ZILA Zila (MM)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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ZILA, INC.
5227 North 7th Street
Phoenix, Arizona 85014-2800

 

NOTICE OF ANNUAL SHAREHOLDERS MEETING

 

November 10, 2008
Phoenix, Arizona

 

To the Holders of Common Stock of Zila, Inc.:

 

We will hold the annual shareholders meeting of Zila, Inc. (“ZILA”) at the Phoenix Airport Marriott, 1101 North 44th Street, Phoenix, AZ 85008, on Thursday, December 11, 2008 at 8:00 a.m. Arizona time. The meeting is being held to:

 

1. Elect six members to ZILA’s Board of Directors;

 

2. Ratify the appointment of BDO Seidman, LLP as ZILA’s independent registered public accounting firm for the fiscal year ending July 31, 2009; and

 

3. Consider any other matters that properly come before the meeting and any adjournments thereof.

 

Only shareholders of record of common stock at the close of business on October 20, 2008 are entitled to receive notice of and to vote at the meeting or any adjournments thereof.

 

We have enclosed our 2008 Annual Report to Shareholders, which includes our Annual Report on Form 10-K for our fiscal year ended July 31, 2008, and the Proxy Statement with this notice of annual meeting.

 

Your proxy is being solicited by ZILA’s Board of Directors. We urge you to vote as soon as possible whether or not you plan to attend the annual meeting of shareholders to assure your representation at such meeting. For your convenience, and to help reduce expenses, you are encouraged to vote by telephone or the internet , as explained on page 2 of the Proxy Statement or on the enclosed proxy card. Alternatively, you can complete, sign and mail the enclosed proxy card. We have enclosed a return envelope for that purpose, which requires no postage if mailed in the United States, if you choose to vote by mail. You may revoke a previously delivered proxy at any time prior to the meeting. If you decide to attend the meeting and wish to change your proxy vote, you may do so automatically by voting in person at the meeting.

 

David R. Bethune
Chairman and Chief Executive Officer

 

PLEASE VOTE — YOUR VOTE IS IMPORTANT

 

TABLE OF CONTENTS

 

ZILA, INC.
5227 North 7th Street
Phoenix, Arizona 85014-2800

 

ANNUAL SHAREHOLDERS MEETING

 

PROXY STATEMENT

 

This summary highlights selected information from this Proxy Statement and may not contain all of the information that is important to you. To understand the proposals fully, you should carefully read this entire Proxy Statement, as well as the other documents to which we refer you.

GENERAL MEETING INFORMATION

 

 

PLEASE VOTE — YOUR VOTE IS IMPORTANT

 

The Board is comprised of six directors, each of whom is elected annually. Accordingly, shareholders will elect six directors this year. Each director is to be elected to hold office until the next annual meeting of shareholders or until his or her successor is elected and qualified. If a director resigns or otherwise is unable to complete his or her term of office, the Board may elect another director for the remainder of the resigning director’s term.

 

The Board’s nominees are listed below. The Board recommends that you vote for Mr. Bethune, Mr. Brooksby, Dr. Garrett, Ms. Green, Mr. Parrish and Dr. Vuturo.

 

 

THE BOARD OF DIRECTORS RECOMMENDS A VOTE “FOR” THE ELECTION OF
THE DIRECTOR NOMINEES.

BOARD INFORMATION

 

RATIFICATION OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

THE BOARD OF DIRECTORS RECOMMENDS THAT SHAREHOLDERS VOTE
“FOR” RATIFICATION OF THE APPOINTMENT OF BDO SEIDMAN, LLP AS
ZILA’S INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.

CURRENT EXECUTIVE OFFICERS

 

 

The following compensation discussion and analysis (“CD&A”) should be read in conjunction with the “Summary Compensation Table” and related tables that are presented elsewhere in this Proxy Statement.

 

The purpose of this CD&A is to provide information about each material element of compensation that we pay or award to, or that is earned by, our named executive officers and to explain the numerical and related information contained in the tables located below. Our continuing named executive officers are:

 

 

Frank J. Bellizzi our former Executive Vice President and President of Zila Pharmaceuticals, Inc. and David A. Barshis, our former Senior Vice President and General Manager of Zila Pharmaceuticals, Inc., are also named executive officers for purposes of the “Summary Compensation Table” and other disclosure required in this Proxy Statement because each served in their respective positions during our 2008 fiscal year.

 

The Compensation Committee acts on behalf of the Board to establish ZILA’s general compensation policies for its executive officers. The Board determines whether the Compensation Committee will make determinations as a committee or will make recommendations to the Board. In fiscal 2008, the Board determined it would make all executive officer compensation decisions, based upon recommendations of the Compensation Committee. Additional information regarding our Compensation Committee can be found under the “Board Committee” heading in the “Board Information” section of this Proxy Statement.

Role of Executives in Determining Executive Compensation

 

As discussed above, the Board made all executive compensation decisions in fiscal 2008. As Chairman and Chief Executive Officer, Mr. Bethune provides information and recommendations to the Compensation Committee or Board on the performance of each executive officer, and, as requested, specific grants and appropriate levels of compensation.

 

With respect to the negotiation of Mr. Bethune’s employment letter entered into in May 2008, the Compensation Committee recommended a package to the Board which acted absent Mr. Bethune’s input. Mr. Bethune did participate in Board discussions regarding salary freezes, decreases and adjustments in fiscal 2008.

