Summary of ZILA INC - Yahoo! Finance

Item 2. Management's 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 Management's 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.

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.

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 Union's ("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 Zila's 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.

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

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.

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.

. . .