
for nine months ended April 30, 1996 and 1995 5
Notes to condensed consolidated financial statements (unaudited) 6-9
Item 2. Management's discussion and analysis of financial
condition and results of operations 10-15
PART II. OTHER INFORMATION
Item 1. Legal proceedings 15
Item 5. Other information 16
Item 6. Exhibits and reports on Form 8-K 16-17
SIGNATURES 18
</TABLE>
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
ZILA, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
CONDENSED CONSOLIDATED BALANCE SHEETS
- ----------------------------------------------------------------------------------------
April July
30, 1996 31, 1995
ASSETS (Unaudited)
------------ ------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 71,024 $ 459,014
Short-term investments 703,384 694,719
Accounts receivable:
Trade, less allowance for doubtful accounts of $20,000 746,817 704,307
Licensing fees and royalty receivables 645,000 135,000
Inventories 450,935 203,647
Prepaid expenses and other assets 208,127 249,294
Related party receivables 16,000 38,331
------------ ------------
Total current assets 2,841,287 2,484,312
------------ ------------
PROPERTY AND EQUIPMENT - Net 1,051,467 739,701
DEFERRED PATENT AND LICENSING COSTS - Net 3,058,842 955,727
------------ ------------
TOTAL $ 6,951,596 $ 4,179,740
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term borrowings $ $ 24,062
Borrowings collateralized by securities 82,290
Accounts payable 335,986 412,137
Accrued royalties 96,738 49,062
Other accrued expenses 104,542 85,719
Deferred revenue 24,878 63,000
Current portion of long-term debt 10,385 9,795
------------ ------------
Total current liabilities 654,819 643,775
LONG-TERM DEBT 406,348 412,502
------------ ------------
Total liabilities 1,061,167 1,056,277
------------ ------------
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 25,038,960 shares
(April 30, 1996) and 24,355,462 shares (July 31, 1995) 25,039 24,355
Capital in excess of par value 15,488,478 12,759,350
Unrealized loss on securities available-for-sale (31,324) (27,961)
Deficit (9,591,339) (9,631,856)
------------ ------------
5,890,854 3,123,888
Less 42,546 common shares held by wholly-owned
subsidiary (at cost) (425) (425)
------------ ------------
Total shareholders' equity 5,890,429 3,123,463
------------ ------------
TOTAL $ 6,951,596 $ 4,179,740
============ ============
</TABLE>
See notes to condensed consolidated financial statements.
3
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ZILA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
QUARTERS AND NINE MONTHS ENDED APRIL 30, 1996 AND 1995
<TABLE>
<CAPTION>
Quarters ended Nine months ended
---------------------------- -----------------------------
April April April April
30, 1996 30, 1995 30, 1996 30, 1995
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
REVENUES
Net sales $ 1,337,641 $ 1,242,311 $ 4,383,896 $ 3,813,174
Licensing fees and royalty revenue 726,966 143,874 834,523 175,955
------------ ------------ ------------ ------------
2,064,607 1,386,185 5,218,419 3,989,129
------------ ------------ ------------ ------------
OPERATING COSTS AND EXPENSES
Cost of products sold 200,472 170,487 633,552 561,741
Selling, general and administrativ 1,689,125 1,405,598 4,550,519 4,044,603
------------ ------------ ------------ ------------
1,889,597 1,576,085 5,184,071 4,606,344
------------ ------------ ------------ ------------
INCOME (LOSS) FROM OPERATIONS 175,010 (189,900) 34,348 (617,215)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSES)
Interest income 13,986 15,122 46,515 44,188
Interest expense (13,160) (22,425) (39,149) (61,911)
Realized gain (loss) on short-term
investments 209 (1,197) (424)
------------ ------------ ------------ ------------
1,035 (7,303) 6,169 (18,147)
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE CUMULATIVE
EFFECT OF ACCOUNTING CHANGE 176,045 (197,203) 40,517 (635,362)
------------ ------------ ------------ ------------
CUMULATIVE EFFECT OF
ACCOUNTING CHANGE 29,945
------------ ------------ ------------ ------------
NET INCOME (LOSS) $ 176,045 $ (197,203) $ 40,517 $ (605,417)
============ ============ ============ ============
INCOME (LOSS) PER SHARE $ 0.01 $ (0.01) $ $ (0.03)
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER
OF COMMON AND COMMON
EQUIVALENT SHARES
OUTSTANDING 26,166,969 24,095,035 25,650,236 24,074,866
============ ============ ============ ============
</TABLE>
See notes to condensed consolidated financial statements.
