UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
(Mark one)
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended January 31, 2009
OR
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period from
to
Commission File Number 0-17521
Zila, Inc.
(Exact Name of Registrant as Specified in its Charter)
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Delaware
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86-0619668
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(State or Other Jurisdiction of
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(I.R.S. Employer
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Incorporation)
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Identification No.)
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16430 North Scottsdale Road, Suite 450, Scottsdale, Arizona, 85254-1770
(Address of Principal Executive Offices) (Zip Code)
(602) 266-6700
(Registrants telephone number, including area code)
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, and (2)
has been subject to such filing requirements for the past 90 days.
Yes
þ
. No
o
.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer
o
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Accelerated
filer
þ
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Non-accelerated filer
o
(Do not check if a smaller reporting company)
|
Smaller reporting company
o
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Indicate by check mark whether the registrant is a shell
company (as defined in Rule 12b-2 of the Exchange Act). Yes
o
No
þ
As of February 28, 2009, 10,437,494 shares of the registrants common stock were outstanding.
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TABLE OF CONTENTS
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PAGE
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PART I FINANCIAL INFORMATION
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Item 1.
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Financial Statements
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Condensed Consolidated Balance Sheets as of January 31, 2009 (unaudited) and July 31, 2008
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2
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Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended
January 31, 2009 and 2008
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3
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Unaudited Condensed Consolidated Statement of Shareholders Equity for the Six
Months Ended January 31, 2009
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4
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Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended
January 31, 2009 and 2008
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5
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Notes to Unaudited Condensed Consolidated Financial Statements
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6
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Item 2.
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Managements Discussion and Analysis of Financial Condition and
Results of Operations
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20
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Item 3.
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Quantitative and Qualitative Disclosures About Market Risk
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33
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Item 4.
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Controls and Procedures
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34
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PART II OTHER INFORMATION
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Item 1.
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Legal Proceedings
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34
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Item 1A.
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Risk Factors
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34
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Item 2.
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Unregistered Sales of Equity Securities and Use of Proceeds
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41
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Item 3.
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Defaults Upon Senior Securities
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41
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Item 4.
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Submission of Matters to a Vote of Security Holders
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41
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Item 5.
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Other Information
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42
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Item 6.
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Exhibits
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42
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Signatures
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43
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1
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
ZILA,
INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
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January 31,
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July 31,
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2009
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2008
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(Unaudited)
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ASSETS
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Current assets:
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Cash and cash equivalents
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$
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2,512,768
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$
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4,462,328
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Trade receivables net of allowances of $271,000 and $229,000
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4,309,757
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5,252,215
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Inventories net
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3,238,154
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3,107,152
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Prepaid expenses and other current assets
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1,332,434
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1,853,373
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Total current assets
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11,393,113
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14,675,068
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Property and equipment net
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4,732,356
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5,317,061
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Goodwill
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10,171,351
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Purchased technology net
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2,338,467
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8,860,475
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Trademarks and other intangible assets net
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2,134,768
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9,533,024
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Other assets
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1,387,851
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1,813,512
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Total assets
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$
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21,986,555
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$
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50,370,491
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LIABILITIES AND SHAREHOLDERS EQUITY
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Current liabilities:
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Accounts payable
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$
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2,808,820
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$
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3,843,262
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Accrued liabilities
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3,372,206
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4,059,017
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Deferred gain on sale leaseback
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75,659
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Short-term borrowings and current portion of long-term debt
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9,512,023
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71,252
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Current liabilities of discontinued operations
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48,486
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67,532
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Total current liabilities
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15,741,535
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8,116,722
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Long-term debt net of current portion
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503,319
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8,974,048
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Total liabilities
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16,244,854
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17,090,770
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Shareholders equity:
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Preferred stock Series B, $.001 par value 2,500,000 shares authorized,
100,000 shares issued and outstanding, liquidation preference of $650,000
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462,500
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462,500
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Common stock, $.001 par value 147,500,000 shares authorized,
10,436,758 and 9,953,818 shares issued and outstanding
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10,437
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69,677
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Additional paid-in capital
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126,496,048
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125,901,682
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Accumulated deficit
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(120,545,765
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)
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(92,471,235
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)
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Accumulated other comprehensive loss
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(130,448
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)
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(131,832
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)
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Treasury stock, at cost (31,202 common shares)
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(551,071
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)
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(551,071
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)
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Total shareholders equity
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5,741,701
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33,279,721
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Total liabilities and shareholders equity
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$
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21,986,555
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$
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50,370,491
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The accompanying notes are an integral part of these condensed consolidated financial statements.
2
ZILA, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
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Three Months Ended January 31,
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Six Months Ended January 31,
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2009
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2008
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2009
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2008
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Net revenues
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$
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8,512,836
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$
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10,490,657
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$
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18,153,685
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$
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21,931,094
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Cost of products sold
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3,772,437
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|
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4,244,551
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7,548,439
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|
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8,826,203
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Gross profit
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4,740,399
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6,246,106
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|
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10,605,246
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13,104,891
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Operating costs and expenses:
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Marketing and selling
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3,348,322
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5,220,677
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7,719,303
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|
|
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10,517,274
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General and administrative
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|
1,813,211
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|
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|
3,128,326
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|
|
|
4,036,253
|
|
|
|
6,602,003
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Impairment of goodwill
and other intangible assets
|
|
|
23,192,967
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|
|
|
|
|
|
|
23,192,967
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|
|
|
|
|
Research and development
|
|
|
77,884
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|
|
|
788,883
|
|
|
|
244,406
|
|
|
|
1,990,668
|
|
Depreciation and amortization
|
|
|
610,931
|
|
|
|
943,711
|
|
|
|
1,534,800
|
|
|
|
1,858,724
|
|
|
|
|
|
|
|
|
|
|
|
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|
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|
|
|
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|
|
|
|
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|
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Total operating costs and expenses
|
|
|
29,043,315
|
|
|
|
10,081,597
|
|
|
|
36,727,729
|
|
|
|
20,968,669
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(24,302,916
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)
|
|
|
(3,835,491
|
)
|
|
|
(26,122,483
|
)
|
|
|
(7,863,778
|
)
|
|
|
|
|
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|
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|
|
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Other income (expense):
|
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|
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|
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|
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Interest income
|
|
|
|
|
|
|
73,319
|
|
|
|
15,816
|
|
|
|
197,501
|
|
Interest expense
|
|
|
(893,926
|
)
|
|
|
(800,819
|
)
|
|
|
(1,816,317
|
)
|
|
|
(1,567,527
|
)
|
Derivative expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(23,600
|
)
|
Other expense
|
|
|
(42,289
|
)
|
|
|
(25,812
|
)
|
|
|
(90,110
|
)
|
|
|
(3,040
|
)
|
|
|
|
|
|
|
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|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
Other expense net
|
|
|
(936,215
|
)
|
|
|
(753,312
|
)
|
|
|
(1,890,611
|
)
|
|
|
(1,396,666
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations before income taxes
|
|
|
(25,239,131
|
)
|
|
|
(4,588,803
|
)
|
|
|
(28,013,094
|
)
|
|
|
(9,260,444
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)
|
Income tax expense
|
|
|
|
|
|
|
|
|
|
|
(13,197
|
)
|
|
|
(11,592
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
|
(25,239,131
|
)
|
|
|
(4,588,803
|
)
|
|
|
(28,026,291
|
)
|
|
|
(9,272,036
|
)
|
Loss from discontinued operations,
net of income tax expense of nil
|
|
|
(17,504
|
)
|
|
|
(146,765
|
)
|
|
|
(28,739
|
)
|
|
|
(319,034
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Net loss
|
|
|
(25,256,635
|
)
|
|
|
(4,735,568
|
)
|
|
|
(28,055,030
|
)
|
|
|
(9,591,070
|
)
|
Preferred stock dividends
|
|
|
9,750
|
|
|
|
9,750
|
|
|
|
19,500
|
|
|
|
19,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common shareholders
|
|
$
|
(25,266,385
|
)
|
|
$
|
(4,745,318
|
)
|
|
$
|
(28,074,530
|
)
|
|
$
|
(9,610,570
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net loss per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
$
|
(2.43
|
)
|
|
$
|
(0.52
|
)
|
|
$
|
(2.76
|
)
|
|
$
|
(1.05
|
)
|
Loss from discontinued operations
|
|
|
|
|
|
|
(0.02
|
)
|
|
|
|
|
|
|
(0.04
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common shareholders
|
|
$
|
(2.43
|
)
|
|
$
|
(0.54
|
)
|
|
$
|
(2.76
|
)
|
|
$
|
(1.09
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares
outstanding basic and diluted
|
|
|
10,398,407
|
|
|
|
8,782,660
|
|
|
|
10,171,558
|
|
|
|
8,777,346
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
ZILA, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
For the Six Months Ended January 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
|
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
Total
|
|
|
|
Preferred Stock
|
|
|
Common Stock
|
|
|
Paid-in
|
|
|
Accumulated
|
|
|
Comprehensive
|
|
|
Treasury
|
|
|
Shareholders
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Deficit
|
|
|
Loss
|
|
|
Stock
|
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance July 31, 2008
|
|
|
100,000
|
|
|
$
|
462,500
|
|
|
|
9,953,818
|
|
|
$
|
69,677
|
|
|
$
|
125,901,682
|
|
|
$
|
(92,471,235
|
)
|
|
$
|
(131,832
|
)
|
|
$
|
(551,071
|
)
|
|
$
|
33,279,721
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
expense
|
|
|
|
|
|
|
|
|
|
|
50,475
|
|
|
|
211
|
|
|
|
319,676
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
319,887
|
|
Common shares withheld
for income taxes
|
|
|
|
|
|
|
|
|
|
|
(13,675
|
)
|
|
|
(51
|
)
|
|
|
(32,561
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(32,612
|
)
|
Issuance of common stock
under employee stock
purchase plan
|
|
|
|
|
|
|
|
|
|
|
11,057
|
|
|
|
47
|
|
|
|
2,471
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,518
|
|
Effect of reverse stock
split approved on
September 12, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(59,882
|
)
|
|
|
59,882
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares issued for payment
of interest
|
|
|
|
|
|
|
|
|
|
|
435,083
|
|
|
|
435
|
|
|
|
244,898
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
245,333
|
|
Foreign currency
translation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,384
|
|
|
|
|
|
|
|
1,384
|
|
Preferred stock dividends
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(19,500
|
)
|
|
|
|
|
|
|
|
|
|
|
(19,500
|
)
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(28,055,030
|
)
|
|
|
|
|
|
|
|
|
|
|
(28,055,030
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance January 31, 2009
|
|
|
100,000
|
|
|
$
|
462,500
|
|
|
|
10,436,758
|
|
|
$
|
10,437
|
|
|
$
|
126,496,048
|
|
|
$
|
(120,545,765
|
)
|
|
$
|
(130,448
|
)
|
|
$
|
(551,071
|
)
|
|
$
|
5,741,701
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
ZILA, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended January 31,
|
|
|
|
2009
|
|
|
2008
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(28,055,030
|
)
|
|
$
|
(9,591,070
|
)
|
Adjustments to reconcile net loss to net cash used
in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
1,762,678
|
|
|
|
2,084,687
|
|
Non-cash amortization of financing costs
|
|
|
451,694
|
|
|
|
196,190
|
|
Non-cash amortization of debt discounts
|
|
|
897,342
|
|
|
|
898,160
|
|
Non-cash interest
|
|
|
245,333
|
|
|
|
245,334
|
|
Non-cash derivative (income) expense
|
|
|
|
|
|
|
23,600
|
|
Non-cash stock-based compensation expense
|
|
|
320,494
|
|
|
|
976,382
|
|
Impairment of goodwill and other intangible assets
|
|
|
23,192,967
|
|
|
|
|
|
Other non-cash items net
|
|
|
(15,232
|
)
|
|
|
18,026
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Trade receivables
|
|
|
942,458
|
|
|
|
(1,522,957
|
)
|
Inventories
|
|
|
(131,002
|
)
|
|
|
(273,475
|
)
|
Prepaid expenses and other assets
|
|
|
688,443
|
|
|
|
65,565
|
|
Accounts payable and accrued liabilities
|
|
|
(1,769,165
|
)
|
|
|
194,859
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
|
(1,469,020
|
)
|
|
|
(6,684,699
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Additions to property and equipment
|
|
|
(150,614
|
)
|
|
|
(549,234
|
)
|
Additions to intangible assets
|
|
|
(197,844
|
)
|
|
|
(205,510
|
)
|
Proceeds from sale of assets
|
|
|
6,344
|
|
|
|
462
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(342,114
|
)
|
|
|
(754,282
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Principal payments on debt
|
|
|
(120,837
|
)
|
|
|
(127,400
|
)
|
Payment of obligation to repurchase common stock and warrants
|
|
|
|
|
|
|
(1,399,993
|
)
|
Dividends paid to preferred stockholders
|
|
|
(19,500
|
)
|
|
|
(19,500
|
)
|
Proceeds from issuance of common stock
|
|
|
1,911
|
|
|
|
11,200
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in financing activities
|
|
|
(138,426
|
)
|
|
|
(1,535,693
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net decrease in cash and cash equivalents
|
|
|
(1,949,560
|
)
|
|
|
(8,974,674
|
)
|
Cash and cash equivalents beginning of period
|
|
|
4,462,328
|
|
|
|
14,859,159
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents end of period
|
|
$
|
2,512,768
|
|
|
$
|
5,884,485
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business and Basis of Presentation
Nature of Business Activities and Basis of Presentation
The accompanying Unaudited Condensed Consolidated Financial Statements include the accounts of
Zila, Inc. and its wholly owned subsidiaries (collectively, Zila, we, us or our). Zila is a
diagnostic company dedicated to the prevention, detection and treatment of oral cancer and
periodontal disease. We manufacture and market ViziLite
®
Plus with TBlue
®
(ViziLite
®
Plus), our flagship product for the early detection of oral abnormalities
that could lead to cancer. ViziLite
®
Plus is an adjunctive medical device cleared by the
FDA for use in a population at increased risk for oral cancer. In addition, Zila designs,
manufactures and markets a suite of proprietary products sold exclusively and directly to dental
professionals for periodontal disease, including the Rotadent
®
Professional Powered
Brush, the Pro-Select Platinum
®
ultrasonic scaler and a portfolio of oral pharmaceutical
products for both in-office and home-care use. Our products are marketed and sold in the United
States and Canada primarily through our direct field sales force and telemarketing organization.
Our products are marketed and sold in other international markets through the sales forces of third
party distributors. Our marketing programs reach most U.S. dental offices by direct marketing
efforts and various media outlets. We are an approved American Dental Association continuing
education provider and recently submitted our renewal application to the Academy of General
Dentistry to continue as an approved continuing education provider.
These unaudited condensed consolidated financial statements have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission (the SEC). All significant
intercompany transactions and accounts have been eliminated. Certain information related to our
organization, significant accounting policies and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles generally accepted in the
United States (GAAP) have been condensed or omitted. The accounting policies followed in the
preparation of these unaudited condensed consolidated financial statements are consistent with
those followed in our annual consolidated financial statements for the year ended July 31, 2008, as
filed on Form 10-K. In the opinion of management, these unaudited condensed consolidated financial
statements contain all material adjustments, consisting only of normal recurring adjustments,
necessary to fairly state our financial position, results of operations and cash flows for the
periods presented and the presentations and disclosures herein are adequate when read in
conjunction with our Form 10-K for the year ended July 31, 2008. The results reported in these
interim condensed consolidated financial statements should not be regarded as being necessarily
indicative of results that might be expected for the full year. Certain reclassifications have been
made to the prior period financial statement amounts to conform to the current presentation.
On September 12, 2008, our shareholders approved a one for seven reverse split of our common
stock. As a result of the reverse split, each holder of seven outstanding shares of common stock
received one share of common stock. Fractional shares resulting from this reverse split have been
issued to our shareholders as applicable, and accordingly, we did not make any cash payments in
lieu of the issuance of fractional shares. The reverse split has been retroactively applied to all
applicable information to the earliest period presented.
The preparation of financial statements in conformity with GAAP 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 revenue and expenses during the reporting period. Actual results could differ from those
estimates. Significant estimates include: (i) useful lives of intangibles; (ii) impairment
analyses; (iii) depreciable lives of assets; (iv) income tax valuation allowances; (v) contingency
and litigation reserves; (vi) inventory valuation; (vii) allowances for accounts receivable, cash
discounts, sales incentives and sales returns; and (viii) valuation assumptions for share-based
payments.
Basic net income (loss) per common share is computed by dividing net income (loss) available
to common shareholders by the weighted average number of common shares outstanding during the
period before giving effect to stock options, stock warrants, restricted stock units and
convertible securities outstanding, which are considered to be dilutive common stock equivalents.
Diluted net income (loss) per common share is calculated based on the weighted average number of
common and potentially dilutive shares outstanding during the period after giving effect to
convertible preferred stock, convertible debt, stock options, warrants and restricted stock units.
Contingently issuable shares are included in the computation of basic earnings (loss) per share
when issuance of the shares is no longer contingent. Due to the losses from continuing operations
for the three and six months ended January 31, 2009 and 2008, basic and diluted loss per common
share were the same, as the effect of potentially dilutive securities would have been
anti-dilutive.
6
ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Potentially dilutive securities not included in the diluted loss per share calculation, due to
net losses from continuing operations, are as follows (unaudited) (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended January 31,
|
|
Six Months Ended January 31,
|
|
|
2009
|
|
2008
|
|
2009
|
|
2008
|
|
Options and warrants to purchase common shares
|
|
|
2
|
|
|
|
44
|
|
|
|
6
|
|
|
|
62
|
|
Common stock awards
|
|
|
20
|
|
|
|
51
|
|
|
|
7
|
|
|
|
52
|
|
Convertible preferred stock
|
|
|
100
|
|
|
|
100
|
|
|
|
100
|
|
|
|
100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total potentially dilutive securities
|
|
|
122
|
|
|
|
195
|
|
|
|
113
|
|
|
|
214
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of January 31, 2009 and 2008, we have approximately $12.0 million of Senior Secured
Convertible Notes outstanding that are convertible into 779,221 shares of our common stock and have
been excluded from the above table. The conversion price of these notes is more than the quoted
market price of our common stock on such dates. As of January 31, 2009, 1,843,997 stock options
and warrants were antidilutive as the strike price of these securities was more than the market
price of our common stock. As of January 31, 2008, 2,591,884 stock options and warrants were
antidilutive as the strike price of these securities was more than the market price of our common
stock.
