UNITED STATES


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON
      D.C. 20549**





**FORM
      10-QSB**




**{x} QUARTERLY
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934**




**For
      the quarterly period ended June30, 2006**




**{
      } TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
      ACT OF 1934**


(No
      Fee
      Required)





For
      the
      transition period from ________________ to




Commission
      file number 333-102629


-----------------------------------





**Dyadic
      International, Inc.**


(Exact
      name of small business issuer as specified in its charter)


****


**Delaware**
            **45-0486747**(State
                or other jurisdiction of incorporation or
                organization)
            (I.R.S.
                Employer Identification No.)**140 Intracoastal Pointe
              Drive, Suite 404, Jupiter, Florida**
            **33477**(Address
                of principal executive offices)
            (Zip
                Code)




**(561)
      743-8333**


(Issuer’s
      telephone number)





Check
      whether the issuer (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 12 months (or for such shorter period
      that the registrant was required to file such reports), and (2) has been subject
      to such filing requirements for the past 90 days. Yes { x } No { }





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act): Yes
      { };
      No {X}





As
      of August 10, 2006, there were 24,778,754 shares of registrant’s common
      stock outstanding, par value $.001 (including 222,539 shares held in
      escrow).





Transitional
      Small Business Disclosure Format (Check One): Yes { }; No {X}











**TABLE
      OF CONTENTS**














**PART
                I. FINANCIAL INFORMATION**
            
            PageItem
                1.
            Financial
                Statements (Unaudited)Condensed
                Consolidated Balance Sheet - June 30, 2006
            3Condensed
                Consolidated Statements of Operations - Three-Months and Six-Months
                ended
                June 30, 2006 and 2005
            4Condensed
                Consolidated Statements of Cash Flows - Six-Months ended June 30,
                2006 and
                2005
            5Notes
                to Condensed Consolidated Financial Statements
            6Item
                2.
            Management's
                Discussion and Analysis or Plan of Operation
            19Item
                3.
            Controls
                and Procedures
            36**PART
                II. OTHER INFORMATION**Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            37Item
                6.
            Exhibits
            37Signatures
            37
































































2


PART
      I.
      FINANCIAL INFORMATION


***Item
      1. Financial Statements (Unaudited)***




**Dyadic
      International, Inc.**


**Condensed
      Consolidated Balance Sheet**


**June
      30, 2006**


**(Unaudited)**





AssetsCurrent
                assets:Cash
                and cash equivalents
            
            $
            10,001,638Restricted
                cash
            
            
            34,887Accounts
                receivable, net of allowance for uncollectible accounts of
                $559,492
            
            
            3,355,105Inventory
            
            
            6,501,296Prepaid
                expenses and other current assets
            
            
            1,605,996Total
                current assets
            
            
            21,498,922Fixed
                assets, net
            
            
            1,809,973Intangible
                assets, net
            
            
            122,111Goodwill
            
            
            1,808,458Other
                assets
            
            
            125,394Total
                assets
            
            $
            25,364,858Liabilities
                and stockholders’ equityCurrent
                liabilities:Accounts
                payable
            
            $
            1,869,427Accrued
                expenses
            
            
            1,378,873Short
                term note payable
            
            
            121,625Income
                taxes payable
            
            
            81,359Total
                current liabilities
            
            
            3,451,284Long-term
                liabilities:Note
                payable to stockholder
            
            
            2,355,778Other
                liabilities
            
            
            75,380Total
                long-term liabilities
            
            
            2,431,158Total
                liabilities
            
            
            5,882,442Stockholders’
                equity:Preferred
                stock, $.0001 par value:Authorized
                shares - 5,000,000; none issued and outstanding
            
            
            --Common
                stock, $.001 par value,Authorized
                shares - 100,000,000; issued and outstanding - 24,507,104
            
            
            24,507Additional
                paid-in capital
            
            
            59,031,044Notes
                receivable from exercise of stock options
            
            
            (212,500
            )Accumulated
                deficit
            
            
            (39,360,635
            )Total
                stockholders’ equity
            
            
            19,482,416Total
                liabilities and stockholders’ equity
            
            $
            25,364,858





*See
      accompanying notes.*


3





**Dyadic
      International, Inc.**


**Condensed
      Consolidated Statements of Operations**


**(Unaudited)**








**Three
                Months Ended**
            
            **Six
                Months Ended****June
                30,**
            
            **June
                30,****2006**
            
            **2005**
            
            **2006**
            
            **2005**Net
                sales
            
            $
            3,969,566
            
            $
            3,988,077
            
            $
            7,795,322
            
            $
            7,722,437Cost
                of goods sold
            
            
            2,893,030
            
            
            3,210,890
            
            
            5,833,413
            
            
            6,195,648Gross
                profit
            
            
            1,076,536
            
            
            777,187
            
            
            1,961,909
            
            
            1,526,789Expenses:Research
                and development
            
            
            990,278
            
            
            954,188
            
            
            1,897,958
            
            
            2,509,162Selling
                and marketing
            
            
            812,948
            
            
            616,966
            
            
            1,615,878
            
            
            1,186,397General
                and administrative
            
            
            2,077,169
            
            
            1,436,899
            
            
            3,411,738
            
            
            2,899,251Foreign
                currency exchangelosses
                (gains), net
            
            
            65,481
            
            
            (38,503
            )
            
            96,742
            
            
            (36,481
            )Total
                expenses
            
            
            3,945,876
            
            
            2,969,550
            
            
            7,022,316
            
            
            6,558,329Loss
                from operations
            
            
            (2,869,340
            )
            
            (2,192,363
            )
            
            (5,060,407
            )
            
            (5,031,540
            )Other
                income (expense):Interest
                expense
            
            
            (273,796
            )
            
            (176,360
            )
            
            (447,750
            )
            
            (349,761
            )Investment
                income, net
            
            
            87,816
            
            
            94,516
            
            
            189,850
            
            
            23,258Minority
                interest
            
            
            (12,692
            )
            
            (3,147
            )
            
            (13,355
            )
            
            (10,571
            )Other
                income (expense), net
            
            
            69,669
            
            
            711
            
            
            11,620
            
            
            (4,016
            )Total
                other expense
            
            
            (129,003
            )
            
            (84,280
            )
            
            (259,635
            )
            
            (341,090
            )Loss
                before income taxes
            
            
            (2,998,343
            )
            
            (2,276,643
            )
            
            (5,320,042
            )
            
            (5,372,630
            )Provision
                for income taxes
            
            
            7,267
            
            
            15,571
            
            
            32,876
            
            
            27,878Net
                loss
            
            $
            (3,005,610
            )
            $
            (2,292,214
            )
            $
            (5,352,918
            )
            $
            (5,400,508
            )Net
                loss per common share:Basic and diluted
            
            $
            (0.13
            )
            $
            (0.10
            )
            $
            (0.23
            )
            $
            (0.25
            )Weighted
                average common sharesused
                in calculating net loss per share:Basic and diluted
            
            
            23,726,130
            
            
            22,060,371
            
            
            23,082,443
            
            
            21,997,824














*See
      accompanying notes.*








4


**Dyadic
      International, Inc.**


**Condensed
      Consolidated Statements of Cash Flows**


**(Unaudited)**


**Six-Months
                Ended June 30,****2006**
            
            **2005****Operating
                activities**Net
                loss
            
            $
            (5,352,918
            )
            $
            (5,400,508
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization of fixed assets
            
            
            117,591
            
            
            245,152Amortization
                of intangible and other assets
            
            
            26,064
            
            
            45,066Amortization
                of costs related to modification of notes payable to
                stockholder
            
            
            301,973
            
            
            185,569Minority
                interest
            
            
            13,355
            
            
            10,571Provision
                for doubtful accounts
            
            
            28,754
            
            
            93,632Stock
                issued to officer
            
            
            50,000
            
            
            2,448Stock
                issued for consulting services
            
            
            319,874
            
            
            49,761Compensation
                expense on stock option grants
            
            
            441,456
            
            
            20,821Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (514,692
            )
            
            178,696Inventory
            
            
            (1,087,738
            )
            
            150,517Prepaid
                expenses and other current assets
            
            
            (801,367
            )
            
            85,683Other
                assets
            
            
            6,886
            
            
            (3,463
            )Accounts
                payable
            
            
            (742,979
            )
            
            (1,192,908
            )Accrued
                expenses
            
            
            164,636
            
            
            (144,894
            )Accrued
                interest payable to stockholders
            
            
            (69,367
            )
            
            (43,037
            )Deferred
                revenue
            
            
            --
            
            
            (75,000
            )Income
                taxes payable
            
            
            27,253
            
            
            29,216Short
                term notes payable
            
            
            (145,965
            )
            
            --Other
                liabilities
            
            
            (31,305
            )
            
            (1,358
            )Total
                adjustments
            
            
            (1,895,571
            )
            
            (363,528
            )Net
                cash used in operating activities
            
            
            (7,248,489
            )
            
            (5,764,036
            )**Investing
                activities**Purchases
                of fixed assets
            
            
            (370,614
            )
            
            (202,551
            )Purchase
                of minority interest
            
            
            (375,000
            )
            
            --Net
                cash used in investing activities
            
            
            (745,614
            )
            
            (202,551
            )**Financing
                activities**Proceeds
                from stock warrant exercises
            
            
            4,920,413
            
            
            --Proceeds
                from stock option exercises
            
            
            925,480
            
            
            --Payment
                for issuance costs related to private offering
            
            
            --
            
            
            (97,764
            )Net
                cash provided by (used in) financing activities
            
            
            5,845,893
            
            
            (97,764
            )Net
                decrease in cash and cash equivalents
            
            
            (2,148,210
            )
            
            (6,064,351
            )Cash
                and cash equivalents at beginning of period
            
            
            12,149,848
            
            
            20,510,650Cash
                and cash equivalents at end of period
            
            $
            10,001,638
            
            $
            14,446,299**Noncash
                investing and financing activities:**Fair
                value of common stock issued for land purchase
            
            $
            --
            
            $
            861,861Fair
                value of common stock issued for minority interest
                purchase
            
            $
            1,328,131
            
            $
            --Common
                stock issued for conversion of convertible notes payable to stockholders
                at an exercise price of $3.33
            
            $
            1,577,872
            
            $
            --


*See
      accompanying notes.*


5


****


**Dyadic
      International, Inc.**


**Notes
      to Condensed Consolidated Financial Statements**


**June
      30, 2006**


**(Unaudited)**








**1.
      Basis of Presentation and Summary of Significant Accounting
      Policies**





*General*





Dyadic
      International, Inc. (the “Company” or “Dyadic”), based in Jupiter, Florida, with
      operations in the United States of America, Hong Kong and mainland China, Poland
      and The Netherlands is engaged in the development, manufacture and sale of
      industrial enzymes and other recombinant proteins for the industrial,
      biorefinery and pharmaceutical industries, including:





·
            the
                textile, pulp and paper, animal feed, alcohol, starch, and food and
                beverage industries, where Dyadic currently sells more than 45 liquid
                and
                dry enzyme products to more than 200 industrial customers in approximately
                50 countries which it refers to as its Enzyme Business;




·
            enzymes
                and related biotechnological processes for use in converting various
                agricultural products (e.g. corn), agricultural residue products
                (e.g.
                dried distillers grains (DDG), wheat straw, and sugar cane
                bagasse) and forestry industry residues (e.g. wood pulp and chips)
                into fermentable sugars, which can then be used in the production
                of
                traditional and cellulosic ethanol, as well as other products currently
                derived from petroleum, such as plastics and polymers, which enzymes
                and
                related biotechnological processes it refers to as "Biorefinery Products";
                and




·
            human
                therapeutic protein candidates, with focus on antibodies, for use
                by
                pharmaceutical and biotechnology companies in pre-clinical and clinical
                drug development applications and commercialization following drug
                approval, which it refers to as its BioSciences Business.





Using
      information gathered from the C1 genome sequence that was performed in 2005
      and
      from the subsequent annotation currently being performed in collaboration with
      Scripps-Florida, Dyadic intends to further improve its capabilities for
      production of therapeutics and other foreign proteins in C1. The first
      phase of the annotation has demonstrated over 11,000 genes in C1. A number
      of those genes have been found to encode the processes that could positively
      or
      negatively affect protein production (i.e. gene expression, protein secretion,
      protein degradation, and protein folding), for example. Using the genetic
      tools developed for C1, those processes potentially can be altered, identified
      and modified in such a way as to improve the yields and range of proteins
      produced in C1.





*Basis
      of Presentation*





The
      accompanying unaudited condensed consolidated financial statements have been
      prepared in accordance with U.S. generally accepted accounting principles for
      interim information and with the United States Securities and Exchange
      Commission’s (the “SEC”) instructions to Form 10-QSB and Regulation S-B.
      Accordingly, they do not include all of the information and footnotes required
      by U.S. generally accepted accounting principles for complete financial
      statements. In the opinion of management, all adjustments of a normal and
      recurring nature considered necessary for a fair presentation have been
      included. Operating results for the three-month and six-month periods ended
      June
      30, 2006 may not necessarily be indicative of the results that may be expected
      for the year ending December 31, 2006.





For
      further information, refer to Dyadic International, Inc.’s audited consolidated
      financial statements and footnotes thereto included in its Annual Report on
      Form
      10-KSB for the year ended December 31, 2005, as filed with the SEC.





*Historical
      Results of Operations*





The
      Company has incurred losses from operations during the last several years,
      which
      have resulted in an accumulated deficit of approximately $39.4 million as of
      June 30, 2006. The Company attributes these operating results to, among other
      things, continuing negative trends in the textile enzymes sector, expansion
      of
      its operations,


6


and
      administrative support staff, its establishment of new affiliates, and its
      increased sales and marketing spending. In order to advance its science and
      to
      develop new products, the Company has continued to incur discretionary research
      and development expenditures during 2005 and through 2006. The Company believes
      these discretionary research and development expenditures will continue in
      2007
      and possibly beyond.





The
        Company believes that there will be sufficient capital to fund its operations
        and meet its obligations for the next twelve months, based on current sales
        volumes and proceeds from the recent warrant and stock option exercises.
        The
        Company currently has a Value Added Tax (VAT) receivable of approximately
        $1.08
        million related to its operations in Poland that it anticipates receiving
        payment on, and which is included in prepaid expenses and other current assets
        in the accompanying condensed consolidated balance sheet. The Company has
        historically built up its inventory levels in the first half of the year
        as a
        result of its contract manufacturer’s summer hiatus for vacation and
        maintenance, which will occur this year in August and part of September.
        For the
        six-month period ended June 30, 2006, the Company produced approximately
        $1,100,0000 of additional inventory, which it intends to utilize during the
        latter half of the year, and in particular, the third quarter of 2006, which,
        in
        combination with reduced production, will result in reduced cash disbursements
        for raw materials. The Company’s accounts receivable balance increased by
        approximately $515,000, which was partially attributable to higher sales
        volumes
        toward the latter half of the  second
        quarter of 2006 as compared to  the
        fourth quarter of 2005, which is indicative of timing differences, not
        collectibility. Subsequent to June 30, 2006 and through August 2, 2006, a
        significant portion of the June 30, 2006 accounts receivable balance has
        been
        received.
  The
        Company has established a number of flexible contractual relationships in
        the
        areas of manufacturing and research and development, enabling it to adjust
        spending in those areas as necessary, to achieve the objectives of its business
        plan, and manage both its resources and cash utilization rate. The Company
        has
        historically funded losses from operations with proceeds from external
        borrowings, borrowings from its stockholders, and sales of preferred and
        common
        equity securities. Additional funds may be needed and raised through public
        or
        private financings, exercise or conversion of equity instruments, collaborative
        relationships, licensing or selling of certain technologies or other
        arrangements. Additional funding, if sought, may not be available at all,
        or may
        not be available on terms acceptable to the Company. Further, any additional
        equity financing may be dilutive to stockholders, and debt financing, if
        available, may involve restrictive covenants. Failure to raise capital when
        needed may harm the Company’s business and operating results.





*Recent
      Accounting Pronouncements*





As
      discussed in Note 3 *,* Share-Based
      Compensation, the Company adopted Financial Accounting Standards Board (FASB)
      No. 123(R) effective January 1, 2006 using the “modified prospective”
method. The Company recognized share-based compensation expense for its
      share-based awards of approximately $310,000 and $441,000 during the three-month
      and six-month periods ended June 30, 2006, respectively which was calculated
      under the provisions of FAS 123(R) The Company estimates that, based on current
      share-based awards granted to date, share-based compensation expense for fiscal
      2006 will be approximately $1.0 million.







