Zila, Inc. (ZILA)

Q4 2008 Earnings Call

October 6, 2008 4:30 pm ET

Executives

Robert Jaffe – Investor Relations, PondelWilkinson

David Bethune - Interim CEO

Diane Klein - VP, Finance

Analysts

Marc Robins - The Robins Group

Ruthanne Roussel – The Robins Group

Unspecified Analyst

Unspecified Analyst

[John Plexigo] – Unspecified Company

Presentation

Operator

Welcome to the Zila’s fiscal 2008 fourth quarter financial results conference call. (Operator Instructions) I would now like to turn the conference over to our host Robert Jaffe, Investor Relations for Zila, Inc.

Robert Jaffe

Good afternoon everyone and welcome to Zila’s fiscal 2008 fourth quarter and full year conference call. On the call today are David Bethune, Zila’s Chairman and Chief Executive Officer and Diane Klein, Vice President of Finance.

Before we get started, I need to remind everyone that this telephone conference call contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

The words believe, expect, anticipate, intend, estimate, plan and other expressions that are predictions of or that indicate future events and trends that do not relate to historical matters, identify these as forward-looking statements.

The forward-looking statements are largely based on Zila’s expectations or forecasts of future events and can be affected by inaccurate assumptions. They are subject to various business risks and unknown and known uncertainties, a number of which are beyond the company’s control. Therefore, actual results could differ materially from the forward-looking statements contained in this call.

A wide variety of factors could cause or contribute to such differences and there can be no assurances that the forward-looking statements will in fact transpire or prove to be accurate. For a more detailed description of the cautionary factors that may affect Zila’s future, please refer to our SEC filings, including the Annual Report on Form 10-K and Quarterly Reports on Form 10-Q. As a reminder and as the operator said this teleconference is being recorded.

I would now like to turn the call over to David Bethune.

David Bethune

Thank you Robert and good afternoon everyone. We appreciate all of you joining us today to discuss our fiscal 2008 fourth quarter and full year financial results. As most of you have seen by now we reported higher revenues and a significant reduction in costs.

This improvement was the result of a number of profit enhancement initiatives we implemented in the second half of the year. The combined effect of the cost reductions and profit enhancements helped us exceed the defined EBITDA required for the fiscal 2008 fourth quarter under our loan covenants.

I’d like to mention a few of the initiatives that led to this performance. We completed the hiring of the targeted level of sales representatives and completed their training across the full portfolio of the company’s products including the product knowledge and selling skills portion.

We implemented selective price increases effective May 15, as well as programs to reduce our cost of goods. We reduced headcount of the non-selling workforce by more then 10%. Temporarily reduced the salaries of certain management and suspended other employee benefits and we eliminated reduced or deferred non-critical programs throughout the company.

I would like to remind everyone that while or cost containment measures were effective in satisfying our EBITDA covenant, we do not expect some of these initiatives such as reducing or deferring salaries, benefits or other operating costs to be sustainable into future periods.

We would expect these factors coupled with the recent economic downturn in the US to likely cause near-term future operating results to be reduced from our fourth quarter financial results.

In addition we made progress on several key operational areas including the implementation of programs for more efficient accounts receivable collections and maintaining lower inventory levels.

We also made strides growing our overall business. In the US ViziLite Plus sales increased 7% over the third quarter on the strength of a 10% increase in reorders from our current customers. We also added more then 1,100 new ViziLite Plus customers during the quarter and we continued to see our reorders outpacing trial volume.

Over the last few months we’ve added a number of new markets for our products. In May ViziLite was launched in the UK and Ireland. And since July we have selected marketing partners in Greece, Cyprus, Spain, France, Germany, Portugal, Russia and Belarus to be exclusive distributors of our product ViziLite Plus.

The combined population of these markets exceeds 350 million. We expect to continue to expand the international market opportunity for ViziLite and we are in the process of identifying distributors in other countries.

In June we selected a distributor to market our powered toothbrush, Rotadent, as well as our line of periodontal probes, Perio Probe and Sensor Probe, in the UK and Ireland. Now I will turn it over to Diane to present the financial results for the fourth quarter.