Liquidity
The accompanying condensed consolidated financial statements have been prepared on a going
concern basis, which assumes that Zila will be able to meet its obligations and continue its
operations for the next twelve months. We have historically sustained recurring losses and negative
cash flows from operations as we changed our strategic direction to focus on the growth and
development of ViziLite
®
Plus and our periodontal product lines. Our liquidity needs
have typically arisen from the funding of our research and development program and the launch of
our new products, such as ViziLite
®
Plus, working capital and debt service requirements,
and strategic initiatives. In the past, we have met these cash requirements through our cash and
cash equivalents, working capital management, the sale of non-core assets and proceeds from certain
private placements of our securities.
To reduce operating losses, during the second half of fiscal 2008, we took steps to reduce
costs in non-direct sales force areas through headcount reductions, furloughs of certain
personnel and discontinuing research and development projects, and have implemented profit
enhancement initiatives. We also took steps to improve revenues and gross profit through the
implementation of selective price increases and implementing initiatives to reduce our cost of
goods. As a result of these steps, during the fourth quarter of fiscal 2008 we achieved positive
cash flow from operations and achieved compliance with the Defined EBITDA covenant contained in our
Senior Secured Convertible Notes, which is discussed in further detail elsewhere herein. Although
these initiatives proved to be effective in our meeting the Defined EBITDA covenant contained in
our Senior Secured Convertible Notes during the fourth quarter of fiscal 2008, we do not expect
some of these initiatives, such as reducing or deferring salaries, benefits and other operating
costs, to be sustainable into future periods.
During the first half of fiscal 2009, our revenues have been negatively impacted as a result
of the severity of the global economic downturn and its impact on discretionary spending on our
products. Additionally, the unwillingness of the holders of the Senior Secured Convertible Notes
to renegotiate their debt has affected revenues as a result of customer concern about our viability
as an ongoing business. We would expect these factors to cause near term future operating results
to be less favorable than our financial results for the fourth quarter of fiscal 2008 and those
previously anticipated for fiscal 2009. To address the impact of this revenue decline, during the
first half of fiscal 2009 we have (i) continued salary reductions for a number of management
personnel; (ii) eliminated additional headcount, including an approximately 15% reduction of our
field sales force as a result of the realignment of our sales territories; (iii) eliminated the
employee stock purchase plan and its associated costs; (iv) furloughed certain manufacturing
production personnel; (v) reduced the number of seminar programs and streamlined the cost structure
of these programs; and (vi) reduced tradeshow expenditures. Excluding the effect of the $23.2
million impairment loss for goodwill and other intangible assets recognized during December 2008,
these actions narrowed our operating loss over the same periods in the prior year. The impairment
loss is more fully described in Note 5, Goodwill and Other Intangible Assets. To address the impact
of the economic downturn on our revenues, we continue to identify cost-reduction and working
capital initiatives to reduce the impact on future cash flows from operations and results of
operations.
7
ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
While we have continued to execute a number of cost reduction strategies, the decline in our revenues has caused
our cash utilization to exceed planned levels. As of January 31, 2009, we had approximately $2.5
million of cash and cash equivalents, compared to $3.2 million at October 31, 2008 and $4.5 million
at July 31, 2008 and a working capital deficit of $4.3 million compared to working capital of $5.7
million at October 31, 2008 and $6.6 million at July 31, 2008. In order to continue as a going
concern and fund our current level of operations over the next twelve months, we will require
additional funds and need to restructure our Senior Secured Convertible Notes. If we are unable
to do so, we will likely be forced to file for protection under Chapter 11 of the Federal Bankruptcy
Code. We have retained financial and legal advisors to assist us in our numerous continuing efforts
to restructure our Senior Secured Convertible Notes, raise capital and explore possible strategic
opportunities.
Our efforts to seek additional funding have included discussions with numerous potential
financial and strategic investors as well as with the holders of the Senior Secured Convertible
Notes. All potential investors with whom we have had discussions required, as a condition of their
investment, that the Senior Secured Convertible Notes be repaid from the funds provided by the
investor(s) and that this repayment be at a substantial discount from the $12.0 million principal
outstanding to reflect the current market value of those notes. However, to date, the holders of
the Senior Secured Convertible Notes have been unwilling to agree to an amount to extinguish this
debt. Also, although the Senior Secured Convertible Notes provide us with the opportunity to
obtain a working capital line of credit secured by our inventory and accounts receivable, we have
been unable to obtain the approval of the majority holder of the Senior Secured Convertible Notes
even though the note agreements provide that such approval is not to be unreasonably withheld.
We have made timely interest payments under the terms of the Senior Secured Convertible Notes
and are otherwise in compliance with the terms of such notes, except for the interest payment due
January 31, 2009, which has not been made as of the date of this filing. The failure to make this
payment is an event of default under our Senior Secured Convertible Notes. Although we have not
received a notice of default or acceleration from the note holders as of the date of this filing,
which is required prior to any of the principal amount becoming due and payable as a result of such
default, we have reclassified the Senior Secured Convertible Notes to current liabilities. In
addition, upon an event of default, the Senior Secured Convertible Notes shall bear interest at a
default rate of 15.0% per annum. However, during the pendency of negotiations, the note holders
have agreed that no default interest will accrue unless and until they provide notice to us.
We were unable to issue shares for the January 31, 2009 interest
payment because, due to our share price at such time the number of shares to be issued would have required shareholder approval under
applicable NASDAQ rules. In addition, given our current level of cash and cash equivalents, the
impact of the global economic downturn on our business and customer concern about our viability as
an ongoing business, it is uncertain whether we will have sufficient cash available to pay our
future quarterly interest payments due under the Senior Secured Convertible Notes.
As a result of the foregoing, there is substantial doubt about our ability to continue as a
going concern. Accordingly, realization values may be substantially different from carrying values
as shown, and these financial statements do not give effect to adjustments that would be necessary
to the carrying values and classification of assets and liabilities should we be unable to continue
as a going concern.
2. Recently Issued Accounting Pronouncements and Adopted Accounting
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements
(SFAS 157), which
defines fair value, establishes a framework for measuring fair value in GAAP, and expands
disclosures about fair value measurements. SFAS 157 does not require any new fair value
measurements, but provides guidance on how to measure fair value by providing a fair value
hierarchy used to classify the source of the information for those instruments measured at fair
value. The fair value hierarchy distinguishes between assumptions based on market data (observable
inputs) and an entitys own assumptions (unobservable inputs). The hierarchy consists of three
levels:
Level 1 Quoted market prices in active markets for identical assets or liabilities;
Level 2 Inputs other than Level 1 inputs that are either directly or indirectly observable;
and
Level 3 Unobservable inputs developed using estimates and assumptions, which are developed by
the reporting entity and reflect those assumptions that a market participant would use.
Determining which category an asset or liability falls within the hierarchy requires
significant judgment. We evaluate our hierarchy disclosures each quarter.
8
ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SFAS 157 is effective for financial instruments issued for years beginning after November 15,
2007, with the exception of certain nonfinancial assets and liabilities, for which the effective
date has been deferred by one year. On August 1, 2008, we adopted the provisions of SFAS 157,
except as it applies to those nonfinancial assets and nonfinancial liabilities for which the
effective date has been delayed by one year. The adoption of SFAS 157 did not have a material
effect on our financial position or results of operations.
Other than our notes payable, the fair value of financial instruments approximates their
carrying value at January 31, 2009. These financial instruments consist of cash and cash
equivalents, receivables, accounts payable and accrued expenses. We do not believe it is currently
practicable to estimate the fair value of the Senior Secured Convertible Notes as there is no
active market for such notes and there are a limited number of investors in the notes. The carrying
amount of other borrowings is estimated to approximate fair value as the actual interest rate is
consistent with the rate estimated to be currently available for borrowings of similar term and
remaining maturity.
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated
Financial Statements an amendment of ARB No. 51
(SFAS 160). SFAS 160 establishes accounting
and reporting standards that require (i) noncontrolling interests to be reported as a component of
equity; (ii) changes in a parents ownership interest while the parent retains its controlling
interest to be accounted for as equity transactions; and (iii) any retained noncontrolling equity
investment upon the deconsolidation of a subsidiary to be initially measured at fair value. SFAS
160 is effective for fiscal years and interim periods within those fiscal years, beginning on or
after December 15, 2008, which for us is the fiscal quarter beginning February 1, 2009. Early
adoption is prohibited. We do not expect the adoption of SFAS 160 to have a material effect on our
financial position or results of operations.
In December 2007, the FASB issued SFAS No. 141 (revised 2007),
Business Combinations
(SFAS
141R). SFAS 141R establishes the principles and requirements for how an acquirer: (i) recognizes
and measures in its financial statements the identifiable assets acquired, the liabilities assumed
and any noncontrolling interest in the acquiree; (ii) recognizes and measures goodwill acquired in
a business combination or a gain from a bargain purchase; and (iii) determines what information to
disclose to enable users of the financial statements to evaluate the nature and financial effects
of a business combination. Additionally, under SFAS 141R transaction related costs must be expensed
as incurred, rather than accounted for as part of the purchase price of an acquisition. SFAS 141R
is to be applied prospectively to business combinations consummated on or after the beginning of
the first annual reporting period on or after December 15, 2008, which for us would be our fiscal
year beginning August 1, 2009. Early adoption is prohibited. Following its effective date, we will
apply the provisions of SFAS 141R to future acquisitions, if any.
In March 2008, the FASB issued SFAS No. 161,
Disclosures about Derivative Instruments and
Hedging Activities, an amendment of FASB Statement No. 133
(SFAS 161), which establishes, among
other things, the disclosure requirements for derivative instruments and hedging activities. SFAS
161 requires qualitative disclosures about objectives and strategies for using derivatives,
quantitative disclosures about fair value amounts of, and gains and losses on, derivative
instruments, and disclosures about credit-risk-related contingent features in derivative
agreements. SFAS 161 is effective for fiscal periods and interim periods beginning after November
15, 2008, which for us would be our third quarter of our fiscal year 2009, which would be the
quarterly period ending April 30, 2009. We are currently evaluating the impact SFAS 161 will have
on our financial statement disclosures.
In April 2008, the FASB issued FASB Staff Position (FSP) No. SFAS 142-3,
Determination of
the Useful Life of Intangible Assets
(FSP SFAS 142-3). FSP SFAS 142-3 amends the factors that
should be considered in developing renewal or extension assumptions used to determine the useful
life of a recognized intangible asset under SFAS 142. The intent of FSP SFAS 142-3 is to improve
the consistency between the useful life of a recognized intangible asset under SFAS 142 and the
period of expected cash flows used to measure the fair value of the asset under SFAS 141R and other
applicable accounting literature. FSP SFAS 142-3 is effective for financial statements issued for
fiscal years beginning after December 15, 2008 and must be applied prospectively to intangible
assets acquired after the effective date. We are currently evaluating the impact FSP SFAS 142-3
will have on our financial position or results of operations.
In May 2008, the FASB issued FSP Accounting Principles Board No. 14-1
Accounting for
Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement)
(FSP APB 14-1). FSP APB 14-1 requires the issuer of certain convertible debt
instruments that may be settled in cash (or other assets) on conversion (including partial cash
settlement) to separately account for the liability and equity components of the instrument in a
manner that reflects the issuers non-convertible debt borrowing rate when interest cost is
recognized in subsequent periods. FSP APB 14-1 is effective for financial statements issued for
fiscal years beginning after December 15, 2008, and interim periods within those fiscal years.
Early adoption is prohibited. We are currently evaluating the impact FSP APB 14-1 will have on our
financial position or results of operations.
9
ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. Inventories
Inventories consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
January 31,
|
|
|
July 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Finished goods
|
|
$
|
852
|
|
|
$
|
675
|
|
Work-in-process
|
|
|
421
|
|
|
|
396
|
|
Raw materials
|
|
|
2,536
|
|
|
|
2,470
|
|
Inventory reserves
|
|
|
(571
|
)
|
|
|
(434
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total inventories
|
|
$
|
3,238
|
|
|
$
|
3,107
|
|
|
|
|
|
|
|
|
4. Property and Equipment
Property and equipment consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
January 31,
|
|
|
July 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land
|
|
$
|
529
|
|
|
$
|
529
|
|
Building and improvements
|
|
|
2,150
|
|
|
|
2,132
|
|
Furniture and equipment
|
|
|
3,282
|
|
|
|
3,408
|
|
Leasehold improvements and other assets
|
|
|
803
|
|
|
|
823
|
|
Production, laboratory and warehouse equipment
|
|
|
4,582
|
|
|
|
4,582
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total property and equipment
|
|
|
11,346
|
|
|
|
11,474
|
|
Less: Accumulated depreciation and amortization
|
|
|
(6,614
|
)
|
|
|
(6,157
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment net
|
|
$
|
4,732
|
|
|
$
|
5,317
|
|
|
|
|
|
|
|
|
For the three months ended January 31, 2009 and 2008, approximately $0.1 million of
depreciation expense was included in cost of products sold. For the six months ended January 31,
2009 and 2008, approximately $0.2 million of depreciation expense was included in cost of products
sold.
10
ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. Goodwill and Other Intangible Assets
Goodwill and other intangible assets consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 31, 2009 (Unaudited)
|
|
|
July 31, 2008
|
|
|
|
Gross
|
|
|
|
|
|
|
Net
|
|
|
Gross
|
|
|
|
|
|
|
Net
|
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
Carrying
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
Carrying
|
|
|
|
Amount
|
|
|
Amortization
|
|
|
Amount
|
|
|
Amount
|
|
|
Amortization
|
|
|
Amount
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortizable intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchased technology
|
|
$
|
9,517
|
|
|
$
|
(7,179
|
)
|
|
$
|
2,338
|
|
|
$
|
15,592
|
|
|
$
|
(6,732
|
)
|
|
$
|
8,860
|
|
Trademarks
|
|
|
174
|
|
|
|
(26
|
)
|
|
|
148
|
|
|
|
168
|
|
|
|
(18
|
)
|
|
|
150
|
|
Patents
|
|
|
757
|
|
|
|
(434
|
)
|
|
|
323
|
|
|
|
2,019
|
|
|
|
(385
|
)
|
|
|
1,634
|
|
Licensing costs
|
|
|
2,028
|
|
|
|
(1,889
|
)
|
|
|
139
|
|
|
|
2,674
|
|
|
|
(1,777
|
)
|
|
|
897
|
|
Customer relationships,
covenants not to
compete and other
|
|
|
2,591
|
|
|
|
(2,585
|
)
|
|
|
6
|
|
|
|
3,556
|
|
|
|
(2,153
|
)
|
|
|
1,403
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total amortizable
intangible assets
|
|
|
15,067
|
|
|
|
(12,113
|
)
|
|
|
2,954
|
|
|
|
24,009
|
|
|
|
(11,065
|
)
|
|
|
12,944
|
|
Unamortizable trademarks
|
|
|
1,519
|
|
|
|
|
|
|
|
1,519
|
|
|
|
5,449
|
|
|
|
|
|
|
|
5,449
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other intangible assets
|
|
|
16,586
|
|
|
|
(12,113
|
)
|
|
|
4,473
|
|
|
|
29,458
|
|
|
|
(11,065
|
)
|
|
|
18,393
|
|
Goodwill
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,171
|
|
|
|
|
|
|
|
10,171
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible assets
|
|
$
|
16,586
|
|
|
$
|
(12,113
|
)
|
|
$
|
4,473
|
|
|
$
|
39,629
|
|
|
$
|
(11,065
|
)
|
|
$
|
28,564
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of amortizable intangible assets is calculated using the following useful lives
(in years):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
Range of
|
|
Remaining Useful Lives
|
|
|
Useful Lives
|
|
January 31, 2009
|
|
July 31, 2008
|
|
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchased technology
|
|
15
|
|
|
9.3
|
|
|
|
11.5
|
|
Trademarks
|
|
7-10
|
|
|
6.2
|
|
|
|
6.6
|
|
Patents
|
|
4-17
|
|
|
9.4
|
|
|
|
7.4
|
|
Licensing costs
|
|
7-10
|
|
|
3.0
|
|
|
|
3.4
|
|
Customer relationships, covenants
not to compete and other
|
|
2-15
|
|
|
2.9
|
|
|
|
6.0
|
|
We assess the impairment of goodwill annually in our fourth fiscal quarter, or whenever events
or changes in circumstances indicate that the carrying value of goodwill may not be recoverable.
During the first half of fiscal 2009, our revenues have been negatively impacted as a result of the
severity of the global economic downturn and its impact on discretionary spending on our products.
The unwillingness of the holders of the Senior Secured Convertible Notes to renegotiate their debt
has also affected revenues as a result of customer concern about our viability as an ongoing
business. We would expect these factors to cause near term future operating results to be less favorable than previously
anticipated for fiscal 2009. We have also experienced a decline in our stock price and a
corresponding decline in our market capitalization and enterprise value throughout the first half
of fiscal 2009. Finally, as of December 2008, we anticipated we would fail to make the interest
payment due January 31, 2009 on our Senior Secured Convertible Notes, which is an event of default
under such notes. Although we have not received a notice of default or acceleration from the note
holders as of the date of this filing, which is required prior to any of the principal amount
becoming due and payable as a result of such default, the note holders may, at any time, accelerate
one-third of the amount outstanding under the Senior Secured Convertible Notes, which in this case
is $4.0 million. In order to continue as a going concern and fund our current level of operations
over the next twelve months, we will be required to seek additional funds and restructure our
Senior Secured Convertible Notes. If we are unable to do so, we will likely be forced to file for
protection under Chapter 11 of the Federal Bankruptcy Code, which may lead to a liquidation of our
business. Primarily as a result of these factors, we assessed goodwill for impairment during
December of 2008 in addition to our annual test. The assessment is performed using the two-step
process prescribed by SFAS No. 142,
Goodwill and Other Intangible Assets
11
ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(SFAS 142). The first
step is a screen for potential impairment, while the second step measures the amount of the
impairment, if any. The first step of the goodwill impairment test compares the fair value of a
reporting unit with its carrying amount, including
goodwill. If the fair value of the reporting unit exceeds its carrying value, goodwill is not
impaired. If the carrying value of the reporting units net assets, including goodwill, exceeds
the fair value of the reporting unit, then we determine the implied fair value of the reporting
units goodwill. If the carrying value of a reporting units goodwill exceeds its implied fair
value, then an impairment of goodwill has occurred and we recognize an impairment loss for the
difference between the carrying amount and the implied fair value of goodwill as a component of
operating income. The implied fair value of goodwill is calculated by subtracting the fair value of
tangible and intangible assets associated with the reporting unit from the fair value of the unit.
For fiscal 2008, the first step of our goodwill impairment test reflected fair value that was in
excess of the carrying value. Accordingly, we did not perform the second step of this test during
fiscal 2008. The December 2008 impairment test resulted in an impairment of the entire balance of
goodwill, or $10.2 million.