In
      June
      2006, the FASB issued Interpretation No. 48, “ *Accounting
      for Uncertainty in Income Taxes - an interpretation of FASB Statement
      No. 109* ”
(FIN
      48). FIN 48 prescribes a recognition threshold and measurement attribute for
      financial statement recognition and measurement of a tax position taken or
      expected to be taken in a tax return, and also provides guidance on
      derecognition, classification, interest and penalties, accounting in interim
      periods, disclosure, and transition. FIN 48 is effective for fiscal years
      beginning after December 15, 2006. The Company does not believe that the
      adoption of FIN 48 will have an impact on its consolidated results of
      operations, financial condition or cash flows.





*Use
      of Estimates*





The
      preparation of condensed consolidated financial statements in conformity with
      U.S. generally accepted accounting principles requires management to make
      estimates and assumptions that affect the amounts reported in the condensed
      consolidated financial statements. Actual results could differ from those
      estimates.








7


*Net
      Loss Per Share*





Basic
      and
      diluted net loss per share have been computed using the weighted-average number
      of shares of common stock outstanding during the periods presented.





The
      following potentially dilutive securities were not included in the calculation
      of diluted net loss per share as they were anti-dilutive for the respective
      periods presented:








**Three-Months
                and Six-Months Ended June 30,****2006**
            
            **2005**Instruments
                to purchase common stock:Stock
                options outstanding pursuant to the 2001 EquityCompensation
                Plan
            
            
            3,133,611
            
            
            1,398,839Other
                stock options
            
            
            --
            
            
            65,000Warrants
                outstanding
            
            
            5,862,674
            
            
            6,952,776Common
                stock issuable pursuant to conversion features:Subordinated
                convertible notes payable
            
            
            --
            
            
            473,835Total
                shares of common stock considered anti-dilutive
            
            
            8,996,285
            
            
            8,890,450





There
      are
      contingently issuable shares under an agreement to conduct research and
      development activities on behalf of the Company pursuant to the arrangement
      described in Note 3 Share-based Compensation - Common Stock Issuances, of which
      222,539 and 300,300 shares are also excluded from the calculation of diluted
      net
      loss per share for the three-month and six-month periods ended June 30, 2006
      and
      2005, respectively. Such shares of common stock are unearned, nonvested,
      restricted shares that will be considered outstanding once earned under the
      agreement. As of June 30, 2006, 77,761 shares have been earned and are
      outstanding. None were earned or outstanding at June 30, 2005.





*Inventory*





Inventory
      consists of raw materials and finished goods, including enzymes used in the
      industrial, chemical and agricultural markets, and is stated at the lower of
      cost or market using the average cost method. Finished goods include raw
      materials and manufacturing costs, substantially all of which are incurred
      pursuant to agreements with independent manufacturers. Provisions have been
      made
      to reduce excess or obsolete inventory to net realizable value.





At
      June
      30, 2006, inventory consisted of the following:





Finished
                goods
            
            $
            5,021,344Raw
                materials
            
            
            1,479,952Total
                inventory
            
            $
            6,501,296








*Goodwill*





To
      apply
      the provisions of Statement of Financial Accounting Standards (SFAS) No.142, *Goodwill
      and Other Intangible Assets* (SFAS
      142) *,* the
      Company is required to identify its reporting units. Based on an analysis of
      economic characteristics and how the Company operates its business, the Company
      has designated its geographic locations as its reporting units: the United
      States (which includes the Company's subsidiary in Poland), The Netherlands,
      Hong Kong and mainland China. All goodwill is associated with the Hong Kong
      reporting unit.





On
      April
      28, 2006, the Company and its 82.5% majority owned Asian Subsidiary entered
      into
      a satisfaction and purchase agreement with the Asian Subsidiary’s two minority
      shareholders, its managing director and one of its


8


other
      key
      employees, effective as of January 1, 2006. The minority shareholders received
      $375,000 in cash and 212,501 shares of unregistered common stock of the Company
      in consideration for: (i) the transfer to the Company of all of the Asian
      Subsidiary’s shares (representing 17.5% of its outstanding shares) held by the
      minority shareholders, bringing the Company’s ownership in the Asian Subsidiary
      to 100% and relieving the Company’s minority interest liability of approximately
      $117,000; (ii) a release of the Company for, among other things, a potential
      $405,000 contingent obligation to the managing director incident to the
      Company’s purchase of its initial majority interest in the Asian Subsidiary in
      1998; and (iii) the cancellation of all indebtedness of the Asian Subsidiary
      owed to the minority shareholders in the amount of approximately $172,000 of
      principal and $70,000 of accrued interest, as of the effective date. The
      Company’s shares were valued at approximately $1,328,000 based on the fair
      market value of the Company’s common stock on April 28, 2006, the measurement
      date for accounting purposes. The Company recorded approximately $1,341,000
      of
      goodwill related to the transaction, bringing the net goodwill balance at June
      30, 2006 to approximately $1,808,000, which is reflected in the accompanying
      condensed consolidated balance sheet. As of May 1, 2006, the Company is
      recording 100% of the Asian Subsidiary’s operating results in the accompanying
      condensed consolidated statements of operations.





In
      accordance with the provisions of SFAS 142, the Company is required to perform
      an annual impairment review of goodwill, which was completed in August 2006.
      This test involved the use of estimates to determine the fair value of the
      Company's Asian reporting unit and the comparison of fair value to the carrying
      value of the reporting unit. The impairment review resulted in no goodwill
      impairment charge.





*Revenue
      Recognition*





The
      Company recognizes revenues in accordance with Staff Accounting Bulletin (SAB)
      No 104, *Revenue
      Recognition in Financial Statements* (SAB
      104). SAB 104 sets forth four basic criteria that must be met before SEC
      registrants can recognize revenue. These criteria are: persuasive evidence
      of an
      arrangement must exist; delivery had to have taken place or services had to
      have
      been rendered; the seller's price to the buyer should be fixed or determinable;
      and collectibility of the receivable should be reasonably assured. Sales not
      meeting any of the aforementioned criteria are deferred. The
      Company recognizes revenue when title passes to the customer, based upon the
      specified freight terms for the respective saleSales are comprised of
      gross revenues less provisions for expected customer returns, if any. Reserves
      for estimated returns and inventory credits are established by the Company,
      if
      necessary, concurrently with the recognition of revenue. The amounts of reserves
      are established based upon consideration of a variety of factors, including
      estimates based on historical returns.





Amounts
      billed to customers in sales transactions related to shipping and handling,
      represent revenues earned for the goods provided and are included in net sales.
      Costs of shipping and handling are included in cost of products
      sold.




Revenue
      received for research and development is
      recognized as the Company meets its obligations under the related agreement. No
      research and development revenue was recognized during the three-month or
      six-month periods ended June 30, 2006. The Company recognized $75,000 of
      research and development revenue during each of the three-month and six-month
      periods ended June 30, 2005, respectively.


*Research
      and Development*





Research
      and development costs related to both present and future products are charged
      to
      operations when incurred.




*Foreign
      Currency Translation*





The
      financial statements of the Company's foreign subsidiaries have been translated
      into United States dollars in accordance with SFAS No. 52, *Foreign
      Currency Translation* .
      Assets
      and liabilities of the Company's foreign subsidiaries are translated at
      period-end exchange rates, and revenues and expenses are translated at average
      rates prevailing during the period. Certain accounts receivable from customers
      are collected and certain accounts payable to vendors are payable in currencies
      other than the functional currencies of the Company and its subsidiaries. These
      amounts are adjusted to reflect period-end exchange rates. Net translation
      adjustments and realized exchange gains and losses are included as a component
      of foreign currency exchange (gains) losses, net, in the accompanying condensed
      consolidated statements of operations.


9


*Reclassifications*





Certain
      prior year amounts have been reclassified to conform to the current year
      presentation. These reclassifications had no effect on net loss as previously
      reported or net loss per common share.





**2.
      Notes Payable**





*Short
      Term Note Payable*





At
      June
      30, 2006, the Company had a short term note payable of approximately $121,625
      related to a bank cash advance from a customer Letter of Credit (“LOC”). The LOC
      was settled in July 2006.





*Long
      Term Note Payable*





Long
      term
      note payable to stockholder consisted of the following at June 30, 2006:




Loan
                payable with a rate of 8% as of June 30, 2006 to Mark A. Emalfarb
                Trust(Bridge
                Loan), secured by all assets of the Company, in the original principal
              amount
                of $3,000,000, principal and accrued interest due January 1, 2008.Accrued
                interest of $239,941 included in principal balance. Net of unamortized
              beneficial
                conversion feature of $69,163.
            
            $
            2,355,778





*Bridge
      Loan*





On
      May
      29, 2003, the Company’s wholly-owned subsidiary, Dyadic International (USA),
      Inc., a Florida corporation (formerly known as Dyadic International, Inc)
      (“Dyadic-Florida), obtained a $3.0 million revolving loan (the “Bridge Loan”)
      from a group of stockholders, including the Chief Executive Officer, who loaned
      $2,185,000, and the rest of whom loaned Dyadic-Florida $815,000, bearing
      interest at 8% per annum, with all unpaid principal and interest originally
      due
      on January 2, 2004, and extended to January 1, 2005 on February 13, 2004.
      Subsequent to a private placement of the Company’s common stock and warrants
      through which the Company raised gross proceeds of approximately $25,405,000
      (the “October 2004 Offering”), approximately $903,000 of the proceeds was used
      to pay off the $815,000 of principal and approximately $88,000 of accrued
      interest for the portion of the Bridge Loan from the group of other
      Dyadic-Florida stockholders. The Bridge Loan is collateralized by a security
      interest in all of the Company's assets.





Incident
      to the Bridge Loan, the Mark A. Emalfarb Trust and other lending Dyadic-Florida
      stockholders in the aggregate, were also granted warrants to purchase up to
      1.5
      million shares of the Company's common stock at the lesser of $4.50 per share
      or
      the Series A Preferred conversion price, expiring ten years from the date of
      grant (the “Bridge Loan Warrants”). In August 2004, the exercise price of the
      Bridge Loan Warrants was reduced to $3.33 and the maturity date was extended
      to
      January 1, 2007 in connection with the Merger (as described in Item 2 -
      Management’s Discussion and Analysis or Plan of Operation - History of Dyadic).
      As a result, approximately $343,000, representing the incremental fair value
      of
      the modified Bridge Loan Warrants as compared to the fair value of the original
      Bridge Loan Warrants immediately before the modification, will be amortized
      to
      interest expense through the new maturity date. The remaining unamortized
      portion of $69,163 is reflected as a reduction of notes payable to stockholders
      in the accompanying condensed consolidated balance sheet as of June 30, 2006.
      Approximately $17,000 and $29,000 was amortized to interest expense during
      the
      three-month periods ended June 30, 2006 and 2005, respectively and $46,000
      and
      $58,000 was amortized to interest expense during the six-month periods ended
      June 30, 2006 and 2005, respectively. Interest expense on the Bridge Loan
      excluding the amortization of the beneficial conversion feature, was
      approximately $48,000 and $96,000 for each of the three-month and six-month
      periods ended June 30, 2006 and 2005, respectively.





On
      April
      30, 2006, the maturity date of the Bridge Loan was extended from January 1,
      2007
      to January 1, 2008. The remaining unamortized portion of $69,163 of the
      beneficial conversion feature related to the modified Bridge Loan Warrants
      will
      be amortized through the new maturity date.


10


*Convertible
      Notes Payable*





In
      connection with the Merger, the conversion prices of the convertible notes
      payable to the Mark A. Emalfarb Trust and the Francisco Trust were fixed at
      $3.33 and the maturity dates were extended to January 1, 2007. As a result
      of
      the modification of the conversion price, a beneficial conversion feature
      totaling approximately $554,000 was recorded in October 2004 and was to be
      amortized to interest expense through the new maturity date. Approximately
      $192,000 and $256,000 was amortized to interest expense during the three-month
      and six-month periods ended June 30, 2006, respectively, and approximately
      $64,000 and $128,000 was amortized to interest expense during the three-month
      and six-month periods ended June 30, 2005, respectively.





Interest
      expense on the convertible notes payable was approximately $8,000 and $31,000
      for the three-month and six-month periods ended June 30, 2006, respectively,
      and
      was approximately $24,000 and $47,000 for the three-month and six-month periods
      ended June 30, 2005, respectively.





On
      May 1,
      2006, the Emalfarb Trust received 251,298 shares of common stock upon the
      conversion in full of its convertible note which had combined principal and
      accrued interest of $836,824. The Francisco Trust received 222,537 shares of
      common stock upon the conversion in full of its convertible note which had
      combined principal and accrued interest of $741,048 as of May 1, 2006. As a
      result of the conversions, a total of approximately $1.6 million of notes
      payable to stockholders, bearing interest at 6% per annum was relieved. This
      represents a future annual reduction in interest expense of approximately
      $95,000. The balances of the related beneficial conversion features were fully
      expensed in April 2006 resulting in a one time adjustment of approximately
      $171,000 to interest expense.




The
      Mark
      A. Emalfarb Trust and Francisco Trust are major stockholders of the Company
      and
      are trusts whose beneficiaries are the Company's President and Chief Executive
      Officer, and the wife and children of Mark A. Emalfarb, respectively.





*Notes
      Payable - Minority Shareholders*





On
      April
      28, 2006, the Company purchased the remaining 17.5% of shares held by the two
      minority shareholders of its Asian subsidiary, giving the Company 100% ownership
      of that subsidiary (see Note 3, Share-Based Compensation, Common Stock
      Issuances). The minority shareholders received $375,000 in cash and 212,501
      shares of unregistered Dyadic common stock in consideration for, among other
      things, the cancellation of the subordinated notes under which the Company
      owed
      the minority shareholders $171,986 of principal and $69,868 of accrued interest;
      relief of the Company’s minority interest liability of approximately $117,000;
      and a release of the Company for a potential $405,000 contingent obligation
      to
      the managing director incident to the Company’s purchase of its initial majority
      interest in the Asian Subsidiary in 1998.




Interest
      expense on the subordinated notes payable to the minority stockholders of the
      Asian subsidiary was approximately $850 and $2,600 for each of the three-month
      periods ended June 30, 2006 and 2005, respectively and was approximately $3,400
      and $5,100 for the six-month periods ended June 30, 2006 and 2005,
      respectively.





**3.
      Share-Based Compensation**





In
      January 2006, the Company adopted SFAS 123(R), *Share-Based
      Payment,* which is
      a revision of SFAS 123, *Accounting
      for Share-based Compensation* .
      SFAS
      123(R) supersedes Accounting Principles Board Opinion (“APB”) No. 25, *Accounting
      for Stock Issued to Employees* (APB
      25) *,* and
      amends SFAS No. 95, *Statement
      of Cash Flows* .
      Generally, the approach in SFAS 123(R) is similar to the approach described
      in
      SFAS 123. However, SFAS 123(R) requires all share-based payments to employees,
      including grants of employee stock options, to be recognized in the statement
      of
      operations based on their fair values. Pro forma disclosure, which has
      previously been used by the Company, is no longer an alternative.





The
      Company adopted the fair value recognition provisions of SFAS 123(R), using
      the
      modified prospective transition method. Under this transition method,
      compensation expense includes options vesting for share-based payments granted
      prior to, but not vested as of December 31, 2005, based on the grant date fair
      value estimated in accordance with the original provisions of SFAS 123 and
      share-based payments granted after December 31, 2005,


11


based
      on
      the grant date fair value estimated in accordance with the provisions of SFAS
      123(R). Because this transition method was selected, results of prior periods
      have not been restated.




Prior
      to
      January 1, 2006, the Company accounted for share-based employee compensation
      plans using the intrinsic value method of accounting in accordance with APB
      25
      and its related interpretations. Under the provisions of APB 25, no compensation
      expense was recognized when stock options were granted with exercise prices
      equal to or greater than market value on the date of grant.





On
      December 15, 2005, the Board of Directors of the Company approved the
      acceleration of vesting for the unvested portion of all outstanding employee
      incentive stock options awarded from May 2001 to December 15, 2005 under the
      2001 Equity Compensation Plan (the “2001 Equity Plan”), as amended. While the
      Company typically issues options that vest equally over four years, as a result
      of this vesting acceleration, stock options to purchase approximately 1.2
      million shares of the Company’s common stock, of which approximately 600,000 are
      held by the Company’s executive officers and directors, became immediately
      exercisable. The exercise prices of the affected stock options range from $1.90
      to $5.93 and the closing price of the Company’s common stock on December 15,
      2005, was $1.75.