 

Each of Messrs. Bellizzi and Barshis resigned prior to the date hereof. In fiscal 2008, Mr. Bellizzi received certain severance payments and other benefits in connection with his resignation. Please see the “All Other Compensation” column in the Summary Compensation Table for the severance payments made to Mr. Bellizzi.

 

In connection with the restructuring of our management team, David R. Bethune, a member of our Board since 2005 and Chairman of our Board since May 21, 2007, accepted an offer letter on May 9, 2008 which replaced his offer letter dated August 14, 2007. Under this employment letter, which is effective until the earlier of Mr. Bethune’s departure from the Board or October 31, 2009, Mr. Bethune’s base salary was increased to $350,000 per year, less applicable withholdings. Mr. Bethune elected to defer receipt of the pay increase (until paid such amount will be accrued by us). In addition, Mr. Bethune is eligible for a performance bonus in an amount up to fifty percent his base salary, based upon our financial performance. Mr. Bethune is also received a grant of 300,000 shares of restricted stock, with a 150,000 shares vesting on the date of grant and the restrictions and the remainder lapsing monthly over the following eighteen months. This employment letter also contains other customary provisions including, provisions related to severance payments following a change of control and termination without cause.

In September 2007, as part of its annual equity grant process, the Board issued options to purchase shares our common stock to our named executive officers as follows: (i) Mr. Bellizzi received 17,143 options to purchase common stock, (ii) Mr. Klinefelter received 5,714 options to purchase common stock, (iii) Ms. Klein received 5,714 options to purchase common stock and (iv) Mr. Barshis received 7,143 options to purchase common stock. The Board also granted stock options to other executives and a significant number of key employees.

 

On December 13, 2007 the Board approved certain option grants to our named executive officers as follows: (i) Mr. Bellizzi received 42,857 options to purchase common stock, (ii) Mr. Klinefelter received 14,286 options to purchase common stock, (iii) Ms. Klein received 33,571 options to purchase common stock, and (iv) Mr. Barshis received 35,714 options to purchase common stock. In addition, on December 13, 2007, the Board approved restricted stock grants for certain of the named executive officers as follows: (i) Mr. Bellizzi received 21,429 shares of restricted stock, (ii) Mr. Klinefelter received 2,143 shares of restricted stock, and (iii) Ms. Klein received 8,571 shares of restricted stock.

 

On December 18, 2007 the Board approved an increase of $35,000 to Mr. Bellizzi’s annual base salary. Effective as of January 1, 2008, Mr. Bellizzi’s base salary was $370,000.

 

On April 2, 2008, the Board approved a salary reduction program pursuant to which our named executive officers salaries were reduced by ten percent as follows: (i) Mr. Bethune’s annual base salary was reduced from $255,000 to $229,500, (ii) Mr. Bellizzi’s base salary was reduced from $360,000 to $324,000, (iii) Mr. Klinefelter’s base salary was reduced from $240,000 to $216,000, (iv) Mr. Klein’s annual base salary was reduced from $185,000 to $166,500, and (v) Mr. Barshis’ annual base salary was reduced from $225,000 to $202,500. As discussed above, Mr. Bethune’s base salary was subsequently increased to $350,000 in May 2008 under his employment letter.

 

On April 9, 2008 the Company also suspended the auto allowances for our named executive officers which, on an annual basis, were as follows: (i) Mr. Bellizzi - $9,600, (ii) Mr. Klinefelter - $9,600, (iii) Mr. Barshis - $8,400, (iv) Ms. Klein - $8,400.

 

On June 16, 2008, ZILA’s management voluntarily agreed to further reduce their annual base salaries as follows: (i) Mr. Bethune’s annual based salary was reduced from $350,000 to $297,500, (ii) Mr. Klinefelter’s annual base salary was reduced from $216,000 to $205,200, (iii) Ms. Klein’s annual base salary was reduced from $166,500 to $158,175, and (iv) Mr. Barshis’ annual base salary was reduced from $202,500 to 192,375.

 

Effective July 1, 2008, Mr. Bethune, Mr. Klinefelter, Ms. Klein and Mr. Barshis voluntarily agreed to suspend the receipt of their base salaries for the month of July, 2008.

 

On August 20, 2008, ZILA paid bonuses to seven (7) members of the Company’s management, including Mr. Bethune, Mr. Klinefelter, Ms. Klein, and Mr. Barshis who had voluntarily agreed to suspend receipt of their base salaries during the month of July, 2008. Each of the bonus recipients received an amount equal to ninety percent of the base salary that he or she voluntarily suspended during the month of July, 2008. In addition, salaries for the current named executive officers were restored to the levels that existed in April 2008.

 

ZILA has developed a compensation program for executives and employees designed to meet the following goals:

 

 

To meet these objectives, the Compensation Committee has, in the past, utilized competitive compensation data to implement the programs discussed below.

 

In setting compensation, the Compensation Committee generally reviews companies similar to ZILA in terms of industry (pharmaceutical, biotech/clinical trial phase III companies, and dental companies), revenue and market capitalization. While this market data is an important factor considered by the Compensation Committee when setting compensation, it is only one of multiple factors considered by the Compensation Committee, including individual performance and responsibilities, the executive’s ability to meet current and future challenges and objectives, ZILA’s expectation of the executive’s contribution to its future success, and ZILA’s cash position.

