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 March31, 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 May
        15, 2006, there were 24,276,585 shares of registrant’s common stock outstanding,
        par value $.001 (including 257,378 shares held in escrow).
 
 Transitional
        Small Business Disclosure Format (Check One): Yes { }; No {X}
 *Table
            of Contents*
  
 
 **TABLE
        OFCONTENTS**
 
 
 
 
 **PART
                  I. FINANCIAL INFORMATION**
              
              PageItem
                  1.
              Financial
                  Statements (Unaudited)Condensed
                  Consolidated Balance Sheet - March 31,
                  2006
              3Condensed
                  Consolidated Statements of Operations - Three-Months
                  ended March 31, 2006 and 2005
              4Condensed
                  Consolidated Statements of Cash Flows -
                  Three-Months ended March 31, 2006 and 2005
              5Notes
                  to Condensed Consolidated Financial
                  Statements
              6Item
                  2.
              Management's
                  Discussion and Analysis or Plan of
                  Operation
              16Item
                  3.
              Controls
                  and Procedures
              27**PART
                  II. OTHER INFORMATION**Item
                  6.
              Exhibits
              28Signatures
              28
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  **2**
 *Table
            of Contents*
 **PART
        I. FINANCIAL INFORMATION**
 ***Item
        1. FinancialStatements
        (Unaudited)***
 
 **Dyadic
        International, Inc.**
 **Condensed
        Consolidated Balance Sheet**
 **March
        31, 2006**
 **(Unaudited)**
 AssetsCurrent
                  assets:Cash
                  and cash equivalents
              
              $
              9,104,190Restricted
                  cash
              
              
              34,658Accounts
                  receivable, net of allowance for uncollectible accounts of
                  $523,326
              
              
              2,788,882Inventory
              
              
              5,952,959Prepaid
                  expenses and other current assets
              
              
              1,030,927Total
                  current assets
              
              
              18,911,616Fixed
                  assets, net
              
              
              1,787,766Intangible
                  assets, net
              
              
              135,143Goodwill
              
              
              467,821Other
                  assets
              
              
              121,038Total
                  assets
              
              $
              21,423,384Liabilities
                  and stockholders’ equityCurrent
                  liabilities:Accounts
                  payable
              
              $
              2,689,922Accrued
                  expenses
              
              
              1,100,027Accrued
                  interest payable to stockholders
              
              
              143,592Current
                  portion of notes payable to stockholders
              
              
              1,557,960Short
                  term notes payable
              
              
              104,250Income
                  taxes payable
              
              
              54,269Total
                  current liabilities
              
              
              5,650,020Long-term
                  liabilities:Notes
                  payable to stockholders, net of current portion
              
              
              2,338,487Other
                  liabilities
              
              
              111,471Minority
                  interest
              
              
              104,556Total
                  long-term liabilities
              
              
              2,554,514Total
                  liabilities
              
              
              8,204,534Stockholders’
                  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 - 22,467,577
              
              
              22,468Additional
                  paid-in capital
              
              
              49,763,907Notes
                  receivable from exercise of stock options
              
              
              (212,500
              )Accumulated
                  deficit
              
              
              (36,355,025
              )Total
                  stockholders’ equity
              
              
              13,218,850Total
                  liabilities and stockholders’ equity
              
              $
              21,423,384
 
 *See
        accompanying notes.*
 **3**
 *Table
            of Contents*
 
 **Dyadic
        International, Inc.**
 **Condensed
        Consolidated Statements of Operations**
 **(Unaudited)**
 
 **Three
                  Months Ended****March
                  31,****2006**
              
              **2005**Net
                  sales
              
              $
              3,825,756
              
              $
              3,734,360Cost
                  of goods sold
              
              
              2,940,383
              
              
              2,984,756Gross
                  profit
              
              
              885,373
              
              
              749,604Expenses:Research
                  and development
              
              
              907,679
              
              
              1,568,006Sales
                  and marketing
              
              
              802,930
              
              
              569,431General
                  and administrative
              
              
              1,334,569
              
              
              1,449,322Foreign currency exchange losses (gains), net
              
              
              31,261
              
              
              (61,262
              )Total
                  expenses
              
              
              3,076,439
              
              
              3,525,497Loss
                  from operations
              
              
              (2,191,066
              )
              
              (2,775,893
              )Other
                  income (expense):Interest expense
              
              
              (173,954
              )
              