The
      purpose of the accelerated vesting was to provide a non-cash benefit to the
      Company’s employees and to eliminate future compensation expense the Company
      would otherwise recognize in its statements of operations with respect to these
      accelerated options upon the adoption of SFAS 123(R). The estimated future
      compensation expense associated with these accelerated options that would have
      been recognized in the Company’s statements of operations upon implementation of
      SFAS 123(R) is approximately $1.3 million. All option grants made on and after
      January 1, 2006 will be accounted for in accordance with SFAS
      123(R).




The
      Company’s 2001 Equity Plan and 2006 Option Plan (see below) are each considered
      to be compensatory plans under SFAS 123(R).





***Description
      of Equity Plans***





***Amended
      and Restated 2001 Equity Compensation Plan***





Effective
      May 2001, the Company adopted the Dyadic International, Inc. 2001 Equity
      Compensation Plan under which 1,302,989 shares of common stock were reserved
      for
      issuance. In September 2004, by written consent, the Company's Board of
      Directors and stockholders approved an increase in the authorized number of
      shares of common stock under the 2001 Equity Plan from 1,302,989 to 5,152,447.
      All employees, as well as members of the Company's Board of Directors and Key
      Advisors, as defined, are eligible to participate in the 2001 Equity Plan.
      Under
      the 2001 Equity Plan, the Company may issue incentive stock options and
      nonqualified stock options to purchase shares of common stock, or the Company
      may issue shares of common stock. Such shares, if issued, may be subject to
      restrictions, as disclosed in the 2001 Equity Plan. In addition to stock options
      and stock grants, the 2001 Equity Plan allows for the issuance of Performance
      Units to an employee or Key Advisor. Each Performance Unit represents the right
      to receive an amount, in cash or in the Company's common stock, as determined
      by
      a committee of the Company's board of directors, based on the value of the
      Performance Unit, if established performance goals are met.





The
      2001
      Equity Plan was amended and restated effective as of January 1, 2005 by the
      Company’s board of directors on April 1, 2006 and approved by the Company’s
      stockholders at the 2006 Annual Meeting of Stockholders in June 2006 to (a)
      reduce the number of shares of common stock reserved for issuance under the
      plan
      to 4,478,475 shares from 5,152,447 shares (b) to conform certain provisions
      of
      the plan to the requirements of Section 409A of the Internal Revenue Code of
      1986, as amended, and (c) to increase the maximum limitation of shares that
      may
      be subject to awards granted under the plan to any one individual for any fiscal
      year during the term of the plan to 1,200,000 shares from 100,000 shares.





***2006
      Stock Option Plan***





The
      Dyadic International, Inc. 2006 Stock Option Plan (the “2006 Option Plan”) was
      adopted by the Company’s board of directors in April 2006 and approved by
      stockholders at the 2006 Annual Meeting of Stockholders in June


12


2006.
      The
      purpose of the 2006 Option Plan is to retain and attract key management,
      employees, nonemployee directors and consultants by providing those persons
      with
      a proprietary interest in the Company. The compensation committee will
      administer the 2006 Option Plan and may grant stock options, which may be
      incentive stock options or nonqualified stock options that do not comply with
      Section 422 of the Internal Revenue Code. Under the 2006 Option Plan, 2,700,000
      shares of common stock have been reserved for issuance. As of June 30, 2006,
      there were no stock options outstanding under the plan.





The
      2001
      Equity Plan and the 2006 Option Plan are sometimes collectively referred to
      as
      the “Equity Compensation Plans”.




The
      Company recognized share-based compensation expense for its share-based awards
      of approximately $310,000 and $13,000 during the three-month periods ended
      June
      30, 2006 and 2005, respectively, and approximately $441,000 and $21,000, for
      the
      six-month periods ended June 30, 2006 and 2005, respectively. These charges
      had
      no impact on the Company’s reported cash flows. Total share-based compensation
      expense was allocated among the following expense categories:




**Three-Months
                Ended June 30,**
            
            **Six-Months
                Ended June 30,****2006**
            
            **2005**
            
            **2006**
            
            **2005**General
                and administrative
            
            $
            274,337
            
            $
            6,800
            
            $
            372,005
            
            $
            12,917Research
                and development
            
            
            5,005
            
            
            6,341
            
            
            38,486
            
            
            7,904Cost
                of goods sold
            
            
            10,232
            
            
            --
            
            
            10,232
            
            
            --Selling
                and marketing
            
            
            20,589
            
            
            --
            
            
            20,733
            
            
            --$
            310,163
            
            $
            13,141
            
            $
            441,456
            
            $
            20,821





Under
      the
      modified prospective method of transition under SFAS 123(R), the Company is
      not
      required to restate its prior period financial statements to reflect expensing
      of share-based compensation under the new standard. Therefore, the results
      for
      the three-months and six-months ended June 30, 2006 are not comparable to the
      same periods in the prior year.




The
      Company has determined its share-based compensation expense under SFAS 123(R)
      for the three-months and six-months ended June 30, 2006 as follows:




***Valuation
      of Stock Options***




Share-based
      compensation related to stock options includes the fair value of options granted
      determined using the multiple option approach under the Black-Scholes method
      for
      options granted after December 31, 2005, determined using the single option
      approach under the Black-Scholes valuation model. The fair value of options
      determined under SFAS 123(R) is amortized to expense over the vesting periods
      of
      the underlying options, generally four years.




The
      fair
      value of stock option awards for the three-months and six-months ended June
      30,
      2006 was estimated on the date of grant using the assumptions in the following
      table. The expected volatility in this model is based on the historical
      volatility of the Company’s stock. The risk-free interest rate is based on the
      U.S. Treasury yield curve in effect at the time awards are granted, based on
      maturities which approximate the expected life of the options. The expected
      life
      of the options granted is estimated using the historical exercise behavior
      of
      employees. The expected dividend rate takes into account the absence of any
      historical payments and management’s intention to retain all earnings, if any,
      for future operations and expansion.




**Three-Months
                Ended**
            
            **Six-Months
                Ended****June
                30, 2006**
            
            **June
                30, 2006**Average
                Risk-Free Interest Rate
            
            
            4.82
            %
            
            4.71
            %Dividend
                Yield
            
            
            0
            %
            
            0
            %Average
                Volatility Factor
            
            
            76
            %
            
            73
            %Average
                Option Life
            
            
            5
                Yrs
            
            
            5
                Yrs




13


***Equity
      Compensation Plans Awards Activity***




Information
      with respect to the Company’s Equity Compensation Plans and grants of 65,000
      options to nonemployees prior to the Company’s adoption of either of the Equity
      Compensation Plans is as follows:







**Shares**
            
            **Weighted
                Average Exercise Price Per Share**
            
            **Aggregate
                Intrinsic Value**Outstanding
                at December 31, 2005
            
            
            1,662,639
            
            $
            3.61
            
            $
            --Granted
            
            
            1,701,722
            
            
            4.61
            
            
            --Exercised
            
            
            (228,250
            )
            
            4.05
            
            
            --Cancelled
            
            
            (2,500
            )
            
            3.20
            
            
            --Outstanding
                at June 30, 2006
            
            
            3,133,611
            
            $
            4.12
            
            $
            3,384,836Exercisable
                at June 30, 2006
            
            
            1,339,443
            
            $
            3.65
            
            $
            2,073,723





The
      weighted average grant date fair value of options granted during the
      three-months and six-months ended June 30, 2006 was $3.03 and $2.71 per share,
      respectively.





A
      further
      detail of the options outstanding as of June 30, 2006 is set forth as follows:





**Range
                of Exercise Prices**
            
            **Options
                Outstanding**
            
            **Weighted-Average
                Remaining Life in Years**
            
            **Weighted-Average
                Exercise Price Per Share**
            
            **Options
                Exercisable**
            
            **Weighted-Average
                Exercise Price Per Share**$1.83
                - $2.90
            
            
            416,667
            
            
            4.19
            
            $
            2.46
            
            
            265,854
            
            $
            2.472.96
                - 3.80
            
            
            1,193,161
            
            
            3.95
            
            
            3.23
            
            
            700,839
            
            
            3.394.39
                - 4.66
            
            
            751,250
            
            
            6.72
            
            
            4.57
            
            
            267,750
            
            
            4.515.92
                - 7.13
            
            
            772,533
            
            
            4.60
            
            
            5.96
            
            
            105,000
            
            
            5.193,133,611
            
            
            4.81
            
            $
            4.12
            
            
            1,339,443
            
            $
            3.65




***Unrecognized
      Share-Based Compensation Expense***




As
      of
      June 30, 2006, there was $3.2 million of total unrecognized compensation expense
      related to nonvested share-based compensation arrangements granted under the
      equity incentive plan. This expense is expected to be recognized over a
      weighted-average period of 2.0 years as follows:




Fiscal
                Year 2006 (July 1, 2006 to December 31, 2006)
            
            $
            743,000Fiscal
                Year 2007
            
            
            1,044,000Fiscal
                Year 2008
            
            
            649,000Fiscal
                Year 2009
            
            
            649,000Fiscal
                Year 2010
            
            
            147,000$
            3,232,000




14




The
      following table sets forth the pro forma disclosure of the Company’s net loss
      and net loss per share for the prior year three and six-month periods ended
      June
      30, 2005 assuming the estimated fair value of the options were calculated
      pursuant to SFAS 123 and amortized to expense over the option-vesting period:







**Three-Months**
              **Ended****June
                30, 2005**
            
            **Six-Months**
              **Ended
                June 30, 2005**Net
                loss applicable to holders of common stock, as reported for basic
                and
                diluted calculations
            
            $
            (2,292,214
            )
            $
            (5,400,508
            )Deduct:
                Total share-based employee compensation expense determined under
                fair
                value based method for all awards
            
            
            (21,656
            )
            
            (95,646
            )Pro
                forma net loss applicable to holders of common stock, basic and diluted
                calculations
            
            $
            (2,313,870
            )
            $
            (5,496,154
            )Basic
                and diluted net loss per common share, as reported
            
            $
            (0.10
            )
            $
            (0.25
            )Basic
                and diluted pro forma net loss per common share
            
            $
            (0.11
            )
            $
            (0.25
            )




1 A
      Black-Scholes option-pricing model was used to develop the fair values of the
      options granted.





Pro
      forma
      information regarding net loss and net loss per share was been determined as
      if
      the Company had accounted for its employee stock options and stock purchase
      plan
      under the fair value method of SFAS 123.





***Common
      Stock Issuances***





During
      the three-months ended June 30, 2006, the Company issued 34,838 shares of common
      stock pursuant to a Development Agreement with a third party for services
      rendered to the Company for research and development projects. The original
      term
      of the Development Agreement was a 26-month period ending September 30, 2006.
      In
      December 2004, the term was extended to December 31, 2006. The Company placed
      300,300 shares of common stock in escrow which is being issued to the third
      party as earned during the contractual period, at which time they will be deemed
      to be outstanding. Per the Development Agreement, the price used to calculate
      the number of shares issued was set at $3.33 per share. The stated value of
      the
      services rendered is then divided by the share price of $3.33 to determine
      the
      number of shares earned. The Company has recognized approximately $207,000
      and
      $320,000 for the three-month and six-month periods ended June 30, 2006,
      respectively, based on the fair market value of the Company’s common stock on
      the measurement dates. The number of shares held in escrow as of June 30, 2006
      is 222,539 and an aggregate of 77,761 shares have been earned.





On
      April
      28, 2006, the Company and its 82.5% majority owned Asian Subsidiary entered
      into
      a satisfaction and purchase agreement with the Asian Subsidiary’s two minority
      shareholders, its managing director and one of its other key employees,
      effective as of January 1, 2006. The minority shareholders received $375,000
      in
      cash and 212,501 shares of unregistered common stock of the Company (see Note
      1
      - Basis of Presentation and Summary of Significant Accounting Policies, *Goodwill* ).
      The
      Company’s shares were valued at approximately $1,328,000 based on the fair
      market value of the Company’s common stock on April 28, 2006, the measurement
      date for accounting purporses. As of May 1, 2006, the Company is recording
      100%
      of the Asian Subsidiary’s operating results in the accompanying condensed
      consolidated statements of operations.





On
      May 1,
      2006, the Company’s two largest stockholders, the Emalfarb Trust and the
      Francisco Trust U/A/D February 28, 1996 (the “Francisco Trust”), increased their
      stock ownership in the Company by 251,298 and 222,537 shares of common stock,
      respectively, as a result of converting in full their convertible promissory
      notes due January 1, 2007, at an exercise price of $3.33 per share. As a result
      of the conversions, a total of approximately $1.6 million of notes and interest
      payable to stockholders, bearing interest at 6% per annum was relieved. The
      balances of the


15


related
      beneficial conversion features were fully expensed in April 2006 resulting
      in a
      one time adjustment of approximately $171,000 to interest expense.




The
      Francisco Trust has as its beneficiaries the wife and children of Mark A.
      Emalfarb, the Chief Executive Officer, President and Chairman of the Company.





During
      the three-months ended June 30, 2006, the Company has received an aggregate
      of
      approximately $5,846,000 in proceeds from the exercises of the following
      instruments: (i) warrants to purchase an aggregate of 495,460 shares of common
      stock, at an exercise price of $3.33 per share, (ii) warrants to purchase an
      aggregate of 594,642 shares of common stock for an exercise price of $5.50
      per
      share, (iii) stock options to purchase an aggregate of 163,250 shares of common
      stock, granted under the Equity Plan, with exercise prices ranging from $2.08
      to
      $4.50 per share, and (iv) stock options to purchase an aggregate of 65,000
      shares of common stock, granted prior to the Equity Plan, with an exercise
      price
      of $4.50 per share. Subsequent to June 30, 2006 through August 3, 2006, the
      Company has received approximately $214,000 of additional proceeds from further
      exercises of warrants and stock options.





**4.
      Commitments and Contingencies**





**Litigation,
      Claims and Assessments**





In
      the
      opinion of management, there are no known pending legal proceedings that would
      have a material effect on the Company's financial position, results of
      operations or cash flows.





**5.
      Segment Data Information**





Operating
      segments are defined as components of an enterprise engaging in business
      activities about which separate financial information is available that is
      evaluated regularly by the chief operating decision maker or group in deciding
      how to allocate resources and in assessing performance. Utilizing these
      criteria, the Company has identified its reportable segments based on the
      geographical markets they serve, which is consistent with how the Company
      operates and reports internally.




The
      Company has three reportable segments: U.S. operations, Asian operations and
      Netherlands operations. The U.S. reportable segment includes a subsidiary in
      Poland that is considered auxiliary and integral to the U.S. operations. The
      accounting policies for the segments are the same as those described in the
      basis of presentation and summary of significant accounting policies. The
      Company accounts for intersegment sales (which are eliminated in consolidation)
      as if the sales were to third parties, that is, at current market prices. The
      U.S. operating segment is a developer, manufacturer and distributor of enzyme
      products, proteins, peptides and other bio-molecules derived from genes, and
      a
      collaborative licensor of enabling proprietary technology for the development
      and manufacturing of biological products and use in research and development.
      The Asian operating segment is engaged in the manufacturing and distribution
      of
      chemical and enzyme products to the textile and pulp and paper industries.
      The
      Netherlands operating segment is also a developer of enzyme products, proteins,
      peptides and other bio-molecules derived from genes and to date has invested
      solely in research and development activities.