4
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ZILA, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED APRIL 30, 1996 AND 1995
- ----------------------------------------------------------------------------------------
1996 1995
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<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ 40,517 $ (605,417)
Cumulative effect of accounting change (29,945)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 177,511 124,343
Realized loss on sale of investments 1,197 424
Change in assets and liabilities:
Trade accounts receivable (552,510) 78,860
Investment interest receivable (1,474) (6,020)
Inventories (247,288) 75,933
Prepaid expenses and other assets 41,167 7,924
Accounts payable, accrued expenses and
deferred revenue (47,774) 259,087
----------- -----------
Net cash used in operating activities (588,654) (94,811)
----------- -----------
INVESTING ACTIVITIES:
Purchases of short-term investments (213,620) (167,419)
Proceeds from sale of short-term investments 201,869 202,840
Purchase of investment in CTM (125,000)
Purchases of property and equipment (426,968) (64,328)
Patents and licensing costs incurred (156,049) (275,894)
Funding of related party receivables (8,836)
Collections of related party receivables 22,331 22,025
----------- -----------
Net cash used in investing activities (697,437) (291,612)
----------- -----------
FINANCING ACTIVITIES:
Principal payments on short-term borrowings (26,406) (261,615)
Net proceeds from short-term borrowings 182,417
Net proceeds from borrowings collateralized by securities 84,634 381,797
Net proceeds from issuance of common stock 845,437 133,915
Principal payments on long-term debt (5,564) (5,645)
----------- -----------
Net cash provided by financing activities 898,101 430,869
----------- -----------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS (387,990) 44,446
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 459,014 37,240
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 71,024 $ 81,686
=========== ===========
CASH PAID FOR INTEREST $ 39,149 $ 61,911
=========== ===========
PURCHASE OF INVESTMENT IN CTM FOR COMMON
STOCK $ 1,884,375 $
=========== ===========
</TABLE>
See notes to condensed consolidated financial statements
5
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ZILA, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. In the opinion of management of Zila, Inc. and Subsidiaries (the
"Company"), all adjustments, consisting of normal recurring accruals,
considered necessary for a fair presentation have been included in the
condensed consolidated financial statements. The results of operations
for the interim period are not necessarily indicative of the results
that may be expected for the entire year. The preparation of financial
statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
2. Net income (loss) per common share is computed based on the weighted
average number of shares outstanding during each period after giving
effect for any dilutive stock options and warrants which are considered
to be common stock equivalents. For the quarters and nine months ended
April 30, 1995, options and warrants that would otherwise qualify as
common stock equivalents are excluded since their inclusion would have
the effect of decreasing the loss per share.
3. On August 1, 1994, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." 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.
Securities that are being held for indefinite periods of time,
including those securities which may be sold in response to needs for
liquidity or changes in interest rates, are classified 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 nine months ended April 30, 1996 is as
follows:
<TABLE>
<S> <C>
Unrealized loss on securities available-for-sale at
July 31, 1995 $(27,961)
Net increase in unrealized loss, due principally to
increases in interest rates (3,363)
--------
Unrealized loss on securities available-for-sale
at April 30, 1996 $(31,324)
========
</TABLE>
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Short-term investments consist of the following at April 30, 1996:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ------------ ---------
<S> <C> <C> <C>
Mutual funds $448,123 20,482 $427,641
Corporate debt
securities 111,186 3,156 108,030
U. S. Government
fixed income securities 175,399 7,686 167,713
---------- --------- -------- --------
$734,708 $31,324 $703,384
========== ========= ======== ========
</TABLE>
Maturities of securities at April 30, 1996 are as follows:
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
--------- -------
<S> <C> <C>
Due in : 1996-1999 $623,311 $596,629
2000-2004 111,397 106,755
-------- --------
$734,708 $703,384
======== ========
</TABLE>
Borrowings of $82,290 at the prime rate minus one eighth percent
(0.125%), collaterized by these investments, are included in current
liabilities as of April 30, 1996.