Diane Klein

Thanks David and good afternoon everyone. Earlier today we filed our Annual Report on Form 10-K for our fiscal year ending July 31 and we issued a news release regarding those financial results right after the market closed. You can find the Form 10-K and the news release on our website www.zila.com under the Investors sections.

Before reviewing our fourth quarter and full year results, I would like to clarify a few items in our financial presentation. As a result of the divestitures of our Nutraceuticals business unit and Peridex brand in the last fiscal year 2007 in the first and fourth quarters respectively, Zila’s business is reported for all periods presented on a continuing operations basis and the divested businesses are reported as discontinued operations.

In addition the company completed the acquisition of Pro-Dentec in November, 2006. Accordingly financial results for fiscal 2007 include eight months of Pro-Dentec’s results of operations.

Separately on September 12, 2008 Zila’s shareholders approved a one for seven reverse split of the company’s common stock. As a result of the reverse split, each holder of seven outstanding shares of common stock received one share of common stock.

Zila’s stock had traded above $1.00 for 10 consecutive trading days and is no longer subject to delisting under applicable Nasdaq Marketplace Rules. The reverse split has been retroactively applied to all applicable information presented in the news release and in the financial statements.

Finally for fiscal 2007, we restated the income tax benefit from continuing operations and the income tax expense from discontinued operations to reflect the increased utilization of $3.9 million of net operating loss carry-forwards from the sale of the Nutraceuticals business unit in the first quarter of fiscal 2007.

This restatement had no effect on net income, the balance sheet or the statement of cash flows and is further described in the Form 10-K in Note 1 to the financial statements.

Now to the results of our fiscal 2008 fourth quarter, net revenues increased 14% to $11.9 million compared with $10.4 million for the fourth quarter of fiscal 2007. Sales of ViziLite Plus grew 46% to $3.9 million compared with the fourth quarter of fiscal 2007 representing the eighth consecutive quarter of revenue growth for the ViziLite Plus product line.

The current annualized revenue run rate of ViziLite Plus is approximately $16 million. Gross profit grew to $7.8 million or 66% of net revenues from $6.3 million or 61% of net revenues in the fourth quarter of fiscal 2007.

The improvement in the gross profit percent reflects the increased level of higher margin ViziLite sales as well as the benefit of selected price increases and cost reduction measures.

Marketing and selling expense decreased to $4.5 million compared with $4.9 million in the fourth quarter of fiscal 2007 and compared with $6 million for the third quarter of fiscal 2008. These decreases reflect the efficiencies of the company’s reengineered professional sales and marketing team and the deferral or elimination of non-critical marketing programs in the current quarter.

G&A expense decreased to $3.4 million from $5.6 million for the fourth quarter of fiscal 2007 primarily due to recent headcount and salary reductions as well as the deferral or elimination of non-critical programs across the organization.

Research and development expense was $187,000 for the quarter compared with $1.7 million for the fourth quarter of fiscal 2007. R&D in last year’s fourth quarter was primarily comprised of costs associated with the OraTest regulatory program.

In the first quarter of fiscal 2008 the company closed enrollment in the OraTest clinical trial and reduced related expenditures.

The loss from continuing operations for the quarter significantly narrowed to $2.4 million or $0.26 per share from a loss from continuing operations of $5.8 million or $0.65 per share for the fourth quarter of fiscal 2007.

The fourth quarter of fiscal 2007 did include an income tax benefit of $1.8 million reflecting the utilization of net operating loss carry-forwards which offset the income tax expense on the taxable gain on the disposition of the Peridex product line which is presented in discontinued operations.

The EBITDA loss from continuing operations narrowed to $197,000 for the fiscal 2008 fourth quarter compared to $2.6 million for the fiscal 2008 third quarter and $5.7 million for the fiscal 2007 fourth quarter.

Moving to the full year results, net revenues increased 57% to $45.1 million compared with the $28.8 million for fiscal 2007. Sales of ViziLite Plus grew 107% to $13.7 million compared with fiscal 2007.