16


The
      following table summarizes the Company's segment information:





**Three-Months
                Ended June 30, 2006****U.S.
                Operating Segment**
            
            **Asian
                Operating Segment**
            
            **Netherlands
                Operating Segment**
            
            **Eliminations**
            
            **Totals**Net
                Sales:External
                customers
            
            $
            2,374,512
            
            $
            1,595,054
            
            $
            --
            
            $
            --
            
            $
            3,969,566Intersegment
            
            
            193,257
            
            
            --
            
            
            --
            
            
            (193,257
            )
            
            --Total
                net sales
            
            
            2,567,769
            
            
            1,595,054
            
            
            --
            
            
            (193,257
            )
            
            3,969,566(Loss)
                income from operations
            
            
            (2,803,391
            )
            
            100,617
            
            
            (194,036
            )
            
            27,470
            
            
            (2,869,340
            )Interest
                expense
            
            
            (270,066
            )
            
            (17,847
            )
            
            --
            
            
            14,117
            
            
            (273,796
            )Investment
                income (loss), net
            
            
            101,425
            
            
            483
            
            
            25
            
            
            (14,117
            )
            
            87,816Depreciation
                and amortization
            
            
            32,447
            
            
            25,854
            
            
            1,269
            
            
            --
            
            
            59,570Capital
                expenditures
            
            
            63,053
            
            
            18,398
            
            
            --
            
            
            --
            
            
            81,451





**Three-Months
                Ended June 30, 2005****U.S.
                Operating Segment**
            
            **Asian
                Operating Segment**
            
            **Netherlands
                Operating Segment**
            
            **Eliminations**
            
            **Totals**Net
                Sales:External
                customers
            
            $
            2,513,500
            
            $
            1,474,577
            
            $
            --
            
            $
            --
            
            $
            3,988,077Intersegment
            
            
            252,911
            
            
            --
            
            
            --
            
            
            (252,911
            )
            
            --Total
                net sales
            
            
            2,766,411
            
            
            1,474,577
            
            
            --
            
            
            (252,911
            )
            
            3,988,077(Loss)
                income from operations
            
            
            (1,958,703
            )
            
            49,711
            
            
            (276,413
            )
            
            (6,958
            )
            
            (2,192,363
            )Interest
                expense (a)
            
            
            (129,424
            )
            
            (16,199
            )
            
            (41,430
            )
            
            10,693
            
            
            (176,360
            )Investment
                income (loss), net
            
            
            105,052
            
            
            157
            
            
            --
            
            
            (10,693
            )
            
            94,516Depreciation
                and amortization
            
            
            19,611
            
            
            11,556
            
            
            93,031
            
            
            --
            
            
            124,198Capital
                expenditures (b)
            
            
            977,748
            
            
            36,290
            
            
            15,919
            
            
            --
            
            
            1,029,957


(a)
      Interest expense relating to the purchase by the U.S. operating segment of
      manufacturing equipment was allocated to the Netherlands
      operating segment.


(b)
      Includes non-cash expenditure of approximately $862,000.






17









**Six-Months
                Ended June 30, 2006****U.S.
                Operating Segment**
            
            **Asian
                Operating Segment**
            
            **Netherlands
                Operating Segment**
            
            **Eliminations**
            
            **Totals**Net
                Sales:External
                customers
            
            $
            4,722,113
            
            $
            3,073,209
            
            $
            --
            
            $
            --
            
            $
            7,795,322Intersegment
            
            
            548,288
            
            
            --
            
            
            --
            
            
            (548,288
            )
            
            --Total
                net sales
            
            
            5,270,401
            
            
            3,073,209
            
            
            --
            
            
            (548,288
            )
            
            7,795,322(Loss)
                income from operations
            
            
            (4,815,606
            )
            
            136,115
            
            
            (363,653
            )
            
            (17,263
            )
            
            (5,060,407
            )Interest
                expense
            
            
            (440,109
            )
            
            (32,333
            )
            
            --
            
            
            24,692
            
            
            (447,750
            )Investment
                income (loss), net
            
            
            213,654
            
            
            855
            
            
            33
            
            
            (24,692
            )
            
            189,850Depreciation
                and amortization
            
            
            64,140
            
            
            50,952
            
            
            2,499
            
            
            --
            
            
            117,591Capital
                expenditures
            
            
            279,767
            
            
            47,983
            
            
            42,864
            
            
            --
            
            
            370,614Total
                assets at June 30, 2006
            
            
            25,180,899
            
            
            5,583,554
            
            
            98,789
            
            
            (5,498,384
            )
            
            25,364,858





**Six-Months
                Ended June 30, 2005****U.S.
                Operating Segment**
            
            **Asian
                Operating Segment**
            
            **Netherlands
                Operating Segment**
            
            **Eliminations**
            
            **Totals**Net
                Sales:External
                customers
            
            $
            4,904,043
            
            $
            2,818,394
            
            $
            --
            
            $
            --
            
            $
            7,722,437Intersegment
            
            
            386,531
            
            
            --
            
            
            --
            
            
            (386,531
            )
            
            --Total
                net sales
            
            
            5,290,574
            
            
            2,818,394
            
            
            --
            
            
            (386,531
            )
            
            7,722,437(Loss)
                income from operations
            
            
            (4,693,293
            )
            
            115,204
            
            
            (479,985
            )
            
            26,534
            
            
            (5,031,540
            )Interest
                expense (a)
            
            
            (262,078
            )
            
            (30,093
            )
            
            (78,858
            )
            
            21,268
            
            
            (349,761
            )Investment
                income (loss), net
            
            
            44,230
            
            
            288
            
            
            8
            
            
            (21,268
            )
            
            23,258Depreciation
                and amortization
            
            
            38,540
            
            
            20,551
            
            
            186,061
            
            
            --
            
            
            245,152Capital
                expenditures (b)
            
            
            1,002,274
            
            
            46,219
            
            
            15,919
            
            
            --
            
            
            1,064,412Total
                assets at June 30, 2005
            
            
            26,628,644
            
            
            2,082,183
            
            
            225,493
            
            
            (1,994,338
            )
            
            26,941,982


(a)
      Interest expense relating to the purchase by the U.S. operating segment of
      manufacturing equipment was allocated to the Netherlands
      operating segment.


(b)
      Includes non-cash expenditure of approximately $862,000.





18







***Item*** ** ***2.*** ** ***Management’s
      Discussion and Analysis or Plan of Operation***





The
      following should be read in conjunction with Management's Discussion and
      Analysis of Financial Condition and Results of Operations included in the
      Company's Annual Report on Form 10-KSB for the year ended December 31,
      2005.





The
      term
“the Company”, “Dyadic”, “we”, “us” or “our” refers to Dyadic International,
      Inc. and its consolidated subsidiaries, unless the context otherwise
      implies.





This
      Quarterly Report on Form 10-QSB 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, that involve substantial risks and
      uncertainties. Forward-looking statements can be identified by the fact that
      they do not relate strictly to historical or current facts. They use words
      such
      as “may”, “will”, “expect”, “intend”, “anticipate”, “believe”, “estimate”,
“continue”, “project”, “plan”, “shall”, “should”, and other similar words. You
      should read statements that contain these words carefully because they discuss
      our future expectations, making projections of our future results of operations
      or our financial condition or state other "forward-looking" information.
      Forward-looking statements involve known and unknown risks and uncertainties
      that may cause the actual results, performance or achievements of our Company
      to
      be materially different from those that may be expressed or implied by such
      statements. Important factors that could cause the actual results, performance
      or achievements of the Company to differ materially from the Company’s
      forward-looking statements include (i) assumptions or cautionary factors
      discussed in connection with a particular forward-looking statement or elsewhere
      in this Form 10-QSB, or (ii) cautionary factors set forth in our Annual Report
      on Form 10-KSB for the year ended December 31, 2005, including the section
      titled “Description of Business - Risk Factors That May Affect Future Results,”
and in our subsequent filings made from time to time with the Securities and
      Exchange Commission. All forward-looking statements attributable to the Company
      are expressly qualified in their entirety by these and other factors. Except
      as
      required by law or regulation, we do not undertake any obligation to publicly
      update forward-looking statements to reflect events or circumstances after
      the
      date on which the statement is made or to reflect the occurrence of
      unanticipated events.





*General*





We
      are a
      biotechnology company engaged in the development, manufacture and sale of
      enzymes, other proteins, peptides and other biomolecules derived from genes,
      and
      the collaborative licensing of our enabling patented and other proprietary
      technologies. We use our patented and other proprietary technologies to develop
      and manufacture biological products, and intend to collaboratively license
      them
      for research, development and manufacturing of biological products, for three
      categories of applications:




·
            enzymes
                and other biological products for a variety of industrial and commercial
                applications, such as in the textile, pulp and paper, animal feed,
                alcohol, starch, and food and beverage industries, where we currently
                sell
                more than 45 liquid and dry enzyme products to more than 200 industrial
                customers in approximately 50 countries, which we refer to as our
                Enzyme
                Business;





·
            enzymes
                and related biotechnological processes for use in converting various
                agricultural products (e.g. corn), agricultural residue products
                (e.g.
                dried distillers grains (DDG), wheat straw, and sugar cane
                bagasse) and forestry industry residues (e.g. wood pulp and chips)
                into fermentable sugars, which can then be used in the production
                of
                traditional and cellulosic ethanol, as well as other products currently
                derived from petroleum, such as plastics and polymers, which enzymes
                and
                related biotechnological processes we refer to as "Biorefinery Products";
                and





·
            human
                therapeutic protein candidates, with focus on antibodies, for use
                by
                pharmaceutical and biotechnology companies in pre-clinical and clinical
                drug development applications and commercialization following drug
                approval, which we refer to as our BioSciences Business.


19


As
      more
      and more industries come to appreciate the financial, process efficiencies,
      environmental and other advantages of applying biological solutions such as
      enzymes to their manufacturing processes in lieu of chemicals and other
      materials leaving damaging environmental footprints, we expect many new market
      opportunities to emerge for our proprietary technologies (e.g. cellulosic
      ethanol for the alternative fuel market).





We
      have
      developed and use a number of proprietary fungal strains to produce enzymes,
      but
      the one on which we have principally focused is a patented system for protein
      production, or protein expression, which we call the C1 Expression System.
      This
      system is based on our patented *Chrysosporium
      lucknowense* fungus,
      known as C1, a host production organism which has been genetically altered
      to
      express homologous and heterologous genes to produce targeted protein products.
      We discovered the C1 microorganism in the mid-1990's and initially developed
      it,
      without the application of molecular biology, to produce neutral cellulases
      for
      our textile manufacturing customers. By 1998, we began to apply molecular
      genetics and other proprietary biotechnology tools to C1 to create a technology,
      which we refer to as the C1 Host Technology. We consider the C1 Expression
      Technology to be fully-developed in that we now have completed all of the tools
      required for expressing genes in C1, inserting new genes into C1, and removing
      unwanted genes from C1. The C1 Expression Technology has been used for about
      three years for the manufacture of enzyme products we currently sell for use
      in
      textile, pulp and paper, and other industries. We also continue to believe
      that
      the C1 Expression Technology may be useful for the expression of therapeutic
      proteins and have recently been encouraged by some of the results of our
      developmental efforts to that end. For example, the C1 Expression Technology
      has
      already demonstrated its ability to produce proteins, including
      biologically-active full-length antibodies.





The
      C1
      Host Technology, once fully developed, is expected to be capable of performing:




·
            two
                screening functions for:





o
            the
                discovery of genes and the proteins they express; and


o
            the
                identification of improved protein variants resulting from modifications
                to their genes;


and




·
            three
                expression functions for:




o
            the
                expression of enzymes, other proteins or other biomolecules (e.g.,
                chemical intermediates, biopolymers, etc.) in commercial volumes
                for
                industrial enzyme applications;




o
            the
                expression of human therapeutic proteins in small volumes for pre-clinical
                testing and clinical trials; and





o
            the
                expression of human therapeutic proteins for drugs in commercial
                volumes.





We
      have
      been, over the last several years, principally focused on the expression
      capabilities of the C1 Host Technology. These efforts culminated in our first
      commercially successful application - our C1 Expression System.





To
      more
      fully exploit the C1 Expression Technology and to identify new products for
      production in C1, the genomic sequence of C1 was determined in 2005 under
      contract with Agencourt Biosciences. Using the information gathered from the
      C1
      genome sequence and from the subsequent annotation currently being performed
      in
      collaboration with Scripps-Florida, Dyadic intends to improve C1’s capabilities
      for production of therapeutics and other foreign proteins. The first phase
      of the annotation has demonstrated over 11,000 genes in C1. A number of
      those genes have been found to encode the processes that could positively or
      negatively affect protein production (i.e. gene expression, protein secretion,
      protein degradation, and protein folding), for example. Using the genetic
      tools developed for C1, those processes can be altered, identified and modified
      in such a way as to improve the yields and range of proteins produced in C1.
      In
      addition, over one hundred enzyme products of potential commercial interest
      for
      applications in the markets targeted by Dyadic have been identified. We
      anticipate that having the sequence of these genes will allow rapid development
      of these products using the C1 Host Technology.


20


Taken
      together, the molecular biological tools, the annotated genome information
      and
      the ability of the C1 strain to be grown at low viscosity and manipulated in
      microtiter dishes all the way up to 150,000 liter fermenters, we expect C1
      to be
      used to accelerate the pace of protein product development for Dyadic as well
      as
      its customers and corporate partners.





We
      believe, however, even larger market opportunities will exist for our C1
      Expression System when the technology is more fully developed. For example,
      we
      have invested heavily over the past decade in research and development
      (“R&D”) for cellulases, xylanases and other hemicellulases for a wide
      variety of applications. Some of these enzymes, as well as others in our R&D
      pipeline, may be able to convert agricultural residue products and energy crops
      (lignocellulosic substrates) into fermentable sugars, which in turn can be
      used
      to produce ethanol and other chemicals that have historically been
      petroleum-derived. Recently, scientists working for Dyadic purified seven
      cellulase and hemicellulase components from C1 and tested mixtures of these
      enzymes against cellulosic substrates for their ability to convert those
      substrates to fermentable sugar. It was shown that these enzyme mixtures could
      rapidly and efficiently degrade these substrates, and we anticipate that these
      results will guide us in the development of strains and processes for the
      production of ethanol from lignocellulosic biomass. These results were presented
      at the BIO World Congress for Industrial Biotechnology and Bioprocessing in
      July
      2006, were the subject of a patent application, and will be submitted for
      publication in a peer-reviewed scientific journal.





In
      addition to C1, we have a stable of well-characterized fungal strains and
      enzymes from those strains from which we have identified and characterized
      a
      number of these activities. We believe that the combination of these R&D
      efforts and our C1 Host Technology position us to address opportunities in
      the
      alternative fuel market, and we intend to develop plans to enter this market
      and
      seek collaborative partners in connection therewith.





We
      also
      believe our C1 Expression System can be successfully harnessed to help solve
      the
      protein expression problem confronting the global drug industry - the
      difficulty, despite enormous historic investment, of cost-effectively and
      expeditiously harnessing existing genomic knowledge to develop new specialized
      biological products, or therapeutic proteins. For the past six years, we have
      been developing our C1 Expression System to serve the drug industry in the
      discovery, development and production of human therapeutic proteins, with our
      primary focus on enabling pharmaceutical and biotechnology companies to not
      only
      successfully carry on the development of drugs from their gene discoveries,
      but
      also to manufacture those drugs at economically viable costs. Within therapeutic
      proteins, the production of antibodies is an area of special focus for us in
      view of the large number of antibodies in pharmaceutical companies’ R&D
      pipelines for which a reliable and cost-effective production process capable
      of
      producing large volumes is required. Still in the development stage, we refer
      to
      these activities as our BioSciences Business.





Although
      the reprogramming of the C1 host is targeted at improving the production of
      biopharmaceuticals from human genes (which remains a significant focus of our
      commercialization strategy for the C1 Expression System), one side benefit
      of
      this core technology development program will be to further improve the
      capabilities of C1 to make even larger quantities of enzymes and other proteins
      associated with genes from diverse living organisms, such as fungi other than
      C1, yeast, bacteria, algae and plants. We believe that this is likely to help
      us
      generate revenues in the shorter term by cost-effective production of enzymes
      and other proteins of commercial interest to potential business partners in
      sectors such as pulp and paper, agriculture, textile, food and animal feed.
      We
      have begun to mine the C1 genome for genes of interest and have identified
      a
      number of genes for enzymes that have the potential to become new products
      for
      several industries, such as textile, pulp and paper, energy, food and animal
      feed.