 

For fiscal 2008, the Compensation Committee did not utilize information prepared by a compensation consultant because salaries were not increased, and in fact, were decreased in fiscal 2008 in connection with operational goals and objectives.

 

At the end of the 2006 fiscal year, the Compensation Committee engaged Pearl Meyer & Partners to review the competitiveness of cash compensation and equity ownership levels for selected executive and senior management positions. In that report, ZILA’s total cash compensation for its named executive officers ranged below the 25th percentile for its identified peer group, and the Compensation Committee has taken that data in account as it has received compensation for 2008 and 2009. The equity ownership of the named executive officers (as a percentage of total shares outstanding) averaged between the 25th and 50th percentiles when compared to its ZILA’s identified peer group. ZILA’s peer group, as determined by Pearl Meyer, consisted of the following companies:

 

 

ZILA’s executive compensation program is composed of cash-based compensation, in the form of base salaries and discretionary bonuses, and equity-based compensation that currently takes the form of stock option and restricted stock grants. In addition, our named executive officers have the opportunity to participate in our company-wide 401(k) plan and our company-wide Employee Stock Purchase Plan (the “ESPP”).

The table below lists each material element of our executive compensation program, the compensation objective or objectives that each element is designed to achieve and the characteristics of each compensation element.

 

 

During fiscal 2008, the Board determined that given ZILA’s current cash position and operational goals and objectives for its business, the Board would maintain base salaries for its management at their current amounts and management actually volunteered to further reductions in base salaries in April and June 2008 and agreed to a temporary month suspension of base salaries in July 2008 (See “Significant Compensation Events in Fiscal 2008” above). During fiscal 2008, the Board also determined that it would not distribute cash bonuses to management for fiscal 2008. The Board has instead focused on long-term equity awards to incentivize its management, as evidenced by grants provided to management in September and December 2007. The Board believes that this approach further aligns management’s interests with ZILA’s shareholders and is also consistent with ZILA’s current goals and objective.

 

Base Salary

 

Base salary, which is designed to attract and retain qualified executives, provides a fixed amount of cash to our named executive officers. Base salaries for named executive officers are generally determined on an individual basis by evaluating each executive’s scope of responsibility, performance, prior experience and salary history and are set forth in letter agreements that allow for discretionary adjustment to base salaries from time to time. We have traditionally targeted our named executive salaries to be in the 25th – 50th percentile, although according to the Pearl Meyer study (as discussed above) we were generally below that range for all our named executive officers in fiscal 2008.

 

The current base salaries for our continuing named executive officers are as follows:

 

 

Incentive Bonuses

 

As part of ZILA’s compensation program, employees may be eligible to participate in its Employee Incentive Bonus Plan (the “Bonus Plan”). The parameters of the Bonus Plan are set, in part, based on publicly available information from comparable companies in our industry, as these companies are most likely to compete with us for the services of our executives. The Compensation Committee has historically viewed cash incentive compensation as a means of closely tying a portion of the total potential annual cash compensation for executives to the financial performance of ZILA.

 

As described below, the letter agreements with each of Mr. Bethune and Mr. Klinefelter provide each with a maximum incentive bonus of 50% of base salary. The letter agreement for Ms. Klein did not specify an incentive bonus, but did provide that she is eligible to participate in the Bonus Plan.

 

As discussed above, the Board determined to that it would not award any cash bonus awards for fiscal 2008 in connection with ZILA’s efforts to direct its cash resources toward activities in support of its operational goals and objectives. However, on August 20, 2008, the Board approved a one-time cash bonus for each of Mr. Bethune, Mr. Klinefelter, Ms. Klein and Mr. Barshis who had voluntarily agreed to suspend receipt of their base salaries during July 2008. Each of the bonus recipients received an amount equal to ninety percent of their base salary that he or she voluntarily suspended in July 2008.

 

Equity-Based Compensation

 

The purpose of the equity-based compensation component is to instill the economic incentives of ownership in our named executive officers and to create long-term incentives for management to increase shareholder value. ZILA frequently uses vesting periods in its awards to encourage executives to remain with it and to focus on longer-term results.

 

Equity-based compensation is awarded pursuant to our 1997 Stock Award Plan, as amended and restated, (the “1997 Plan”), which is described in greater detail in Proposal Two of this Proxy Statement. Although the 1997 Plan allows the Compensation Committee to make a variety of awards, typically the Compensation Committee will award stock options and shares of restricted stock under the 1997 Plan.

 

The Compensation Committee recommends, on a discretionary basis, whether to grant stock options or restricted stock, as well as the amount of shares of common stock subject to, and the terms of, the grants. The Compensation Committee does not adhere to a policy in recommending the mix between stock options and restricted stock, but prefers a flexible approach to permit awards to be tailored to the needs and motivations of each recipient. In making these discretionary recommendations, the Compensation Committee takes into account eligibility and participation in the Bonus Plan and the executive’s responsibilities and position. In addition, based on publicly available information, the Compensation Committee considers option grants by comparable companies in our industry, as these companies are most likely to compete with ZILA for the services of our executives. The Compensation Committee also seeks the recommendation of senior management with respect to awards granted to all employees.