For fiscal 2009 and 2008, our business has been managed and operated as one operating segment
and one reporting unit, and accordingly, our goodwill impairment tests conducted during these years
were based on one reporting unit. We relied upon the discounted cash flow method under
the income approach, and the orderly and forced liquidation method, as the primary means to
calculate fair value. Significant estimates used in the fair value calculation include, but are not
limited to: (i) estimates of future revenue and expense growth; (ii) future estimated effective tax
rates, which we estimate to be approximately 40%; (iii) future estimated capital expenditures and
future required investments in working capital; (iv) average cost of capital, which we base on
expectations for market participants and estimate to be approximately 43% for fiscal 2009 and 25%
for fiscal 2008; (v) the ability to utilize certain tax attributes and (vi) the future terminal
value of the reporting unit. The primary factors leading to impairment for the December 2008
interim impairment test were (i) lower levels of projected cash flows, which were affected by the
recent declines in our revenues, (ii) an increase in the average cost of capital, which is
primarily attributable to general increases in the cost of capital relative to the recent global
economic downturn and increased risks associated with the cash flows from our business and (iii) an
increased likelihood of a liquidation of our business. There have been no substantial changes in
the methodologies employed, significant assumptions used, or calculations applied in the first step
of the SFAS 142 impairment test over the past several years; however, due to the factors discussed
above, for the December 2008 interim impairment test we placed more emphasis on liquidation scenarios. Prior to fiscal 2008 we divested and acquired certain businesses, and
accordingly, the number of business units identified in prior periods was different than those
identified for the fiscal 2009 and 2008 impairment tests.
We assess impairment of other intangibles and long-lived assets whenever events or changes in
circumstances indicate that the carrying value of any of these assets may not be recoverable. Such
events or circumstances might include a significant decline in market share and/or significant
negative industry or economic trends, a significant decline in profits and/or significant
underperformance relative to expected historical or projected operating results, significant
changes in the manner of our use of the acquired assets or the strategy for our overall business,
rapid changes in technology, significant litigation or other items. As a result of the factors
discussed above, we assessed our other intangible assets for impairment during December 2008. In
evaluating the recoverability of intangibles and other long-lived assets, our policy is to first
compare the carrying amounts of such assets with the estimated undiscounted future operating cash
flows. If the carrying amount exceeds the undiscounted future operating cash flows, an impairment
charge is recognized for the excess of the carrying amount of the asset over its fair value. We
calculate fair value of trademark and know-how intangible assets by using a relief from royalty
method. The relief from royalty method is based on the assumption that, in lieu of ownership of an
intangible asset, a company would be willing to pay a royalty in order to enjoy the benefits of the
asset. Under this method, value is estimated by discounting the hypothetical royalty payments to
their present value over the economic life of the asset. We calculate fair value of our customer
relationships by using the excess earnings method. The excess earnings method estimates the value
of an intangible asset by quantifying the amount of residual (or excess) cash flows generated by
the asset, and discounting those cash flows to the present. Growth rates of net sales and average
cost of capital used for discounting cash flows for the December 2008 impairment assessment are consistent with those utilized in the December
2008 interim goodwill test. We recognized an impairment charge of approximately $13.0 million
relative to these intangible assets, which was primary driven by lower levels of projected cash
flows, an increase in the average cost of capital and lower estimated royalty rates of our products
relative to other products in the market.
12
ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
A summary of changes in our goodwill and other intangible assets for the first six months of
fiscal 2009, and the impairment charges recognized during December 2008, is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended January 31, 2009
|
|
|
|
Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
|
|
|
|
Carrying
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Carrying
|
|
|
|
Amount -
|
|
|
|
|
|
|
|
|
|
|
Amortization
|
|
|
|
|
|
|
Amortization
|
|
|
Amount -
|
|
|
|
Beginning
|
|
|
|
|
|
|
|
|
|
|
Prior to
|
|
|
Impairment
|
|
|
Subsequent to
|
|
|
End
|
|
|
|
of Period
|
|
|
Additions
|
|
|
Disposals
|
|
|
Impairment
|
|
|
Charge
|
|
|
Impairment
|
|
|
of Period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortizable intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchased technology
|
|
$
|
8,860
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
(426
|
)
|
|
$
|
(6,075
|
)
|
|
$
|
(21
|
)
|
|
$
|
2,338
|
|
Trademarks
|
|
|
150
|
|
|
|
9
|
|
|
|
(1
|
)
|
|
|
(7
|
)
|
|
|
(2
|
)
|
|
|
(1
|
)
|
|
|
148
|
|
Patents
|
|
|
1,634
|
|
|
|
189
|
|
|
|
(47
|
)
|
|
|
(47
|
)
|
|
|
(1,404
|
)
|
|
|
(2
|
)
|
|
|
323
|
|
Licensing costs
|
|
|
897
|
|
|
|
|
|
|
|
|
|
|
|
(108
|
)
|
|
|
(646
|
)
|
|
|
(4
|
)
|
|
|
139
|
|
Customer relationships,
covenants not to
compete and
other
|
|
|
1,403
|
|
|
|
|
|
|
|
|
|
|
|
(432
|
)
|
|
|
(965
|
)
|
|
|
|
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total amortizable
intangible assets
|
|
|
12,944
|
|
|
|
198
|
|
|
|
(48
|
)
|
|
|
(1,020
|
)
|
|
|
(9,092
|
)
|
|
|
(28
|
)
|
|
|
2,954
|
|
Unamortizable trademarks
|
|
|
5,449
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,930
|
)
|
|
|
|
|
|
|
1,519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other intangible assets
|
|
|
18,393
|
|
|
|
198
|
|
|
|
(48
|
)
|
|
|
(1,020
|
)
|
|
|
(13,022
|
)
|
|
|
(28
|
)
|
|
|
4,473
|
|
Goodwill
|
|
|
10,171
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10,171
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible assets
|
|
$
|
28,564
|
|
|
$
|
198
|
|
|
$
|
(48
|
)
|
|
$
|
(1,020
|
)
|
|
$
|
(23,193
|
)
|
|
$
|
(28
|
)
|
|
$
|
4,473
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The above impairment charge was recognized as of December 31, 2008 and is stated separately on
the accompanying Unaudited Condensed Consolidated Statements of Operations under the caption
Impairment of goodwill and other intangible assets. Estimated future amortization expense for the
remainder of fiscal 2009 through fiscal 2014, based on balances existing at January 31, 2009, is as
follows (in thousands):
|
|
|
|
|
Six months ended July 31,
2009
|
|
$
|
166
|
|
Fiscal year 2010
|
|
|
331
|
|
Fiscal year 2011
|
|
|
331
|
|
Fiscal year 2012
|
|
|
239
|
|
Fiscal year 2013
|
|
|
183
|
|
Fiscal year 2014
|
|
|
174
|
|
If we have future changes in events or circumstances, including reductions in anticipated cash flows
generated by our operations or determinations to divest of certain assets, certain assets could be
impaired, which would result in additional charges to earnings.
6. Accrued Liabilities
Accrued liabilities consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
January 31,
|
|
|
July 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued research and development
|
|
$
|
1,154
|
|
|
$
|
1,154
|
|
Accrued employee compensation and related
taxes
|
|
|
652
|
|
|
|
1,000
|
|
Accrued professional and consulting fees
|
|
|
525
|
|
|
|
795
|
|
Other accrued expenses
|
|
|
1,041
|
|
|
|
1,110
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total accrued expenses
|
|
$
|
3,372
|
|
|
$
|
4,059
|
|
|
|
|
|
|
|
|
13
ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. Debt
Debt consists of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
January 31,
|
|
|
July 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term borrowings and current portion of long-term debt:
|
|
|
|
|
|
|
|
|
Senior Secured Convertible Notes
|
|
$
|
12,000
|
|
|
$
|
|
|
Unamortized discount Senior Secured Convertible
Notes
|
|
|
(2,663
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior Secured Convertible Notes net
|
|
|
9,337
|
|
|
|
|
|
Short-term borrowings
|
|
|
112
|
|
|
|
|
|
Current portion of capital lease obligations
|
|
|
63
|
|
|
|
71
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total short-term borrowings and current portion of long-term debt
|
|
$
|
9,512
|
|
|
$
|
71
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt:
|
|
|
|
|
|
|
|
|
Senior Secured Convertible Notes
|
|
$
|
|
|
|
$
|
12,000
|
|
Unamortized discount Senior Secured Convertible
Notes
|
|
|
|
|
|
|
(3,560
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior Secured Convertible Notes net
|
|
|
|
|
|
|
8,440
|
|
PharmaBio
|
|
|
500
|
|
|
|
500
|
|
Capital lease obligations
|
|
|
66
|
|
|
|
105
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total long-term debt
|
|
|
566
|
|
|
|
9,045
|
|
Less: Current portion
|
|
|
(63
|
)
|
|
|
(71
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt net of current portion
|
|
$
|
503
|
|
|
$
|
8,974
|
|
|
|
|
|
|
|
|
Short-term Borrowings
As of January 31, 2009, we had short-term borrowings for installments due on an insurance
policy, with an interest rate of 6.6%.
Senior Secured Convertible Notes
Our Third Amended and Restated Secured Notes (the Senior Secured Convertible Notes) were
originally entered into in November 2006 as part of a private placement offering. The Senior
Secured Convertible Notes are in the aggregate principal amount of $12.0 million, are due July 31,
2010 and 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 Senior Secured Convertible Notes are convertible into shares of
our common stock at a conversion price of $15.40 per share at the option of the holders of such
notes. In addition, the Senior Secured Convertible Notes contain comprehensive covenants that
restrict the way in which we can operate, and contain financial covenants that require us to:
(i) maintain a minimum cash and cash equivalents balance of $1.0 million at the end of each fiscal
quarter and (ii) achieve a required EBITDA level, as defined in the Senior Secured Convertible
Notes (Defined EBITDA), of at least $1.00 for any one fiscal quarter on or prior to our quarter
ending July 31, 2009. The Defined EBITDA covenant was satisfied during the fourth quarter of fiscal
2008. The Senior Secured Convertible Notes are secured by certain of our existing and future
property.
14
ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Failure to satisfy the financial covenants, or to maintain compliance with other covenants,
could, at the option of the Senior Secured Convertible Note holders, result in an acceleration of
some or all of the amounts outstanding thereunder. Upon the occurrence of the first specified event
of default, the holders of the Senior Secured Convertible Notes could accelerate and demand
repayment of one-third of the outstanding principal balance and all accrued but unpaid interest on
the Senior Secured Convertible Notes. Upon the occurrence of the second specified event of default,
the holders of the Senior Secured Convertible Notes could accelerate and demand repayment of
one-half of the outstanding principal balance and all accrued but unpaid interest on these notes.
Upon the occurrence of the third specified event of default, the entire principal balance and all
accrued but unpaid interest may become due and payable. Additionally, upon the occurrence and
during the continuation of any event of default, all amounts outstanding under the Senior Secured
Convertible Notes shall bear interest at a rate of 15.0% per annum.
On September 11, 2008, we entered into a Third Amendment Agreement with the Investors that
serves to limit the amount of the Senior Secured Convertible Notes that each Investor is allowed to
convert into Zilas common shares. Under the Third Amendment Agreement, holders shall not have the
right to convert any portion of their Senior Secured Convertible Notes in the event that the holder
would beneficially own in excess of 4.999% of our common stock issued and outstanding immediately
after giving effect to such conversion.
We have made timely interest payments under the terms of the Senior Secured Convertible Notes
and are otherwise in compliance with the terms of such notes, except for the interest payment due
January 31, 2009, which has not been made as of the date of this filing. The failure to make this
payment is an event of default under our Senior Secured Convertible Notes. Although we have not
received a notice of default or acceleration from the note holders as of the date of this filing,
which is required prior to any of the principal amount becoming due and payable as a result of such
default, we have reclassified the Senior Secured Convertible Notes to current liabilities. In
addition, upon an event of default, the Senior Secured Convertible Notes shall bear interest at a
default rate of 15.0% per annum. However, during the pendency of negotiations, the note holders
have agreed that no default interest will accrue unless and until they provide notice to us. We
recently retained financial advisors to assist in exploring financing alternatives. As of the date
of this filing, we were engaged in negotiations with the note holders regarding the repayment
provisions of these notes, but have been unable to reach an agreement.
PharmaBio Development, Inc.
In December 2002, we entered into an agreement with PharmaBio Development, Inc. (PharmaBio),
the strategic investment group of Quintiles Transnational Corp., our then contract research
organization. Under this agreement, PharmaBio invested $0.5 million in us. In return for the
investment, we agreed to pay PharmaBio an amount equal to 5.0% of all net sales of an oral cancer
diagnostic drug product in the European Union and the United States. The aggregate amount of the
royalty cannot exceed $1.25 million and the royalty is payable quarterly. The investment was
recorded as long-term debt and will be amortized using the effective interest method.
8. Share-Based Payments
We have one active share-based stock award plan that provides for the grant of stock options
and stock awards, such as restricted stock and restricted stock units (RSUs), to our employees,
members of our Board of Directors and non-employee consultants, as approved by our Board of
Directors. We typically grant stock option awards to our employees and to members of our Board of
Directors at prices equal to the market value of our stock on the date of grant. These awards vest
over a period determined at the time of the grant and generally range from one to three years of
continuous service, with maximum terms ranging from five to ten years. Certain awards granted to
our employees provide for accelerated vesting if there is a change in control of Zila (as defined
in the plan). As of January 31, 2009 there were 408,973 shares available for grant under the plan.
During the six months ended January 31, 2009, we granted options to purchase 50,000
shares of our common stock. During the six months ended January 31, 2008, we granted
options to purchase 3,128,166 shares of our common stock. The fair
value of options granted for the six months ended January 31, 2009 and 2008 is estimated using the
Black-Scholes option pricing model using the following assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended January 31,
|
|
|
|
2009
|
|
2008
|
|
Risk-free interest
rate
|
|
|
1.1
|
%
|
|
|
3.5
|
%
|
|
Expected volatility
|
|
|
98
|
%
|
|
|
60
|
%
|
|
Expected term (in years)
|
|
|
3.3
|
%
|
|
|
5.2
|
|
|
Dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
|
15
ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The risk free interest rate is based on U.S. Treasury rates with maturity dates approximating
the expected term of the grant. The historic volatility of our stock is used as the primary basis
for the expected volatility assumption. Expected term is based on evaluations of historic and
expected future employee exercise behavior. Our ability to pay dividends is restricted and
therefore we have assumed no dividend yield.
SFAS No. 123 (revised 2004),
Share-Based Payment
requires the estimation of forfeitures when
recognizing compensation expense and that this estimate of forfeitures be adjusted over the
requisite service period should actual forfeitures differ from such estimates. Changes in estimated
forfeitures are recognized through an adjustment, which is recognized in the period of change and
which impacts the amount of unamortized compensation expense to be recognized in future periods.
A summary of stock option activity for our stock award plan for the six months ended January
31, 2009 is as follows (in thousands except exercise price per share and option term amounts)
(unaudited):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
Weighted
|
|
Average
|
|
|
|
|
|
|
|
|
Average
|
|
Remaining
|
|
Aggregate
|
|
|
Number
|
|
Exercise
|
|
Contractual
|
|
Intrinsic
|
|
|
of Options
|
|
Price
|
|
Term (Years)
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding beginning of period
|
|
|
515
|
|
|
$
|
11.55
|
|
|
|
6.7
|
|
|
$
|
|
|
Granted
|
|
|
50
|
|
|
|
0.34
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(69
|
)
|
|
|
7.94
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(36
|
)
|
|
|
19.20
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding end of period
|
|
|
460
|
|
|
|
10.23
|
|
|
|
5.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options vested or expected to vest end of
period
|
|
|
435
|
|
|
|
10.43
|
|
|
|
5.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable end of period
|
|
|
273
|
|
|
|
12.78
|
|
|
|
4.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
A summary of unvested common stock award activity within our share-based compensation plan for
the six months ended January 31, 2009 is as follows (in thousands except grant value and
recognition period amounts) (unaudited):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Weighted
|
|
Average
|
|
|
|
|
|
|
Average
|
|
Remaining
|
|
|
Number
|
|
Grant
|
|
Recognition
|
|
|
of Shares
|
|
Value
|
|
Period (Years)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unvested balance beginning of period
|
|
|
56
|
|
|
$
|
7.00
|
|
|
|
1.1
|
|
Granted
|
|
|
21
|
|
|
|
2.10
|
|
|
|
|
|
Vested
|
|
|
(50
|
)
|
|
|
5.29
|
|
|
|
|
|
Forfeited
|
|
|
(7
|
)
|
|
|
7.98
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unvested balance end of period
|
|
|
20
|
|
|
|
5.09
|
|
|
|
0.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation costs are reflected in the following financial statement captions (in
thousands) (unaudited):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended January 31,
|
|
|
Six Months Ended January 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketing and selling
expense
|
|
$
|
34
|
|
|
$
|
55
|
|
|
$
|
95
|
|
|
$
|
110
|
|
General and administrative
expense
|
|
|
81
|
|
|
|
460
|
|
|
|
180
|
|
|
|
856
|
|
Research and development
expense
|
|
|
|
|
|
|
1
|
|
|
|
1
|
|
|
|
2
|
|
Inventory
|
|
|
15
|
|
|
|
7
|
|
|
|
44
|
|
|
|
8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock-based compensation
|
|
$
|
130
|
|
|
$
|
523
|
|
|
$
|
320
|
|
|
$
|
976
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16
ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As of January 31, 2009, total unrecognized compensation cost related to unvested stock options
and unvested common stock awards was approximately $1.3 million and $0.1 million, respectively,
with a weighted average period over which these costs are expected to be recognized of
approximately 1.5 years and less than one year, respectively.
9. Warrants
As of January 31, 2009 and July 31, 2008, we have warrants outstanding for the purchase of
1,384,424 shares of our common stock, all of which are exercisable. As of January 31, 2009, these
warrants have a weighted average exercise price of $14.76 and a weighted average remaining
contractual term of approximately three years.
10. Convertible Preferred Stock
During February 2001, we issued 100,000 shares of Series B Convertible Preferred Stock
(Preferred Stock) as part of an acquisition, all of which were outstanding as of January 31, 2009
and July 31, 2008. The holders of the Preferred Stock are entitled to receive cumulative quarterly
dividends at a rate of $0.0975 per share per fiscal quarter, payable in arrears, which represents
an aggregate annual dividend of $39,000. As of January 31, 2009 and July 31, 2008, accumulated
accrued dividends were less than $0.1 million. The Preferred Stock can be redeemed at our option if
our common stock maintains a closing price on each trading day equal to or greater than $9.00 per
share for any ten trading day period. The redemption price shall be the average bid closing price
of our common stock for the five trading days immediately proceeding the date we give notice. The
Preferred Stock is convertible at the option of the holder at any time on or before December 31,
2010 into our common stock at the ratio of one-to-one. On December 31, 2010, all of the remaining
Preferred Stock will be converted into our common stock at a ratio of one-to-one. Holders of the
preferred stock have no voting rights except as required by applicable law and have a liquidation
preference of $0.65 million. The shares of Preferred Stock were issued pursuant to the exemption
set forth in Section 4(2) of the Securities Act. There is no established public trading market for
the Preferred Stock.