We
      have
      also been developing the screening potential of our C1 Host Technology for
      gene
      discovery and the identification of protein variants resulting from
      modifications to their genes, which we refer to as our C1 Screening System.
      These efforts include a collaborative relationship with a Netherlands-based
      scientific organization, TNO Quality of Life (f/k/a TNO Nutrition and Food
      Research Institute), and the establishment of a wholly-owned subsidiary, Dyadic
      Nederland BV, which has engaged in, and partially completed, the development
      of
      a fully-automated fungal high throughput screening system, or HTS system for
      which we are seeking new collaboration partners to help us complete. We believe
      that if our BioSciences Business' application of our C1 Expression System and
      our C1 Screening System can each be perfected, we will be able to offer a
      potentially unique end-to-end solution for drug companies: a single host
      production organism usable throughout the discovery, pre-clinical and clinical
      testing and commercial production phases of drug development that would greatly
      increase drug


21


development
      efficiency, economy and speed to market, as well as the probability of
      developing a discovery lead into a product, because the need for switching
      host
      cells during different phases of R&D will be minimized. By the same
      reasoning, we believe that the C1 Host Technology is expected to benefit the
      development of industrial or specialty enzyme products by allowing discovery,
      improvement, development and large-scale manufacturing in a single host
      organism, which should result in shorter inception-to-commercialization time
      and
      greater probability of success.




Currently,
      we own 3 issued and 1 allowed U.S. patents, 26 issued and 1 allowed
      International patents and 50 U.S. and International filed and pending patent
      applications which we believe provide broad protection for our C1 Expression
      System, our underlying C1 Host Technology, our C1 Screening System and their
      products and commercial applications.




*History
      of Dyadic*





Between
      May 2003 and March 2004, we began to focus principally on our C1 Expression
      System, even as we continued to develop our C1 Screening System with its related
      HTS hardware and software and to assemble more scientific data to support our
      claims regarding that System's potential. During this interval of time, we
      also
      continued to grow our Enzyme Business, as we used our C1 Expression System
      and
      other proprietary technologies to successfully develop several industrial
      enzymes, while continuing to seek equity financing.




Between
      April and July 31, 2004, we raised common equity capital of approximately
      $4,735,000, prior to expenses of approximately $118,000, through a private
      placement (the “April 2004 Offering”). Between October 1 and November 4, 2004,
      we raised additional common equity capital of approximately $25,400,000, prior
      to estimated expenses of approximately $2,700,000, in the October 2004 Offering
      we conducted companion to our merger with Dyadic-Florida, in which it became
      our
      wholly-owned subsidiary and its shareholders received shares of our stock
      representing a majority of our outstanding shares (the “Merger”).




During
      the three-months ended June 30, 2006, we have received an aggregate of
      approximately $5,846,000 in proceeds from the exercises of warrants and stock
      options and approximately $214,000 of additional proceeds through August 3,
      2006
      from further exercises of warrants and stock options. The proceeds have
      significantly reduced the net amount of cash the Company used during the first
      half of 2006, thereby improving our working capital available to support future
      operations.





During
      2005, we focused our efforts on, among other things, expanding the
      introduction of our pulp and paper enzymes product offering and
      significantly expanding our marketing efforts. We have assembled a team of
      seasoned sales and marketing executives and technical sales personnel with
      extensive pulp and paper industry experience and contacts. During 2006, we
      have
      been conducting an increasing number of new customer plant trials and our
      aim is to convert a number of these trials into significant and sustained levels
      of pulp and paper product sales. In March 2006, we secured our first order
      of
      our proprietary enzymes from a North American paper manufacturer. We continue
      to
      estimate the addressable market for our existing enzyme products in the
      pulp and paper industry to be in excess of $1.0 billion.





We
      have
      also focused some of our efforts on other industries and expect to pursue these
      other industries, such as food and animal feed in a possible collaborative
      effort with third parties. To assist us in our endeavors in the animal feed
      market in Europe and elsewhere, we have hired a sales consultant with
      significant experience and expertise in this industry, who began in April 2006
      to help identify and articulate our marketing and commercial strategy.
      Historically, we have sold into this industry without any sales support staff
      and it is our expectation that this addition will increase our sales effort
      in
      the animal feed market in the latter part of 2006. There is no guarantee,
      however, that our sales will increase significantly or in the time frame that
      we
      anticipate. However, we continue to support our textile customers, directing
      the
      necessary resources to customer support and R&D innovation to maintain our
      market share in this segment.





We
      have
      invested heavily over the past decade in R&D for cellulases, xylanases and
      other hemicellulases for a wide variety of applications. Some of these enzymes,
      as well as others in our R&D pipeline, may be applicable to the conversion
      of agricultural residue products and energy crops (lignocellulosic substrates)
      and forestry industry residues into fermentable sugars, which in turn can be
      used to produce ethanol and other chemicals that have


22


historically
      been petroleum-derived. We have a stable of well characterized fungal strains
      and enzymes which we believe has the required activities. We believe that our
      C1
      Host Technology or other proprietary technologies, coupled with our R&D
      efforts, will enable us to offer products that address energy problems more
      effectively and economically. Collectively, we believe we have resources with
      significant expertise in this area, including our Scientific Advisory Board
      members, our strategic collaborations with leading scientific organizations
      such
      as Moscow State University and the Russian Academy of Sciences as well as our
      employees, including the addition of a Chief Scientific Officer in March of
      2006.





In
      2006,
      we have begun to shift some of our focus to energy market opportunities and
      the
      need for alternative fuels such as cellulosic ethanol. We have invested
      significant resources over the past decade in the development of our C1 and
      other technologies for the production of cellulases, xylanases and other
      hemicellulases. Some of these enzymes, as well as others currently in
      development, may be applicable in the conversion of agricultural and forestry
      industry residues such as dry distillers grains (DDG), corn stover, wheat straw,
      sugar cane bagasse, and wood chips and waste from the pulp and paper mills,
      into
      fermentable sugars, which in turn can be used to produce ethanol and other
      chemicals historically derived from petroleum. The current U.S. biofuels market
      (corn starch to ethanol) is currently estimated to be approximately over $12
      billion (4.3 billion gallons of ethanol at a current contract price of $2.70
      per
      gallon). The current market for amylases in this corn to ethanol conversion
      market is in the hundreds of millions of dollars. Additional corn to ethanol
      production capacity is becoming available from many manufacturers and it is
      estimated by the Renewable Fuels Association that by 2007 there will be
      approximately a 6.3 billion gallon capacity in the U.S. While this is a
      significant increase over current capacity, this represents less than 5% of
      the
      U.S. transportation fuel requirement. It is estimated that conversion of corn
      starch to ethanol could provide between 5-10% of U.S. transportation fuel needs,
      though greater use of corn-derived ethanol could potentially disrupt the food
      and feed corn markets. The U.S. Dept of Energy has estimated that the U.S.
      has
      enough annual biomass for ethanol conversion to replace approximately 30% of
      our
      transportation fuels. Thus, significant expansion of ethanol capacity above
      existing levels will necessitate the use of agricultural residue feedstock
      (e.g.
      corn stover, wheat straw, sugar cane bagasse, wood chips and waste from the
      pulp
      and paper mills) and energy crops. Such biomass requires the use of cellulase
      and hemicellulose enzymes for the conversion of biomass ,into fermentable
      sugars. Depending on the market share and feedstock involved, the potential
      for
      enzymes alone in the cellulosic to ethanol market is estimated to be in the
      hundreds of millions of dollars.





Currently,
      ethanol producers sell DDG, the corn mash byproduct from ethanol, for use as
      animal feed. We are applying our C1Host Technology and other technologies
      to discover, develop and manufacture enzymes which we believe will result in
      increased recovery of fermentable sugars from DDG. Working with the Iowa Corn
      Promotion Board on a Department of Energy funded program, we have been providing
      enzymes to convert cellulose and hemicellulose, which comprise as much as half
      of the weight of DDG, to fermentable sugars. These sugars can be utilized to
      produce additional ethanol and other chemicals that have historically been
      petroleum-derived.  We are looking to further develop the technology to
      convert DDG and other agricultural bioproducts into fermentable sugars by
      applying for additional government grants and through strategic collaborations
      with partners with complementary technologies.  We have begun to expand our
      R&D programs to develop and manufacture enzymes that will be more effective
      in converting these byproducts into larger volumes of lower cost fermentable
      sugars, thereby lowering the cost of cellulosic ethanol production. We have
      been
      testing a number of multicomponent enzyme products, including both commercial
      products and others in development, for their ability to convert various sources
      of untreated and pretreated lignocellulosic biomass substrates to fermentable
      sugars. Using these enzymes and the expression tools that have been developed,
      we believe Dyadic may be one of a small number of companies able to produce
      the
      necessary enzymes for an efficient and economical biomass to fermentable sugar
      process. In collaboration with appropriate partners, those sugars would then
      be
      converted to ethanol, other fuels, or chemical feedstocks. To this end, we
      are
      engaged in multiple active sets of discussions with prospective industry
      collaboration partners and others, to assist us in these efforts. We believe
      that this may be a significant market opportunity for us as a technology
      provider; however, there is no guarantee that our efforts in this area will
      ultimately produce sales.





We
      derive
      almost all of our sales from our Enzyme Business, and have thus far generated
      only nominal sales from our BioSciences Business. We have an accumulated deficit
      at June 30, 2006 of approximately $39.4 million. These losses resulted primarily
      from expenses associated with research and development activities and general
      and administrative expenses. To become profitable, we must continue to grow
      our
      Enzyme Business (see Sales & Marketing Strategy below) and/or generate
      significant revenue from our Biorefinery Products and our


23


BioSciences
      Business, either directly or through potential future license agreements and
      collaborative partnerships with industrial and drug companies, respectively.





For
      additional information on Dyadic’s history, refer to Management's Discussion and
      Analysis of Financial Condition and Results of Operations included in the
      Company's Annual Report on Form 10-KSB for the year ended December 31,
      2005.





*Research
      and Development - C1 Host Technology*





With
      the significant
      increase in our capital
      funding, we completed
      a genomic sequencing project performed by Agencourt Bioscience to
      sequence the DNA of our C1 host organism in March 2005. Leveraging
      the information gained from the Agencourt C1 genome sequencing project, we
      have
      identified by manual searches over one hundred genes of potential commercial
      interest. To more fully realize the potential of the genomic sequence, it will
      be necessary to annotate the genome. On March 31, 2006, we announced the
      engagement of The Scripps Research Institute to work with Dyadic scientists
      to
      provide a comprehensive annotation of the C1 genome. We expect that the
      annotation will provide tools for identifying and classifying genes, their
      corresponding proteins, and metabolic pathways in a searchable and user-friendly
      format. These tools would allow us to identify additional commercial enzyme
      product leads, including improved cellulases and hemicellulases for use in
      textile, pulp and paper, food and animal feed applications, and for the
      production of ethanol from lignocellulosic biomass. We anticipate that this
      annotation will also allow us to identify genes that influence the physiology
      of
      protein production in C1. Modification of these genes or their expression is
      expected to lead to improvements in the C1 Host Technology, the C1 Expression
      System and the C1 Screening System, making them more robust and versatile.
      Those
      improvements would likely enable them to produce a wider variety of proteins
      at
      higher yields and at lower cost. The annotation project is currently in progress
      and on schedule, and we have already begun to receive preliminary information
      on
      the genome structure of C1. Over
      11,000 genes have been located and are in the process of being
      identified. This initial annotation was accomplished using a number of
      computer algorithms. We are now beginning the process of further refining
      the computer-called genes through manual annotation.  As the
      annotation program progresses, we expect to build a comprehensive genetic and
      biochemical blueprint of C1 by continually referencing our genomic data and
      data derived from the genome against databases of known genes, proteins, and
      metabolic pathways. The blueprint will be readily searchable and
      user-friendly, allowing Dyadic to identify numerous products of potential
      commercial interest as well as genes and proteins affecting protein production
      process in C1, with the goal of improving the versatility and robustness of
      the
      C1 technology platform.





With
      petroleum prices over $70 a barrel, there has been an increased interest in
      biofuels from both the public and politicians. Reflecting this sentiment,
      President Bush proposed in his State of the Union Address on January 31, 2006
      the Advanced Energy Initiative, which could amount to a 22% increase in the
      Department of Energy's funding for clean energy research. The proposal calls
      for
      the 2007 Federal Budget to include $150 million for research into new methods
      for making ethanol, not just from corn kernels (which is the current method),
      but also from wood chips, corn stover, wheat straw, switchgrass and other
      sources of lignocellulosic biomass. President Bush has set a goal to make this
      cellulosic biomass based ethanol cost-competitive and commercially viable within
      six years.





Making
      ethanol from lignocellulosic biomass requires cellulase and hemicellulase
      enzymes, a market segment in which Dyadic has been a producer since the early
      1990's. Filamentous fungi are widely known to be the most prolific producers
      of
      such enzymes in their natural state to breakdown various agricultural
      lignocellulosic matters into fermentable sugars, which can be further converted
      into ethanol. We believe that our existing portfolio of enzymes from C1 and
      other proprietary fungi, as well as a large number of cellulase and
      hemicellulase enzymes in the C1 genome and others could play a significant
      role
      in realizing the President's goal of launching cellulosic ethanol within six
      years. We also expect to bring to bear the power of our integrated C1 Host
      Technology gene discovery and expression technology - a unique and powerful
      proprietary tool set - in order to find and develop novel and highly efficient
      enzymes for producing ethanol from lignocellulosic biomass. If we are successful
      in this endeavor, we believe we could play a significant role in the industry's
      achievement of its goal to eventually extract 80 billion gallons of ethanol
      from
      the more than one billion tons of lignocellulosic biomass that is available
      to
      be produced in the U.S., according to the U.S. Department of Energy. That is
      estimated to be enough to cover approximately one third of the transportation
      fuel needs in the U.S., which would represent a significant improvement over
      the
      approximate maximum of 5% - 10% of energy needs that can be met with corn
      derived ethanol.
        Our role would be to supply enzymes to meet the needs of the cellulosic ethanol
        producers and/or become a business partner in the production of ethanol
        itself.
  With
          the
          addition of Dr. Glenn E. Nedwin as our Chief Scientific Officer and President
          of
          our BioSciences Business, we have begun to focus on a search for one or
          more
          industry collaboration partners and others to assist us in the funding
          and
          development of multiple enzyme products for this ethanol market. There
          can be no
          assurance, however, that the Company will be successful in securing any
          such
          collaboration partners or others, or that even if successful in doing so,
          that
          the Company will be successful in developing a commercially viable enzyme
          mixture for this market.  24


We
      are
      also developing our C1 Host Technology to facilitate the discovery, development
      and large-scale production of human antibodies and other high-value therapeutic
      proteins. One of the major hurdles in the development of our C1 Expression
      System for the production of heterologous proteins has been degradation of
      the expressed
      proteins by proteases normally produced by C1. As a result of our focused effort
      to identify, clone the genes for, and eliminate those proteases, we have
      generated strains with very low levels of protease as compared to the original
      host strains. Recent preliminary data, based on *in
      vitro* stability of several therapeutically relevant human antibodies and other
      proteins in the presence of culture broth from those strains, suggests that
      the
      protease-reduced strains will be useful for the production of
      biopharmaceuticals. We anticipate that during 2006, we will see further
      increases in antibody yields and will have data that demonstrate whether
      antibodies expressed in C1 are biologically active. Initial results, obtained
      in
      the first half of 2006 have indicated that C1 is capable of producing
      biologically-active full length antibodies at good yield. Further efforts will
      focus on biochemically characterizing the antibody products produced from C1
      and
      further improving yields through fermentation development. As a longer term
      endeavor, we intend to leverage our genomics tools to develop further improved
      host strains for production of antibodies, other therapeutics, and
      enzymes.





Based
      on
      the foregoing and other R&D initiatives we continue to
      pursue in
      2006,
      we expect to incur significant costs
      funding our R&D initiatives, including costs related to enhancements
      to our core
      technologies.  If
      certain projects continue to show promise,
      such as the discovery, development and large-scale production of human
      antibodies, and new and better enzymes for converting DDG’s and/or other
      agricultural feedstocks such as sugarcane bagasse, wheat straw, corn stover,
      citrus peel, pulp waste, etc., we may need to accelerate those projects and
      therefore will require increased R&D funding. The source of the funding may
      be from our cash resources, private and public debt or equity financings,
      partnerships with third party entities, other strategic relationships, or a
      combination of one or more of the foregoing. As a result, we expect to continue
      to incur losses as we further develop our C1
      Expression and Screening Systems, and build other required infrastructure to
      exploit our C1 Host Technology, our C1 Expression System, our C1 Screening
      System and our other technologies .
      There
      can be no assurance that our efforts with regard to these objectives will be
      successful.