The overall revenue growth was largely driven by the acquisition of Pro-Dentec in November, 2006 as well as selling directly to dental offices through the company’s national sales organization and the positive impact this had on sales of ViziLite Plus.

Gross profit grew to $27.7 million or 62% of net revenues from $16.9 million or 59% of net revenues for fiscal 2007. Marketing and selling expense increased to $21.1 million compared with $14.4 million for fiscal 2007 largely due to the acquisition of Pro-Dentec in November, 2006 as well as additional national sales representatives and an increased number of seminar programs.

General and administrative expense decreased to $13.3 million compared with $15.1 million for fiscal 2007. R&D expense was $2.4 million compared with $7.5 million for fiscal 2007. The loss from continuing operations improved to $16.1 million or $1.80 per share from a loss from continuing operations of $19.1 million or $2.37 per share for fiscal 2007.

The prior year results include an income tax benefit of $9.7 million that resulted from the utilization of net operating loss carry-forwards to offset the income tax expense on the taxable gains of the dispositions of the Nutraceuticals business unit and the Peridex product as discussed earlier.

Cash and cash equivalents at July 31, 2008 were $4.5 million compared with $14.9 million at July 31, 2007. The decrease for fiscal 2008 reflects cash used in operations of $7.6 million, the repurchase of $1.4 million of common stock and warrants related to the restructuring of the company’s senior convertible notes in August, 2007; $350,000 of principal payments on debt and $1.1 million for investing activities primarily related to capital expenditures for new systems and equipment and for intellectual property.

Working capital was $6.1 million at July 31, 2008 compared with $14.3 million at July 31, 2007. I will now turn things back to David.

David Bethune

Thank you Diane and finally I’d like to make a few summary comments. We’ve been busy building a foundation upon which to grow this company and there’s been a ton of hard work going on in this company.

Strategic business opportunities to grow our business will require additional funding. The traditional way to obtain funding for this would be through a working capital line of credit secured by our inventory and accounts receivable.

However we’ve been unable to obtain the approval from the holder of our notes even though the notes provide that such approval is not to be unreasonably withheld.

With our cost reduction measures and by maintaining existing revenues from our product lines we believe that our cash and cash equivalents along with the cash flows generated from operations and working capital management will allow us to fund our operations over the next 12 months.

We expect the current state of the US and global economies will have some impact on our business. Market intelligence has revealed reduced patient volume in dental offices throughout the US and in some areas by as much as 30% to 40%.

Zila’s product portfolio is focused on the prevention of oral cancer and periodontal disease. During these turbulent economic times patients will focus on their preventive oral health to avert the high cost associated with the treatment of disease.

And with our excellent sales force we believe this is an opportunity for Zila to help dental practices establish preventive oral care protocols for oral cancer screening and periodontal disease; diseases that impact every adult patient.

In order to offset the decline in patient volume Zila sales representatives are working very hard with dental practices to implement their preventive oral care protocols to focus on their patients wellness and improve the dentist revenue which is at this point very important in most of these private dental office practices.

We remain focused on expanding the market opportunity for our products, strengthening our capital structure and building a sustainable and growing enterprise and to that end, last week we announced that we retained William Blair and Company to assist us in exploring strategic business opportunities and evaluating opportunities for growth.

Now, at this time I’ll be happy to address any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Marc Robins - The Robins Group

Marc Robins - The Robins Group

Let’s talk about the Arizona facility there in Phoenix, any thought of closing that down and moving things to Arkansas?

David Bethune

We are going to close this particular corporate headquarters down and move but we’re not going to move to Arkansas, we’re going to move down the street so to speak in an effort to again save a little bit of money and have a place for our headquarters to operate. In fact, what we’re really doing is going to try and consolidate somewhat especially in the financial area and some of our opportunities will exist to consolidate up here in some regards in our financial structure.

Marc Robins - The Robins Group

So it’s just going to be general savings on SG&A then.

David Bethune

To some degree, yes.

Marc Robins - The Robins Group

How much capacity do you have with your sales team? I take it that now all 75 folks are well trained and getting out there and spreading the word. How do you feel they are, what level of confidence do you feel they’re at now?