11. Treasury Stock
During fiscal 2001, we began acquiring shares of our common stock under a stock repurchase
program announced in November 1999. The program authorized the repurchase of up to 142,857 shares
of Zila common stock from time to time on the open market depending on market conditions and other
factors. Under this repurchase program, we purchased 32,157 shares of common stock at an aggregate
cost of approximately $0.6 million, and made the last purchases under this program in fiscal 2003,
after which we suspended purchases under the program. In fiscal 2005, we reissued 955 shares of
treasury stock for a stock award.
12. Supplemental Cash Flow Information
Supplemental cash flow information is as follows (unaudited) (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended January 31,
|
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
7
|
|
|
$
|
235
|
|
Income taxes paid
|
|
|
10
|
|
|
|
8
|
|
Insurance policy financed with short-term
borrowings
|
|
|
193
|
|
|
|
275
|
|
13. Comprehensive Loss
Comprehensive loss includes the effects of foreign currency translation and does not reflect
an income tax effect due to the recording of valuation allowances. Comprehensive loss is as
follows (unaudited) (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended January 31,
|
|
|
Six Months Ended January 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(25,257
|
)
|
|
$
|
(4,736
|
)
|
|
$
|
(28,055
|
)
|
|
$
|
(9,591
|
)
|
Foreign currency translation adjustment
|
|
|
|
|
|
|
24
|
|
|
|
1
|
|
|
|
11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss
|
|
$
|
(25,257
|
)
|
|
$
|
(4,712
|
)
|
|
$
|
(28,054
|
)
|
|
$
|
(9,580
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17
ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
14. Commitments and Contingencies
Legal Proceedings
Except as described below, as of January 31, 2009, we were not a party to any pending legal
proceedings other than claims that arise in the conduct of our business. While we currently believe
that the ultimate outcome of these proceedings will not have a material adverse effect on our
consolidated financial condition or results of operations, litigation is subject to inherent
uncertainties. If an unfavorable ruling were to occur, there exists the possibility of a material
adverse impact on our net income in the period in which a ruling occurs. Our estimate of the
potential impact of the following legal proceedings on our financial position and our results of
operation could change in the future.
In connection with the acquisition of patent rights in 1980, we agreed to pay to Dr. James E.
Tinnell (Tinnell), the inventor of one of our former treatment compositions, a royalty of 5.0% of
gross sales of the invention disclosed in Tinnells then pending patent application. In September
2000, we notified Tinnell that we would no longer pay such royalties because the obligations ceased
in August 1998 when the related product patents expired and we requested reimbursement of royalties
paid since August 1998. We then filed suit on November 8, 2000, in the United States District Court
for the District of Nevada requesting a declaratory judgment that we had no royalty obligations to
Tinnell and judgment for the overpaid royalties. On April 22, 2004, the Court, in part, ruled in
our favor, stating that our royalty obligations to Tinnell ceased in August 1998, however, our
request for reimbursement of overpaid royalties was dismissed. Tinnell filed a notice of appeal and
we filed a notice of cross-appeal. On September 5, 2007, the Ninth Circuit Court of Appeals
reversed the decision of the lower court and remanded the case for a determination of whether or
not Tinnell should be credited with inventing the improvement embodied in a 1992 patent. Both
parties filed motions for summary judgment and on September 30, 2008, the court denied both motions
and the parties met and conferred on pre-trial matters in January 2009. No trial date has been
set.
For the three months ended January 31, 2009 and 2008 and six months ended January 31, 2009 and
2008, we incurred expense of less than $0.1 million, $0.1 million, less than $0.1 million and $0.3
million, respectively, relative to the pending litigation with Tinnell. This expense is reflected
in our loss from discontinued operations on the accompanying Unaudited Condensed Consolidated
Statements of Operations since this litigation relates to our previously disposed
Zilactin
®
brand of over-the-counter lip and oral care products. The disposal of the
Zilactin
®
brand of over-the-counter lip and oral care products was completed during
June 2005.
Indemnifications
During the normal course of business, we make certain indemnities, commitments and guarantees
under which we may be required to make payments in relation to certain transactions. These include:
(i) intellectual property indemnities to customers in connection with the use, sales and/or license
of products and services; (ii) indemnities to customers in connection with losses incurred while
performing services on their premises; (iii) indemnities to vendors and service providers
pertaining to claims based on negligence or willful misconduct; and (iv) indemnities involving the
representations and warranties in certain contracts. In addition, under our by-laws we are
committed to our directors and officers for providing for payments upon the occurrence of certain
prescribed events. The majority of these indemnities, commitments and guarantees do not provide for
any limitation on the maximum potential for future payments that we could be obligated to make. To
help address these risks, we maintain general business liability insurance coverage, including
product, commercial, general, fiduciary, employment practices and directors and officers
liability coverages. We have not recorded a liability for these indemnities, commitments and other
guarantees.
18
ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Registration Payment Arrangements
We have entered into various registration rights agreements in connection with financing
transactions. In some instances, these registration rights agreements contain provisions that may
call for us to pay penalties in certain circumstances. These registration payment arrangements
primarily relate to our ability to either file a registration statement within a particular time
period, have a registration statement declared effective within a particular time period or to
maintain the effectiveness of a registration statement for a particular time period. As of January
31, 2009, all registration statements related to registration rights agreements containing penalty
provisions have been filed and declared effective, or the securities covered by such registration
rights agreements have been sold or can be sold under Rule 144 of the Securities Act of 1933 by the
investors who purchased such securities, and accordingly, we are in compliance with such
registration payment arrangements. We will be required to file registration statements in the
future for shares that are issued as payment of interest on our Senior Secured Convertible Notes.
If we do not file such registration statements, we would be subject to cash penalties equal to 1.0%
of the Market Price (as defined in the Senior Secured Convertible Notes) of the registrable
securities for each 30-day period or pro rata for any portion thereof following the filing
deadline. We do not believe it is probable that penalty payments will be made for the registration
rights agreements discussed above, and accordingly we have not accrued for such potential penalties
as of January 31, 2009.
FDA Observation Letter
During September 2008, after completion of a cGMP audit of our fluoride manufacturing
facility, we received notice from the FDA regarding certain deficiencies in our documentation,
processes and procedures relative to certain of our fluoride products. We have halted production of
these products while an action plan was developed to address these deficiencies. The resulting
action plan included the voluntary recall of a select group of lots of certain fluoride products.
During October 2008 we resumed distribution of fluoride products purchased from third party
vendors. As of January 31, 2009 and July 31, 2008, we have provided an estimated reserve of
approximately $0.3 million and $0.2 million related to these products and this issue, respectively.
Corporate Office Lease
During October 2008, we entered into a lease agreement for new corporate office facilities,
which we have relocated to in the second quarter of fiscal 2009. The lease agreement is for a term
of approximately two years and calls for monthly rental payments of approximately $26,000.
19
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis (MD&A) should be read in conjunction with the
Unaudited Condensed Consolidated Financial Statements and Notes thereto included elsewhere herein
as well as our annual report on Form 10-K for the year ended July 31, 2008, as filed with the SEC,
including the factors set forth in the section titled Forward-looking Statements, as well as our
other filings made with the SEC. In this MD&A, Zila, we, us, or our refer to Zila, Inc. and
its wholly-owned subsidiaries.
Forward-Looking Statements
This Quarterly Report on Form 10-Q, including this Managements Discussion and Analysis of
Financial Condition and Results of Operations, contains forward-looking statements regarding future
events and our future results that are subject to the safe harbors created under the Securities Act
of 1933 (the Securities Act) and the Securities Exchange Act of 1934 (the Exchange Act). These
statements are based on current expectations, estimates, forecasts and projections about the
industries in which we operate and the beliefs and assumptions of our management. Words such as
expects, anticipates, targets, goals, projects, intends, plans, believes, seeks,
estimates, continues, may,
could, foresees, should,
likely, and variations of such words and
similar expressions are intended to identify such forward-looking statements. In addition, any
statements that refer to projections of our future financial performance, our anticipated growth
and trends in our businesses, and other characterizations of future events or circumstances are
forward-looking statements. Readers are cautioned that these forward-looking statements are only
predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict,
including those identified in our Form 10-K for the year ended July 31, 2008 under Item 1A Risk
Factors, and in Item 1A, Risk Factors under Part II hereof. Therefore, actual results may differ
materially and adversely from those expressed in any forward-looking statements. We undertake no
obligation to revise or update any forward-looking statements for any reason.
Overview
Business
Zila is a diagnostic company dedicated to the prevention, detection and treatment of oral
cancer and periodontal disease. We manufacture and market ViziLite
®
Plus with
TBlue
®
(ViziLite
®
Plus), our flagship product for the early detection of
oral abnormalities that could lead to cancer. ViziLite
®
Plus is an adjunctive medical
device cleared by the FDA for use in a population at increased risk for oral cancer. In addition,
Zila designs, manufactures and markets a suite of proprietary products sold exclusively and
directly to dental professionals for periodontal disease, including the Rotadent
®
Professional Powered Brush, the Pro-Select Platinum
®
ultrasonic scaler and a portfolio
of oral pharmaceutical products for both in-office and home-care use. Our products are marketed and
sold in the United States and Canada primarily through our direct field sales force and
telemarketing organization. Our products are marketed and sold in other international markets
through the sales forces of third party distributors. Our marketing programs reach most U.S. dental
offices by direct marketing efforts and various media outlets. We are an approved American Dental
Association continuing education provider and recently submitted our renewal application to the
Academy of General Dentistry to continue as an approved continuing education provider.
Recent Developments and Continuance of Operations
Our business is sensitive to general economic conditions since our products are somewhat
discretionary in nature. Accordingly, the recent global economic downturn has had a negative impact
on our revenues. We implemented profit enhancement initiatives in the second half of fiscal 2008
that resulted in satisfying the Defined EBITDA covenant contained in our Senior Secured Convertible
Notes, which are discussed in more detail elsewhere herein, including: (i) completing the hiring of
the targeted level of sales representatives and completing their training across the full portfolio
of our products; (ii) improving revenues and gross profit through the implementation of selective
price increases and implementing initiatives to reduce our cost of goods; (iii) reducing headcount
in our non-selling workforce, temporarily reducing the salaries of our management employees and
reducing certain other employee benefits; and (iv) reducing, deferring or eliminating non-critical
programs across the organization while maintaining key selling initiatives. Although these
initiatives proved to be effective in satisfying the Defined EBITDA covenant contained in our
Senior Secured Convertible Notes during the fourth quarter of fiscal 2008, we do not expect some of
these initiatives, such as reducing or deferring salaries, benefits and other operating costs, to
be sustainable into future periods.
20
During the first half of fiscal 2009, our revenues have been negatively impacted as a result
of the severity of the global economic downturn and its impact on discretionary spending on our
products. Additionally, the unwillingness of the holders of the Senior Secured Convertible Notes
to renegotiate their debt has affected revenues as a result of customer concern about our viability
as an ongoing business. We would expect these factors to cause near term future operating results
to be less favorable than our financial results for the fourth quarter of fiscal 2008 and those
previously anticipated for fiscal 2009. To address the impact of this revenue decline, during the
first half of fiscal 2009 we have (i) continued salary reductions for a number of management
personnel; (ii) eliminated additional headcount, including an approximately 15% reduction of our
field sales force as a result of the realignment of our sales territories; (iii) eliminated the
employee stock purchase plan and its associated costs; (iv) furloughed certain manufacturing
production personnel; (v) reduced the number of seminar programs and streamlined the cost structure
of these programs; and (vi) reduced tradeshow expenditures. Excluding the effect of the $23.2
million impairment loss for goodwill and other intangible assets recognized during December 2008,
these actions narrowed our operating loss over the same periods in the prior year. The impairment
loss is more fully described in Note 5 of the accompanying Unaudited Condensed Consolidated Financial Statements,
Goodwill and Other Intangible Assets, and elsewhere in this MD&A. To address the impact
of the economic downturn on our revenues, we continue to identify cost-reduction and working
capital initiatives to reduce the impact on future cash flows from operations and results of
operations.
While we have continued to execute a number of cost reduction strategies, the decline in our revenues has caused
our cash utilization to exceed planned levels. As of January 31, 2009, we had approximately $2.5
million of cash and cash equivalents, compared to $3.2 million at October 31, 2008 and $4.5 million
at July 31, 2008 and a working capital deficit of $4.3 million compared to working capital of $5.7
million at October 31, 2008 and $6.6 million at July 31, 2008. In order to continue as a going
concern and fund our current level of operations over the next twelve months, we will require
additional funds and need to restructure our Senior Secured Convertible Notes. If we are unable
to do so, we will likely be forced to file for protection under Chapter 11 of the Federal Bankruptcy
Code. We have retained financial and legal advisors to assist us in our numerous continuing efforts
to restructure our Senior Secured Convertible Notes, raise capital and explore possible strategic
opportunities.
Our efforts to seek additional funding have included discussions with numerous potential
financial and strategic investors as well as with the holders of the Senior Secured Convertible
Notes. All potential investors with whom we have had discussions required, as a condition of their
investment, that the Senior Secured Convertible Notes be repaid from the funds provided by the
investor(s) and that this repayment be at a substantial discount from the $12.0 million principal
outstanding to reflect the current market value of those notes. However, to date, the holders of
the Senior Secured Convertible Notes have been unwilling to agree to an amount to extinguish this
debt. Also, although the Senior Secured Convertible Notes provide us with the opportunity to
obtain a working capital line of credit secured by our inventory and accounts receivable, we have
been unable to obtain the approval of the majority holder of the Senior Secured Convertible Notes
even though the note agreements provide that such approval is not to be unreasonably withheld.
We have made timely interest payments under the terms of the Senior Secured Convertible Notes
and are otherwise in compliance with the terms of such notes, except for the interest payment due
January 31, 2009, which has not been made as of the date of this filing. The failure to make this
payment is an event of default under our Senior Secured Convertible Notes. Although we have not
received a notice of default or acceleration from the note holders as of the date of this filing,
which is required prior to any of the principal amount becoming due and payable as a result of such
default, we have reclassified the Senior Secured Convertible Notes to current liabilities. In
addition, upon an event of default, the Senior Secured Convertible Notes shall bear interest at a
default rate of 15.0% per annum. However, during the pendency of negotiations, the note holders
have agreed that no default interest will accrue unless and until they provide notice to us.
We were unable to issue shares for the January 31, 2009 interest
payment because, due to our share price at such time, the number of shares to be issued would have required shareholder approval under
applicable NASDAQ rules. In addition, given our current level of cash and cash equivalents, the
impact of the global economic downturn on our business and customer concern about our viability as
an ongoing business, it is uncertain whether we will have sufficient cash available to pay our
future quarterly interest payments due under the Senior Secured Convertible Notes.
As a result of the foregoing, there is substantial doubt about our ability to continue as a
going concern. Accordingly, realization values may be substantially different from carrying values
as shown, and these financial statements do not give effect to adjustments that would be necessary
to the carrying values and classification of assets and liabilities should we be unable to continue
as a going concern.
21
Other Key Operating Initiatives
During the second quarter of fiscal 2009, we completed the first phase of the global rollout
of our proprietary oral cancer screening product, ViziLite
®
Plus. Beginning in North
America and through our direct sales force, we now market ViziLite
®
Plus in all 50
states of the U.S., as well as Canada. Since May 2008, we have expanded to Western Europe by forming
strategic alliances to distribute ViziLite
®
Plus in a number of European markets.
ViziLite
®
Plus is now available in the United Kingdom, Ireland, Germany, Spain,
Portugal, France and Greece. For the next phase of our expansion, we have formed distribution
agreements in other international markets, including Russia and Belarus, where product registration
is in process. During February 2009, we furthered this expansion
initiative with the selection of
Getwell Life Sciences to distribute ViziLite
®
Plus throughout India. We expect these
markets and others in the Pacific Rim region, especially China and India, will form the bulk of our
continued global expansion for ViziLite
®
Plus.
During October 2008, the U.K. Medicines and Healthcare products Regulatory Agency (MHRA)
issued an indefinite renewal of the marketing authorization for OraTest
®
, our
proprietary oral cancer diagnostic kit. Under the European Unions (EU) mutual recognition
process, we expect to receive renewal licenses for member states including Finland, Greece,
Luxembourg, The Netherlands, Belgium, the U.K. and Portugal, over the next quarter. We are seeking
marketing partners in the seven EU countries. Adding OraTest
®
to our international
product portfolio provides the opportunity to expand the potential market for our oral cancer
screening and testing product franchise. The OraTest
®
diagnostic kit and
ViziLite
®
Plus are complementary products with distinct indications, which will allow us
to market to a more diverse group of healthcare professionals within the EU.
During November 2008, Essex Dental Benefits began offering coverage for ViziLite
®
Plus examinations. Essex Dental Benefits joins the growing list of premiere and national insurance
plans that provide coverage for ViziLite
®
Plus, which also includes Humana, United
Healthcare, Cigna, Guardian, SafeGuard, Northeast Delta Dental and a number of regional plans and
self-insured employers. With the addition of Essex Dental Benefits, approximately 25 million lives
are part of dental plans that cover oral cancer screening; however, not all dental professionals in
these plans have made ViziLite
®
Plus available to their patients. We are actively
working with several large dental plans to co-promote ViziLite
®
Plus to their national
contracted dentist networks. Additionally, there has been an increased focus, by Zila sales staff,
on dentists contracted with dental plans that offer coverage for ViziLite
®
Plus.
During October 2008, we announced encouraging results of an in vivo animal study, which
demonstrated evidence of photodestruction of premalignant lesions and invasive squamous cell
carcinoma when Zilas patented pharmaceutical-grade toluidine blue was used as a photosensitizer
and light activated. Due to these results, we are hopeful it will demonstrate efficacy during
photodynamic therapy for oral dysplasia and oral cancer. Due to inadequate funding at the current
time, we are postponing any further clinical studies, including human trial.