*Sales
      & Marketing Strategy - Enzymes*





One
      of our top priorities during 2005 was to sharply expand the
      introduction of our pulp and paper enzyme products to that industry. While
      we believe these products offer a strong value proposition for this industry,
      we
      made a strategic decision to penetrate this market with an acute sensitivity
      to
      the fact that our target customer decision-makers are responsible for physical
      plants costing, in many instances, several hundred million dollars or more,
      and
      are accustomed to dealing with highly technical sales teams with strong support
      competencies, following long-term trials of new products. Accordingly, we set
      about to recruit and assemble a team of seasoned sales and marketing
      executives and technical salesmen with extensive pulp and paper industry
      experience and contacts in promoting and maintaining sales relationships
      involving substantial on-going sales and technical servicing. During 2005,
      we
      successfully recruited a Vice President of Sales & Marketing -
      Enzymes, a Vice President - Pulp & Paper, and 6 technical sales
      representatives whom we believe fit this description as well as additional
      technical sales representatives in our Asian subsidiary. The addition of the
      sales and marketing personnel occurred throughout the third quarter of 2005,
      and
      accordingly, we do not expect to see significant sales results from these
      additions until the latter half of 2006. For the first six months of 2006,
      pulp
      and paper sales increased to 15% of net sales as compared to 10% for the
      comparable period in 2005, which represents a 57% increase for the six-month
      period ended June 30, 2006 over the comparable 2005 period. Pulp and paper
      sales
      increased from 13% of net sales in the first quarter of 2006 to 18% of net
      sales
      for the second quarter of 2006.




During
      2006, we are continuing to expand our pulp
      and paper sales and marketing initiatives, as we work to capture both an
      increasing number of new customer trials and convert existing and new
      customer trials into significant and sustained levels of pulp and paper product
      sales. As a next step, we are working to expand our indirect sales force through
      the selective addition of distributors in key regions of the world and by
      training the sales forces of our new and existing distributors. We continue
      to
      estimate the addressable market for our existing enzyme products in the
      pulp and paper industry and potential enzyme products for the pulp and paper
      industry currently in our research and development pipeline to be in excess
      of
      $1.0 billion.


We
        have
        worked with several existing
        pulp and paper customers to generate product trial data for
        our
        use in selling to other
        global companies Bleach - boosting,
        Bio-refining and De-inking products. As we had expected, the sales
        cycle for
        capturing a new customer trial is a long one
        (often 6 months to 18 months, or longer), though
        we have nonetheless been
        able to commence mill trials with
        several key potential customers over the
        past year .


25


Our
      marketing and field efforts were recently recognized by recording our first
      sale
      of our pulp and paper enzymes in the United States during the three-month period
      ended March 31, 2006. Some of the benefits that this paper mill has realized
      from the use of our enzymes include increased paper production of up to 8%,
      a
      reduction in paper basis weights of up to 4%, and significant reductions in
      refiner energy consumption.





The animal
      feed market has
      represented approximately 7% and 6% of our Enzyme
      Business net
      sales
      in 2005 and 2004, respectively. For
      the
      first six months of 2006, animal feed sales increased to 8% of net sales as
      compared to 7% for the comparable period in 2005. We have begun funding the
      registration of our existing products and
      new
      products under development for these applications in the
      European Union ( the largest
      market) ,
      and
      expect material growth in this geographical market and
      elsewhere over the next two to three years. We also expect to be able to focus additional product
      development and sales efforts
      in other markets , such as
      energy, starch and brewery markets,
      as a consequence of recruitment of additional personnel charged with direct
      responsibility for overseeing the registration
      of our products
      and greater
      focused attention on these
      market opportunities.





To
      assist
      us in our efforts in the animal feed market in Europe and elsewhere, we have
      hired a sales consultant with significant experience and expertise in this
      industry who began April 1, 2006. Historically, we have sold in this industry
      without any sales support dedicated to this market, and it is our expectation
      that this addition will increase our sales in the animal feed market in the
      latter part of 2006. There is no guarantee, however, that our sales will
      increase significantly or in the time frame that we anticipate.





**Results
      of Operations for the Three-Months Ended June 30, 2006 Compared to the
      Three-Months Ended June 30, 2005**





The
      following table sets forth the amount of increase or decrease represented by
      certain items reflected in the Company's condensed consolidated statements
      of
      operations in comparing the three-months ended June 30, 2006 to the three-months
      ended June 30, 2005 (in thousands):





**Three-Months
                Ended June 30,**(In
                thousands)
            
            **2006**
            
            **2005**
            
            **Increase
                (Decrease)**Net
                sales
            
            $
            3,970
            
            $
            3,988
            
            $
            (18
            )Cost
                of goods sold
            
            
            2,893
            
            
            3,211
            
            
            (318
            )Gross
                profit
            
            
            1,077
            
            
            777
            
            
            300Operating
                expenses:Research
                and development
            
            
            990
            
            
            954
            
            
            36Selling
                and marketing
            
            
            813
            
            
            617
            
            
            196General
                and administrative
            
            
            2,077
            
            
            1,437
            
            
            640Foreign
                currency exchange losses (gains), net
            
            
            66
            
            
            (39
            )
            
            1053,946
            
            
            2,969
            
            
            977Loss
                from operations
            
            
            (2,869
            )
            
            (2,192
            )
            
            677Other
                income (expense):Interest
                expense
            
            
            (274
            )
            
            (176
            )
            
            (98
            )Investment
                income, net
            
            
            88
            
            
            95
            
            
            (7
            )Minority
                interest
            
            
            (13
            )
            
            (3
            )
            
            (10
            )Other
                expense, net
            
            
            69
            
            
            --
            
            
            69Total
                other expense
            
            
            (130
            )
            
            (84
            )
            
            (46
            )Loss
                before income taxes
            
            
            (2,999
            )
            
            (2,276
            )
            
            (723
            )Provision
                for income taxes
            
            
            (7
            )
            
            (16
            )
            
            9Net
                loss
            
            $
            (3,006
            )
            $
            (2,292
            )
            $
            714




26






**Net
        Sales**
 
 The
        following table reflects the Company’s net sales by industry for the three-month
        periods ended June 30, 2006 and 2005 (in thousands):






**Three-Months
                Ended June 30,**(In
                thousands)
            
            **2006**
            
            %**of Net
                Sales**
            
            **2005**
            
            **% of Net
                Sales**
            
            **Increase
                / (Decrease)**
            
            **%**Textile
            
            $
            2,624
            
            
            66
            %
            $
            2,752
            
            
            69
            %
            $
            (128
            )
            
            (5
            %)Animal
                Feed
            
            
            319
            
            
            8
            %
            
            362
            
            
            9
            %
            
            (43
            )
            
            (12
            %)Pulp
                & Paper
            
            
            723
            
            
            18
            %
            
            536
            
            
            13
            %
            
            187
            
            
            35
            %Others
                (5 industries)
            
            
            304
            
            
            8
            %
            
            263
            
            
            7
            %
            
            41
            
            
            16
            %Total
                Industrial Enzymes
            
            $
            3,970
            
            
            
            
            $
            3,913
            
            
            
            
            
            57
            
            
            1
            %Bioscience
            
            
            --
            
            
            0
            %
            
            75
            
            
            2
            %
            
            (75
            )
            
            (100
            %)Total
                Net Sales
            
            $
            3,970
            
            
            100
            %
            $
            3,988
            
            
            100
            %
            $
            (18
            )
            
            --
            %








For
      the
      three-months ended June 30, 2006, we generated net sales of approximately
      $3,970,000, compared to net sales of approximately $3,988,000 for the
      three-months ended June 30, 2005, a decrease of approximately $18,000. During
      the three-months ended June 30, 2005, we generated $75,000 of Bioscience
      revenue. The decrease of approximately $18,000 net sales is due in part to the
      lack of Bioscience revenue during the three-month period ended June 30, 2006.
      The Company is not currently generating Bioscience revenues on a regular basis,
      but does anticipate some revenue in the latter half of 2006. There is no
      guarantee, however, that these revenues will be realized. Industrial Enzyme
      revenues increased by approximately $57,000, from approximately $3,913,000
      to
      approximately $3,970,000 for three-month period ended June 30, 2006, primarily
      due to the approximately $187,000 increase in pulp and paper sales (a 35%
      increase over the comparable period in 2005) which was offset by a decrease
      of
      approximately $128,000 from the textile industry (a 5% decrease over the
      comparable period in 2005).


To
        what
        degree our net sales from the textiles market will continue to decline in
        the
        future will depend not only on that market’s dynamics, but also on the extent to
        which pricing pressure created by our competitors continues. Our success
        in
        developing new products and our ability to lower our production costs will
        also
        have an impact.  We believe our sales will resume growth when new products
        being developed from our C1 Host Technology and other technologies for new
        markets (e.g. pulp & paper, food and animal feed) begin to achieve
        penetration and other new products are introduced both to existing and other
        new
        markets. We have made and continue to make substantial investments both in
        personnel and other initiatives since November 2004 to expand our sales,
        marketing and product development efforts and in advancing our C1 host
        technology and other technologies. We continue to support our textile customers,
        directing the necessary resources to customer support and R&D innovation to
        maintain market share in this segment. To this end, we are launching eight
        new
        products into the Textile market in the third quarter of 2006. The Textile
        market is one of the core markets for our Enzyme Business
        and we expect that these products, which are the result of our continued
        research & development in support of this core market, will help to
        stabilize and ultimately enable us to recapture our market share. However,
        we
        intend to exercise discipline over the application of resources to the textiles
        market (which is characterized by low profit margins and intense competition)
        relative to other higher profit and larger market opportunities we identify,
        the
        initial effects of which are beginning to be seen. Nonetheless, the markets
        for
        a number of our new products are generally characterized by longer sales
        cycles
        for reasons relating to various factors, such as required governmental
        registration processes (e.g. food and animal feed enzymes in Europe) and
        required product trials at customers’ facilities of multi-month durations or
        longer (e.g. pulp & paper, starch, alcohol, ethanol), and we can, therefore,
        offer no guidance as to when, or if, these new products will penetrate those
        markets.
  **Cost
      of Goods Sold**





For
      the
      three-months ended June 30, 2006, cost of goods sold was approximately
      $2,893,000, or 73% of net sales, as compared to approximately $3,211,000, or
      81%
      of net sales for the three-months ended June 30, 2005. The improvement in cost
      of goods sold is a result of the shift in sales from the textile industry to
      higher margin industries such as pulp and paper, animal feed and others such
      as
      brewing and alcohol. In addition, during the three-months ended June 30, 2005,
      the Company recorded an increase in the inventory provision of approximately
      $261,000, with no comparable amount during the three-months ended June 30,
      2006.





**Research
      and Development**




For
      the
      three-months ended June 30, 2006, research and development expenses were
      approximately $990,000, or 25% of net sales, as compared to approximately
      $954,000, or 24% of net sales for the three-months ended June 30, 2005,
      representing an increase of approximately $36,000. This increase is attributable
      to our continuing research and development initiatives.







Research
      and development costs incurred by type of project were as follows (in
      thousands):





(In
                thousands)
            
            **Three-Months
                Ended June 30,****2006**
            
            **2005**Internal
                development
            
            $
            320
            
            $
            509Collaborations
            
            
            670
            
            
            445$
            990
            
            $
            954








Research
      and development costs based upon type of cost were as follows (in
      thousands):





(In
                thousands)
            
            **Three-Months
                Ended****June
                30,****2006**
            
            **2005**Personnel
                related
            
            $
            195
            
            $
            276Laboratory
                and supplies
            
            
            24
            
            
            73Outside
                services
            
            
            670
            
            
            445Equipment
                and depreciation
            
            
            15
            
            
            98Facilities,
                overhead and other
            
            
            86
            
            
            62$
            990
            
            $
            954





**Selling
      and Marketing**





For
      the
      three-months ended June 30, 2006, selling and marketing expenses were
      approximately $813,000, or 20% of net sales, compared to approximately $617,000,
      or 15% of net sales for the three-months ended June 30,


28


2005,
      representing an increase of approximately $196,000. This increase is
      attributable to several factors, including an increase in salaries and wages
      of
      approximately $71,000, and increased travel and commission expense of
      approximately $73,000, due to the addition of seven employees in the latter
      half
      of 2005 including a Vice President of Sales & Marketing - Enzymes, and the
      addition of contract labor as well as technical sales representatives to our
      Asian subsidiary. These additions are a part of the substantial investment
      both
      in personnel and other initiatives we have made to expand our sales, marketing
      and product development efforts.





**General
      and Administrative**





For
      the
      three-months ended June 30, 2006, general and administrative expenses were
      approximately $2,077,000, or 52% of net sales, compared to approximately
      $1,437,000, or 36% of net sales for the three-months ended June 30, 2005,
      representing an increase of approximately $640,000. This increase is
      attributable to several factors, including an increase in salaries and wages
      of
      approximately $172,000 due to the addition of four new employees, including
      Dr.
      Glenn Nedwin, our Chief Scientific Officer and President of our BioSciences
      Business, approximately $286,000 in additional stock option compensation expense
      which is a result of the adoption of FAS No. 123(R), and approximately $175,000,
      related to changes in allocations of expenses between research and development
      and sales and marketing.





**Foreign
      Currency Exchange Gains (Losses), Net**




For
      the
      three-months ended June 30, 2006, the Company incurred a net foreign currency
      exchange loss of approximately $66,000 as compared to a net gain of
      approximately $39,000 for the three-months ended June 30, 2005. The $105,000
      change is the result of a shift in the proportion of sales transactions to
      expenditure transactions that are denominated in a foreign currency coupled
      with
      the timing of the settlement of the transactions. A large portion of our
      business is transacted with foreign customers and vendors in foreign currency
      denominations. Accordingly, fluctuations in foreign currency exchange rates,
      primarily relating to the Euro, can greatly impact the amount of foreign
      currency gains (losses) we recognize in future periods relating to these
      transactions. We do not, and have no current plans to, engage in foreign
      currency exchange hedging transactions.





**Other
      Income (Expense)**




*Interest
      Expense*




For
      the
      three-months ended June 30, 2006, interest expense was approximately $274,000
      as
      compared to approximately $176,000 for the three-months ended June 30, 2005,
      representing an increase of approximately $98,000. The increase is primarily
      due
      to the write off of the balance of beneficial conversion features related to
      the
      convertible stockholders notes payable of approximately $128,000, which were
      converted to common stock on May 1, 2006, and a reduction in interest from
      notes
      payable to stockholders of approximately $17,000.




*Investment Income, Net*




For
      the
      three-months ended June 30, 2006 and 2005, income from investments in money
      market funds was approximately $88,000 and $95,000, respectively. The decrease
      in income from investments in money market funds for the three-months ended
      June
      30, 2006 was attributable to maintaining lower cash balances, partially offset
      by increased yields due to higher interest rates.





*Provision
      for Income Taxes*




We
      have
      no provision for U.S. income taxes as we have incurred operating losses in
      all
      periods presented and provide full valuation allowances against the resulting
      tax benefits. For the three-months ended June 30, 2006, we had a foreign income
      tax provision of approximately $7,000 compared to approximately $16,000 for
      the
      three-months ended June 30, 2005, which is primarily attributable to our Asian
      subsidiary, which operates in Hong Kong and mainland China.