4. Inventories consist of the following:
<TABLE>
<CAPTION>
April 30, 1996 July 31, 1995
-------------- -------------
<S> <C> <C>
Finished goods $241,636 $91,690
Raw materials, primarily empty
tubes and packaging materials 209,299 111,957
-------- --------
$450,935 $203,647
======== ========
</TABLE>
5. Deferred income taxes reflect the net tax effects of (a) temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes, and (b) operating loss and tax credit carryforwards. The tax
effects of significant items comprising the Company's net deferred tax
asset as of April 30, 1996 and July 31, 1995 are as follows:
<TABLE>
<CAPTION>
April 30, 1996 July 31, 1995
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<S> <C> <C>
Deferred tax assets:
Operating loss carryforwards $5,150,000 $5,096,000
Other 15,000 15,000
---------- ----------
5,165,000 5,111,000
Valuation allowance (5,165,000) (5,111,000)
----------- ----------
Net deferred tax asset $0 $0
=========== ==========
</TABLE>
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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 $1,530,000 of the deferred
tax asset relates to deductions generated by the exercise of stock
options, which upon realization will result in an increase in capital
in excess of par value.
6. The Company has a $250,000 revolving bank line of credit which expires
in April 1997 and which is collateralized by trade accounts receivable,
inventories and rights to payments. Interest is payable monthly on the
unpaid balance at the bank's prime rate plus one and three quarters
percent (1.75%). At July 31, 1995, and April 30,1996, the Company had
no short-term borrowings against this line of credit. Included in
short-term borrowings at July 31, 1995 is $24,062 for installments due
on the Company's product liability insurance.
7. The Company has refinanced the mortgage on its building at 5227 North
Seventh Street, Phoenix, Arizona 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 rate (8.25% at April 30, 1996) plus two and one quarter percent
(2.25%), to move with prime on a daily basis. Within the first twelve
months of the refinancing, the Company has the option to convert to a
fixed rate of four and one quarter percent (4.25%) over the Treasury
rate. Principal and interest payments are due monthly based on a 20
year amortization, with a balloon payment due April 1, 2001.
8. On April 13, 1994, the Company filed a complaint in the United States
District Court for the District of Arizona, titled Zila
Pharmaceuticals, Inc. v. Colgate-Palmolive Company ("Colgate"). 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
the Company's non-prescription, film-forming, bioadhesive medications.
The complaint seeks to enjoin Colgate's manufacture and distribution of
Orabase Gel and requests an award of damages in an appropriate amount.
On May 27, 1994, Colgate filed its answer to the Company's complaint,
denying infringement and asserting that the '158 Patent is invalid and
unenforceable. The Company has received an opinion of its patent
counsel that the '158 Patent was duly and validly issued, that the
Patent is valid and enforceable and that Colgate is infringing the '158
Patent by its manufacture and distribution of the Orabase Gel product.
The Company intends to vigorously prosecute its claims for injunctive
relief and damages against Colgate. Colgate has requested the Court to
enter Summary Judgment that the '158 Patent is invalid. The Company has
filed its written Opposition to this request and the parties are
waiting the Court's decision. The Company's patent counsel has advised
that the Court should deny Colgate's request for Summary Judgment. If
Colgate's request is denied, the case will be scheduled for trial.
9. On March 7, 1996, the Company purchased one-third of the outstanding
common stock of CTM Associates ("CTM") from Raymond J. Tucci ("Tucci"),
one of the three directors and shareholders of CTM. On June 3, 1996,
the Company announced that it has acquired the remaining two-thirds of
the outstanding shares of CTM. The only significant asset of CTM
8
<PAGE> 9
was its right to receive certain royalties from sales of OraTest
(formerly known as OraScan). Accordingly, the acquisition of CTM
eliminates the Company's obligation to pay royalties to CTM on revenues
generated from sales of OraTest. The acquisition also results in a
complete settlement of the litigation between CTM and the Company. 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,
paid $125,000, and assumed certain liabilities of approximately
$70,000.