              (173,402
              )Investment (loss) income, net
              
              
              102,034
              
              
              (71,259
              )Minority interest
              
              
              (663
              )
              
              (7,424
              )Other expense, net
              
              
              (58,050
              )
              
              (68,010
              )Total
                  other expense
              
              
              (130,633
              )
              
              (320,095
              )Loss
                  before income taxes
              
              
              (2,321,699
              )
              
              (3,095,988
              )Provision
                  for income taxes
              
              
              25,609
              
              
              12,307Net
                  loss
              
              $
              (2,347,308
              )
              $
              (3,108,295
              )Net
                  loss per common share:Basic and Diluted
              
              $
              (0.10
              )
              $
              (0.14
              )Weighted
                  average common shares used in
                calculating net loss per share:Basic and diluted
              
              
              22,431,596
              
              
              21,934,583
 
  *See
        accompanying notes.*
 **4**
 *Table
            of Contents*
  **Dyadic
        International, Inc.**
 **Condensed
        Consolidated Statements of Cash Flows**
 **(Unaudited)**
 
 **Three-Months
                  Ended March 31,****2006**
              
              **2005****Operating
                  activities**Net
                  loss
              
              $
              (2,347,308
              )
              $
              (3,108,295
              )Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:Depreciation
                  and amortization of fixed assets
              
              
              58,021
              
              
              120,954Amortization
                  of intangible and other assets
              
              
              13,032
              
              
              22,533Amortization
                  of costs related to modification of notes payable to
                  stockholder
              
              
              92,784
              
              
              92,785Minority
                  interest
              
              
              663
              
              
              7,424(Reversal
                  of) provision for doubtful accounts
              
              
              (6,331
              )
              
              7,200Stock
                  issued to officer
              
              
              50,000
              
              
              --Stock
                  issued for consulting services
              
              
              112,756
              
              
              3,740Compensation
                  expense on stock option grants
              
              
              131,293
              
              
              7,680Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              86,616
              
              
              1,036Inventory
              
              
              (539,401
              )
              
              (105,036
              )Prepaid
                  expenses and other current assets
              
              
              (226,299
              )
              
              117,226Other
                  assets
              
              
              11,241
              
              
              (952
              )Accounts
                  payable
              
              
              78,074
              
              
              (29,293
              )Accrued
                  expenses
              
              
              (114,208
              )
              
              (28,657
              )Accrued
                  interest payable to stockholders
              
              
              963
              
              
              (45,611
              )Income
                  taxes payable
              
              
              163
              
              
              (2,763
              )Short
                  term notes payable
              
              
              (163,340
              )
              
              --Other
                  liabilities
              
              
              4,786
              
              
              (1,358
              )Total
                  adjustments
              
              
              (409,187
              )
              
              166,908Net
                  cash used in operating activities
              
              
              (2,756,495
              )
              
              (2,941,387
              )**Investing
                  activity**Purchases
                  of fixed assets
              
              
              (289,163
              )
              
              (34,455
              )Net
                  cash used in investing activity
              
              
              (289,163
              )
              
              (34,455
              )**Financing
                  activity**Payment
                  for issuance costs related to private offering
              
              
              --
              
              
              (97,764
              )Net
                  cash used in financing activity
              
              
              --
              
              
              (97,764
              )Net
                  decrease in cash and cash equivalents
              
              
              (3,045,658
              )
              
              (3,073,606
              )Cash
                  and cash equivalents at beginning of period
              
              
              12,149,848
              
              
              20,510,650Cash
                  and cash equivalents at end of period
              
              $
              9
                  ,104,190
              
              $
              17,437,044**Supplemental
                  cash flow information:**Cash
                  paid for interest
              
              $
              80,201
              
              $
              137,410Cash
                  paid for income taxes
              
              $
              2,140
              
              $
              24,093
 
 *See
        accompanying notes.*
 **5**
 *Table
            of Contents*
 **Dyadic
        International, Inc.**
 **Notes
        toCondensed Consolidated Financial
        Statements**
 **March
        31, 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
        biological products using a number of proprietary fungal strains to produce
        enzymes and other biomaterials, principally focused on a system for protein
        production based on the patented Chrysosporium lucknowense fungus, known
        as C1.
        Dyadic is applying its technologies to produce enzymes for use in converting
        various agricultural products (e.g. corn) and waste products (e.g. switch
        grass,
        wheat straw, sugar cane bagasse, etc.) 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. Dyadic's C1 technology also is
        being
        developed to facilitate the discovery, development and large-scale production
        of
        human antibodies and other high-value therapeutic proteins. Dyadic currently
        sells more than 45 liquid and dry enzyme products to more than 200 industrial
        customers in approximately 50 countries for the textile, pulp and paper and
        animal feed industries.
 