22
Results of Operations
The following table summarizes our results of operations and related statistical information
for the three and six months ended January 31, 2009 and 2008 (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended January 31,
|
|
|
|
|
|
|
|
% of
|
|
|
|
|
|
|
% of
|
|
|
%
|
|
|
|
2009
|
|
|
Revenue
|
|
|
2008
|
|
|
Revenue
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues
|
|
$
|
8,513
|
|
|
|
100.0
|
%
|
|
$
|
10,491
|
|
|
|
100.0
|
%
|
|
|
(18.9
|
)%
|
Cost of products sold
|
|
|
3,773
|
|
|
|
44.3
|
|
|
|
4,245
|
|
|
|
40.5
|
|
|
|
(11.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
4,740
|
|
|
|
55.7
|
|
|
|
6,246
|
|
|
|
59.5
|
|
|
|
(24.1
|
)
|
|
Operating costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketing and selling
|
|
|
3,348
|
|
|
|
39.3
|
|
|
|
5,221
|
|
|
|
49.8
|
|
|
|
(35.9
|
)
|
General and administrative
|
|
|
1,813
|
|
|
|
21.3
|
|
|
|
3,127
|
|
|
|
29.8
|
|
|
|
(42.0
|
)
|
Impairment of goodwill
and other intangible assets
|
|
|
23,193
|
|
|
|
272.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
78
|
|
|
|
0.9
|
|
|
|
789
|
|
|
|
7.5
|
|
|
|
(90.1
|
)
|
Depreciation and amortization
|
|
|
611
|
|
|
|
7.3
|
|
|
|
944
|
|
|
|
9.0
|
|
|
|
(35.3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(24,303
|
)
|
|
|
(285.5
|
)
|
|
|
(3,835
|
)
|
|
|
(36.6
|
)
|
|
|
533.7
|
|
Other expense net
|
|
|
(936
|
)
|
|
|
(11.0
|
)
|
|
|
(754
|
)
|
|
|
(7.1
|
)
|
|
|
24.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
$
|
(25,239
|
)
|
|
|
(296.5
|
)
|
|
$
|
(4,589
|
)
|
|
|
(43.7
|
)
|
|
|
450.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Six Months Ended January 31,
|
|
|
|
|
|
|
|
% of
|
|
|
|
|
|
|
% of
|
|
|
%
|
|
|
|
2009
|
|
|
Revenue
|
|
|
2008
|
|
|
Revenue
|
|
|
Change
|
|
Net revenues
|
|
$
|
18,154
|
|
|
|
100.0
|
%
|
|
$
|
21,931
|
|
|
|
100.0
|
%
|
|
|
(17.2
|
)%
|
Cost of products sold
|
|
|
7,549
|
|
|
|
41.6
|
|
|
|
8,826
|
|
|
|
40.2
|
|
|
|
(14.5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
10,605
|
|
|
|
58.4
|
|
|
|
13,105
|
|
|
|
59.8
|
|
|
|
(19.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketing and selling
|
|
|
7,719
|
|
|
|
42.5
|
|
|
|
10,517
|
|
|
|
48.0
|
|
|
|
(26.6
|
)
|
General and administrative
|
|
|
4,036
|
|
|
|
22.2
|
|
|
|
6,602
|
|
|
|
30.1
|
|
|
|
(38.9
|
)
|
Impairment of goodwill
and other intangible assets
|
|
|
23,193
|
|
|
|
127.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
244
|
|
|
|
1.3
|
|
|
|
1,991
|
|
|
|
9.1
|
|
|
|
(87.7
|
)
|
Depreciation and amortization
|
|
|
1,535
|
|
|
|
8.5
|
|
|
|
1,859
|
|
|
|
8.5
|
|
|
|
(17.4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(26,122
|
)
|
|
|
(143.9
|
)
|
|
|
(7,864
|
)
|
|
|
(35.9
|
)
|
|
|
232.2
|
|
Other expense net
|
|
|
(1,891
|
)
|
|
|
(10.4
|
)
|
|
|
(1,396
|
)
|
|
|
(6.3
|
)
|
|
|
35.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
before income taxes
|
|
|
(28,013
|
)
|
|
|
(154.3
|
)
|
|
|
(9,260
|
)
|
|
|
(42.2
|
)
|
|
|
202.5
|
|
Income tax expense
|
|
|
(13
|
)
|
|
|
(0.1
|
)
|
|
|
(12
|
)
|
|
|
(0.1
|
)
|
|
|
8.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from continuing operations
|
|
$
|
(28,026
|
)
|
|
|
(154.4
|
)%
|
|
$
|
(9,272
|
)
|
|
|
(42.3
|
)%
|
|
|
202.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
23
Net Revenues
Net revenues were $8.5 million and $10.5 million for the three months ended January 31, 2009
and 2008, respectively, a decrease of $2.0 million or 18.9%. Net revenues were $18.2 million and
$21.9 million for the six months ended January 31, 2009 and 2008, respectively, a decrease of
$3.7 million or 17.2%. ViziLite
®
Plus net revenues decreased to $2.7 million and $5.9
million for the three and six months ended January 31, 2009, a decrease of 16.6% and 6.0% from the
same periods in the previous year, respectively. Also contributing to the decrease in net revenues
were lower sales of our Rotadent
®
Professional Powered Brush and Pro-Select
Platinum
®
ultrasonic scalers. Although we have recently been successful in increasing
the utilization of ViziLite
®
Plus, expanding our international programs and driving
increases in the number of insurance companies reimbursing for the ViziLite
®
Plus
examination, the deepening of the global economic downturn and customer concern about our viability
as an ongoing business have had a significant negative impact on our business. As discussed above,
our business is sensitive to general economic conditions since our products are somewhat
discretionary in nature.
Gross Profit
Gross profit was $4.7 million and $6.2 million for the three months ended January 31, 2009 and
2008, respectively, a decrease of $1.5 million or 24.1%. Gross profit was $10.6 million and $13.1
million for the six months ended January 31, 2009 and 2008, respectively, a decrease of $2.5
million or 19.1%. Gross profit as a percentage of net revenues was 55.7% and 59.5% for the three
months ended January 31, 2009 and 2008, respectively, and 58.4% and 59.8% for the six months ended
January 31, 2009 and 2008, respectively. Our gross profit margin for the three and six months
ended January 31, 2009 was negatively impacted by selective discounting programs that were
implemented in the first half of fiscal 2009 in an effort to stimulate sales and counteract the
revenue declines discussed above. During the three months ended January 31, 2009, we have also
experienced product cost increases as a result of decreased purchasing volumes and the resulting
impact on discounts for products purchased.
Marketing and Selling Expense
Marketing and selling expense was $3.3 million and $5.2 million for the three months ended
January 31, 2009 and 2008, respectively, a decrease of $1.9 million or 35.9%. Marketing and selling
expense was $7.7 million and $10.5 million for the six months ended January 31, 2009 and 2008,
respectively, a decrease of $2.8 million or 26.6%. The decline in marketing and selling expense for
the three and six months ended January 31, 2009 results from the reduction in the level of
commissions and bonuses for the sales force as a result of reduced sales levels, reduced sales
force headcount as a result of a realignment of our sales territories to gain efficiencies and
reductions in expenditures in non-direct selling related expenses. Additionally, our marketing
expenditures have been temporarily reduced in connection with our profit enhancement initiatives, which include reductions in expenditure levels for tradeshows, seminars and other
marketing activities.
General and Administrative Expense
General and administrative expense was $1.8 million and $3.1 million for the three months
ended January 31, 2009 and 2008, respectively, a decrease of $1.3 million or 42.0%. General and
administrative expense was $4.0 million and $6.6 million for the six months ended January 31, 2009
and 2008, respectively, a decrease of $2.6 million or 38.9%. The decrease in general and
administrative expense primarily relates to profitability initiatives that were implemented during
the second half of fiscal 2008 and the first half of fiscal 2009. These profitability initiatives
included reducing headcount in our non-selling workforce by approximately 25% in the first half of
fiscal 2009, continuing the temporary reduction of the salaries of certain management employees,
reducing certain other employee benefits and reducing, deferring or eliminating non-critical
programs across the organization.
24
General and administrative expense consists of the following for the three and six months
ended January 31, 2009 and 2008 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended January 31,
|
|
|
Six Months Ended January 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash basis salaries and benefits
|
|
$
|
712
|
|
|
$
|
1,136
|
|
|
$
|
1,531
|
|
|
$
|
2,346
|
|
Audit, accounting and other professional
fees
|
|
|
272
|
|
|
|
405
|
|
|
|
802
|
|
|
|
1,276
|
|
Investment banking fees and
shareholder related expense
|
|
|
160
|
|
|
|
165
|
|
|
|
296
|
|
|
|
243
|
|
Legal and intellectual property related fees
|
|
|
147
|
|
|
|
359
|
|
|
|
386
|
|
|
|
652
|
|
Insurance
|
|
|
114
|
|
|
|
119
|
|
|
|
224
|
|
|
|
248
|
|
Non-cash stock-based compensation expense
|
|
|
81
|
|
|
|
460
|
|
|
|
180
|
|
|
|
856
|
|
Other general and administrative expense
|
|
|
327
|
|
|
|
483
|
|
|
|
617
|
|
|
|
981
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total general and administrative expense
|
|
$
|
1,813
|
|
|
$
|
3,127
|
|
|
$
|
4,036
|
|
|
$
|
6,602
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impairment of Goodwill and Other Intangible Assets
We assess the impairment of goodwill annually in our fourth fiscal quarter, or whenever events
or changes in circumstances indicate that the carrying value of goodwill may not be recoverable.
During the first half of fiscal 2009, our revenues have been negatively impacted as a result of the
severity of the global economic downturn and its impact on discretionary spending on our products.
The unwillingness of the holders of the Senior Secured Convertible Notes to renegotiate their debt
has also affected revenues as a result of customer concern about our viability as an ongoing
business. We would expect these factors to cause near term future operating results to be less favorable than previously
anticipated for fiscal 2009. We have also experienced a decline in our stock price and a
corresponding decline in our market capitalization and enterprise value throughout the first half
of fiscal 2009. Finally, as of December 2008, we anticipated we would
fail to make the interest payment due January 31, 2009 on our
Senior Secured Convertible Notes, which is an event
of default under such notes. Although we have not received a notice of
default or acceleration from the note holders as of the date of this filing, which is required
prior to any of the principal amount becoming due and payable as a result of such default, the note
holders may, at any time, accelerate one-third of the amount outstanding under the Senior Secured
Convertible Notes, which in this case is $4.0 million. In order
to continue as a going concern and fund our current level of
operations over the next twelve months, we will require additional
funds and need to restructure our Senior Secured Convertible Notes. Primarily as a result of these factors, we
assessed goodwill for impairment during December of 2008 in addition to our annual test. We assess
impairment of other intangibles and long-lived assets whenever events or changes in circumstances
indicate that the carrying value of any of these assets may not be recoverable. As a result of the
factors discussed above, we also assessed our other intangible assets for impairment during
December 2008.
We
recognized an impairment charge of $23.2 million during
December 2008 as a result of these impairment
assessments. This impairment charge consists of $10.2 million for goodwill and $13.0 million for
other intangible assets. The impairment loss is more fully described in Note 5 to the accompanying
Unaudited Condensed Consolidated Financial Statements, Goodwill and Other Intangible Assets, and in
the Summary of Critical Accounting Policies and Estimates section of this MD&A.
Research and Development Expense
Research and development expense was $0.1 million and $0.8 million for the three months ended
January 31, 2009 and 2008, respectively, a decrease of $0.7 million or 90.1%. Research and
development expense was $0.2 million and $2.0 million for the six months ended January 31, 2009 and
2008, respectively, a decrease of $1.8 million or 87.7%. In the first quarter of fiscal 2008 we
closed enrollment in a clinical trial related to an oral cancer diagnostic drug and ceased
expenditures for CMC and non-clinical aspects of the regulatory program. The curtailment of the
regulatory program is the primary driver of the overall decrease in research and development
expense.
Depreciation and Amortization Expense
Depreciation and amortization expense was $0.6 million and $0.9 million for the three months
ended January 31, 2009 and 2008, respectively, a decrease of
$0.3 million or 35.3%. Depreciation
and amortization expense was $1.5 million and $1.9 million for the six months ended January 31,
2009 and 2008, respectively, a decrease of $0.4 million or 17.4%. During the second quarter of
fiscal 2009, depreciation and amortization was favorably affected by certain long-lived assets
becoming fully depreciated or amortized, which is offset by depreciation for our recently acquired
property and equipment and amortizable intangible assets. Depreciation and
amortization also decreased in the three and six months ended January 31, 2009 compared to the
same period in prior years as a result of the impairment of intangible assets, which is discussed
elsewhere herein.
25
Other Expense Net
Other expense, net was $0.9 million and $0.8 million for the three months ended January 31,
2009 and 2008, respectively, and $1.9 million and $1.4 million for the six months ended January 31,
2009 and 2008. Other expense primarily consists of interest expense, which is summarized as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended January 31,
|
|
|
Six Months Ended January 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
Senior secured convertible
notes
|
|
$
|
215
|
|
|
$
|
245
|
|
|
$
|
460
|
|
|
$
|
461
|
|
Amortization of financing costs
|
|
|
226
|
|
|
|
97
|
|
|
|
452
|
|
|
|
196
|
|
Amortization of debt discounts
|
|
|
448
|
|
|
|
451
|
|
|
|
897
|
|
|
|
898
|
|
Capital leases and other
|
|
|
5
|
|
|
|
8
|
|
|
|
7
|
|
|
|
13
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest expense
|
|
$
|
894
|
|
|
$
|
801
|
|
|
$
|
1,816
|
|
|
$
|
1,568
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in interest expense primarily relates to increased amortization of financing
costs, which relates to costs incurred in connection with amendments to our Senior Secured
Convertible Notes during fiscal 2008.
Income Taxes
Income tax expense for the three and six months ended January 31, 2009 and 2008 was less than
$0.1 million and primarily relates to state income taxes.
Inflation and Seasonality
We do not believe that inflation has a unique or material effect on the operations or
financial condition of our businesses. However, we are sensitive to general economic conditions
since our products are somewhat discretionary in nature. Sales for the dental industry are
generally affected by holiday and vacation related seasonality, which impacts the number of
available selling days in each fiscal quarter. We sell directly to dental professionals in the
United States and Canada, and accordingly, our sales are subject to these seasonal trends.
Liquidity and Capital Resources
Overview
We have historically sustained recurring losses and negative cash flows from operations as we
changed our strategic direction to focus on the growth and development of ViziLite
®
Plus
and our periodontal product lines. Our liquidity needs have typically arisen from the funding of
our research and development program and the launch of our new products, such as
ViziLite
®
Plus, working capital and debt service requirements, and strategic
initiatives. In the past, we have met these cash requirements through our cash and cash
equivalents, working capital management, the sale of non-core assets and proceeds from certain
private placements of our securities.
Previously, our research and development program for our oral cancer diagnostic drug required
the commitment of substantial resources to conduct the time-consuming research and development,
clinical studies and regulatory activities necessary to bring any potential product to market and
to establish production, marketing and sales capabilities. We believe that in order to maximize
shareholder value our resources must be directed to those products and programs with the greatest
probability of financial return. We believe that our greatest potential lies with our continued
development and commercialization of our already existing oral cancer screening product,
ViziLite
®
Plus. The incremental market potential of the oral cancer diagnostic drug,
considering the availability of ViziLite
®
Plus, did not justify the cost, time and
uncertain study outcomes associated with continuing the program in its current form. In order to
pursue our strategy with our currently available funds, during fiscal 2008 we curtailed activity
and spending related to the oral cancer diagnostic drug program. We have continued this strategy
into fiscal 2009. As a result of this curtailment, research and
development expenditures decreased during fiscal 2008 compared to historic levels, and have
continued to decrease into fiscal 2009. We believe that our level of expenditures for research and
development in fiscal 2009 will be reduced further from our historic levels.
26
To reduce operating losses, during the second half of fiscal 2008, we took steps to reduce
costs in non-direct sales force areas through further headcount reductions, furloughs of certain
personnel and discontinuing research and development projects, and have implemented profit
enhancement initiatives. We also took steps to improve revenues and gross profit through the
implementation of selective price increases and implementing initiatives to reduce our cost of
goods. As a result of these steps, during the fourth quarter of fiscal 2008 we achieved positive
cash flow from operations and achieved compliance with the Defined EBITDA covenant contained in our
Senior Secured Convertible Notes, which is discussed in further detail elsewhere herein. Although
these initiatives proved to be effective in our meeting the Defined EBITDA covenant contained in
our Senior Secured Convertible Notes during the fourth quarter of fiscal 2008, we do not expect
some of these initiatives, such as reducing or deferring salaries, benefits and other operating
costs, to be sustainable into future periods.
During the first half of fiscal 2009, our revenues have been negatively impacted as a result
of the severity of the global economic downturn and its impact on discretionary spending on our
products. Additionally, the unwillingness of the holders of the Senior Secured Convertible Notes
to renegotiate their debt has affected revenues as a result of customer concern about our viability
as an ongoing business. We would expect these factors to cause near term future operating results
to be less favorable than our financial results for the fourth quarter of fiscal 2008 and those
previously anticipated for fiscal 2009. To address the impact of this revenue decline, during the
first half of fiscal 2009 we have (i) continued salary reductions for a number of management
personnel; (ii) eliminated additional headcount, including an approximately 15% reduction of our
field sales force as a result of the realignment of our sales territories; (iii) eliminated the
employee stock purchase plan and its associated costs; (iv) furloughed certain manufacturing
production personnel; (v) reduced the number of seminar programs and streamlined the cost structure
of these programs; and (vi) reduced tradeshow expenditures. Excluding the effect of the $23.2
million impairment loss for goodwill and other intangible assets recognized during December 2008,
these actions narrowed our operating loss over the same periods in the prior year. The impairment
loss is more fully described in Note 5 of the accompanying Unaudited
Condensed Consolidated Financial Statements, Goodwill and Other Intangible
Assets, and elsewhere in this MD&A. To address the impact
of the economic downturn on our revenues, we continue to identify cost-reduction and working
capital initiatives to reduce the impact on future cash flows from operations and results of
operations.
While
we have continued to execute a number of cost reduction strategies, the decline in our revenues has caused
our cash utilization to exceed planned levels. As of January 31, 2009, we had approximately $2.5
million of cash and cash equivalents, compared to $3.2 million at October 31, 2008 and $4.5 million
at July 31, 2008 and a working capital deficit of $4.3 million compared to working capital of $5.7
million at October 31, 2008 and $6.6 million at July 31, 2008. In order to continue as a going
concern and fund our current level of operations over the next twelve months, we will require
additional funds and need to restructure our Senior Secured Convertible Notes. If we are unable
to do so, we will likely be forced to file for protection under Chapter 11 of the Federal Bankruptcy
Code. We have retained financial and legal advisors to assist us in
our numerous continuing efforts
to restructure our Senior Secured Convertible Notes, raise capital and explore possible strategic
opportunities.