 

Stock Options

 

Stock options align executives’ interests with those of shareholders, as options only have realizable value if the share price of ZILA stock increases relative to the grant, or exercise, price. The exercise price of options granted under the 1997 Plan is never less than the fair market value of ZILA’s common stock on the grant date.

 

Traditionally, in connection with the first Board meeting of the fiscal year in September the Board makes grants of option awards to ZILA’s employees, including its named executive officers. The grant date and exercise price of such option awards are set as of the date of such Board meeting. Quarterly grants are made if special circumstances demand and generally coincide with the date of a regularly planned meeting, with grant dates and exercise price set as of the date of such meeting.

2008

 

In fiscal 2008, we granted to our named executive officers options to purchase shares of our common stock. As compared to the number of options in fiscal 2007 these grant in fiscal 2008 were as follows:

 

 

Restricted Stock

 

Restricted stock is granted to executives to facilitate retention and, for newly hired executives, recruitment. The restrictions on the restricted stock awards granted to executives typically lapse periodically over the course of three years. The restrictions generally provide that, unless the Compensation Committee in its discretion determines otherwise, during the term of the restrictions the shares may not be sold or otherwise transferred, and the shares will be immediately forfeited in the event of the executive’s termination of employment for any reason other than death, disability or retirement. The grant price of restricted stock granted under the 1997 Plan is never less than the fair market value of ZILA’s common stock on the grant date.

 

2008

 

In fiscal 2008, we granted to our named executive officers shares of restricted stock. As compared to the number of shares of restricted stock in fiscal 2007 these grant in fiscal 2008 were as follows:

 

 

Other Compensation

 

Our named executive officers also either participate or are eligible to participate in our other benefit plans and programs on the same terms as other employees, including a 401(k) plan, the ESPP, medical and dental insurance, term life insurance, short-term disability insurance, long-term disability insurance and paid time-off plan.

 

We also provide certain of our named executive officers with severance and change in control benefits. We believe these arrangements are a fair reward for hard work and value creation, assist us in retaining our named

executive officers, and provide incentives to our named executive officers to remain with us during periods of uncertainty at the end of which such executives may not be retained. Generally, the Compensation Committee does not provide benefits if employment is terminated for cause, death or disability or if employment is voluntarily terminated by the named executive officer.

 

In general, severance payments, other than those made in connection with a change in control, are only payable upon termination of a named executive officer without cause because the Compensation Committee does not believe named executive officers should be rewarded for failing to perform their respective jobs.

 

With respect to payments upon changes of control, the Compensation Committee requires a “double trigger” prior to any payment in that both a change in control and a termination of employment must occur. The letter agreements for Mr. Klinefelter and Ms. Klein establish a presumption that a termination was because of a change in control if the termination occurs within 18 months following the change in control. Similar to severance payments made for termination without cause, payments made following a termination upon a change in control are only payable if the named executive officer provides a release of claims to ZILA and the named executive officer does not violate any other contractual obligations to ZILA or solicit additional employees to leave ZILA following the departure.

 

Please see the “Employment Agreement” discussion below the Summary Compensation Table for additional information on these arrangements and agreements.

 

Tax Code Considerations

 

Section 162(m) of the Internal Revenue Code disallows a corporate income tax deduction for executive compensation paid to its chief executive officer or any of its four other highest compensated “covered employees” in excess of $1 million per year unless it is performance-based and is paid under a plan satisfying the requirements of Section 162(m). Qualifying performance-based compensation is not subject to the deduction limit if certain requirements are met. The Compensation Committee believes that the compensation arrangements with ZILA’s executive officers will not exceed the limits on deductibility during the current fiscal year. The Compensation Committee currently intends to structure the performance-based portion of the compensation of executive officers in a manner that complies with Section 162(m).

 

Accounting Considerations

 

The Board and Compensation Committee generally consider accounting considerations related to forms and amounts of compensation of our named executive officers, although this has not typically been a significant factor in compensation decisions for ZILA.

SUMMARY COMPENSATION TABLE

 

 

 

 

Named Executive Officers

 

David R. Bethune

 

We entered into an employment letter, on May 9, 2008, with Mr. Bethune, which replaced his offer letter dated August 14, 2007. The employment letter is effective until the earlier of Mr. Bethune’s departure from the Board or October 31, 2009. The terms of the employment letter increased Mr. Bethune’s base salary to $350,000 per year, less applicable withholdings. At the time of the effectiveness of the letter, Mr. Bethune elected to defer receipt of the pay increase (until paid, such amount will be accrued by us). In addition, the employment letter provides that Mr. Bethune is eligible for a performance bonus in an amount up to fifty percent of his base salary based upon our financial performance. Mr. Bethune also received a grant of 300,000 shares of restricted stock, with 150,000 shares vesting on the date of grant and the restrictions on the remainder lapsing monthly over the following eighteen months. This employment letter also contains other customary provisions including provisions related to severance payments following a change of control and termination without cause.