 *Basis
        of Presentation*
 
 The
        accompanying unaudited condensed consolidated financial statements have been
        prepared in accordance with accounting principles generally accepted in the
        United States 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 accounting principles generally accepted in the United States
        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 period ended March 31,
        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 $36.4 million as
        of
        March 31, 2006. The Company attributes these operating results to, among
        other
        things, negative trends in the textile enzymes sector, expansion of its
        operations, establishment of new affiliates, and increased research and
        development 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 has established a number of flexible partnerships 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 favorable 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.
  **6**
 *Table
            of Contents*
 
 *Recent
        Accounting Pronouncements*
 
 In
        May
        2005, the
        Financial Accounting Standards Board (FASB) issued Statement
        of Financial Accounting Standards (SFAS) No. 154, *Accounting
        Changes and Error Corrections-a replacement of APB Opinion No. 20 and FASB
        Statement No. 3* (SFAS
        154).  This Statement replaces APB Opinion No. 20, *Accounting
        Changes* ,
        and
        SFAS No. 3, *Reporting
        Accounting Changes in Interim Financial Statements* ,
        and
        changes the requirements for the accounting for and reporting of a change
        in
        accounting principle and error corrections.  This Statement applies to all
        voluntary changes in accounting principle.  It also applies to changes
        required by an accounting pronouncement in the unusual instance that the
        pronouncement does not include specific transition provisions.  When a
        pronouncement includes specific transition provisions, those provisions should
        be followed.  SFAS 154 is effective for accounting changes and corrections
        of errors made in fiscal years beginning after December 15, 2005.  Earlier
        application was permitted for accounting changes and corrections of errors
        made
        occurring in fiscal years beginning after September 1, 2005.  The
        Company addopted this standard on January 1, 2006. The
        adoption of this standard did not have a significant impact on the Company’s
        consolidated financial position, results of operations or cash
        flows.
 
 In
        March
        2005, the FASB issued Interpretation No. 47,  *Accounting
        for Conditional Asset Retirement Obligations* (FIN
        47). The document is an interpretation of FASB Statement 143, *Asset
        Retirement Obligations* ,
        which
        was issued in June 2001. The FASB issued the Interpretation to address diverse
        accounting practices that have developed with regard to the timing of liability
        recognition for legal obligations associated with the retirement of a tangible
        long-lived asset in which the timing and (or) method of settlement are
        conditional on a future event that may or may not be within the control of
        the
        entity. According to the Interpretation, uncertainty about the timing and
        (or)
        method of settlement of a conditional asset retirement obligation should
        be
        factored into the measurement of the liability when sufficient information
        exists. FIN 47 also clarifies when an entity would have sufficient information
        to reasonably estimate the fair value of an asset retirement obligation.
        FIN 47
        was effective no later than the end of fiscal years ending after December
        15,
        2005 (December 31, 2005, for calendar year-end companies). The Company addopted
        this standard on January 1, 2006. The adoption of this standard did not have
        a
        significant impact on the Company’s consolidated financial position, results of
        operations or cash flows.
 
 As
        discussed in Note 3 *,* Share-Based
        Compensation, the Company adopted FASB No. 123(R) effective January 1,
        2006 under the “modified prospective” method. The Company recorded $131,293 in
        stock based compensation during the first quarter of 2006, and estimates
        that,
        based on current share-based awards granted to date, share-based compensation
        expense for fiscal 2006 will be approximately $1.2 million.
 
 *Use
        of Estimates*
 
 The
        preparation of condensed consolidated financial statements in conformity
        with
        accounting principles generally accepted in the United States 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.
 
 *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.
 