David Bethune

Well I think they’re growing in experience. Obviously they’re a young organization. There’s been a fair number of young folks that we’ve hired in the last six or seven months and they’re in the process of being trained and kept up to training in a way and we’ve gotten a new program. Wendy [Nugent] our marketing director has done a fine job in helping us do that and put, we’ve done some adjustments in that as time goes on as we learn.

We’re learning that more and more, there is perhaps a little bit more of a scientific approach that one would take with our product ViziLite Plus then we have. Not that we haven’t had a good science behind it but to strengthen the scientific area, technical skill set of our reps is very important. But there’s nothing that’s going to replace good experience and repeated effort of our sales reps to gain the knowledge necessary on the job to improve their performance.

Marc Robins - The Robins Group

It’s too early for Zila to be, the thing that’s so attractive about Zila besides ViziLite is the fact that you have an exceedingly well trained and honed sales team, detailed team and in the dental arena that’s somewhat unusual, in the pharmaceutical arena that’s somewhat common place. Unlike the distributors you could take other outside sophisticated products and begin to sell them through your channel and it’s too early for that to occur.

David Bethune

Its not necessarily too early, its an excellent point and I wholeheartedly agree with that that we do have a unique force out there, technically trained, they’re not just handing out the catalogues asking what do you need today. They’re out there talking and making, helping the dentists make decisions about his profitability in his practice and that’s really a great thing and sure, if somebody walks in and we’ve had, I just talked to one last week, a person that has a business that does not have a sales force and they have some products and they’re asking me well now is there any of these products that we could [license] to you or have you co-promote or co-market for us and that’s a good thing.

So we’re going to have an opportunity yes to, at the right time, the right place and the right products to add to our line potentially.

Marc Robins - The Robins Group

So that’s something that if they really wanted to get into the market and it was a sophisticated sale, they could beat you up with enough money on the frontend to (a) get your sales teams’ attention and (b) help [assuage] some of those capital needs?

David Bethune

Yes. I’ll be glad to give my phone number out here on that very point.

Operator

Your next question comes from the line of Ruthanne Roussel – The Robins Group

Ruthanne Roussel – The Robins Group

Would you mind speaking specifically to the VA opportunity? The last time that we visited this if I recall there had been a plan drawn up and now it should be about time I think to be implementing the plan.

David Bethune

Yes, we are making calls. Now here’s another area that I mentioned earlier we need to expand this company. We need additional capital and we’re somewhat limited by that ability and this is a very good point to make in regards to the VA.

We do not have any specialty VA representatives. We do not have any people that, other then our current sales reps that call on the VA hospital so that somewhat limits the intensity of which we can spread the word about our product ViziLite Plus in the VA.

However at the top, I’ve spent a fair amount of time in Washington, DC myself along with some helpers to call on the executives in the VA and get that top down approach but we certainly need the bottoms up and with additional capital, additional funding we certainly could advance that VA effort. But along those lines I’d like to point out a very interesting thing that happened to us not too long ago.

I made calls on the federal prison systems and the head of dentistry in the federal prison systems happens to be located in Washington, DC and working hard there. This person recently had an oral cancer patient in the prison there that had a Stage 4 oral cancer and he was extremely motivated with our product and as a result we have now our federal prisoners have the benefit of having a ViziLite exam.

I used that example with some of the politicians recently in saying if ViziLite is good enough for our prisoners but not quite yet ready to be used in the VA hospitals, but I say that a little bit trying to motivate them because certainly this product ought to be used routinely in the VA hospitals. But there’s inertia to deal with. There’s people that still believe that visual examination alone is just fine and they have to be reminded that they always find the cancer but it’s usually in Stage 4 where there’s a 55% chance of being alive after five years.

Operator

Your next question comes from the line of Unspecified Analyst

Unspecified Analyst

What do you think it would take for you to get the note holder to be reasonable and allow you to be able to raise the capital you need?