 

Gary V. Klinefelter

 

We entered into a letter agreement, effective as of December 15, 2004, with Gary V. Klinefelter setting forth the terms of his employment as Vice President and General Counsel. The agreement provides for an initial annual base salary of $200,000 and an automobile allowance of $800 per month. It also provides for an initial grant of options to purchase 100,000 shares of common stock, vesting in two equal increments on the second and third anniversary of the grant. Also included was an additional grant of options to purchase 50,000 shares of common stock on the first anniversary of the date of hire, with such options vesting equally on the first, second and third anniversary of the grant. The letter agreement does not obligate us to employ Mr. Klinefelter for any period of time, but provides for severance payments equivalent to his then-current base salary for (i) twelve months in the event of a change in control and (ii) six months under certain other circumstances. In connection with the execution of the letter agreement, Mr. Klinefelter received a $25,000 signing bonus.

 

On March 30, 2007, the Compensation Committee approved changes to Mr. Klinefelter’s letter agreement increasing his base salary, effective January 1, 2007, to $240,000 and providing Mr. Klinefelter with a severance payment equal to two years base salary and two years base salary plus bonuses if Mr. Klinefelter is terminated upon a change in control of ZILA. Any such severance payment will be in the form of a lump sum on the six-month anniversary of termination of employment. These arrangements were memorialized in an amended letter agreement on March 30, 2007. For additional information regarding severance and change in control payments that could become due to Mr. Klinefelter, please see the “Severance and Change in Control Payments” section below and in the “Compensation Programs Design and Discussion” section above.

 

Diane E. Klein

 

We entered into a letter agreement, effective as of March 30, 2007, with Diane E. Klein setting forth the terms of her employment as Vice President and Treasurer. The agreement does not provide for an annual base salary. The letter agreement provides that Ms. Klein is eligible for future awards of stock options. The letter agreement does not obligate us to employ Ms. Klein for any period of time, but provides for severance payments equivalent to her then-current base salary for (i) eighteen months in the event of a change in control and (ii) eighteen months under certain other circumstances.

 

On December 14, 2006, the Compensation Committee granted to Mr. Klein a cash bonus award of $7,000 and increased her then current annual base salary to $160,000, effective January 1, 2007. In addition, the Compensation Committee approved changes to Ms. Klein’s letter agreement, providing her with a severance payment equal to 18 months base salary plus bonuses if Ms. Klein is terminated upon a change in control of ZILA. Any such severance payment will be in the form of a lump sum on the six-month anniversary of termination of employment. These arrangements were memorialized in an amended letter agreement on March 30, 2007. Effective August 1, 2007, Diane E. Klein, Vice President and Treasurer, was promoted to Vice President of Finance and Treasurer and has assumed the duties of the principal financial officer of the Company. On September 27, 2007, the Board

approved an increase in annual base salary for Ms. Klein from $160,000 to $185,000 related to the assumption of duties as the ZILA’s principal financial officer. For additional information regarding severance and change in control payments that could become due to Ms. Klein, please see the “Severance and Change in Control Payments” section below and in the “Compensation Programs Design and Discussion” section above.

 

Former Executives that are Named Executive Officers

 

Severance Agreement of Mr. Bellizzi.   On June 6, 2008, we entered into a Severance Agreement and release of claims with Frank J. Bellizzi (the “Severance Agreement”). Effective June 30, 2008, Mr. Bellizzi’s employment with us terminated. Under the Severance Agreement, Mr. Bellizzi provided a general release of claims against us and we agreed to pay Mr. Bellizzi a $25,000 severance payment. In addition, we issued 600,000 shares of stock (net of applicable withholdings) to Mr. Bellizzi. In addition, on June 30, 2008, we issued stock to Mr. Bellizzi with a value of $52,500 (reduced by applicable withholdings) based on the closing price of our stock on that date. All of Mr. Bellizzi’s vested and unvested options to purchase shares of our common stock terminated upon resignation; provided, however, that the vesting of 125,000 shares of restricted stock previously granted to Mr. Bellizzi was accelerated. Finally, we agreed to pay Cobra coverage for Mr. Bellizzi for one (1) year. The Severance Agreement also contains other customary provisions including mutual non-disparagement and cooperation covenants in a mutual release of claims.

 

David A. Barshis Departure.   On October 7, 2008, the employment of David A. Barshis with us terminated. Mr. Barshis formerly served as Senior Vice President and General Manager of Zila Pharmaceuticals, Inc.

GRANTS OF PLAN-BASED AWARDS

 

The following table sets forth information regarding grants of plan-based awards made during the year ended July 31, 2008 to the named executive officers.

 

 

 

 

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END

 

The following table sets forth information regarding outstanding equity awards at July 31, 2008 for the named executive officers.

 

 

 

 

OPTION EXERCISES AND STOCK VESTED

 

The following table sets forth information with respect to shares of ZILA common stock acquired through exercises of stock options and vesting of restricted shares and the number of shares acquired and value realized on exercise or vesting by the named executive officers.

 

 

 

 

As discussed elsewhere in this Proxy Statement, we have letter agreements with certain of our current named executive officers that provide severance benefits to the named executive officers upon termination following a change in control or without cause. In the table below, we summarize the estimated payments that will be made to each of our current named executive officers upon a termination of employment without cause or in connection with a change in control of ZILA. The major assumptions that we used in creating the table are set forth directly below. The table includes an estimate of the compensation that would accrue for each executive if the triggering event occurred on July 31, 2008 (our fiscal year-end) and, unless otherwise noted, is based on each executive’s compensation on that date. Calculations requiring a per share stock price are made on the basis of the closing price of $1.89 per share of our common stock on the NASDAQ Global Market on July 31, 2008.