 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
                  Ended March 31,****2006**
              
              **2005**Instruments
                  to purchase common stock:Stock
                  options outstanding pursuant to the 2001 EquityCompensation
                  Plan
              
              
              2,810,361
              
              
              1,395,389Other
                  stock options
              
              
              65,000
              
              
              65,000Warrants
                  outstanding
              
              
              6,952,776
              
              
              6,952,776Common
                  stock issuable pursuant to conversion features:Subordinated
                  convertible notes payable
              
              
              473,835
              
              
              473,835Total
                  shares of common stock considered anti-dilutive
              
              
              10,301,972
              
              
              8,887,000
 **7**
 *Table
            of Contents*
 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 257,378 and 300,300 shares are also excluded from the calculation of
        diluted net income (loss) per share for the three-months ended March 31,
        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 March 31, 2006, 42,922 shares have been earned and are
        outstanding. None were earned or outstanding at March 31, 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
        March
        31, 2006, inventory consisted of the following:
 
 Finished
                  goods
              
              $
              4,538,862Raw
                  materials
              
              
              1,414,097Total
                inventory
              
              $
              5,952,959
 
 *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. Sales 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.
 
 *Research
        and Development*
 
 Research
        and development costs related to both present and future products are charged
        to
        operations when incurred. 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 periods
        ended March 31, 2005 and 2006.
 
 *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.
  *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.
 **8**
 *Table
            of Contents*
 **2.
        Notes Payable to Stockholders**
 
 Notes
        payable to stockholders consist of the following at March 31, 2006:
  **Current
                  portion of notes payable to stockholders:**Unsecured
                  convertible note payable to Mark A. Emalfarb Trust (Emalfarb Trust
                  Note)with
                  a rate of 6%, in the original principal amount of $750,766, dated
                  May
                  2001,
                principal
                  and accrued interest due January 1, 2007. Conversion price of $3.33.Accrued
                  interest of $86,058 included in principal balance. Net of unamortizedbeneficial
                  conversion feature of $101,763. (1)
              
              $
              735,061Unsecured
                  convertible note payable to Francisco Trust u/a/d February 28,
                  1996 (theFrancisco
                  Trust) (Francisco Trust Note) with a rate of 6%, in the original
                  principal
                amount
                  of $664,839, dated May 2001, principal and accrued interest due
                  January1,
                  2007. Conversion price of $3.33. Accrued interest of $76,209 included
                  inprincipal
                  balance. Net of unamortized beneficial conversion feature of $90,135.
                  (1)
              
              
              650,913Subordinated
                  notes payable to the minority stockholders of a subsidiary, interest
                  at aweighted
                  average rate of 6.0% as of March 31, 2006, no fixed prepaymentterms,
                  classified as current (2)
              
              
              171,986$
              1,557,960**Long
                  term note payable to stockholder:**Loan
                  payable with a rate of 8% as of March 31, 2006 to Mark A. Emalfarb
                  Trust(Bridge
                  Loan), secured by all assets of the Company, in the original principalamount
                  of $3,000,000, principal and accrued interest due January 1, 2008.Accrued
                  interest of $239,941 included in principal balance. Net of unamortizedbeneficial
                  conversion feature of $86,454.
              
              $
              2,338,487(1)
                  On May 1, 2006, the Emalfarb Trust Note and the Francisco Trust
                  Note were
                  converted in full into 251,298 and 222,537 shares of common stock,
                  respectively.(2)
                  On April 28, 2006, the notes payable to the minority stockholders
                  were
                  paid in full, including all accrued interest, as part of a satisfaction
                  and purchase agreement between the Company, its Asian subsidiary
                  and the
                  minority stockholders.
 
 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 provate placement of our common stock and warrants through
        which
        we raised gross proceeds of approximately $25,405,000 (the "October 2004
        offering"), approximately $903,000 of the proceeds from the October 2004
        Offering 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 $86,454 is reflected as a reduction of notes payable to stockholders
        in the accompanying condensed consolidated balance sheet as of March 31,
        2006.
        Approximately $29,000 was amortized to interest expense during each of the
        three-month periods ended March 31, 2006 and 2005, respectively. Interest
        expense on the Bridge Loan excluding the amortization of the beneficial
        conversion feature, was approximately $48,000 for each of the three-month
        periods ended March 31, 2006 and 2005, respectively.
  **9**
 *Table
            of Contents*
  On
          April 30, 2006, the maturity date of the Bridge Loan
          was extended from January 1, 2007 to January 1, 2008.
  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 will be
        amortized to interest expense through the new maturity date. The remaining
        unamortized portion of $191,898 is reflected as a reduction of notes payable
        to
        stockholders in the accompanying condensed consolidated balance sheet as
        of
        March 31, 2006. Approximately $64,000 was amortized to interest expense during
        each of the three-month periods ended March 31, 2006 and 2005,
        respectively.
 