David Bethune

We’ve asked them and they’re fine people and we’re working with them and we hope that our new partners, William Blair, will be able to help along those lines and work with our note holders and come up with a good solution that benefits our shareholders. That’s obviously what everybody wants and the good news is, is that our note holder is also a good shareholder.

Unspecified Analyst

When do you think you’ll start paying salaries and doing, and regain your salaries? Have you decided how long before, how long you can continue the way you are now?

David Bethune

We did go from, not some of the top management receiving no salaries to returning a salary but we still maintain a salary reduction over what everyone has and Diane and I we’re right now at 10% below. We’re paying a good number of our executives and managers 10% less then their authorized salary and we’ll continue to do that to tighten up and be as tight on our cost as we possibly can be until we get this refinancing out of the way and completed and move forward.

Operator

Your next question comes from the line of Unspecified Analyst

Unspecified Analyst

On the strategic side, curious as to maybe a little more color on the different scenarios of the William Blair engagement and I kind of view this business very similar to the traditional [Speck] Farm business, it’s tough to bend a corner and really get profitability. You’re very close to that and it’s a scale business. Are those kinds of strategic considerations in the mix here as you’ve hired them and you’re looking at different possibilities for the business?

David Bethune

Yes they are and we certainly don’t have all of the resources we need to do everything we need to do and therefore we reached out to investment bankers and we were fortunate that William Blair was very interested in us. We know that they’re a fine quality group of people. In fact we’re having meetings with them today. But specifically they are just going to be a broad range helper. We’re pretty lean here. We don’t have business development people. We have a pretty lean organization overall and therefore to have some more thinking going into a strategic alternatives is just a wonderful thing and I’m just very happy to have them on board to help us look at opportunities.

We’ve had people call us and people talk to us and ask us about this and that and people that are interested in all sorts of alliances and mergers and that sort of thing but we haven’t had the real good experienced curve of having some real knowledgeable people involved with those kind of decisions and so it’ll be a wonderful help to have things coming in and William Blair folks looking at opportunities to see if there’s ways to form alliances out there to do other things.

But I think, I would say that we’ll have to say that William Blair is across the whole spectrum of range of activities that say of what are the strategic alternatives for Zila and that’s there general charge is to be looking at all avenues including importantly the restructuring of our debt.

Operator

Your final question comes from the line of [John Plexigo] – Unspecified Company

[John Plexigo] – Unspecified Company

On your marketing initiatives going on with [Emuhana] and United Health, I know that reimbursement just started to kick in and that takes time to penetrate and get a footprint among the dental offices, but how is that coming along?

David Bethune

It’s coming along fine. We added insurance plan representing 900,000 additional covered lives during the fourth quarter of this year ending July 31, and that’s brings the total number of covered lives to more then 23.5 million. That’s just a wonderful number. Of course the challenge to all of us in our fine sales force is to bring that to the attention of the dentists out there. Unfortunately some of the dentists have coverage for their patients but do not now use ViziLite and we’ve got to get them motivated to have an opportunity to have extra income in their practice at no cost to their patients or themselves and to add profit.

And also help protect the lives of their patients and that is extremely important and we’ve got to push hard to do that. We’re working on some mail programs to help improve the visibility and the awareness of dentists that they have these coverages going alone with the additional plans for example where North East Delta Dental and Essex Dental Benefits, both of these were regional plans.

And a lot of places we have these regional plans, we do not have representative coverage so it makes it equally challenging to figure out how to get visibility for those dentists in those particular areas.

[John Plexigo] – Unspecified Company

I imagine in a tight economy if there’s a way to make money through reimbursement in your dentist, it’s pretty appealing to learn about this.

David Bethune

Absolutely and we’re, there again a good experienced sales representative that we have and those that really have that skill set that are learning that skill set can get in there and make that story real live for that dentist, makes it all the better and makes that decision turn to a positive one for the use of ViziLite routinely in their office.

I think at this time we will close the program and I would like to thank everyone for joining us this afternoon. As always we appreciate your continued support and interest in our new company, Zila. If anyone has further questions, please don’t hesitate to contact the corporate or investor relations team at Zila or Robert Jaffe at PondelWilkinson at 310-279-5969.

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