Zila Saw Palmetto Inventory Loss Offset By Strong Ester-C Sales

A roughly $300,000 decrease in the value of Zila's saw palmetto inventory negatively impacted the firm's fourth quarter earnings in fiscal 2002.

The decline in Zila's saw palmetto holdings was mostly due to spoilage and faulty storage observed after the close of the quarter, the firm explained. The storage problem has been rectified, Zila said, adding it is confident in the "stability of the remaining material."

Zila reported a net loss of $1.9 mil. in the fiscal fourth quarter (ended July 31), versus net income of $673,000 in the year-ago period. EBITDA from continuing operations was negative $86,000 in Q4 compared with $1.6 mil. in the 2001 quarter, the Phoenix-based company reported in its ¹ Q4 financials release Nov. 14.

Net loss for the year was $12.1 mil. versus net income of $6.4 mil. in fiscal 2001.

Zila's financials were adjusted to account for a Securities & Exchange Commission-mandated restatement of prior-period results related to the "timing of recognition of revenues and expenses," according to the firm.

The company clarified that the restatements did not negatively affect cash flow or ongoing operations.

Other factors affecting the loss in the quarter included an $800,000 drop in net income due to a one-time earnings gain in the year-ago quarter related to a patent settlement involving Zila Nutraceuticals, launch expenses for the firm's ViziLite oral cancer test and a $400,000 increase in OraTest clinical trial expenses.

The value of Zila's saw palmetto stock also was impacted by low prices reflecting a poor annual crop of the plant. The firm believes the price will rise sometime within the next year.

Zila estimates its saw palmetto inventory to be worth around $3.8 mil., "representing an approximately 1.6-year supply based on FY 2002 sales," the firm reports in its 10-K filed Nov. 13. Zila bought a "large amount" of inventory in fiscal years 2001 and 2002 in order to benefit from bulk purchase discounts and "establish a reputation as a reliable supplier."

The company entered the saw palmetto business in early 2000 when subsidiary Inter-Cal launched Palmettx , a standardized saw palmetto extract designed to retain high concentrations of the plant's phytosterol components. The product is sold in several forms, including saw palmetto oil, whole berry powder, two extract powders and ground berry powder.

Zila plans to continue selling its saw palmetto products in the normal course of business. Recent sales have yielded a "nominal" profit margin, the company said.

The firm has been "contacted by several companies interested in purchasing the saw palmetto inventory in bulk," but "none of the terms have been acceptable," according to the 10-K filing.

"While we have not made a decision to pursue such a sale, if all or a substantial portion of the inventory is sold in bulk, the ultimate sales price may be substantially less than the current carrying value of the inventory," Zila notes.

Among its primary competitors in the bulk saw palmetto market are European suppliers Indena S.p.A and Euromed. Domestically, competitors - or possible buyers - include U.S. Nutraceuticals, Saw Palmetto Berry Co-op and Bio-Botanicals.

As Zila Nutraceuticals considers its options for Palmettx, the firm continues to focus its attention on building the Ester-C business, which also falls under the Inter-Cal division.

Zila said it plans to expand its direct-to-consumer ads for the bulk vitamin C ingredient following promising results from its recent campaign.

The TV and radio campaign, created by Karlen Williams Graybill (New York), broke in early fall on network and cable TV programs, including Dateline, 20/20 and Today, as part of Zila's $4.3 mil. ad spend in fiscal 2002 (² (Also see "Zila Ester-C Ad Campaign Features Radio, TV Spots Debuting This Fall" - Pink Sheet, 12 Aug, 2002.), p. 8).

Over the 52-week period ended July 31, retail sales of Ester-C rose 14% in food, drug and mass outlets, compared to an estimated 9.4% decrease in the overall vitamin C market, Zila reports in its 10-K.

The company plans to boost its Ester-C marketing budget in FY 2003, including a 60% increase in TV spending, and is considering print ads for the coming year.

Led by Ester-C, Zila Nutraceuticals' sales were $19.6 mil. for the year, a gain of 27% over fiscal 2001. The vitamin C brand accounted for roughly half of Zila's net revenues in 2002.

"We believe our nutraceuticals business has tremendous potential for growth," President & CEO Douglas Burkett, PhD, told analysts Nov. 18.

Burkett highlighted the firm's ongoing work on two additional products under the Ester brand as key to the division's progression.

Although further details were not disclosed, Zila is focusing on the "big" vitamin categories for potential extensions. The new Ester products, which currently are undergoing testing, likely will be introduced in fiscal 2004, the exec noted.

Nutraceuticals - namely Ester-C - accounted for more than half of Zila's net sales in fiscal 2002. Net revenue jumped 14% to $34.9 mil. in the year, while net sales for the fourth quarter rose a slight 1% to $8.8 mil.

Sales of Zila's Zilactin family of OTC oral care products fell 12% in 2002, the firm noted.

However, the company is seeking creative ways to bolster the brand's performance, including a cross-promotion of Zilactin Cold Sore Gel and Zilactin-L Cold Sore Liquid with Matrixx' Zicam Cold Remedy.

During the promotion, announced Nov. 20, packages of homeopathic Zicam will carry a $1-off coupon for Zilactin items, and Zilactin products will carry a $1-off coupon for Zicam. The campaign will continue through the spring of 2003.

Pending its success, Zila could introduce similar initiatives during the height of the cough/cold season, the company said, noting it plans to cross-promote Zilactin products to key Ester-C consumers, and vice versa.

In addition, Zila is bringing the manufacturing of its Zilactin products in-house in a move to "reduce costs and improve quality control for [its] pharmaceutical business," the firm said Nov. 19.

Zilactin items will be produced at Zila's technical operations facility in Phoenix, which currently is equipped to manufacture tolonium chloride, the active ingredient in Zila's OraTest oral cancer detection rinse kits.