10. On January 18, 1996, the Company entered into an agreement in which The
Procter & Gamble Company ("P&G") agreed to market and distribute
OraTest in the U.S. and 55 other countries worldwide, pending needed
regulatory approvals. On April 3, 1996, P&G notified the Company that
it was terminating its license agreement. The terms of the license
agreement provide that P&G may terminate the agreement upon 90-days
notice. Under such provisions, P&G is required to continue to pay
certain nonrefundable licensing fees to the Company through July 3,
1996.
11. In March 1995, the Financial Accounting Standards Board issued SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of," (SFAS 121) which is effective for
fiscal years beginning after December 15, 1995. The Company does not
believe the adoption of SFAS 121 will have a significant impact on the
Company's financial position, results of operations, or cash flows.
9
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
ZILA, INC. AND SUBSIDIARIES
RESULTS OF OPERATIONS
For the quarter ended April 30, 1996, the Company had net income of
$176,045 compared to a net loss of $197,203 for the quarter ended April 30,
1995. For the nine month period ended April 30, 1996, the Company had net income
of $40,517 compared to a net loss of $605,417 for the nine month period ended
April 30, 1995.
Sales during the third quarter of the current fiscal year totaled
$1,337,641 compared to sales of $1,242,311 during the third quarter of the
previous fiscal year, a 7.7% increase. For the first nine months of this fiscal
year, sales were $4,383,896 compared to $3,813,174 for the same period of the
prior fiscal year, a 15.0% increase. This increase was primarily the result of
sales of Zilactin-B which continue to increase since its introduction in the
first quarter of fiscal year 1995.
In the third quarter ended April 30, 1996, cost of sales increased
17.6% to $200,472 from $170,487 for the same period last year, primarily as a
result of increased net sales. For the nine month period ended April 30, 1996,
cost of sales increased 12.8% from the same period last year, $561,741 to
$633,552, as a result of increased net sales during the first nine months of
fiscal 1996. Cost of sales as a percentage of net sales increased from 13.7% in
the quarter ended April 30, 1995 to 15.0% in the quarter ended April 30, 1996.
This increase is due to the introduction of new products during the quarter
ended April 30, 1996 with lower margins. The Company expects cost of sales as a
percentage of net sales to continue to increase as sales of the new products
increase. Cost of sales as a percentage of net sales decreased from 14.7% in the
nine months ended April 30, 1995 to 14.5% in the nine months ended April 30,
1996. The decrease is attributable to the Company's continued efforts to control
product costs through volume price breaks and competitive purchases of packaging
and other components.
Licensing fees and royalty revenues were $726,966 for the quarter ended
April 30, 1996 compared to $143,874 for the quarter ended April 30, 1995. For
the nine months ended April 30, 1996, licensing fees and royalty revenues were
$834,523 compared to $175,955 for the nine months ended April 30, 1995. These
increases were attributable to 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 is payable by Procter &
Gamble as a one-time licensing fee required in connection with the termination
of the license agreement with the Company. Licensing expenses increased by
$27,792 from $46,675 for the quarter ended April 30, 1995 to $74,467 for the
quarter ended April 30, 1996. For the nine months ended April 30, 1996,
licensing expenses increased to $112,219 from $52,717 for the same period of the
previous fiscal year, an increase of $59,502. These increases were attributed to
expenses incurred in connection with negotiations to license OraTest for the UK
and US markets.
Selling, general and administrative expenses increased $283,527 from
$1,405,598 for the third quarter of fiscal year 1995 to $1,689,125 for the same
period in fiscal year 1996, and increased $505,916 from $4,044,603 for the first
nine months of fiscal year 1995 to $4,550,519 for the first nine months of
fiscal year 1996.
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<PAGE> 11
As a result of the Company's increased sales volume, the expenses for
sales commissions, royalties, product liability insurance and freight charges
increased by $50,500 for the quarter and by $38,684 for the nine months ended
April 30, 1996 as compared to the same periods in the prior fiscal year.
Marketing and sales expense increased $80,726 for the quarter and $68,778 for
the nine months ended April 30, 1996, as compared to similar periods of the
prior fiscal year. These increases were primarily the result of increased
advertising, sales promotion and staffing.