 

Change in Control

 

No cash payment will be made solely because of a “Change in Control.” For each current named executive officer, the cash payments described under the table heading “Change in Control” will be triggered upon a termination in connection with a “Change in Control.” Cash payments described under the table heading “Without Cause” will be triggered upon a termination without cause as further described below in “Terms of Officer Agreements.”

Acceleration upon a Change in Control

 

Under the 1997 Plan, all outstanding options accelerate upon a “Change in Control,” as defined in such plan, if the option holder is employed by us on the date of the “Change in Control.” However, the exercise price for all such options that would be accelerated for the current named executive officers is higher than the closing price of our common stock at July 31, 2008 ($1.89), so our named executive officers would derive no intrinsic value from the acceleration of these unvested option awards. Accordingly, for purposes of the table, we have assumed no value for all outstanding options accelerated on a Change in Control.

 

For purpose of the “Restricted Stock Award” column, we have assumed the acceleration of the restricted stock awards for Messrs. Bethune, Klinefelter and Ms. Klein upon a “Change in Control” as defined in the 1997 Plan. However, only Mr. Klinefelter’s letter agreement provides for acceleration of restricted stock upon a termination “Without Cause.”

 

Medical and Other Benefits

 

The table below does not discuss certain medical, disability or outplacement services benefits that may be payable on termination to our current named executive officers. We also do not include any amounts payable on termination that are generally available to all employees on a non-discriminatory basis. In addition, this table does not include specific treatment of a normal retirement.

 

Terms of Officer Agreements

 

Mr. Bethune, Mr. Klinefelter and Ms. Klein are entitled to severance payments upon a termination in connection with either a change in control event or a termination “Without Cause.” For purposes of their letter agreements, “Change in Control” is defined and governed by the definition of “change in control” contained in the 1997 Plan. By the terms of their letter agreements, if Mr. Bethune, Mr. Klinefelter or Ms. Klein are terminated within eighteen (18) months of a “Change in Control,” there is a rebuttable presumption that such termination was as a result of such “Change in Control.” “Without Cause” means (i) a failure to correct a specific conduct or job-performance issue or issues about which he or she has been informed in writing and been given an opportunity to correct; or (ii) conduct or job performance that ZILA believes is sufficiently willful and/or egregious for which providing written notice and an opportunity to correct is an inadvisable business practice, or (iii) an inability to perform the job (e.g., due to incapacity or death). If Mr. Bethune’s, Mr. Klinefelter’s or Ms. Klein’s employment is terminated for any other reason (with the exception of a Change in Control) such termination will be deemed “Without Cause.”

 

In addition, our severance benefits are subject to the current named executive officers signing a general release acceptable to ZILA in order for such severance benefits to take effect.

 

 

 

 

Employee directors do not receive any separate compensation for their Board activities. Non-employee directors each receive a $10,000 annual retainer. The Audit Committee Chairman receives an additional $5,000 annual retainer and the Compensation Committee Chairman and the Nomination Committee Chairman each receive an additional $2,500 annual retainer. Each non-employee director also receives $2,000 for each Board meeting attended in person and $1,000 for each telephonic meeting. Each non-employee director receives $1,000 for each committee meeting he or she attends. We reimburse directors for any reasonable expenses related to their Board service.

 

On November 9, 2006, ZILA’s Board amended the 1997 Stock Award Plan to eliminate the annual automatic grant of options to non-employee directors.

 

The following table summarizes compensation paid to our each of our non-employee directors who served in such capacity during fiscal 2008. Wade F. Brooksby was appointed to the Board on October 13, 2008, and therefore no compensation is reflected for him in the table below.

 

 

 

EQUITY COMPENSATION PLAN INFORMATION

 

The following table summarizes options, warrants and securities available for issuance under ZILA’s equity compensation plans as of July 31, 2008:

 

 

 

 

The following Compensation Committee Report does not constitute soliciting material and should not be deemed filed or incorporated by reference into any Company filing under the Securities Act of 1933, as amended (the “Securities Act”), or the Securities Exchange Act of 1934, as amended (the “Exchange Act”), except to the extent the intention to do so is expressly indicated.

COMPENSATION COMMITTEE REPORT

 

The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of the Commission’s Regulation S-K with management and, based on such review and discussions, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this Proxy Statement.

 

O.B. Parrish (Chair)
J. Steven Garrett
Leslie H. Green
Members, Compensation Committee

 

The Board has adopted a “Code of Ethical Conduct for Financial Personnel,” which applies solely to our finance personnel. The Board has also adopted a “Code of Business Conduct,” which applies to our Directors and employees (including our principal executive officer, principal financial officer and principal accounting officer). Both of these codes are posted in the “Corporate Governance” section of the Investor Relations portion of our website at www.zila.com. We intend to satisfy any disclosure requirement under Item 5.05 of Form 8-K regarding an amendment to, or waiver from, a provision of these codes relating to an executive officer by posting such information on our website, unless otherwise required by NASDAQ Marketplace Rules to disclose any such waiver on Form 8-K.

AUDIT AND RELATED FEES

 

The following table sets forth the total fees billed by BDO Seidman, LLP for audit and other services for fiscal year 2007 and fiscal year 2008:

 

 

Each year, the Audit Committee approves the annual audit engagement in advance. The Audit Committee also has established procedures to pre-approve all non-audit services provided by the principal independent registered public accounting firm. All fiscal year 2007 and 2008 non-audit services listed above were pre-approved.