 Interest
        expense on the convertible notes payable was approximately $23,000 for each
        of
        the three-month periods ended March 31, 2006 and 2005, respectively. The
        notes
        payable and accrued interest due on the convertible notes payable are
        convertible in whole or part into shares of the Company's common stock at
        any
        time, at a conversion price of $3.33.
 
 On
        May 1,
        2006, the Emalfarb Trust received 251,298 shares of common stock upon the
        conversion in full of its convertible promissory note which had combined
        principal and accrued interest of $836,824 as of May 1, 2006. The Francisco
        Trust received 222,537 shares of common stock upon the conversion in full
        of its
        convertible promissory note which had combined principal and accrued interest
        of
        $741,048 as of May 1, 2006.
  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.
  Interest
        expense on the subordinated notes payable to the minority stockholders of
        a
        subsidiary was approximately $2,500 for each of the three-month periods ended
        March 31, 2006 and 2005, respectively. Accrued interest of $72,414 is included
        in accrued interest payable to stockholders as of March 31, 2006.
 
 **3.
        Share-Based Compensation**
  In
        January 2006, the Company adopted SFAS No. 123(R), *Share-Based
        Payment,* which is
        a revision of SFAS No. 123, *Accounting
        for Share-based Compensation* .
        SFAS
        No. 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 No. 123(R) is similar to the approach described
        in SFAS No. 123. However, SFAS No. 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 No. 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 No. 123
        and
        share-based payments granted after December 31, 2005, based on the grant
        date
        fair value estimated in accordance with the provisions of SFAS No. 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 “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 123R. The estimated future
        compensation expense associated with these accelerated options that would
        have
        been recognized in the Company’s statements of
 **10**
 *Table
            of Contents*
  operations
        upon implementation of SFAS 123R is approximately $1.3 million. All option
        grants made on and after January 1, 2006 will be accounted for in accordance
        with SFAS 123R.
  The
        Company’s Equity Plan is considered to be a compensatory plan under SFAS No.
        123(R).
  ***Description
        of Equity 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 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 Equity Plan. Under
        the
        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 Equity Plan. In addition to stock options and stock grants,
        the 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
        Company recognized approximately $131,000 and $8,000 in share-based compensation
        expense for its share-based awards during the three-month periods ended March
        31, 2006 and 2005, respectively. Of
        these
        amounts, approximately $105,000 of employee stock option compensation expense
        was calculated under the provisions of FAS 123(R) and is included in total
        share-based compensation for the three-month period ended March 31, 2006.These charges had no impact on the Company’s reported cash flows.
        Share-based compensation expense was allocated among the following expense
        categories:
  **Three-Months
                  Ended March 31****2006**
              
              **2005**Research
                  and development
              
              $
              78,789
              
              $
              1,104Selling
                  and marketing
              
              
              144
              
              
              --General
                  and administrative
              
              
              52,360
              
              
              6,576$
              131,293
              
              $
              7,680
 
 Under
        the
        modified prospective method of transition under FASB No. 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 ended March 31, 2006 are not comparable to the
        same
        period in the prior year.
  The
        Company has determined its share-based compensation expense under FASB No.
        123(R) for the three-months ended March 31, 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 (“BS”) for
        options granted after December 31, 2005, determined using the single option
        approach under the BS valuation model. The fair value of options determined
        under FASB No. 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 ended March 31, 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 for future operations and
        expansion.
  **Average
                  Risk-Free Interest Rate**
              **Dividend
                  Yield**
              **Average
                  Volatility Factor**
              **Average
                  Option Life**4.66%
              0%
              66%
              5
                  Yrs
  **11**
 *Table
            of Contents*
  ***Equity
          Incentive Awards Activity***
  Information
          with respect to the Company’s Equity Plan and grants of 65,000 options to
          nonemployees prior to the Equity Plan's adoption is as follows:
 
 **Shares**
              
              **Weighted
                  Average Exercise Price Per Share**
              
              **Aggregate
                  Intrinsic Value**Outstanding
                  at December 31, 2005
              
              
              1,662,639
              
              $
              3.61
              
              $
              --Granted
              
              
              1,214,222
              
              
              4.56
              
              
              --Exercised
              
              
              --
              
              
              --
              
              
              --Cancelled
              
              
              (1,500
              )
              
              4.11
              
              
              --Outstanding
                  at March 31, 2006
              
              
              2,875,361
              
              $
              4.01
              
              $
              1,925,188Exercisable
                  at March 31, 2006
              
              
              1,536,443
              
              $
              3.65
              
              $
              1,581,067
 
 The
        weighted average grant date fair value of options granted during the
        three-months ended March 31, 2006 was $2.48 per share.
 