Administrative expenses increased $129,549 and $213,116, respectively,
for the three and nine month periods ended April 30, 1996, as compared to
similar periods of the prior fiscal year. Such increases were primarily a result
of salary increases, and increases in public relations, legal, accounting and
shareholder expenses. Internal funding of product development decreased by
$5,040 for the three months ended April 30, 1996, as compared to the same period
of fiscal year 1995. Such decreases were primarily due to the reimbursement of
expenses under the licensing agreement with Procter & Gamble. P&G reimbursed
$114,824 in expenses to the Company during the quarter ended April 30, 1996. The
expenses reimbursed by P&G were primarily for the funding of OraTest research.
For the nine months ended April 30, 1996, internal funding of product
development increased by $125,836 as compared to the same period of fiscal year
1995, primarily 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 (See "Part II - Other Information; Item 1 -
Legal Proceedings"). Internal funding of product development without
reimbursements by P&G would have increased by $109,784 for the quarter and
$240,660 for the nine months ended April 30, 1996 as compared to the same
periods of the previous fiscal year.
Interest income during the third quarter of fiscal year 1996 decreased
$1,136 from $15,122 in the third quarter of fiscal year 1995 to $13,986 during
the same period in fiscal 1996. For the nine months ended April 30, 1996,
interest income increased $2,327 to $46,515 from the same period last year.
Interest expense decreased from $22,425 in the third quarter of the 1995 fiscal
year to $13,160 in the third quarter of the 1996 fiscal year and from $61,911 to
$39,149 for the nine month periods in 1995 and 1996, respectively. The decreases
were attributable to lower debt obligations during the first nine months of
fiscal year 1996 as compared to fiscal year 1995.
MARKETING STRATEGY
The Company uses three strategies to market its product line. The
primary focus has been on educating health professionals on the uniqueness of
each of the products. Targeted efforts to build awareness of the product line
are made by direct mailings and attending medical conventions and advertising in
key publications. The Company believes that its product line is unsurpassed in
terms of efficacy; accordingly, impartial clinical studies regarding the
efficacy of the Company's products are sent by the Company to dentists,
pharmacists and physicians. The second strategy is to participate in retailer
driven activities designed to make the Company's retail products available at
more outlets and offer value to consumers at the store level. The third strategy
is to build consumer awareness of the Company's products through focused efforts
such as targeted advertising.
During the third quarter of fiscal year 1996, the Company participated
in eleven 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 these types of marketing efforts combined with a superior
product are the reason that Zilactin is the number one product
11
<PAGE> 12
recommended by pharmacists for treating canker sores and cold sores according to
three independently conducted pharmacist research studies.
Interest in the Company's products by health professionals continues to
grow. Sales of sample dispensers to dentists and physicians for the third
quarter of fiscal year 1996 are up approximately 30.3% in dollars and 40.8% in
units as compared to the same period of the prior fiscal year. The distribution
of the Company's new patient information pamphlet on mouth sores (it also
mentions the Zilactin product line) has grown into an excellent tool for health
professionals to educate their patients. Response has been strong as evidenced
by thousands of requests for the pamphlets for placement in the doctors'
offices. Over 160,000 pamphlets have been distributed to dental offices via
medical conventions and doctors calling the Company to request pamphlets.
Additionally, over 40,000 pamphlets have been distributed to pharmacists. The
Company believes that the sample dispenser and brochure distribution efforts
will have a positive effect on the sale of the Company's products.
PRODUCT INFORMATION UPDATE
In the fourth quarter of the 1995 fiscal year, the Company began
testing a lip balm in the Arizona market. The product, called Zilactin-Lip, is
positioned to be a premium priced, effective alternative to existing lip balms.
Zilactin-Lip prevents sun blisters, treats cold sores and treats dry, chapped
lips. Most other products perform only one or two of such applications. Based on
results to date, Zilactin-Lip is being expanded into additional markets.
At the national American Dental Association meeting in October 1995,
the Company introduced Quik Floss, a unique dental flosser. Quik Floss 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. This new product has been
received well by the dental community and has been taken on by several drug
chains.
In February 1996, the Company introduced a new toothbrush clip called
ExtendGuard, to the dental community. ExtendGuard straightens toothbrush
bristles for more effective brushing. It also prevents cross contamination from
germs on bathroom counters. The dental community has shown a keen interest in
ExtendGuard as a gift to give patients.