 

Audit Fees:   This category includes the audit of our annual financial statements and review of financial statements included in our annual and period reports that are filed with the Commission, the audit of internal control over financial reporting and services that are normally provided by the independent registered public accounting firm in connection with regulatory filings or engagements for those fiscal years. This category also includes advice on audit and accounting matters that arose during, or as a result of, the audit or the review of interim financial statements, and the preparation of an annual “management letter” on internal control and other matters.

 

Audit-Related Fees:   This category consists of assurance and related services by BDO Seidman, LLP that are reasonably related to the performance of the audit or review of our financial statements and are not reported above under “Audit Fees.” There were no audit-related fees in fiscal years 2007 and 2008.

 

Tax Fees:   This category consists of professional services rendered by BDO Seidman LLP for tax compliance and tax advice in fiscal years 2007 and 2008. Any services for the fees to be disclosed under this category would include technical tax advice. There were no tax fees in fiscal years 2007 and 2008.

 

All Other Fees:   There were no other professional services rendered by BDO Seidman, LLP in fiscal years 2007 or 2008.

AUDIT COMMITTEE REPORT

 

The Board of Directors has appointed an Audit Committee, consisting of three directors: Dr. Vuturo (Chair), Mr. Brooksby and Ms. Green. Each of the members is “independent,” as defined in NASDAQ Marketplace Rule 4200(a)(15).

 

The purpose of the Audit Committee is to assist the oversight of our Board in the integrity of the financial statements of ZILA, ZILA’s compliance with legal and regulatory matters, the independent registered public accountant’s qualifications and independence, and the performance of ZILA’s independent registered public accountant. The primary responsibilities of the Audit Committee include overseeing ZILA’s accounting and financial reporting process and audits of the financial statements of ZILA on behalf of the Board.

 

Management has the primary responsibility for the financial statements and reporting process, including the systems of internal controls. The independent registered public accountant is responsible for auditing the financial statements and expressing an opinion on the conformity of those audited financial statements with accounting principles generally accepted in the United States of America.

 

In fulfilling its oversight responsibilities, the Audit Committee reviewed the audited financial statements with management and the independent auditor. The Audit Committee discussed with the independent registered public accountant the matters required to be discussed by Statement of Accounting Standards No. 61, as amended by SAS 89 and SAS 90, “Communications with Audit Committees,” and Rule 2-07 of Regulation S-X including the auditors’ judgments about the quality, not just the acceptability, of ZILA’s accounting principles and such other matters as are required to be discussed with the Audit Committee under the standards of the Public Company

Accounting Oversight Board. In addition, the Audit Committee received from the independent registered public accountant the written disclosures and the letter required by Independence Standards Board Standard No. 1, “Independence Discussions with Audit Committees.” The Audit Committee also discussed with the independent registered public accountant the auditor’s independence from management and our company, including the matters covered by the written disclosures and letter provided by the independent registered public accountant.

 

The Audit Committee discussed with the independent registered public accountant the overall scope and plans for their audit. The Audit Committee met with the independent registered public accountant, with and without management present, to discuss the results of the examinations, its evaluations of our company, the internal controls, and the overall quality of the financial reporting. The Audit Committee held 4 meetings during the fiscal year ended July 31, 2008.

 

Based on the reviews and discussions referred to above, the Audit Committee recommended to the Board, and the Board approved, the inclusion of the audited financial statements in the Annual Report on Form 10-K for the fiscal year ended July 31, 2008, for filing with the Commission.

 

This report has been furnished by the Audit Committee of our Board.

 

George J. Vuturo (Chair)
Leslie H. Green
Wade F. Brooksby
Members, Audit Committee

 

No member of the Compensation Committee was at any time during fiscal 2008 or at any other time an officer or employee of ZILA, and no member had any relationship with ZILA requiring disclosure under Item 404 of Regulation S-K. David R. Bethune, our Chairman and Chief Executive Officer, formerly served on the compensation committee of The Female Health Corporation, the Chief Executive Officer for which is O.B. Parrish, one of our directors and the Chair of our Compensation Committee. No other executive officer of ZILA has served on the Board or Compensation Committee of any other entity that has or has had one or more executive officers who served as a member of the Board or the Compensation Committee during the 2008 fiscal year.

 

Section 16(a) of the Exchange Act requires our directors, executive officers and our ten percent or greater shareholders to file reports of ownership of our equity securities and changes in such ownership with the Commission and NASDAQ and to furnish copies of such reports to us.

 

Based solely on a review of the copies of such reports furnished to us and written representations that no other reports were required, all Section 16(a) filing requirements applicable to our directors, executive officers and our ten percent or greater shareholders were complied with during the fiscal year ended July 31, 2008.

 

The following tables list the ownership of our common stock for the persons or the groups specified. Ownership includes direct and indirect (beneficial) ownership, as defined by the SEC’s rules. To our knowledge, each person, along with his or her spouse, has sole voting and investment power over the shares unless otherwise noted. The following tables set forth information concerning the beneficial owners of our common stock by (i) the directors, (ii) the “named executive officers” (as such term is defined under the SEC’s rules), (iii) the director nominees, (iv) any person holding at least 5% of our shares and (v) all current directors, director nominees and executive officers of ZILA as a group. Beneficial ownership and percentage ownership of shares of our common stock is as of the record date, October 20, 2008, based on 9,989,954 shares of our common stock outstanding.