29


Results
      of Operations for the Six-Months
      Ended June 30, 2006 Compared to the Six-Months Ended June 30,
      2005




The
      following table sets forth the amount of increase or decrease represented by
      certain items reflected in the Company's condensed consolidated statements
      of
      operations in comparing the six-months ended June 30, 2006 to the six-months
      ended June 30, 2005 (in thousands):





**Six-Months
                Ended June 30,**(In
                thousands)
            
            **2006**
            
            **2005**
            
            **Increase
                (Decrease)**Net
                sales
            
            $
            7,795
            
            $
            7,722
            
            $
            73Cost
                of goods sold
            
            
            5,833
            
            
            6,196
            
            
            (363
            )Gross
                profit
            
            
            1,962
            
            
            1,526
            
            
            436Operating
                expenses:Research
                and development
            
            
            1,898
            
            
            2,509
            
            
            (611
            )Selling
                and marketing
            
            
            1,616
            
            
            1,186
            
            
            430General
                and administrative
            
            
            3,412
            
            
            2,899
            
            
            513Foreign
                currency exchange losses (gains), net
            
            
            97
            
            
            (37
            )
            
            1347,023
            
            
            6,557
            
            
            466Loss
                from operations
            
            
            (5,061
            )
            
            (5,031
            )
            
            30Other
                income (expense):Interest
                expense
            
            
            (448
            )
            
            (350
            )
            
            (98
            )Investment
                income, net
            
            
            190
            
            
            23
            
            
            167Minority
                interest
            
            
            (13
            )
            
            (11
            )
            
            (2
            )Other
                income (expense), net
            
            
            12
            
            
            (4
            )
            
            16Total
                other expense
            
            
            (259
            )
            
            (342
            )
            
            83Loss
                before income taxes
            
            
            (5,320
            )
            
            (5,373
            )
            
            53Provision
                for income taxes
            
            
            (33
            )
            
            (28
            )
            
            (5
            )Net
                loss
            
            $
            (5,353
            )
            $
            (5,401
            )
            $
            48




**Net
      Sales**





The
      following table reflects the Company’s net sales by industry for the six-month
      periods ended June 30, 2006 and 2005 (in thousands):




**Six-Months
                Ended June 30,**(In
                thousands)
            
            **2006**
            
            ****%**of Net
                Sales**
            ****
            **2005**
            ****
            ****%**of Net
              Sales**
            ****
            **Increase
                / (Decrease)**
            ****
            **%**Textile
            
            $
            5,343
            
            
            69
            %
            $
            5,826
            
            
            75
            %
            $
            (483
            )
            
            (8
            %)Animal
                Feed
            
            
            629
            
            
            8
            %
            
            550
            
            
            7
            %
            
            79
            
            
            14
            %Pulp
                & Paper
            
            
            1,201
            
            
            15
            %
            
            764
            
            
            10
            %
            
            437
            
            
            57
            %Others
                (5 industries)
            
            
            622
            
            
            8
            %
            
            507
            
            
            7
            %
            
            115
            
            
            23
            %Total
                Industrial Enzymes
            
            $
            7,795
            
            
            
            
            $
            7,647
            
            
            
            
            
            148
            
            
            2
            %Bioscience
            
            
            --
            
            
            0
            %
            
            75
            
            
            1
            %
            
            (75
            )
            
            100
            %Total
              Net Sales
            
            $
            7,795
            
            
            100
            %
            $
            7,722
            
            
            100
            %
            $
            73
            
            
            1
            %







30


For
      the
      six-months ended June 30, 2006, we generated net sales of approximately
      $7,795,000, compared to net sales of approximately $7,722,000 for the six-months
      ended June 30, 2005, an increase of approximately $73,000. This increase in
      net
      sales reflects the Company’s efforts to transition its revenue base from the
      lower margin textile enzymes to higher margin areas such as enzymes for the
      pulp
      and paper (a 57% increase over the 2005 comparable period), animal feed and
      other industries, which in the aggregate, represents an increase in net sales
      in
      these industries of 35% over sales for the six-months ended June 30, 2005 (or
      31% of net sales versus 24%). This increase is offset by the continuing margin
      pressure experienced in the textile industry and aggressive pricing by
      competitors which has created a strong downward pressure on pricing, and has
      caused the Company’s sales to the textiles market to decrease (69% vs. 75% for
      the six-months ended June 30, 2006 and 2005, respectively, as a percentage
      of
      net sales) as well as a decrease in Bioscience revenue during the six-month
      period ended June 30, 2006. The Company is not currently generating Bioscience
      revenues on a regular basis, but does anticipate some revenue in the latter
      half
      of 2006. There is no guarantee, however, that these revenues will be
      realized.


To
        what
        degree our net sales from the textiles market will continue to decline in
        the
        future will depend not only on that market’s dynamics, but also on the extent to
        which pricing pressure created by our competitors continues. Our success
        in
        developing new products and our ability to lower our production costs will
        also
        have an impact.  We believe our sales will resume growth when new products
        being developed from our C1 Host Technology and other technologies for new
        markets (e.g. pulp & paper, food and animal feed) begin to achieve
        penetration and other new products are introduced both to existing and other
        new
        markets. We have made and continue to make substantial investments both in
        personnel and other initiatives since November 2004 to expand our sales,
        marketing and product development efforts and in advancing our C1 host
        technology and other technologies. We continue to support our textile customers,
        directing the necessary resources to customer support and R&D innovation to
        maintain market share in this segment. To this end, we are launching eight
        new
        products into the Textile market in the third quarter of 2006. The Textile
        market is one of the core markets for our Enzyme Business
        and we expect that these products, which are the result of our continued
        research & development in support of this core market, will help to
        stabilize and ultimately enable us to recapture our market share. However,
        we
        intend to exercise discipline over the application of resources to the textiles
        market (which is characterized by low profit margins and intense competition)
        relative to other higher profit and larger market opportunities we identify,
        the
        initial effects of which are beginning to be seen. Nonetheless, the markets
        for
        a number of our new products are generally characterized by longer sales
        cycles
        for reasons relating to various factors, such as required governmental
        registration processes (e.g. food and animal feed enzymes in Europe) and
        required product trials at customers’ facilities of multi-month durations or
        longer (e.g. pulp & paper, starch, alcohol, ethanol), and we can, therefore,
        offer no guidance as to when, or if, these new products will penetrate those
        markets.


**Cost
      of Goods Sold**





For
      the
      six-months ended June 30, 2006, cost of goods sold was approximately $5,833,000,
      or 75% of net sales, as compared to approximately $6,196,000, or 80% of net
      sales for the six-months ended June 30, 2005. The improvement in cost of goods
      sold is a result of the shift in sales from the textile industry to higher
      margin industries such as pulp and paper, animal feed and others such as brewing
      and alcohol. In addition, during the six-months ended June 30, 2005, the Company
      recorded an increase in the inventory provision of approximately $295,000,
      with
      no comparable amount during the six-months ended June 30, 2006.




**Research
      and Development**




For
      the
      six-months ended June 30, 2006, research and development expenses were
      approximately 1,898,000, or 24% of net sales, as compared to approximately
      $2,509,000, or 32% of net sales for the six-months ended June 30, 2005,
      representing a decrease of approximately $611,000. In March 2005, we completed
      a
      genomic sequencing project with Agencourt Bioscience to sequence our C1 host
      organism, which contributed significantly to the higher expense in the six-month
      period ended June 30, 2005. With
      the
      completion of this project, we have begun to identify a large variety of novel
      commercially useful genes that were previously unavailable to us, which should
      greatly assist our ability to accelerate our product development efforts and
      further improve
      the efficiencies of our C1 Host Technology for making proteins and enzymes
      for
      diverse markets, including pharmaceuticals, textiles, pulp and paper, animal
      feed, and food. To more fully realize the potential of the genomic sequence,
      it
      will be necessary to annotate the genome.




31




On
      March
      31, 2006, we announced the engagement of The Scripps Research Institute to
      work
      with Dyadic scientists to provide a comprehensive annotation of the C1 genome. Over
      11,000 genes have been located and are in the process of being
      identified. This initial annotation was accomplished using a number of
      computer algorithms.  We are now beginning the process of further refining
      the computer-called genes through manual annotation.  As the
      annotation program progresses, we expect to build a comprehensive genetic and
      biochemical blueprint of C1 by  continually referencing our genomic data
      and data derived from the genome against databases of known genes, proteins,
      and
      metabolic pathways. We expect that the annotation will provide tools for
      identifying and classifying genes, their corresponding proteins, and metabolic
      pathways in a searchable and
      user-friendly format. These tools will allow us to identify additional
      commercial enzyme product leads, including improved cellulases and
      hemicellulases for use in textile, pulp and paper, food and animal feed
      applications, and for the production of ethanol from lignocellulosic biomass.
      We
      anticipate that annotation also will allow Dyadic to identify genes that
      influence the physiology of protein production in C1. Modification of these
      genes or their expression will lead to improvements in the C1 Expression and
      Screening Systems, making them more robust and versatile. Those improvements
      will likely lead to Systems able to produce a wider variety of proteins at
      higher yields and at lower cost. The annotation project is currently in progress
      and on schedule, and we have already begun to receive preliminary information
      on
      the genome structure of C1.




Another
      contributing factor to our decrease in R&D expense was the reduction in
      depreciation expense due to the full depreciation of certain R&D equipment
      at the end of 2005 which contributed approximately $183,000.





Research
      and development costs incurred by type of project were as follows (in
      thousands):





(In
                thousands)
            
            **Six-Months
                Ended****June
                30,****2006**
            
            **2005**Internal
                development
            
            $
            713
            
            $
            965Collaborations
            
            
            1,185
            
            
            1,544$
            1,898
            
            $
            2,509








Research
      and development costs based upon type of cost were as follows (in
      thousands):





(In
                thousands)
            
            **Six-Months
                Ended****June
                30,****2006**
            
            **2005**Personnel
                related
            
            $
            401
            
            $
            544Laboratory
                and supplies
            
            
            53
            
            
            107Outside
                services
            
            
            1,185
            
            
            1,544Equipment
                and depreciation
            
            
            20
            
            
            194Facilities,
                overhead and other
            
            
            239
            
            
            120$
            1,898
            
            $
            2,509





**Selling
      and Marketing**





For
      the
      six-months ended June 30, 2006, selling and marketing expenses were
      approximately $1,616,000, or 21% of net sales, compared to approximately
      $1,186,000, or 15% of net sales for the six-months ended June 30, 2005,
      representing an increase of approximately $430,000. This increase is
      attributable to several factors, including an increase in salaries and wages
      of
      approximately $193,000, and increased travel expense and commission of
      approximately $161,000, due to the addition of seven employees in the latter
      half of 2005 including a Vice President of Sales & Marketing - Enzymes, and
      the addition of contract labor as well as technical sales representatives to
      our
      Asian subsidiary. These additions are a part of the substantial investment
      both
      in personnel and other initiatives we have made to expand our sales, marketing
      and product development efforts.


32





**General
      and Administrative**





For
      the
      six-months ended June 30, 2006, general and administrative expenses were
      approximately $3,412,000, or 44% of net sales, compared to approximately
      $2,899,000, or 38% of net sales for the six-months ended June 30, 2005,
      representing an increase of approximately $513,000. This increase is
      attributable to several factors, including an increase in salaries and wages
      of
      approximately $315,000 due to the addition of four new employees, approximately
      $339,000 in additional stock option compensation expense which is a result
      of
      the adoption of FAS No. 123(R) and approximately $154,000 related to changes
      in
      allocations of expenses between research and development and sales and
      marketing.





**Foreign
      Currency Exchange Gains (Losses), Net**




For
      the
      six-months ended June 30, 2006, the Company incurred a net foreign currency
      exchange loss of approximately $97,000 as compared to a net gain of
      approximately $37,000 for the six-months ended June 30, 2005. The $134,000
      change is the result of a shift in the proportion of sales transactions to
      expenditure transactions that are denominated in a foreign currency coupled
      with
      the timing of the settlement of the transactions. A large portion of our
      business is transacted with foreign customers and vendors in foreign currency
      denominations. Accordingly, fluctuations in foreign currency exchange rates,
      primarily relating to the Euro, can greatly impact the amount of foreign
      currency gains (losses) we recognize in future periods relating to these
      transactions. We do not, and have no current plans to, engage in foreign
      currency exchange hedging transactions.





**Other
      Income (Expense)**




*Interest
      Expense*





For
      the
      six-months ended June 30, 2006, interest expense was approximately $448,000
      as
      compared to approximately $350,000 for the six-months ended June 30, 2005,
      representing an increase of approximately $98,000. The increase is primarily
      due
      to the write off of the balance of beneficial conversion features related to
      the
      convertible stockholders notes payable of approximately $128,000, which were
      converted to common stock on May 1, 2006, and a reduction in interest from
      notes
      payable to stockholders of approximately $17,000.




*Investment Income, Net*




For
      the
      six-months ended June 30, 2006 and 2005, income from investments in money market
      funds was approximately $190,000 and $23,000 respectively. The decrease in
      income from investments in money market funds for the six-months ended June
      30,
      2006 was attributable to maintaining lower cash balances, partially offset
      by
      increased yields due to higher interest rates.





*Provision
      for Income Taxes*




We
      have
      no provision for U.S. income taxes as we have incurred operating losses in
      all
      periods presented and provide full valuation allowances against the resulting
      tax benefits. For the six-months ended June 30, 2006, we had a foreign income
      tax provision of approximately $33,000 compared to approximately $28,000 for
      the
      six-months ended June 30, 2005, which is primarily attributable to our Asian
      subsidiary, which operates in Hong Kong and mainland China.




**Non-Cash,
      Share-Based Compensation Charges**




In
      January 2006 we adopted Financial Accounting Standards Board Statement (“FASB”),
      Statement of Accounting Standard (“SFAS”) No. 123(R), *Share-Based
      Payment,* which
      requires all share-based payments to employees and non-employee directors,
      including stock option grants, to be recognized in the statement of operations
      based on their fair values. Pro forma disclosure, which we previously used,
      is
      no longer an alternative.




Prior
      to
      January 1, 2006, we accounted for share-based employee compensation plans
      using the intrinsic value method of accounting in accordance with Accounting
      Principles Board Opinion, or APB, No. 25, *Accounting*


33




*for
      Stock Issued to Employees* (APB
      25),
      and its related interpretations. Under the provisions of APB 25, no compensation
      expense was recognized when stock options were granted with exercise prices
      equal to or greater than market value on the date of grant.




We
      recognized share-based compensation expense for our share-based awards of
      approximately $310,000 and $13,000 during the three-month periods ended June
      30,
      2006 and 2005, respectively, and approximately $441,000 and $21,000, for the
      six-month periods ended June 30, 2006 and 2005, respectively. Of these amounts,
      approximately $304,000 and $409,000 of employee stock option compensation
      expense was calculated under the provisions of SFAS 123(R) and is included
      in
      total share-based compensation for each of the three-month and six-month periods
      ended June 30, 2006, respectively. These charges had no impact on our reported
      cash flows. Share-based compensation expense was allocated among the following
      expense categories:





**Three-Months
                Ended June 30,**
            
            **Six-Months
                Ended June 30,****2006**
            
            **2005**
            
            **2006**
            
            **2005**General
                and administrative
            
            $
            274,337
            
            $
            6,800
            
            $
            372,005
            
            $
            12,917Research
                and development
            
            
            5,005
            
            
            6,341
            
            
            38,486
            
            
            7,904Cost
                of goods sold
            
            
            10,232
            
            
            --
            
            
            10,232
            
            
            --Selling
                and marketing
            
            
            20,589
            
            
            --
            
            
            20,733
            
            
            --$
            310,163
            
            $
            13,141
            
            $
            441,456
            
            $
            20,821




Under
      the
      modified prospective method of transition under SFAS 123(R), we are not required
      to restate our prior period financial statements to reflect expensing of
      share-based compensation under the new standard. Therefore, the results for
      the
      three-months and six-months ended June 30, 2006 are not comparable to the same
      periods in the prior year.





On
      December 15, 2005, our Board of Directors approved the acceleration of vesting
      for the unvested portion of all outstanding employee incentive stock options
      awarded from May 2001 to present under the 2001 Equity Plan, as amended. While
      the Company typically issues options that vest equally over four years, as
      a
      result of this vesting acceleration, stock options to purchase approximately
      1.2
      million shares of the Company’s common stock, of which approximately 600,000 are
      held by the Company’s executive officers and directors, became immediately
      exercisable. The exercise prices of the affected stock options range from $1.90
      to $5.93 and the closing price of the Company’s common stock on December 15,
      2005, was $1.75.




The
      purpose of the accelerated vesting was to provide a non-cash benefit to the
      Company’s employees and to eliminate future compensation expense we would
      otherwise recognize in our statements of operations with respect to these
      accelerated options upon the adoption of SFAS 123(R). The estimated future
      compensation expense associated with these accelerated options that would have
      been recognized in the Company’s statements of operations upon implementation of
      SFAS 123(R) is approximately $1.3 million.





**Liquidity
      and Capital Resources**





*Capital
      Raising Activities*




Since
      inception, the Company has financed operations primarily with proceeds from
      the
      sales of the products from its Enzyme Business, external borrowings, borrowings
      from its stockholders and sales of preferred and common equity
      securities




In
      November 2004, in accordance with Subscription Agreements and a Private Offering
      Memorandum in connection with the October 2004 Offering, the Company sold
      7,629,204 Investment Units, realizing gross proceeds of approximately
      $25,405,000. An Investment Unit consisted of one share of the Company's common
      stock and one five-year callable warrant to purchase one share of the Company's
      common stock at $5.50 per share for every two Investment Units purchased.
      Accordingly, 3,814,602 warrants to purchase the Company's common stock were
      issued to participants in the October 2004 Offering. Concurrently, the Company
      issued 711,050 warrants to purchase the Company's common stock at $5.50 per
      share to participants in the April 2004 Offering completed in July
      2004,


34


as
      well
      as 247,730 warrants to purchase the Company's common stock at $5.50 per share
      and 495,460 warrants to purchase the Company's common stock at $3.33 per share,
      both to placement agents in the October 2004 Offering.