OraTest, which the Company believes to be the world's first oral cancer
diagnostic, was introduced in Canada during the third quarter of fiscal 1993.
Canada has turned out to be an excellent test market for OraTest by providing
the Company with valuable training and experience in the areas of insurance
coverage, training, sales strategy, advertising, public relations, marketing and
dentist perspectives. The Company believes that such experiences will assist
with OraTest's introduction in Europe, the United States and elsewhere.
OraTest received regulatory approval in the United Kingdom by the
Medicines Control Agency ("MCA") during the third quarter of fiscal year 1995.
The MCA is the UK counterpart of the United States FDA. With this approval,
OraTest can be marketed in the UK and the Company has started the approval
process for OraTest throughout the European Union ("EU"). In addition to the UK
approval, OraTest has received the necessary governmental approvals to be
marketed in Canada and Australia.
The Company has already made arrangements for the production of OraTest
for the United States domestic market once FDA approval is received. The Company
has also
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<PAGE> 13
established its own manufacturing facility for the manufacture of toluidine blue
a key component for the production of OraTest. All other components necessary
for the production of OraTest have been designed and sourced.
LIQUIDITY AND CAPITAL RESOURCES
At July 31, 1995, the Company had net working capital of $1,840,537 and
a current ratio of 3.9 to 1. At April 30, 1996, the Company had net working
capital of $2,186,468 and a current ratio of 4.3 to 1.
Accounts receivable at April 30, 1996 were $1,391,817, consisting of
$645,000 in licensing fee and royalty receivables and $746,817 in trade accounts
receivable as compared to accounts receivable at July 31, 1995 of $839,307 which
consisted of $135,000 in licensing fee and royalty receivables and $704,307 in
trade accounts receivable. Trade accounts receivables as a percentage of
quarterly net sales of $1,337,641 were 55.8% at April 30, 1996 as compared to
52.8% at July 31, 1995 which had quarterly net sales of $1,334,493. The increase
in licensing fee and royalty receivables is primarily due to an increase in
licensing fee receivables of $525,000 at April 30, 1996, related to the payment
due upon termination of the Company's license agreement with Procter & Gamble.
There continues to be an emphasis on strong credit management.
At April 30, 1996, the Company had inventories of $450,935, an increase
of $247,288 from inventories at July 31, 1995. The increase is primarily due to
a build up of components and finished goods for new products and depleted
inventory levels at July 31, 1995 due to sales exceeding forecasted demand. The
Company believes current inventories are at levels necessary to support market
expansion and to maintain adequate liquidity.
As of April 30, 1996, the Company had no material commitments for
capital expenditures. However; the Company will continue to seek FDA approval of
OraTest, and in connection therewith the Company believes that approximately
$100,000 of additional capital may be necessary to receive such approval. Also,
the Company plans to lease additional space and expand the current manufacturing
facility to accommodate growth. The Company believes that approximately $200,000
of additional capital may be necessary to complete the expansion. Funding for
such projects will be from existing licensing fee receivables. Other than the
funds necessary for FDA approval of the OraTest product and the manufacturing
facility expansion, the Company does not believe there are any known trends,
demands, commitments, events or uncertainties which are likely to significantly
affect the Company's liquidity.
On January 4, 1991, the Company purchased a 16,000 square foot building
located at 5227 North Seventh Street, Phoenix, Arizona 85014-2800. 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 rate plus two and
one quarter percent (2.25%), to move with prime on a daily basis. Within the
first twelve months of refinancing, the Company has the option to convert to a
fixed rate of four and one quarter percent (4.25%) over the Treasury rate.
The Company also leases 1,751 square feet for a manufacturing facility
in Phoenix, Arizona. This facility will produce toluidine blue which will be
used in the manufacture of OraTest. The facility is leased under a two year
agreement which expires August 14, 1997, and is located in
13
<PAGE> 14
an area with property available for expansion. The agreement has an option to
renew for an additional five years. Monthly lease payments are $912.
Management believes that continued growth in the Company's sales will
provide sufficient funding for the Company's current operations for the next
twelve months. The Company may require additional financing to support
production of its products in quantities sufficient to support market expansion.