 

Certain Beneficial Owners

 

 

 

 

Directors and Executive Officers

 

 

 

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

 

Policies and Procedures:   We have established policies and other procedures regarding approval of transactions between our company and any employee, officer, director, and certain of their family members and other related persons, including those required to be reported under Item 404 of Regulation S-K. These policies and procedures are generally not in writing, but are evidenced by long standing principles set forth in our Code of Business Conduct or adhered to by our Board. As set forth in the Audit Committee Charter, unless submitted to the Compensation Committee by delegation from the Board, as and to the extent required under applicable federal securities laws and related rules and regulations, and/or the NASDAQ listing standards, related party transactions are submitted to the Audit Committee for ongoing review, and the Audit Committee approves or disapproves such related party transactions. Generally speaking, we enter into such transactions only on terms that we believe are at least as favorable to our company as those that we could obtain from an unrelated third party.

Related Party Transactions:

 

In November 2006, we consummated two private placements (the “Private Placements”) for gross proceeds of approximately $40.0 million. Pursuant to the first purchase agreement, we issued and sold:

 

(i) 1,300,000 shares of our common stock for $12.25 per share (the “Shares”);

 

(ii) Approximately $12.1 million in aggregate principal amount of 12.0% Unsecured Convertible Notes (the “Unsecured Notes”), which converted into 985,714 shares (the “Unsecured Note Shares”) of our common stock at a conversion price of $12.25 per share on December 14, 2006, the date on which our stockholders approved, among other things, the Private Placements;

 

(iii) Warrants to purchase approximately 772,000 shares of our common stock, which became exercisable in May 2007 for five years at an exercise price of $15.47 per share (the “Initial Warrants”);

 

(iv) Warrants to purchase approximately 444,000 shares of our common stock, which became exercisable for five years at an exercise price of $15.47 per share following approval by our stockholders on December 14, 2006 (the “Additional Warrants”).

 

Pursuant to the second purchase agreement, we issued and sold:

 

(i) Approximately $12.0 million in aggregate principal amount of 6.0% Senior Secured Convertible Notes (the “Secured Notes”), are due in November 2009 and became convertible into 779,221 shares of our common stock at a conversion price of $15.40 following approval by our stockholders on December 14, 2006; and

 

(ii) Warrants to purchase 272,727 shares of our common stock, which became exercisable for five years at an exercise price of $15.47 per share following approval by our stockholders on December 14, 2006 (the “Secured Note Warrants”).

 

We granted registration rights for the Shares and shares of common stock issuable upon conversion of the debt instruments and exercise of the warrants. A dispute arose with certain investors (the “Investors”) regarding the extent of the registration rights. On August 13, 2007, we reached an agreement with the Investors to restructure the Investors’ holdings (the “Restructuring”) and to provide us with relief from certain financial and non-financial covenants contained in the Secured Notes (the “Amendment Agreement”). As amended and restated (the “Amended and Restated Secured Notes”) are in the same aggregate principal amount as the Secured Notes, or approximately $12.0 million, but are due July 31, 2010. The Amended and Restated Secured Notes bear interest, payable quarterly, at 7.0% per annum, but at our option, interest payments can be made at an 8.0% annual rate in shares of our common stock at a price equal to 90.0% of the average closing bid price of such common stock for the ten trading days immediately prior to the relevant interest payment date. The Amended and Restated Secured Notes remain convertible into shares of common stock at a conversion price of $15.40 per share at the option of the holders of such notes. In addition, the Amended and Restated Secured Notes contain comprehensive covenants that restrict the way in which we can operate, and contain financial covenants that require us to maintain specified cash and defined EBITDA levels.

 

As part of the Restructuring, we also agreed to:

 

(i) Repurchase 133,262 Unsecured Note Shares from the Investors for approximately $1.25 million in cash, at a price based on the average closing bid price of our common stock for the ten trading days prior to August 13, 2007, or $9.38 per Unsecured Note Share;

 

(ii) Repurchase 32,467 Secured Note Warrants from the Investors for approximately $0.15 million in cash, at a price based on a Black-Scholes valuation, or $4.62 per Secured Note Warrant; and

 

(iii) Pay the Investors a $0.6 million fee.

 

The Amendment Agreement contained a mutual release of claims. We concluded that the Amended and Restated Secured Notes are not substantially different from the original Secured Notes and accordingly, the Amendment Agreement has not been accounted for as a debt extinguishment. As of July 31, 2007, the $0.6 million fee has been accrued as the resolution of the registration rights dispute with the Investors and the fair value of the

shares and warrants has been reclassified from permanent equity to a current liability. No income or loss was recognized as a result of this reclassification. The increase in the fair value of these financial instruments from July 31, 2007 to the date they were repurchased on August 13, 2007 of less than $0.1 million has been accounted for as a charge to earnings in the first quarter of fiscal 2008. Separately, we have expensed approximately $0.1 million during the year ended July 31, 2007 for costs incurred with third parties that were directly related to the Amendment Agreement, which is included in general and administrative expense in the accompanying Consolidated Statement of Operations.