Our efforts to seek additional funding have included discussions with numerous potential
financial and strategic investors as well as with the holders of the Senior Secured Convertible
Notes. All potential investors with whom we have had discussions required, as a condition of their
investment, that the Senior Secured Convertible Notes be repaid from the funds provided by the
investor(s) and that this repayment be at a substantial discount from the $12.0 million principal
outstanding to reflect the current market value of those notes. However, to date, the holders of
the Senior Secured Convertible Notes have been unwilling to agree to an amount to extinguish this
debt. Also, although the Senior Secured Convertible Notes provide us with the opportunity to
obtain a working capital line of credit secured by our inventory and accounts receivable, we have
been unable to obtain the approval of the majority holder of the Senior Secured Convertible Notes
even though the note agreements provide that such approval is not to be unreasonably withheld.
We have made timely interest payments under the terms of the Senior Secured Convertible Notes
and are otherwise in compliance with the terms of such notes, except for the interest payment due
January 31, 2009, which has not been made as of the date of this filing. The failure to make this
payment is an event of default under our Senior Secured Convertible Notes. Although we have not
received a notice of default or acceleration from the note holders as of the date of this filing,
which is required prior to any of the principal amount becoming due and payable as a result of such
default, we have reclassified the Senior Secured Convertible Notes to current liabilities. In
addition, upon an event of default, the Senior Secured Convertible Notes shall bear interest at a
default rate of 15.0% per annum. However, during the pendency of negotiations, the note holders
have agreed that no default interest will accrue unless and until they provide notice to us.
We were unable to issue shares for the January 31, 2009 interest
payment because, due to our share price at such time, the number of shares to be issued would have required shareholder approval under
applicable NASDAQ rules. In addition, given our current level of cash and cash equivalents, the
impact of the global economic downturn on our business and customer concern about our viability as
an ongoing business, it is uncertain whether we will have sufficient cash available to pay our
future quarterly interest payments due under the Senior Secured Convertible Notes.
27
As a result of the foregoing, there is substantial doubt about our ability to continue as a
going concern. Accordingly, realization values may be substantially different from carrying values
as shown, and these financial statements do not give effect to adjustments that would be necessary
to the carrying values and classification of assets and liabilities should we be unable to continue
as a going concern.
Selected Cash Flow and Working Capital Information
Selected cash flow and working capital information is summarized as follows (dollars in
thousands):
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended January 31,
|
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
$
|
(1,469
|
)
|
|
$
|
(6,685
|
)
|
Net cash used in investing activities
|
|
|
(342
|
)
|
|
|
(754
|
)
|
Net cash used in financing activities
|
|
|
(138
|
)
|
|
|
(1,536
|
)
|
|
|
|
|
|
|
|
|
|
|
|
January 31,
|
|
July 31,
|
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
2,513
|
|
|
$
|
4,462
|
|
Working capital
|
|
|
(4,348
|
)
|
|
|
6,558
|
|
Current ratio
|
|
|
0.7
|
|
|
|
1.8
|
|
As of January 31, 2009, our primary sources of liquidity included cash and cash equivalents of
$2.5 million compared to $4.5 million as of July 31, 2008. Our working capital was negative
$4.3 million as of January 31, 2009 compared to $6.6 million as of July 31, 2008. The decrease in
working capital primarily relates to our decreased cash balance and the reclassification of our
Senior Secured Convertible Notes to current liabilities, offset by a decline in accounts payable
and other accrued expenses. Our current ratio declined to 0.7 as of January 31, 2009 from 1.8 as of
July 31, 2008 due primarily to the reclassification for our Senior Secured Convertible Notes and
the decline in cash and cash equivalents.
Cash Flows from Operating Activities
Cash used in operating activities was $1.5 million and $6.7 million for the six months ended
January 31, 2009 and 2008, respectively. The improvement in cash used in operating activities
relates to the recent profit enhancement initiatives undertaken and the curtailment of activity and
spending related to the oral cancer diagnostic drug program. Also contributing to the lower amount
of cash used in operating activities was a decrease in cash used for changes in working capital,
which was $0.3 million and $1.5 million for the six months ended January 31, 2009 and 2008,
respectively, or a $1.2 million reduction. Working capital changes for the six months ended
January 31, 2009 primarily relate to a decline in accounts payable and accrued liabilities of $1.8
million for payments made on these balances, offset by a reduction in our accounts receivable
balances of $0.9 million, which in part relates to our decline
in revenue from the levels experienced in the fourth quarter
of fiscal 2008 compared to the first half of fiscal 2009. During the first six months of fiscal 2009, our
accounts payable and accrued liabilities have declined as a result of lower expense levels coupled
with the tightening of payment terms from our vendors. However, we did have $0.1 million in cash
provided by working capital changes for the second quarter of fiscal 2009 as we adjusted purchasing
patterns for the recently experienced sales declines in order to lower our inventory levels.
Cash Flows from Investing Activities
Cash used in investing activities was $0.3 million and $0.8 million for the six months ended
January 31, 2009 and 2008, respectively, and consists primarily of disbursements for additional
property and equipment and development of intangible assets.
Cash Flows from Financing Activities
Cash used in financing activities was $0.1 million and $1.5 million for the six months ended
January 31, 2009 and 2008, respectively. During the first six months of fiscal 2008, we paid $1.4
million for the repurchase of common stock and warrants in connection with an amendment to our
Senior Secured Convertible Notes.
28
Senior Secured Convertible Notes
Our Third Amended and Restated Secured Notes (the Senior Secured Convertible Notes) were
originally entered into in November 2006 as part of a private placement offering. The Senior
Secured Convertible Notes are in the aggregate principal amount of $12.0 million, are due July 31,
2010 and 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 Senior Secured Convertible Notes are convertible into shares of
our common stock at a conversion price of $15.40 per share at the option of the holders of such
notes. In addition, the Senior Secured Convertible Notes contain comprehensive covenants that
restrict the way in which we can operate, and contain financial covenants that require us to:
(i) maintain a minimum cash and cash equivalents balance of $1.0 million at the end of each fiscal
quarter and (ii) achieve a required EBITDA level, as defined in the Senior Secured Convertible
Notes (Defined EBITDA), of at least $1.00 for any one fiscal quarter on or prior to our quarter
ending July 31, 2009. The Defined EBITDA covenant was satisfied during the fourth quarter of fiscal
2008. The Senior Secured Convertible Notes are secured by certain of our existing and future
property.
Failure to satisfy the financial covenants, or to maintain compliance with other covenants,
could, at the option of the Senior Secured Convertible Note holders, result in an acceleration of
some or all of the amounts outstanding thereunder. Upon the occurrence of the first specified event
of default, the holders of the Senior Secured Convertible Notes could accelerate and demand
repayment of one-third of the outstanding principal balance and all accrued but unpaid interest on
the Senior Secured Convertible Notes. Upon the occurrence of the second specified event of default,
the holders of the Senior Secured Convertible Notes could accelerate and demand repayment of
one-half of the outstanding principal balance and all accrued but unpaid interest on these notes.
Upon the occurrence of the third specified event of default, the entire principal balance and all
accrued but unpaid interest may become due and payable. Additionally, upon the occurrence and
during the continuation of any event of default, all amounts outstanding under the Senior Secured
Convertible Notes shall bear interest at a rate of 15.0% per annum.
On September 11, 2008, we entered into a Third Amendment Agreement with the Investors that
serves to limit the amount of the Senior Secured Convertible Notes that each Investor is allowed to
convert into Zilas common shares. Under the Third Amendment Agreement, holders shall not have the
right to convert any portion of their Senior Secured Convertible Notes in the event that the holder
would beneficially own in excess of 4.999% of our common stock issued and outstanding immediately
after giving effect to such conversion.
We anticipate we will need to refinance our Senior Secured Convertible Notes by their due date
of July 31, 2010. We have made timely interest payments under the terms of the Senior Secured
Convertible Notes and are otherwise in compliance with the terms of such notes, except for the
interest payment due January 31, 2009, which has not been made as of the date of this filing. The
failure to make this payment is an event of default under our Senior Secured Convertible Notes.
Although we have not received a notice of default or acceleration from the note holders as of the
date of this filing, which is required prior to any of the principal amount becoming due and
payable as a result of such default, we have reclassified the Senior Secured Convertible Notes to
current liabilities. In addition, upon an event of default, the Senior Secured Convertible Notes
shall bear interest at a default rate of 15.0% per annum. However, during the pendency of
negotiations, the note holders have agreed that no default interest will accrue unless and until
they provide notice to us. We recently retained financial advisors to assist in exploring financing
alternatives. As of the date of this filing, we were engaged in negotiations with the note holders
regarding the repayment provisions of these notes, but have been unable to reach an agreement.
Should we refinance the Senior Secured Convertible Notes before their scheduled maturity, we may
incur an additional non-cash interest charge relative to our unamortized debt issue costs and debt
discounts. As of January 31, 2009 there were $1.3 million of unamortized debt issue costs and
$2.7 million of debt discounts relative to the Senior Secured Convertible Notes.
PharmaBio Development, Inc.
In December 2002, we entered into an agreement with PharmaBio Development, Inc. (PharmaBio),
the strategic investment group of Quintiles Transnational Corp., our then contract research
organization. Under this agreement, PharmaBio invested $0.5 million in us. In return for the
investment, we agreed to pay PharmaBio an amount equal to 5.0% of all net sales of an oral cancer
diagnostic drug product in the European Union and the United States. The aggregate amount of the
royalty payments cannot exceed $1.25 million and the royalty is payable quarterly. The investment
was recorded as long-term debt and will be amortized using the effective interest method.
29
Convertible Preferred Stock
During February 2001, we issued 100,000 shares of Series B Convertible Preferred Stock
(Preferred Stock) as part of an acquisition, all of which were outstanding as of January 31, 2009
and July 31, 2008. The holders of the Preferred Stock are entitled to receive cumulative quarterly
dividends at a rate of $0.0975 per share per fiscal quarter, payable in arrears, which represents
an aggregate annual dividend of $39,000. As of January 31, 2009 and July 31, 2008, accumulated
accrued dividends were less than $0.1 million. The Preferred Stock can be redeemed at our option if
our common stock maintains a closing price on each trading day equal to or greater than $9.00 per
share for any ten trading day period. The redemption price shall be the average bid closing price
of our common stock for the five trading days immediately proceeding the date we give notice. The
Preferred Stock is convertible at the option of the holder at any time on or before December 31,
2010 into our common stock at the ratio of one-to-one. On December 31, 2010, all of the remaining
Preferred Stock will be converted into our common stock at a ratio of one-to-one. Holders of the
preferred stock have no voting rights except as required by applicable law and have a liquidation
preference of $0.65 million. The shares of Preferred Stock were issued pursuant to the exemption
set forth in Section 4(2) of the Securities Act. There is no established public trading market for
the Preferred Stock.
Off-Balance Sheet Financing Arrangements
We do not have any off-balance sheet financing arrangements.
Summary of Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based
upon our condensed consolidated financial statements, which have been prepared pursuant to the
rules and regulations of the SEC. Certain information related to our organization, significant
accounting policies and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States have been condensed
or omitted. The preparation of the financial statements in accordance with accounting principles
generally accepted in the United States requires us to make estimates and assumptions that affect
the amounts reported in the financial statements and accompanying notes. On an ongoing basis, we
evaluate our estimates related to (i) useful lives of intangibles; (ii) impairment analyses; (iii)
depreciable lives of assets; (iv) income tax valuation allowances; (v) contingency and litigation
reserves; (vi) inventory valuation; (vii) allowances for accounts receivable, cash discounts, sales
incentives and sales returns; and (viii) valuation assumptions for share-based payments. We base
our estimates on historic experience and various other factors related to each circumstance. Actual
results could differ from those estimates based upon future events, which could include, among
other risks, changes in the business environment in which we operate and changes in the regulations
governing the manner in which we manufacture and/or sell our products.
There are several accounting policies that we believe are significant to the presentation of
our financial statements and require managements most difficult, complex or subjective judgments
about matters that are inherently uncertain. We believe our most critical accounting policies
include (i) revenue recognition; (ii) use of estimates, which is described more fully above; and
(iii) the carrying values of goodwill and other long-lived assets. Our significant accounting
policies and critical accounting estimates are disclosed more fully in our Annual Report on Form
10-K for the year ended July 31, 2008. With the exception of our goodwill and other intangible
assets disclosure below, we do not believe there have been significant changes to our critical
accounting policies and estimates subsequent to July 31, 2008.
30
Goodwill, Intangibles and Other Long-Lived Assets We have made acquisitions of products and
businesses that include goodwill, license agreements, patents and trademarks, product rights and
other intangible and long-lived assets. We assess the impairment of goodwill annually in our fourth
fiscal quarter, or whenever events or changes in circumstances indicate that the carrying value of
goodwill may not be recoverable. During the first half of fiscal 2009, our revenues have been
negatively impacted as a result of the severity of the global economic downturn and its impact on
discretionary spending on our products. The unwillingness of the holders of the Senior Secured
Convertible Notes to renegotiate their debt has also affected revenues as a result of customer
concern about our viability as an ongoing business. We would expect
these factors to cause near term future operating
results to be less favorable than previously anticipated for fiscal 2009. We have also experienced
a decline in our stock price and a corresponding decline in our market capitalization and
enterprise value throughout the first half of fiscal 2009. Finally, as of December 2008, we
anticipated we would fail to make the interest payment due January 31, 2009 on our Senior Secured
Convertible Notes, which is an event of default under such notes. Although we have not received a
notice of default or acceleration from the note holders as of the date of this filing, which is
required prior to any of the principal amount becoming due and payable as a result of such default,
the note holders may, at any time, accelerate one-third of the amount outstanding under the Senior
Secured Convertible Notes, which in this case is $4.0 million. In order to continue as a going
concern and fund our current level of operations over the next twelve
months, we will require additional funds and need to restructure our Senior Secured Convertible Notes. If we are unable
to do so, we will likely be forced to file for protection under Chapter 11 of the Federal
Bankruptcy Code, which may lead to a liquidation of our business. Primarily as a result of these
factors, we assessed goodwill for impairment during December of 2008 in addition to our annual
test. The assessment is performed using the two-step process
prescribed by SFAS No. 142,
Goodwill and Other
Intangible Assets
(SFAS 142). The first step is a screen for potential impairment,
while the second step measures the amount of the impairment, if any. The first step of the goodwill
impairment test compares the fair value of a reporting unit with its carrying amount, including
goodwill. If the fair value of the reporting unit exceeds its carrying value, goodwill is not
impaired. If the carrying value of the reporting units net assets, including goodwill, exceeds
the fair value of the reporting unit, then we determine the implied fair value of the reporting
units goodwill. If the carrying value of a reporting units goodwill exceeds its implied fair
value, then an impairment of goodwill has occurred and we recognize an impairment loss for the
difference between the carrying amount and the implied fair value of goodwill as a component of
operating income. The implied fair value of goodwill is calculated by subtracting the fair value of
tangible and intangible assets associated with the reporting unit from the fair value of the unit.
For fiscal 2008, the first step of our goodwill impairment test reflected fair value that was in
excess of the carrying value. Accordingly, we did not perform the second step of this test during
fiscal 2008. The December 2008 impairment test resulted in an impairment of the entire balance of
goodwill, or $10.2 million.
For fiscal 2009 and 2008, our business has been managed and operated as one operating segment
and one reporting unit, and accordingly, our goodwill impairment
tests conducted during these years were based
on one reporting unit. We relied upon the discounted cash flow method
under the income approach, and the orderly and forced liquidation
method, as the primary means to calculate fair value. Significant estimates used in the fair value calculation include, but are not limited
to: (i) estimates of future revenue and expense growth; (ii) future estimated effective tax rates,
which we estimate to be approximately 40%; (iii) future estimated capital expenditures and future
required investments in working capital; (iv) average cost of capital, which we base on
expectations for market participants and estimate to be approximately 43% for fiscal 2009 and 25%
for fiscal 2008; (v) the ability to utilize certain tax attributes and (vi) the future terminal
value of the reporting unit. The primary factors leading to impairment for the December 2008
interim impairment test were (i) lower levels of projected cash flows, which were affected by the
recent declines in our revenues, (ii) an increase in the average cost of capital, which is
primarily attributable to general increases in the cost of capital relative to the recent global
economic downturn and increased risks associated with the cash flows from our business and (iii) an
increased likelihood of a liquidation of our business.
For our annual fiscal 2008 goodwill impairment test, we performed
a sensitivity analysis considering a decline in revenues in all years of 12.5%, and variable
expenses of 10.8% of revenues. Fixed expenses were grown at a 3.0% annual inflation rate over the
projection period. Although we considered this projection set to be much less risky than our base
case used for SFAS 142 step one conclusion purposes, we kept the average cost of capital constant
at approximately 25%. This analysis did not indicate impairment of goodwill. We also performed an
internal rate of return analysis that indicated an average cost of capital of 51.0% is required to
tie our projections to the market value of total invested capital for Zila.
There have been no substantial changes in the methodologies employed, significant assumptions
used, or calculations applied in the first step of the SFAS 142 impairment test over the past
several years; however, due to the factors discussed above, for the December 2008 interim
impairment test we placed more emphasis on liquidation scenarios. Prior to
fiscal 2008 we divested and acquired certain businesses, and accordingly, the number of business
units identified in prior periods was different than those identified for the fiscal 2009 and 2008
impairment tests.
31
We assess impairment of other intangibles and long-lived assets whenever events or changes in
circumstances indicate that the carrying value of any of these assets may not be recoverable. Such
events or circumstances might include a significant decline in market share and/or significant
negative industry or economic trends, a significant decline in profits and/or significant
underperformance relative to expected historical or projected operating results, significant
changes in the manner of our use of the acquired assets or the strategy for our overall business,
rapid changes in technology, significant litigation or other items. As a result of the factors
discussed above, we assessed our other intangible assets for impairment during December 2008. In
evaluating the recoverability of intangibles and other long-lived assets, our policy is to first
compare the carrying amounts of such assets with the estimated undiscounted future operating cash
flows. If the carrying amount exceeds the undiscounted future operating cash flows, an impairment
charge is recognized for the excess of the carrying amount of the asset over its fair value. We
calculate fair value of trademark and know-how intangible assets by using a relief from royalty
method. The relief from royalty method is based on the assumption that, in lieu of ownership of an
intangible asset, a company would be willing to pay a royalty in order to enjoy the benefits of the
asset. Under this method, value is estimated by discounting the hypothetical royalty payments to
their present value over the economic life of the asset. We calculate fair value of our customer
relationships by using the excess earnings method. The excess earnings method estimates the value
of an intangible asset by quantifying the amount of residual (or excess) cash flows generated by
the asset, and discounting those cash flows to the present. Growth rates of net sales and average
cost of capital used for discounting cash flows for the december 2008
impairment assessment are consistent with those utilized in the December
2008 interim goodwill test. We recognized an impairment charge of approximately $13.0 million
relative to these intangible assets, which was primary driven by lower levels of projected cash
flows, an increase in the average cost of capital and lower estimated royalty rates of our products
relative to other products in the market. This impairment charge consists of $6.1 million for
purchased technology, $3.9 million for trademarks, $1.4 million for patents, $0.6 million for
licensing costs and $1.0 million for customer relationships and other intangible assets. If we
have future changes in events or circumstances, including reductions in anticipated cash flows generated
by our operations or determinations to divest of certain assets,
certain assets could be impaired,
which would result in additional charges to earnings.