In anticipation of these potential requirements, the Company has a $250,000 line
of credit with Bank One, Arizona, NA, which is collateralized by trade
receivables, inventories and rights to payment. This line of credit expires in
April of 1997. Interest is payable monthly on the unpaid balance at the bank's
prime rate plus one and three quarters percent (1.75%). At April 30, 1996, the
Company had no borrowings against this line of credit. The Company also has the
availability of additional financing by borrowing against the Company's
short-term investments. At April 30, 1996, the Company had borrowed $82,290
against it's short-term investments.
FORWARD LOOKING INFORMATION
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. See the Company's registration statement on Form S-3
(Registration No. 333-00654), which identifies some important factors that could
cause actual results to differ materially from those contained in such
forward-looking statements.
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
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-CAM. 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 seeks to enjoin Colgate's manufacture and distribution of Orabase
Gel and requests an award of damages in an appropriate amount. On May 27, 1994,
Colgate filed its answer to Zila's complaint, denying infringement and asserting
that the '158 Patent is invalid and unenforceable. The Company has received an
opinion of its patent counsel that the '158 Patent was duly and validly issued,
that the Patent is valid and enforceable and that Colgate is infringing the '158
Patent by its manufacture and distribution of the Orabase Gel product. The
Company intends to vigorously prosecute its claims for injunctive relief and
damages against Colgate. Colgate has requested the Court to enter Summary
Judgment that the '158 Patent is invalid. Zila has filed its written Opposition
to this request and the parties are waiting the Court's decision. Zila's patent
counsel has advised that the Court should deny Colgate's request for Summary
Judgment. If Colgate's request is denied, the case will be scheduled for trial.
Item 5 - Other Information
Procter & Gamble Company. On April 3, 1996, The Procter & Gamble
Company notified the Company that it was terminating its license agreement to
market the Company's oral cancer diagnostic, OraTest. The terms of the license
agreement provide that P&G may terminate the agreement upon 90-days notice.
Under such provisions, P&G is required to continue to pay certain nonrefundable
licensing fees to the Company through July 3, 1996.
14
<PAGE> 15
Bio-Dental Technologies. On June 3, 1996, the Company announced that is
had signed a letter of intent with Bio-Dental Technologies Corporation
("Bio-Dental") for the merger of Bio-Dental into Zila. It is the intention of
the parties that the merger be treated as a "pooling of interests" transaction.
The terms of the letter of intent provide for a per share exchange rate of
between 0.75 and 0.825 share of the Company's common stock for each share of
Bio-Dental common stock. Bio-Dental has 6,427,134 shares of common stock
outstanding as of March 31, 1996. The completion of the transaction is subject
to a number of conditions, including the satisfactory completion of due
diligence by both parties, the negotiation and execution of definitive
agreements and the approval of Bio-Dental shareholders.
CTM. On March 7, 1996, the Company purchased one-third of the
outstanding common stock of CTM Associates ("CTM") from Raymond J. Tucci
("Tucci"), one of the three directors and shareholders of CTM. On June 3, 1996,
the Company announced that it has acquired the remaining two-thirds of the
outstanding shares of CTM. The only significant asset of CTM was its right to
receive certain royalties from sales of OraTest (formerly known as OraScan).
Accordingly, the acquisition of CTM eliminates the Company's obligation to pay
royalties to CTM on revenues generated from sales of OraTest. The acquisition
also results in a complete settlement of the litigation between CTM and the
Company. 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, paid
$125,000, and assumed certain liabilities of approximately $70,000.
Item 6 - Exhibits and Reports on Form 8-K
(a) 27. Financial Data Schedule
(b) Reports on Form 8-K
The Company has filed a Current Report on Form 8-K dated
February 1, 1996, to report that it had entered into a license
agreement with The Procter & Gamble Company relating to the
distribution and marketing of OraTest.
The Company has filed a Current Report on Form 8-K dated April
3, 1996, to report that The Procter & Gamble Company gave
notice of termination of the license agreement to market and
distribute OraTest.
The Company has filed a Current Report on Form 8-K dated June
3, 1996, to report that i) the Company had signed a letter of
intent with Bio-Dental Technologies Corporation for the merger
of Bio-Dental into Zila and ii) the Company acquired the
remaining two-thirds of the outstanding shares of CTM
Associates.
15
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