Ancillary
      to the Merger and October 2004 Offering, in November 2004, an additional 367,868
      Investment Units were sold to Mark A. Emalfarb through the Mark A. Emalfarb
      Trust in exchange for the cancellation of the Company's note payable to the
      Mark
      A. Emalfarb Trust with a principal balance of $1,225,000. Incident
      to the Company’s completion of the Merger and the equity issuance transactions
      described above, a warrant
      to purchase 1.5 million shares of the Company's common stock issued in
      connection with the Bridge Loan (see Note 2 to our condensed consolidated
      financial statements) was modified to reduce the exercise price from $4.50
      to
      $3.33 per share. Additionally, the maturity date of this Bridge Loan was
      extended to January 1, 2007. As a result, approximately $343,000, representing
      the incremental fair value of the modified warrant as compared to the fair
      value
      of the original warrant immediately before the modification (determined using
      the Black-Scholes option pricing model, using the following assumptions:
      risk-free interest rate of 3.91%, dividend yield of 0%, expected volatility
      of
      50% and an expected remaining life of 8.6 years, the remaining term of the
      warrant) will be amortized to interest expense through the new maturity date.
      The estimated fair value of the original warrant had been fully amortized to
      interest expense during the year ended December 31, 2004.





On
      April
      30, 2006, the maturity date of the Bridge Loan was extended from January 1,
      2007
      to January 1, 2008. The remaining unamortized portion of $69,163 of the
      beneficial conversion feature related to the modified Bridge Loan Warrants will
      be amortized through the new maturity date.





As
      another incident to the Company’s completion of the Merger and the equity
      transactions described above ,
      the
      conversion prices with respect to the October 29, 2004 principal and accrued
      interest balances on the Emalfarb Trust Note and the Francisco Trust Note (see
      Note 2 to our condensed consolidated financial statements) were fixed at $3.33
      per share, and the due dates were extended to January 1, 2007. As a result
      of
      the modification of the conversion price, a beneficial conversion feature
      totaling approximately $554,000 was to be amortized to interest expense through
      the new maturity date.





On
      May 1,
      2006, the Emalfarb Trust received 251,298 shares of common stock upon the
      conversion in full of its convertible note which had combined principal and
      accrued interest of $836,824. The Francisco Trust received 222,537 shares of
      common stock upon the conversion in full of its convertible note which had
      combined principal and accrued interest of $741,048 as of May 1, 2006. As a
      result of the conversions, a total of approximately $1.6 million of notes
      payable to stockholders, bearing interest at 6% per annum was relieved. This
      represents a future annual reduction in interest expense of approximately
      $95,000. The balances of the related beneficial conversion features were fully
      expensed in April 2006 resulting in a one time adjustment of approximately
      $171,000 to interest expense.





*Cash
      Flow*




*Operating
      Activities*




As
      reflected in our condensed consolidated statements of cash flows, we have
      incurred losses from operations during the six-month periods ending June 30,
      2006 and 2005, resulting in net cash used in operating activities of
      approximately $7,248,000 and $5,764,000, respectively. The increase in net
      cash
      used in operating activities was primarily due to our net loss of approximately
      $5,353,000, Other contributing factors include: the temporary outlay of cash
      for
      Value Added Tax (VAT) of approximately $742,000 related to our operations in
      Poland, which we anticipate receiving payment on, and the historical buildup
      of
      our inventory levels in the first half of the year as a result of our contract
      manufacturer’s summer hiatus for vacation and maintenance, which will occur this
      year in August and part of September. During the six-month period ended June
      30,
      2006, we produced approximately $1,100,000 of additional inventory, which we
      intend to utilize during the latter half of the year, and in particular, the
      third quarter of 2006, which, in combination with reduced production, will
      result in reduced cash disbursements for raw materials. In addition, our
      accounts receivable balance increased by approximately $515,000, which was
      partially attributable to higher sales volumes toward the latter half of the
      second quarter of 2006 as compared to the fourth quarter of 2005, which is
      indicative of timing differences, not collectibility. Subsequent
      to


35


June
      30,
      2006 and through August 2, 2006, a significant portion of the June 30, 2006
      accounts receivable balance has been received.





*Investing
      Activities*





For
      the
      six-months ended June 30, 2006, net cash used in investing activities was
      approximately $746,000 as compared to approximately $203,000 for the six-months
      ended June 30, 2005, which relates to purchases of fixed assets of approximately
      $371,000 and $203,000 for the six-months ended June 30, 2006 and 2005,
      respectively. The increase was primarily due to the purchase of manufacturing
      equipment located at our contract manufacturer in Poland as well as asset
      additions due to the expansion of the Jupiter office. In addition, $375,000
      was
      paid to the minority shareholders of our Asian subsidiary as part of a purchase
      and settlement agreement (see Note 3 to the accompanying condensed consolidated
      financial statements).





*Financing
      Activities*




For
      the
      six-month periods ended June 30, 2005, our net cash used in financing activities
      was approximately $98,000, for payment of issuance costs related to the October
      2004 private offering. Net cash provided by financing activities for the
      six-months ended June 30, 2006 was approximately $5,846,000 form the exercise
      of
      stock options and warrants (see *Financial
      Condition and Liquidity at June 30, 2006* below).





*Financial
      Condition and Liquidity at June 30, 2006*





As
      of
      June 30, 2006, stockholders' equity was approximately $19,482,000 and we had
      a
      total of approximately $10,002,000 in cash and cash equivalents and restricted
      cash of approximately $35,000. Our outstanding indebtedness was approximately
      $2,477,000 as of June 30, 2006, and consisted of notes payable for Letter of
      Credit advances and the Bridge Loan.





During
      the three-months ended June 30, 2006, the Company has received an aggregate
      of
      approximately $5,846,000 in proceeds from the exercises of the following
      instruments: (i) warrants to purchase an aggregate of 495,460 shares of common
      stock, at an exercise price of $3.33 per share, (ii) warrants to purchase an
      aggregate of 594,642 shares of common stock for an exercise price of $5.50
      per
      share, (iii) stock options to purchase an aggregate of 163,250 shares of common
      stock, granted under the 2001 Equity Plan, with exercise prices ranging from
      $2.08 to $4.50 per share, and (iv) stock options to purchase an aggregate of
      65,000 shares of common stock, granted prior to the 2001 Equity Plan, with
      an
      exercise price of $4.50 per share. Subsequent to June 30, 2006 and through
      August 3, 2006, the Company has received approximately $214,000 of additional
      proceeds from further exercises of warrants and stock options.





On
      May 1,
      2006, the Company’s two largest stockholders, the Emalfarb Trust and the
      Francisco Trust U/A/D February 28, 1996 (the “Francisco Trust”), increased their
      stock ownership in the Company by 251,298 and 222,537 shares of common stock,
      respectively, as a result of converting in full their convertible promissory
      notes due January 1, 2007, at an exercise price of $3.33 per share. As a result
      of the conversions, a total of approximately $1,600,000 of notes payable to
      stockholders, bearing interest at 6% per annum was relieved. This represents
      a
      future annual reduction in interest expense of approximately $95,000. The
      balances of the related beneficial conversion features were fully expensed
      in
      April 2006 resulting in a one time adjustment of approximately $171,000 to
      interest expense. The Francisco Trust has as its beneficiaries the wife and
      children of Mark A. Emalfarb, the Chief Executive Officer, President and
      Chairman of the Company.





We
      are
      committed to make annual minimum payments under our operating leases aggregating
      approximately $368,500 for 2006, approximately $263,000 in 2007, approximately
      $72,000 in 2008, approximately $72,000 in 2009, and approximately $251,000
      thereafter. We also are committed to make annual minimum payments under our
      Polish contract manufacturing agreement of approximately $318,000 in 2006,
      approximately $310,000 in 2007 and approximately $101,000 in 2008. We have
      also
      entered into various agreements with independent third parties to conduct
      R&D activities on our behalf. One such agreement, entered into in July 2004,
      is with a third party to assist the Company in various research and development
      projects, for a total of $1.8 million in services, over the 26-month period
      ending September 30, 2006, which has been extended to December 31, 2006. Under
      the Development Agreement, the Company is required to utilize, and the third
      party has committed to provide


36


research
      and development assistance valued at approximately $1.25 million. The
      consideration for these services includes 300,300 shares of the Company's common
      stock, and cash, $250,000 of which was paid upon execution of the Development
      Agreement and the remaining $550,000 is being paid pro rata on a monthly basis
      over the term of the agreement. Pursuant to the Development Agreement, the
      300,300 shares of common stock were placed in escrow and are being issued to
      the
      third party as earned during the contractual period, at which time they will
      be
      deemed to be outstanding. At June 30, 2006, 77,761 shares of common stock were
      earned and are outstanding for services rendered under this agreement. The
      Development Agreement imposes cash penalties upon the third party in the event
      of nonperformance under the Development Agreement, beyond the forfeiture of
      any
      shares of common stock placed in escrow.





*Funding
      of Future Operations*




We
      believe that our operating losses will continue in 2006. In addition, our future
      capital requirements will be substantial. We believe that we will have
      sufficient capital to fund our operations and meet our obligations for the
      next
      twelve months, based on current sales volumes and proceeds from the recent
      warrant and stock option exercises. The
      Company currently has a Value Added Tax (VAT) receivable of approximately $1.08
      million related to its operations in Poland that it anticipates receiving
      payment on, and which is included in prepaid expenses and other current assets
      in the accompanying condensed consolidated balance sheet. We have
      historically built up our inventory levels in the first half of the year as
      a
      result of our contract manufacturer’s summer hiatus for vacation and
      maintenance, which will occur this year in August and part of September. During
      the six-month period ended June 30, 2006, we produced approximately $1,100,000
      of additional inventory, which we intend to utilize during the latter half
      of
      the year, and in particular, the third quarter of 2006, which, in combination
      with reduced production, will result in reduced cash disbursements for raw
      materials. Our accounts receivable balance increased by approximately $515,000,
      which was partially attributable to higher sales volumes toward the latter
      half
      of the second quarter of 2006 as compared to the fourth quarter of 2005, which
      is indicative of timing differences, not collectibility. Subsequent to June
      30,
      2006 and through August 2, 2006, a significant portion of the June 30, 2006
      accounts receivable balance has been received.





We
      have
      established a number of flexible contractual relationships in the areas of
      manufacturing and research and development, enabling us to adjust spending
      in
      those areas as necessary, to achieve the objectives of our business plan, and
      manage both our resources and cash utilization rate. It is possible that we
      will
      seek additional financing within this timeframe. We have historically funded
      losses from operations with proceeds from external borrowings, borrowings from
      our stockholders, and sales of preferred and common equity securities. We may
      raise additional funds through public or private financings, exercise or
      conversion of equity instruments, collaborative relationships, licensing or
      selling of certain technologies or other arrangements. Additional funding,
      if
      sought, may not be available at all, or may not be available on terms acceptable
      to us. Further, any additional equity financing may be dilutive to stockholders,
      and debt financing, if available, may involve restrictive covenants. Our failure
      to raise capital when needed may harm our business and operating results.





***Off-Balance
      Sheet Arrangements***




We
      do not
      have any off-balance sheet arrangements .





ITEM
      3.
      CONTROLS AND PROCEDURES





(a)
      Evaluation of Disclosure Controls and Procedures





As
      required by Rule 13a-15 under the Securities Exchange Act of 1934, as of the
      end
      of the period covered by this Quarterly Report, the Company carried out an
      evaluation under the supervision and with the participation of the Company’s
      management, including the Company’s Chief Executive Officer and Chief Financial
      Officer, of the effectiveness of the design and operation of the Company’s
      disclosure controls and procedures.  Based upon that evaluation, the Chief
      Executive Officer and Chief Financial Officer concluded that the Company’s
      disclosure controls and procedures were effective as of June 30,
      2006.





(b)
      Changes in Internal Controls


37


There
      were no changes in the Company's internal controls over financial reporting
      identified in connection with the evaluation required by paragraph (d) of
      Exchange Act Rules 13a-15 and 15d-15 that occurred during the quarter ended
      June
      30, 2006 that have materially affected, or are reasonably likely to materially
      affect, the Company's internal control over financial reporting.




**PART
      II. OTHER INFORMATION**





ITEM
      4.
 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS




Dyadic’s
      2006 annual meeting of stockholders was held on June 12, 2006 at the Doubletree
      Hotel located at 4431 PGA Boulevard, Palm Beach Gardens, Florida to vote
      on (1) the election of two Class II directors, each for a three-year
      term ending in 2009; (2) the approval of the Amended and Restated Dyadic
      International, Inc. 2001 Equity Compensation Plan effective as of January 1,
      2005 in order to (a) reduce the number of shares of common stock reserved for
      issuance under the Plan to 4,478,475 shares from 5,152,447 shares, (b) conform
      certain provisions of the Plan to the requirements of Section 409A of the
      Internal Revenue Code of 1986, as amended, and (c) increase the maximum
      limitation of shares that may be subject to awards granted under the Plan to
      any
      one individual for any fiscal year during the term of the Plan to 1,200,000
      shares from 100,000 shares; (3) the approval of the Dyadic International, Inc.
      2006 Stock Option Plan; and (4) the ratification of the appointment of Ernst
      & Young LLP as Dyadic’s independent registered public accounting firm for
      the year ending December 31, 2006.




Proxies
      for the annual meeting were solicited pursuant to Regulation 14A under the
      Securities Exchange Act of 1934, as amended, and there was no solicitation
      in
      opposition to Dyadic’s solicitation.  The holders of record of an
      aggregate of 17,989,641 shares of Dyadic’s common stock, out
      of 23,140,467 shares outstanding on the record date (April 26, 2006)
      for the annual meeting, were present either in person or by proxy, and
      constituted a quorum for the transaction of business at the annual
      meeting.




All
      nominees for Class II director were elected, each of the 2001 Equity
      Compensation Plan and the 2006 Stock Option Plan were approved by stockholders
      and the appointment of Ernst & Young LLP was ratified by stockholders, with
      voting as detailed below:




1-Election
      of Class II Directors:




Director
                Nominee
            
            For
            
            Withheld
            
            AbstentionsStephen
                J. Warner
            
            
            17,833,563
            
            
            75,714
            
            
            4,900Harry
                Z. Rosengart
            
            
            17,833,813
            
            
            75,464
            
            
            4,900





2-Approval
      of the Amended and Restated Dyadic International, Inc. 2001 Equity Compensation
      Plan:





For
            
            Against
            
            Abstentions
            
            Broker
                Non-Votes13,873,525
            
            
            135,939
            
            4,478
            
            
            3,907,535








3-Approval
      of the Dyadic International, Inc. 2006 Stock Option Plan:





For
            
            Against
            
            Abstentions
            
            Broker
                Non-Votes13,649,228
            
            361,496
            
            3,218
            
            3,907,535





4-Ratification
      of the Appointment of Ernst & Young LLP:





For
            
            Against
            
            Abstentions17,892,006
            
            22,164
            
            7









38


ITEM
      6.
      EXHIBITS





**A)**
            **Index
                to Exhibits**


Exhibits
            Description
                of Documents31.1
            Certification
                of Chief Executive Officer pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002 (1)31.2
            Certification
                of Chief Financial Officer pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002 (1)32.1
            Certification
                of Chief Executive Officer required by 18 U.S.C. Section 1350 (as
                adopted
                pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)
                (1)32.2
            Certification
                of Chief Financial Officer required by 18 U.S.C. Section 1350 (as
                adopted
                pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)
                (1)


(1)
            Filed
                herewith.

















SIGNATURES





In
      accordance with the requirements of the Exchange Act, Dyadic International,
      Inc.
      caused this report to be signed on its behalf by the undersigned, thereunto
      duly
      authorized.








DYADIC
                INTERNATIONAL, INC.(Registrant)Date:
                August 11, 2006
            By:
                /s/ Mark A. EmalfarbMark
                A. EmalfarbChief
                Executive OfficerDate:
                August 11, 2006
            By:
                /s/ Wayne MoorWayne
                MoorChief
                Financial Officer














39