The impairment charge for goodwill and other intangible assets was recognized as of December
31, 2008 and is stated separately on the accompanying Unaudited Condensed Consolidated Statements
of Operations under the caption Impairment of goodwill and other intangible assets.
Recently Issued Accounting Pronouncements and Adopted Accounting
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements
(SFAS 157), which
defines fair value, establishes a framework for measuring fair value in GAAP, and expands
disclosures about fair value measurements. SFAS 157 does not require any new fair value
measurements, but provides guidance on how to measure fair value by providing a fair value
hierarchy used to classify the source of the information for those instruments measured at fair
value. The fair value hierarchy distinguishes between assumptions based on market data (observable
inputs) and an entitys own assumptions (unobservable inputs). The hierarchy consists of three
levels:
Level 1 Quoted market prices in active markets for identical assets or liabilities;
Level 2 Inputs other than Level 1 inputs that are either directly or indirectly observable;
and
Level 3 Unobservable inputs developed using estimates and assumptions, which are developed by
the reporting entity and reflect those assumptions that a market participant would use.
Determining which category an asset or liability falls within the hierarchy requires
significant judgment. We evaluate our hierarchy disclosures each quarter.
SFAS 157 is effective for financial instruments issued for years beginning after November 15,
2007, with the exception of certain nonfinancial assets and liabilities, for which the effective
date has been deferred by one year. On August 1, 2008, we adopted the provisions of SFAS 157,
except as it applies to those nonfinancial assets and nonfinancial liabilities for which the
effective date has been delayed by one year. The adoption of SFAS 157 did not have a material
effect on our financial position or results of operations.
Other than our notes payable, the fair value of financial instruments approximates their
carrying value at January 31, 2009. These financial instruments consist of cash and cash
equivalents, receivables, accounts payable and accrued expenses. We do not believe it is currently
practicable to estimate the fair value of the Senior Secured Convertible Notes as there is no
active market for such notes and there are a limited number of investors in the notes. The carrying
amount of other borrowings is estimated to approximate fair value as the actual interest rate is
consistent with the rate estimated to be currently available for borrowings of similar term and
remaining maturity.
32
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated
Financial Statements an amendment of ARB No. 51
(SFAS 160). SFAS 160 establishes accounting
and reporting standards that require (i) noncontrolling interests to be reported as a component of
equity; (ii) changes in a parents ownership interest while the parent retains its controlling
interest to be accounted for as equity transactions; and (iii) any retained noncontrolling equity
investment upon the deconsolidation of a subsidiary to be initially measured at fair value. SFAS
160 is effective for fiscal years and interim periods within those fiscal years, beginning on or
after December 15, 2008, which for us is the fiscal quarter beginning February 1, 2009. Early
adoption is prohibited. We do not expect the adoption of SFAS 160 to have a material effect on our
financial position or results of operations.
In December 2007, the FASB issued SFAS No. 141 (revised 2007),
Business Combinations
(SFAS
141R). SFAS 141R establishes the principles and requirements for how an acquirer: (i) recognizes
and measures in its financial statements the identifiable assets acquired, the liabilities assumed
and any noncontrolling interest in the acquiree; (ii) recognizes and measures goodwill acquired in
a business combination or a gain from a bargain purchase; and (iii) determines what information to
disclose to enable users of the financial statements to evaluate the nature and financial effects
of a business combination. Additionally, under SFAS 141R transaction related costs must be expensed
as incurred, rather than accounted for as part of the purchase price of an acquisition. SFAS 141R
is to be applied prospectively to business combinations consummated on or after the beginning of
the first annual reporting period on or after December 15, 2008, which for us would be our fiscal
year beginning August 1, 2009. Early adoption is prohibited. Following its effective date, we will
apply the provisions of SFAS 141R to future acquisitions, if any.
In March 2008, the FASB issued SFAS No. 161,
Disclosures about Derivative Instruments and
Hedging Activities, an amendment of FASB Statement No. 133
(SFAS 161), which establishes, among
other things, the disclosure requirements for derivative instruments and hedging activities. SFAS
161 requires qualitative disclosures about objectives and strategies for using derivatives,
quantitative disclosures about fair value amounts of, and gains and losses on, derivative
instruments, and disclosures about credit-risk-related contingent features in derivative
agreements. SFAS 161 is effective for fiscal periods and interim periods beginning after November
15, 2008, which for us would be our third quarter of our fiscal year 2009, which would be the
quarterly period ending April 30, 2009. We are currently evaluating the impact SFAS 161 will have
on our financial statement disclosures.
In April 2008, the FASB issued FASB Staff Position (FSP) No. SFAS 142-3,
Determination of
the Useful Life of Intangible Assets
(FSP SFAS 142-3). FSP SFAS 142-3 amends the factors that
should be considered in developing renewal or extension assumptions used to determine the useful
life of a recognized intangible asset under SFAS 142. The intent of FSP SFAS 142-3 is to improve
the consistency between the useful life of a recognized intangible asset under SFAS 142 and the
period of expected cash flows used to measure the fair value of the asset under SFAS 141R and other
applicable accounting literature. FSP SFAS 142-3 is effective for financial statements issued for
fiscal years beginning after December 15, 2008 and must be applied prospectively to intangible
assets acquired after the effective date. We are currently evaluating the impact FSP SFAS 142-3
will have on our financial position or results of operations.
In May 2008, the FASB issued FSP Accounting Principles Board No. 14-1
Accounting for
Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement)
(FSP APB 14-1). FSP APB 14-1 requires the issuer of certain convertible debt
instruments that may be settled in cash (or other assets) on conversion (including partial cash
settlement) to separately account for the liability and equity components of the instrument in a
manner that reflects the issuers non-convertible debt borrowing rate when interest cost is
recognized in subsequent periods. FSP APB 14-1 is effective for financial statements issued for
fiscal years beginning after December 15, 2008, and interim periods within those fiscal years.
Early adoption is prohibited. We are currently evaluating the impact FSP APB 14-1 will have on our
financial position or results of operations.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Our exposure to market risk for a change in interest rates relates primarily to our
investments, which consists of cash and cash equivalents. The primary objective of our investment
activities is to preserve principal while maximizing yields without significantly increasing risk.
We maintain our portfolio in high credit quality cash deposits and money market funds with carrying
values that approximate market value. Because our investments consist of cash and cash equivalents,
a hypothetical 100 basis point change in interest rates is not likely to have a material effect on
our consolidated financial statements.
We also have market risk arising from changes in foreign currency exchange rates through our
subsidiaries that conduct business in Canada and Europe and have functional currencies denominated
in Canadian dollars and British pounds. We believe that such exposure does not present a
significant risk due to the limited number of transactions and/or accounts denominated in foreign
currency.
33
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures.
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended (the Exchange Act)) that are designed: (i)
to ensure that information required to be disclosed in the reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time periods specified in
the SECs rules and forms and (ii) to ensure that such information is accumulated and communicated
to management, including our Principal Executive Officer and Principal Financial Officer, as
appropriate, to allow for timely decisions regarding required disclosure. Our management, with the
participation of our Principal Executive Officer and Principal Financial Officer, evaluated the
effectiveness of our disclosure controls and procedures as of the end of the period covered by this
report, and, based on that evaluation, our Principal Executive Officer and Principal Financial
Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e)
and 15d-15(e)) are effective.
Changes in Internal Control over Financial Reporting
.
There were no changes in our internal control over financial reporting (as such term is
defined in Rules 13a-15(f) and15d-15(f) of the Exchange Act) during the most recent fiscal quarter
that have materially affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
Part II OTHER INFORMATION
Item 1. Legal Proceedings.
Information regarding our legal proceedings may be found under the Legal Proceedings section
of the footnote titled Commitments and Contingencies to our Unaudited Condensed Consolidated
Financial Statements contained elsewhere herein.
Item 1A. Risk Factors.
You should consider carefully the risk factors described below, and all other information
contained in this filing and our other filings made with the SEC, before deciding to invest in our
common stock. If any of the following risks actually occur, they may materially harm our business,
financial condition, operating results or cash flow. As a result, the market price of our common
stock could decline, and you could lose all or part of your investment. Additional risks and
uncertainties that are not yet identified or that we think are immaterial may also materially harm
our business, operating results or financial condition and could result in a complete loss of your
investment.
Trends, Risks and Uncertainties Related to Our Business
We are in default with respect to our Senior Secured Convertible Notes.
The interest payment in the amount of approximately $0.2 million due January 31, 2009 on the
Senior Secured Convertible Notes has not been made as of the date of this filing. The failure to
make this payment is an event of default under our Senior Secured Convertible Notes. Although we
have not received a notice of default or acceleration from the note holders as of the date of this
filing, which is required prior to any of the principal amount becoming due and payable as a result
of such default, the note holders may, at any time, accelerate one-third of the amount outstanding
under the Senior Secured Convertible Notes, which in this case is $4.0 million. In addition, upon
an event of default, the Senior Secured Convertible Notes shall bear interest at the default rate
of 15% per annum. However, during the pendency of negotiations described elsewhere in this
filing, the note holders have agreed that no default interest will accrue unless and until they
provide notice to us. As a result of the foregoing, there can be no assurance that the debt
holders will not accelerate the maturity of our obligations and proceed against their collateral.
In that event, we would likely be forced to file for protection under Chapter 11 of the
Federal Bankruptcy Code, which would likely result in our common stock becoming worthless.
34
Adverse economic conditions could negatively affect our business and operating results.
Our operating results may be adversely affected by market and economic challenges, including
the crisis currently impacting global credit and financial markets that may result in a continued
or exacerbated general economic slowdown. Such a slowdown has negatively affected sales of our
products, including ViziLite
®
Plus. We have received reports that dental visits by
patients for routine checkups are down as a result of the slowing economy. The length and severity
of any economic slowdown or downturn cannot be predicted. If the current economic crisis is
prolonged or becomes more severe, its adverse impact on our business and operating results could be
significant.
Our lack of earnings history could adversely affect our financial health and prevent us from
fulfilling our payment obligations, and if we are unable to generate funds or obtain funds on
acceptable terms, we may not be able to develop and market our present and potential products.
Our revenues during the first half of fiscal 2009 have been negatively impacted as a result of
the severity of the global economic downturn and customer concern about our viability as an ongoing
business. We have historically sustained recurring losses and negative cash flows from operations
as we changed our strategic direction to focus on the growth and development of
ViziLite
®
Plus and our periodontal product lines. Our liquidity needs have typically
arisen from the funding of our research and development program and the launch of our new products,
such as ViziLite
®
Plus, working capital and debt service requirements, and strategic
initiatives. In the past, we have met these cash requirements through our cash and cash
equivalents, working capital management, the sale of non-core assets and proceeds from certain
private placements of our securities.
The development of products requires the commitment of substantial resources to conduct the
time-consuming research and development, clinical studies and regulatory activities necessary to
bring any potential product to market and to establish production, marketing and sales
capabilities. Our ability to develop our products, to service our debt obligations, to fund working
capital and capital expenditures and for other purposes that cannot at this time be quantified will
depend on our future operating performance, which will be affected by factors discussed elsewhere
in this filing and in the other reports we file with the SEC, including, without limitation,
receipt of regulatory approvals, economic conditions and financial, business, and other factors,
many of which are beyond our control.
While
we have continued to execute a number of our cost reduction strategies, the decline in our revenues has caused
our cash utilization to exceed planned levels. As of January 31, 2009, we had approximately $2.5
million of cash and cash equivalents, compared to $3.2 million at October 31, 2008 and $4.5 million
at July 31, 2008 and a working capital deficit of $4.3 million compared to working capital of $5.7
million at October 31, 2008 and $6.6 million at July 31, 2008. In order to continue as a going
concern and fund our current level of operations over the next twelve months, we will require
additional funds and need to restructure our Senior Secured Convertible Notes. If we are unable
to do so, we will likely be forced to file for protection under Chapter 11 of the Federal Bankruptcy
Code. We have retained financial and legal advisors to assist us in
our numerous continuing efforts
to restructure our Senior Secured Convertible Notes, raise capital and explore possible strategic
opportunities.
Our efforts to seek additional funding have included discussions with numerous potential
financial and strategic investors as well as with the holders of the Senior Secured Convertible
Notes. All potential investors with whom we have had discussions required, as a condition of their
investment, that the Senior Secured Convertible Notes be repaid from the funds provided by the
investor(s) and that this repayment be at a substantial discount from the $12.0 million principal
outstanding to reflect the current market value of those notes. However, to date, the holders of
the Senior Secured Convertible Notes have been unwilling to agree to an amount to extinguish this
debt. Also, even though the Senior Secured Convertible Notes provide us with the opportunity to
obtain a working capital line of credit secured by our inventory and accounts receivable, we have
been unable to obtain the approval of the majority holder of the Senior Secured Convertible Notes
even though the note agreements provide that such approval is not to be unreasonably withheld.
We have made timely interest payments under the terms of the Senior Secured Convertible Notes
and are otherwise in compliance with the terms of such notes, except for the interest payment due
January 31, 2009, which has not been made as of the date of this filing. The failure to make this
payment is an event of default under our Senior Secured Convertible Notes. Although we have not
received a notice of default or acceleration from the note holders as of the date of this filing,
which is required prior to any of the principal amount becoming due and payable as a result of such
default, we have reclassified the Senior Secured Convertible Notes to current liabilities. In
addition, upon an event of default, the Senior Secured Convertible Notes shall bear interest at a
default rate of 15.0% per annum. However, during the pendency of negotiations, the note holders
have agreed that no default interest will accrue unless and until they provide notice to us.
35
We were unable to issue shares for the January 31, 2009 interest
payment because, due to our share price at such time, the number of shares to be issued would have required shareholder approval under
applicable NASDAQ rules. In addition, given our current level of cash and cash equivalents, the
impact of the global economic downturn on our business and customer concern about our viability as
an ongoing business, it is uncertain whether we will have sufficient cash available to pay our
future quarterly interest payments due under the Senior Secured Convertible Notes.
As a result of the foregoing, there is substantial doubt about our ability to continue as a
going concern. Accordingly, realization values may be substantially different from carrying values
as shown, and these financial statements do not give effect to adjustments that would be necessary
to the carrying values and classification of assets and liabilities should we be unable to continue
as a going concern. If we would be forced to file for protection
under Chapter 11 of the Federal Bankruptcy Code, our common stock
would likely become worthless.
Strategic business opportunities to accelerate the growth of our business may require
additional funding. However, in light of recent economic conditions, there can be no assurance that
we will be successful in achieving our current sales projections or in executing our strategies.
Furthermore, there can be no assurance that additional funding will be obtainable on terms that are
favorable to us, if at all.
Our
lack of earnings history, liquidity concerns and our level of debt could have important
consequences, such as:
|
|
|
making it more difficult for us to satisfy our obligations with respect to our Senior
Secured Convertible Notes;
|
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|
|
increasing our vulnerability to general adverse economic and industry conditions;
|
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|
limiting our flexibility in planning for, or reacting to, changes in our business and
our industry;
|
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|
restricting us from making strategic acquisitions, introducing new products or
exploiting business opportunities;
|
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|
requiring us to dedicate a substantial portion of our cash flow from operations to
payments on our indebtedness, which will reduce the amount of our cash flow available for
other purposes, including capital expenditures and other general corporate purposes;
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|
requiring us to sell debt securities or to sell some of our core assets, possibly on
unfavorable terms;
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limiting our ability to obtain additional financing; and
|
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placing us at a possible competitive disadvantage compared to our competitors that may
have greater financial resources.
|
We may not be able to maintain compliance with our debt covenants in the future.
Our Senior Secured Convertible Notes contain comprehensive covenants that restrict the way in
which we can operate, and contain financial covenants that require us to, among other things,
maintain, at the end of each fiscal quarter, cash and cash equivalents in an amount not less than
$1.0 million. As of January 31, 2009, we were in compliance with this covenant
and had approximately $2.5 million in cash and cash equivalents. We had cash and cash equivalents
of approximately $3.2 million, $4.5 million, $3.5 million, $5.9 million and $8.7 million as of
October 31, 2008, July 31, 2008, April 30, 2008, January 31, 2008 and October 31, 2007,
respectively. If, as a result of recent economic conditions or other reasons, we are unable to
achieve our currently projected sales, we may be unable to remain in compliance with this covenant.
We may also be required to use cash for working capital purposes should we experience delays in
collecting receivables from our customers, which would increase the number of days our sales are
outstanding. Cash flows would also be negatively affected through the tightening of payment terms
from our vendors and our inability to match our inventory levels with increased or decreased sales
levels. Deterioration in one or all of these factors given our current level of cash and cash
equivalents could have significant adverse consequences in maintaining compliance with this
covenant.
Failure to maintain compliance with this or other covenants could, at the option of the Senior
Secured Convertible Note holders, result in an additional event of default under the Senior Secured
Convertible Notes. Upon the occurrence of the first specified event of default, the holders of the
Senior Secured Convertible Notes could accelerate and demand repayment of one-third of the
outstanding principal balance and all accrued but unpaid interest on the Senior Secured Convertible
Notes. Upon the occurrence of the second specified event of default, the holders of the Senior
Secured Convertible Notes could accelerate and demand repayment of one-half of the outstanding
principal balance and all accrued but unpaid interest on the Senior Secured Convertible Notes. Upon
the occurrence of the third specified event of default, the entire principal balance and all
accrued but unpaid interest may become due and payable.
