here's the nail in the coffin post#812:
Evolution Capital Report
11:08am EST 8-Jan-99 Evolution Capital (Kellie Seringer 415-989-3525) ZILA MS
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From Zila to Zero? Initiating Coverage Of Zila With a SELL Rating (Pt. 1/2)
Kellie Seringer (415) 989-3525 - Health Care Equity Research
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We are initiating coverage of Zila, Inc. with a SELL rating. We believe recent, over-exuberant speculation surrounding Zila's OraTest (tolonium chloride), a pharmaceutical grade toluidine blue stain for the detection of oral cancer, has resulted in the current inflated valuation.
OraTest is scheduled for an FDA panel meeting on Wednesday, January 13, 1999. We do not anticipate OraTest to be a shoe-in at the FDA, an expectation which has caused investor frenzy driving the stock from $4 to $11-$12 levels over the last several months. In fact, one of the most stringent committees at the FDA, the oncology panel, will evaluate OraTest without guidance from a completed company-sponsored, controlled trial showing the accuracy of the cancer diagnostic.
The company points to anecdotal reports and results from an uncontrolled study in Sri Lanka to support its claims of 100% sensitivity (no false negative diagnosis) in screening for oral tumors. However, we site a study published in the April 1998 Journal of Oral Surgery, Oral Medicine and Oral Pathology which demonstrated a disturbing false negative rate of 42% for oral carcinoma in situ and 58% for moderate to severe dysplasia (precancerous cells) using toluidine blue in mucosal resections.
A multicenter study is currently ongoing evaluating OraTest as a diagnostic for cancerous and precancerous oral lesions, however, only partial data on 19 lesions is presently available. Until complete results of this controlled, clinical trial are at hand, it is difficult to determine the true measure of toluidine stain as a screening tool for oral cancer.
Zila participated in a preferred convertible share offering in November 1997 raising $30 million for the acquisition of Oxycal, the maker of a patented form of vitamin C. These potential shares along with options and warrants account for roughly 42 million shares fully diluted. At current price levels, we believe a corresponding market capitalization of $475 million is not justified given the moderate prospects for Zila's core business and the risk associated with OraTest approval in the U.S.
Based on our analysis, we calculate a target price of $4 based on a multiple of 27 times July fiscal year 2002 earning of $0.24 (including a $15 million revenue contribution of OraTest) discounted conservatively at 25%. Given the inherent risks of a U.S. OraTest approval, we believe this valuation is more than fair and justify a SELL rating.
Significant Research Conclusions The OraTest mouth rinse is a solution containing toluidine blue, a stain which has been used for nearly 30 years in the medical community to aid in the detection of cancerous lesions. Zila hopes that pharmaceutical grade (stable and pure form) OraTest will expand the role of toluidine blue as a diagnostic screening procedure for use in the detection of invasive carcinoma and asymptomatic early stage oral cancer. As is the case with most cancer classes, earlier detection of oral cancer would result in early treatment and an enhanced ability to prevent the progression of invasive carcinoma. With one American dying each hour from oral cancer, there is clearly a need for a diagnostic which may provide for earlier treatment and increased survival. Management at Zila has suggested OraTest will be used as a general screen for all high risk patients including smokers and heavy drinkers. Unfortunately, in our opinion, without a results from a controlled clinical trial, Zila cannot make these claims with any certainty and the variability of results observed from trials in the past, point to the necessity of definitive clinical results. We do not expect the Oncology Drug Advisory Committee (ODAC) panel of the FDA to grant approvable status for OraTest without the support of clinical data, however, if the diagnostic procedure is approved, we assume the panel will dictate a narrow indication with a strict product label. A summary of our evaluation is outlined below:
* Zila has no previous FDA experience. Zila's current pharmaceutical product portfolio consists of over-the-counter cold sore medication, Zilactin, and Peridex, an antibacterial rinse acquired from Proctor & Gamble. Zila does not have the experience of working through any previous new drug applications (NDAs) with the FDA, experience which is invaluable in gaining marketing approval. This is evidenced by the fact that OraTest has been filed at the FDA for roughly six years since the IND was filed in 1993. It has only now secured an advisory committee meeting. A priority review has been granted because OraTest is a cancer diagnostic and the FDA has embarked on an initiative to fast track all cancer products. This expedited review does not necessarily reflect special consideration by the FDA for panel review.
* No controlled clinical studies are completed and available for evaluation. We expect that the ODAC panel will find it difficult to draw conclusions regarding the OraTest application without guidance from controlled clinical studies. Partial results on 19 lesions from a multicenter clinical trial using the new purified form of toluidine blue will be available as part of the NDA package. However, it will be difficult for the FDA to make a decision without definitive evidence that Zila's purified form of toluidine blue adds incremental benefit in the staining of cancerous and precancerous lesions. Zila's management maintains it now manufactures a pharmaceutical grade, purified version of toluidine blue which has certified consistency versus the reagent grade toluidine blue. Reagent grade material is currently manufactured by nearly 35 chemical suppliers and used off label by the dental community to detect cancerous lesions and facilitate biopsies. However, Zila has submitted retrospective material from uncontrolled trials and anecdotal evidence from use with reagent grade toluidine blue for its OraTest NDA application. We suspect the FDA will view this critical lack of controlled clinical data using a different form of the product evaluated for approval as insufficient grounds for approval. In addition, we suspect the ODAC panel may have difficulty approving a product with the bulk of the clinical trial data generated from an uncontrolled trial in Sri Lanka.