36
We anticipate we will need to refinance our Senior Secured Convertible Notes by their due date
of July 31, 2010. We have made timely interest payments under the terms of the Senior Secured
Convertible Notes and are otherwise in compliance with the terms of such notes, except for the
interest payment due January 31, 2009, which has not been made as of the date of this filing. We
recently retained financial advisors to assist in exploring financing alternatives. As of the date
of this filing, we were engaged in negotiations with the note holders regarding the repayment
provisions of these notes and have not received notice of acceleration from the note holders with
respect to the January 31, 2009 interest payment. However, there can be no assurance that we will
be successful in obtaining sufficient replacement financing or that any funding will be obtainable
on terms that are favorable to us, especially in light of our reduced sales and the recent
developments in the global credit and other financial markets. There can also be no assurance that
the note holders will not accelerate amounts due under the Senior Secured Convertible Notes, as
well as charge an increased default interest rate. As such, we may incur greater interest expense
and financing costs in future periods. If we are unable to refinance our Senior Secured Convertible
Notes or obtain alternative sources of funding, we may be required to sell additional equity in
order to meet our repayment obligations, which may not be possible. Should we refinance the Senior
Secured Convertible Notes before their scheduled maturity, we may incur an additional non-cash
interest charge relative to our unamortized debt issue costs and debt discounts. As of January 31,
2009 there were $1.3 million of unamortized debt issue costs and $2.7 million of debt discounts
relative to the Senior Secured Convertible Notes.
The restrictive covenants contained in our senior debt could adversely affect our business by
limiting our flexibility.
Our Senior Secured Convertible Notes impose restrictions that affect, among other things, our
ability to incur debt, pay dividends, sell assets, create liens, make capital expenditures and
investments, merge or consolidate, enter into transactions with affiliates, and otherwise enter
into certain transactions outside the ordinary course of business. Our Senior Secured Convertible
Notes also require us to maintain a minimum of $1.0 million of cash and cash equivalents and that
we generate at least $1.00 of Defined EBITDA for one quarter ending on or before July 31, 2009. We
satisfied the Defined EBITDA covenant in our fourth quarter of fiscal 2008.
Our ability to comply with the other covenants and restrictions of the Senior Secured
Convertible Notes may be affected by events beyond our control. If, as a result of current economic
conditions or other reasons, we are unable to achieve our currently projected sales, we may be
unable to remain in compliance with these covenants. If we are unable to comply with the terms of
our Senior Secured Convertible Notes, or if we fail to generate sufficient cash flow from
operations to service our debt, we may default on our debt instruments. In the event of a default
under the terms of any of our indebtedness, the debt holders may, under certain circumstances,
accelerate the maturity of our obligations and proceed against their collateral.
Historically we have been dependent on a few key products and our future growth is dependent on the
growth of ViziLite
®
Plus and on the development and/or acquisition of new products.
In the past, nearly all of our revenues were derived from the sales of Ester-C
®
,
Peridex
®
and ViziLite
®
Plus products. We divested our Nutraceuticals business
unit and the Ester-C
®
products in October 2006 and Peridex
®
in May 2007. With
the acquisition and addition of the products of Pro-Dentec, and the change in our distribution
method for ViziLite
®
Plus, we now sell direct to thousands of dental offices in the
United States and Canada and we believe we have reduced our dependency on key customers.
If any of our major products were to become subject to a problem such as loss of patent
protection, unexpected side effects, regulatory proceedings, publicity adversely affecting user
confidence or pressure from competing products, or if a new, more effective treatment should be
introduced, the impact on our revenues could be significant. Additionally, we are reliant on third
party manufacturers and single suppliers for our ViziLite
®
Plus product, and any supply
problems resulting from regulatory issues applicable to such parties or failures to comply with the
FDAs current cGMP standards could have a material adverse impact on our financial condition.
Our future growth is dependent on the growth of the ViziLite
®
Plus product and new
product development and/or acquisition. New product initiatives may not be successfully implemented
because of many factors, including, but not limited to, difficulty in assimilation, development
costs and diversion of management time. There can be no assurance that we will successfully develop
and integrate new products into our business that will result in growth and a positive impact on
our business, financial condition and results of operation.
37
A number of factors could impact our plans to commercialize our new products, including, but
not limited to:
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difficulties in the production process, controlling the costs to produce, market and
distribute the product on a commercial scale, and our ability to do so with favorable gross
margins and otherwise on a profitable basis;
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the inherent difficulty of gaining market acceptance for a new product;
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competition from larger, more established companies with greater resources;
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changes in raw material supplies that could result in production delays and higher raw
material costs;
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difficulties in promoting consumer awareness for the new product;
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adverse publicity regarding the industries in which we market our products; and
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the cost, timing and ultimate results of regulatory program studies that we undertake.
|
Our proprietary rights may prove difficult to enforce.
Our current and future success depends on a combination of patent, trademark, and trade secret
protection and nondisclosure and licensing agreements to establish and protect our proprietary
rights. We own and have exclusive licenses to a number of United States and foreign patents and
patent applications and intend to seek additional patent applications as we deem necessary and
appropriate to operate our business. We can offer no assurances regarding the strength of the
patent portfolio underlying any existing or new product and/or technology or whether patents will
be issued from any pending patent applications related to a new product and/or technology, or if
the patents are issued, that any claims allowed will be sufficiently broad to cover the product,
technology or production process. Although we intend to defend our proprietary rights, policing
unauthorized use of intellectual property is difficult or may prove materially costly and any
patents that may be issued relating to new products and technology may be challenged, invalidated
or circumvented.
We are dependent on our senior management and other key personnel.
Our ability to operate successfully depends in significant part upon the experience, efforts,
and abilities of our senior management and other key scientific, technical, sales and managerial
personnel. Competition for talented personnel is intense. The future loss of services of one or
more of our key executives could adversely impact our financial performance and our ability to
execute our strategies. Additionally, if we are unable to attract, train, motivate and retain key
personnel, our business could be harmed.
We currently do not have a head of our sales and marketing function. Our inability to fill
this position or to make adequate adjustments in our corporate organizational structure to properly
delegate this role to an existing member of our management team could adversely impact our
financial performance and our ability to execute our strategies.
We and our products are subject to regulatory oversight that could substantially interfere with our
ability to do business.
We and our present and future products are subject to risks associated with new federal,
state, local, or foreign legislation or regulation or adverse determinations by regulators under
existing regulations, including the interpretation of and compliance with existing, proposed, and
future regulatory requirements imposed by the FDA. We are also subject to other governmental
authorities such as the Department of Health and Human Services, the Consumer Products Safety
Commission, the Department of Justice and the United States Federal Trade Commission with its
regulatory authority over, among other items, product safety and efficacy claims made in product
labeling and advertising. Individual states, acting through their attorneys general, have become
active as well, seeking to regulate the marketing of prescription drugs under state consumer
protection and false advertising laws. A regulatory determination or development that affects our
ability to market or produce one or more of our products could have a material adverse impact on
our business, results of operation, and financial condition and may include product recalls, denial
of approvals and other civil and criminal sanctions.
We are at risk with respect to product liability claims.
We could be exposed to possible claims for personal injury resulting from allegedly defective
products manufactured by third parties with whom we have entered into manufacturing agreements or
by us. We maintain $6.0 million in product liability insurance coverage for claims arising from the
use of our products, with limits we believe are commercially reasonable under the circumstances,
and, in most instances, require our manufacturers to carry product liability insurance. While we
believe our insurance coverage is adequate, we could be subject to product liability claims in
excess of our insurance coverage. In addition, we may be unable to retain our existing coverage in
the future. Any significant product liability claims not within the scope of our insurance coverage
could have a material adverse effect on us.
38
We face significant competition that could adversely affect our results of operation and financial
condition.
The pharmaceutical, medical device and related industries are highly competitive. A number of
companies, many of which have financial resources, marketing capabilities, established
relationships, superior experience and operating history, and research and development capacities
greater than ours, are actively engaged in the development of products similar to the products we
produce and market. The pharmaceutical industry is characterized by extensive and ongoing research
efforts. Other companies may succeed in developing products superior to those we market. It may be
difficult for us to maintain or increase sales volume and market share due to such competition
which would adversely affect our results of operations and financial condition. The loss of any of
our products patent protection could lead to a significant loss in sales of our products in the
United States market.
If the use of our technology is determined to infringe on the intellectual property rights of
others, our business could be harmed.
Litigation may result from our use of registered trademarks or common law marks and, if
litigation against us were successful, a resulting loss of the right to use a trademark could
reduce sales of our products and could result in a significant damage award. International
operations may be affected by changes in intellectual property legal protections and remedies in
foreign countries in which we do business.
Furthermore, if it were ultimately determined that our intellectual property rights are
unenforceable, or that our use of our technology infringes on the intellectual property rights of
others, we may be required or may desire to obtain licenses to patents and other intellectual
property held by third parties to develop, manufacture and market products using our technology. We
may not be able to obtain these licenses on commercially reasonable terms, if at all, and any
licensed patents or intellectual property that we may obtain may not be valid or enforceable. In
addition, the scope of intellectual property protection is subject to scrutiny and challenge by
courts and other governmental bodies. Litigation and other proceedings concerning patents and
proprietary technologies can be protracted, expensive and distracting to management and companies
may sue competitors as a way of delaying the introduction of competitors products. Any litigation,
including any interference proceedings to determine priority of inventions, oppositions to patents
in foreign countries or litigation against our partners, may be costly and time-consuming and could
significantly harm our business.
Because of the large number of patent filings in our industry, our competitors may have filed
applications or been issued patents and may obtain additional patents and proprietary intellectual
property rights relating to products or processes competitive with or similar to ours. We cannot be
certain that United States or foreign patents do not exist or will not be issued that would harm
our ability to commercialize our products and product candidates. In addition, our exposure to
risks associated with the use of intellectual property may be increased as a result of an
acquisition as we have lower visibility into any potential targets safeguards and infringement
risks. In addition, third party claims may be asserted after we have acquired technology that had
not been asserted prior to such acquisition.
We require certain raw materials for our manufacturing processes that may only be acquired through
limited sources.
Raw materials essential to our business are generally readily available. However, certain raw
materials and components used in the manufacture of pharmaceutical and medical device products are
available from limited sources, and in some cases, a single source. Any curtailment in the
availability of such raw materials could be accompanied by production delays, and in the case of
products, for which only one raw material supplier exists, could result in a material loss of
sales. In addition, because raw material sources for products must generally be approved by
regulatory authorities, changes in raw material suppliers could result in production delays, higher
raw material costs and loss of sales and customers. Production delays may also be caused by the
lack of secondary suppliers.
We have, in the past, received minor deficiencies from regulatory agencies related to our
manufacturing facilities.
The FDA, Occupational Safety and Health Administration (OSHA) and other regulatory agencies
periodically inspect our manufacturing facilities and certain facilities of our suppliers. In the
past, such inspections resulted in the identification of certain minor deficiencies in the
standards we are required to maintain by such regulatory agencies. We developed and implemented
action plans to remedy the deficiencies; however, there can be no assurance that such deficiencies
will be remedied to the satisfaction of the applicable regulatory body. In the event that we are
unable to remedy such deficiencies, our product supply could be affected as a result of plant
shutdown, product recall or other similar regulatory actions, which would likely have an adverse
affect on our business, financial condition, and results of operation.
39
Trends, Risks and Uncertainties Related to Our Capital Stock
The Private Placements and other financing arrangements or corporate events could significantly
dilute existing ownership.
An additional 2,163,645 shares of our common stock would be issued should investors convert
all of our outstanding Senior Secured Convertible Notes and exercise all of our outstanding
warrants, which would dilute existing shareholders current ownership percentages and voting power.
The Senior Secured Convertible 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. We paid interest in kind with shares
of our common stock in the second, third and fourth quarters of fiscal 2008 and in the first
quarter of fiscal 2009, which resulted in the issuance of an additional 788,653 shares of our
common stock. As discussed above, as of the date of this filing, we have not made the interest
payment due January 31, 2009.
If we choose to pay future interest on our Senior Secured Convertible Notes in kind or to
raise additional funds through the issuance of shares of our common or preferred stock, or
securities convertible into our common stock, significant dilution of ownership in our company may
occur, and holders of such securities may have rights senior to those of the holders of our common
stock. If we obtain additional financing by issuing debt securities, the terms of these securities
could restrict or prevent us from paying dividends and could limit our flexibility in making
business decisions. Moreover, other corporate events such as the exercise of outstanding options
would result in further dilution of ownership for existing shareholders.
In the past, we have experienced volatility in the market price of our common stock and we may
experience such volatility in the future.
The market price of our common stock has fluctuated significantly in the past. Stock markets
have experienced extreme price volatility in recent years, especially in connection with the crisis
currently impacting global credit and financial markets. This volatility has had a substantial
effect on the market prices of securities we and other pharmaceutical and health care companies
have issued, often for reasons unrelated to the operating performance of the specific companies.
In the past, stockholders of other companies have initiated securities class action litigation
against such companies following periods of volatility in the market price of the applicable common
stock. We anticipate that the market price of our common stock may continue to be volatile. If the
market price of our common stock continues to fluctuate and our stockholders initiate this type of
litigation, we could incur substantial costs and expenses and such litigation could divert our
managements attention and resources, regardless of the outcome, thereby adversely affecting our
business, financial condition and results of operation.
We may take actions which could dilute current equity ownership or prevent or delay a change in our
control.
Subject to the rules and regulations promulgated by NASDAQ and the SEC, our Board of Directors
could authorize the sale and issuance of additional shares of common stock, which would have the
effect of diluting the ownership interests of our stockholders. In addition, our Board of Directors
has the authority, without any further vote by our stockholders, to issue up to 2,500,000 shares of
Preferred Stock in one or more series and to determine the designations, powers, preferences and
relative, participating, optional or other rights thereof, including without limitation, the
dividend rate (and whether dividends are cumulative), conversion rights, voting rights, rights and
terms of redemption, redemption price and liquidation preference. On February 1, 2001, we issued
100,000 shares of our Series B Convertible Preferred Stock in connection with an acquisition. As of
January 31, 2009 and the date of this filing, all of these shares remained outstanding. If the
Board of Directors authorizes the issuance of additional shares of Preferred Stock, such an
issuance could have the effect of diluting the ownership interests of our common stockholders.
40
Failure to maintain NASDAQ Marketplace Rules could materially and adversely affect our business.
NASDAQ Marketplace Rule 4450(a)(5) requires us to maintain a closing bid price for our common
stock of at least $1.00. On January 31, 2009 and as of the date of this filing, the closing bid
price was less than $1.00. NASDAQ has suspended the enforcement of this rule through April 19,
2009. If, for 30 consecutive business days beginning April 19, 2009, the bid price of our common
stock closes below $1.00 per share, NASDAQ will notify us of the non-compliance. In accordance with
Marketplace Rule 4450(e)(2), we would be provided 180 calendar days to regain compliance. If we do
not regain compliance during that period our stock may be delisted. In the event that our common
stock is delisted from the NASDAQ Global Market, our common stock would become significantly less
liquid, which would adversely affect its value. Although our common stock would likely be traded
over-the-counter or on pink sheets, these types of listings involve more risk and trade less
frequently and in smaller volumes than securities traded on the NASDAQ Global Market.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None
Item 3. Defaults Upon Senior Securities.
The interest payment in the amount of $0.2 million due January 31, 2009 on the Senior Secured
Convertible Notes has not been made as of the date of this filing. The failure to make this
payment is an event of default under our Senior Secured Convertible Notes. We have not received a
notice of default or acceleration from the note holders as of the date of this filing (which is
required before any of the principal amount becomes due and payable), but the note holders may, at
any time, accelerate one-third of the amount outstanding under the Senior Secured Convertible
Notes, or $4.0 million. Also, upon an event of default, the Senior Secured Convertible Notes begin
accruing interest at the default rate of 15%. However, during the pendency of negotiations
described elsewhere in this filing, the note holders have agreed that no default interest will
accrue unless and until they provide notice to us. Accordingly, the total
arrearage on the date hereof is approximately $0.2 million.
Item 4. Submission of Matters to a Vote of Security Holders
.
The Company held its Annual Meeting of Stockholders in Phoenix, Arizona on December 11, 2008.
A total of 7,724,747 shares of common stock, or 77% of the outstanding shares, were represented in
person or by proxy. The results of the matters voted on at the Annual Meeting are as follows:
(i) Election of Directors:
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Number of Shares
|
Name
|
|
For
|
|
Withheld
|
David R. Bethune
|
|
|
7,129,338
|
|
|
|
595,409
|
|
J. Steven Garrett
|
|
|
6,817,301
|
|
|
|
907,446
|
|
Wade R. Brooksby
|
|
|
7,193,853
|
|
|
|
530,894
|
|
Leslie H. Green
|
|
|
6,790,530
|
|
|
|
934,217
|
|
O.B. Parrish
|
|
|
6,711,762
|
|
|
|
1,012,985
|
|
George J. Vuturo
|
|
|
6,866,647
|
|
|
|
858,100
|
|
(ii) The ratification of the appointment of BDO Seidman, LLP as Zila, Inc.s Independent
Registered Public Accounting Firm for the fiscal year ending July 31, 2009.
|
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|
For
|
|
Against
|
|
Abstain
|
7,587,768
|
|
95,049
|
|
41,930
|
41
Item 5. Other Information.
The interest payment in the amount of $0.2 million due January 31, 2009 on the Senior Secured
Convertible Notes has not been made as of the date of this filing. The failure to make this
payment is an event of default under our Senior Secured Convertible Notes. We have not received a
notice of default or acceleration from the note holders as of the date of this filing (which is
required before any of the principal amount becomes due and payable), but the note holders may, at
any time, accelerate one-third of the amount outstanding under the Senior Secured Convertible
Notes, or $4.0 million. Also, upon an event of default, the Senior Secured Convertible Notes begin
accruing interest at the default rate of 15%. However, during the pendency of negotiations
described elsewhere in this filing, the note holders have agreed that no default interest will
accrue unless and until they provide notice to us. Accordingly, the total
arrearage on the date hereof is approximately $0.2 million.
Item 6. Exhibits.
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Exhibit
|
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Number
|
|
Description
|
|
|
|
|
|
|
31.1
|
|
|
Section 302 Certification of the Principal Executive Officer
|
|
|
|
|
|
|
31.2
|
|
|
Section 302 Certification of the Principal Financial Officer
|
|
|
|
|
|
|
32.1
|
|
|
Section 1350 Certification of the Principal Executive Officer and Principal Financial Officer
|
42
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
|
|
|
|
Date: March 17, 2009
|
Zila, Inc.
|
|
|
|
By:
|
/s/ DAVID R. BETHUNE
|
|
|
|
David R. Bethune
|
|
|
|
Chairman and Interim Chief Executive Officer
(Principal Executive Officer)
|
|
|
|
|
|
By:
|
/s/ DIANE E. KLEIN
|
|
|
|
Diane E. Klein
|
|
|
|
Vice President Finance and Treasurer
(Principal Financial Officer)
|
|
|
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
|
|
|
|
|
|
31.1
|
|
|
Section 302 Certification of the Principal Executive Officer
|
|
|
|
|
|
|
31.2
|
|
|
Section 302 Certification of the Principal Financial Officer
|
|
|
|
|
|
|
32.1
|
|
|
Section 1350 Certification of the Principal Executive Officer and Principal Financial Officer
|
43
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