* Variability in false negative results may mislead clinicians and patients. The results from the trial in Sri Lankan and Pakistani subjects published in the Journal of Oral Pathology & Medicine in 1996 reflect nearly 100% sensitivity or insignificant observation of false negative diagnosis in patients with oral carcinoma. False negative diagnosis indicates patients with actual oral cancer diagnosed as disease free. However, other studies in the literature are less convincing. For example, one study published by clinicians from the Royal College of Surgeons in the UK found markedly different results from the Sri Lankan trial. This study of toluidine blue was published in the April 1998 Journal of Oral Surgery, Oral Medicine and Oral Pathology and demonstrated a disturbing false negative rate of 42% for oral carcinoma in situ and 58% for moderate to severe dysplasia (precancerous cells) in mucosal resections.
* We pause here to explain the three different types of oral cancer and the significance of screening. The most rapidly proliferating and visible tumors are called fungating, invasive carcinoma, tumors in a single location are referred to as carcinoma in situ and premalignancies are known as dysplasia. Toluidine blue appears to be 100% sensitive in detecting fungating tumors, but less accurate in earlier stages of cancer. This begs the question: If invasive tumors are visible to the naked eye, is there a need to stain at all? Zila refers to 100% sensitivity across the board without breaking-out the actual false negative rates for different stages of tumors. It is our understanding fals negative diagnosis occurs more frequently in earlier stages of cancer. Inadvertent false negative diagnosis could give many clinicians and patients a false sense of security and actually harm patients who should receive early treatment for oral cancer. In our opinion, OraTest, has yet to be proven as a diagnostic for mass screening of high risk patients, a concept perpetuated by the company, and is clearly no substitute for thorough clinical examination of the oral mucosa.
* Specificity or false positive diagnosis is also an issue. Patients with a false positive stain for oral carcinoma or dysplasia are left to believe they have cancer until a biopsy is taken or a second examination with OraTest is performed. OraTest appears to have a false positive rate of 40%, however this rate is substantially improved to less than 10%, if a re-examination with OraTest is conducted 10-14 days later.
* The ODAC panel is stringent and one of the most difficult to pass. The oncology division of the FDA has historically proven itself to be one of the most arduous for companies seeking approval for oncologic drugs. In addition, members of the ODAC panel are all medical doctors who rely heavily on clinical data, unlike dentists, a typically more lenient group. The FDA consistently requires two well controlled clinical trials for the approval of drug products. Zila has submitted an NDA with no completed company-sponsored clinical trials of any kind. partial data from a multicenter clinical trial will be part of the NDA package. The FDA may have allowed this submission because the toluidine blue stain has been used off-label for the detection of oral cancer for at least 30 years with no safety issues. It is quite another thing to assume the FDA will approve a product with no controlled clinical data. In fact, ODAC is a difficult panel to convince even when clinical data from the sponsor is available. In our opinion, OraTest could have a difficult time at the FDA until conclusive results are available from the ongoing controlled clinical trial.
* If approval for OraTest is obtained in the U.S., it will most likely garner a narrow indication and a strict label. In the event Zila is successful in gaining FDA approval of OraTest in the U.S. market, we believe it will be with a narrow indication and a strict product label. We expect the indication to be limited to use in patients with visible oral lesions suspected or known to be malignant to assist in the selection of sites to be biopsied. Zila is seeking approval for OraTest as a diagnostic adjunct in patients with oral lesions suspected or known to be malignant, to help in detection of all sites of cancer, definition of borders (of cancerous lesions) and selection of sites to be biopsied. In our discussions with dentists in the U.S. who currently use toluidine blue for this purpose, it has become apparent that the toluidine blue stain is brushed on the areas of oral lesions to help define the margins which aids in the selection of tissue for biopsy. Zila plans to market OraTest as a mouthrinse at a cost of $20 per rinse. If dentists continue to use the brush-on method, as has been established in the 30 years of product use, a single vial of OraTest could be used sparingly for multiple applications. This would result in significant cost savings to patients and the health care system, but a drag on sales and profit margins for Zila. For this reason, we project marginal worldwide sales of $1.0 million estimated in fiscal 1998 rising to $15.0 million in 2002.
Evolution Capital does not make a market in the company mentioned in this report. The study on these pages is not a complete analysis of every material fact respecting any company, industry or security. The opinions here expressed reflect the judgment of the author at this date and are subject to change. Facts have been obtained from sources considered reliable, but are not guaranteed. Evolution Capital (or its affiliates), its partners and/or employees may have an interest in the securities and options on securities of the issuer described herein and may make purchases or sales, as principal or agent in securities mentioned, while this report is in circulation. Neither the information nor any opinion expressed herein constitutes a solicitation by us of the purchase or sales of any securities or option thereon. Evolution Capital may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any company mentioned in this report.
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