 A
        further
        detail of the options outstanding as of March 31, 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
              454,417
              4.44
              $
                  2.45
              302,604
              $
                  2.452.96 - 3.80
              1,209,161
              1.36
              3.23
              716,839
              3.384.39 - 5.93
              1,211,783
              2.27
              5.38
              517,000
              4.722,875,361
              2.23
              $
                  4.01
              1,536,443
              $
                  3.65
  ***Unrecognized
        Share-Based Compensation Expense***
  As
        of
        March 31, 2006, there was $2.8 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 1.9 years as follows:
  (in
                  thousands)Fiscal
                  Year 2006 (April 1, 2006 to December 31, 2006)
              
              $
              871Fiscal
                  Year 2007
              
              
              1,076Fiscal
                  Year 2008
              
              
              488Fiscal
                  Year 2009
              
              
              331Fiscal
                  Year 2010
              
              
              66$
              2,832
 **12**
 *Table
            of Contents*
  ***Prior
        Year Quarter Pro forma Disclosure of Share-Based Compensation Expense***
  The
        following table sets forth the pro forma disclosure of the Company’s net loss
        and net loss per share for the prior year quarter assuming the estimated
        fair
        value of the options were calculated pursuant to SFAS No. 123 and amortized
        to
        expense over the option-vesting period:
 **March
                  31, 200****5**Net
                  loss applicable to holders of common stock, as reported for basic
                  and
                  diluted calculations
              
              $
              (3,108,295
              )Deduct:
                  Total share-based employee compensation expense determined under
                  fair
                  value based method for all awards
              
              
              (74,080
              )Pro
                  forma net loss applicable to holders of common stock, basic and
                  dilutedcalculations
              
              $
              (3,182,375
              )Basic
                  and diluted net loss per common share, as reported
              
              $
              (0.14
              )Basic
                  and diluted pro forma net loss per common share
              
              $
              (0.15
              )Weighted
                  average fair value per option granted during the period1
              
              $
              1.76Assumptions:Average
                  risk free interest rate
              
              
              3.74
              %Average
                  volatility factor
              
              
              50
              %Expected
                  dividend yield
              
              
              0
              %Expected
                  life (in years)
              
              
              5.00
 1 A
        BS
        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 No. 123.
 
 ***Common
        Stock Issuances***
 
 On
        March
        22, 2006, the Company issued under the Equity Plan, 11,990 shares of common
        stock to Glenn E. Nedwin, Ph.D. the Company’s Chief Scientific Officer,
        Executive Vice President, President of the BioSciences Business and a director,
        as a signing bonus per his employment agreement. The shares were valued at
        $50,000 based on the fair market value of the Company’s common stock on the date
        of grant.
 
 During
        the first quarter of 2006, the Company issued 35,399 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 will be 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 shares were valued at approximately $123,000
        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 March 31, 2006 is
        257,378.
 
 **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
  **13**
 *Table
            of Contents*
  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.
  The
        following table summarizes the Company's segment information:
 **Three-Months
                    Ended March 31, 2006****U.S.
                    Operating Segment**
                
                **Asian
                    Operating Segment**
                
                **Netherlands
                    Operating Segment**
                
                **Eliminations**
                
                **Totals**Net
                    Sales:External
                    customers
                
                $
                2,347,601
                
                $
                1,478,155
                
                $
                --
                
                $
                --
                
                $
                3,825,756Intersegment
                
                
                355,031
                
                
                --
                
                
                --
                
                
                (355,031
                )
                
                --Total
                    net sales
                
                
                2,702,632
                
                
                1,478,155
                
                
                --
                
                
                (355,031
                )
                
                3,825,756(Loss)
                    income from operations
                
                
                (2,012,214
                )
                
                35,498
                
                
                (169,617
                )
                
                (44,733
                )
                
                (2,191,066
                )Interest
                    expense
                
                
                (170,043
                )
                
                (14,486
                )
                
                --
                
                
                10,575
                
                
                (173,954
                )Investment
                    income, net
                
                
                112,229
                
                
                372
                
                
                8
                
                
                (10,575
                )
                
                102,034Depreciation
                    and amortization
                
                
                31,693
                
                
                25,098
                
                
                1,230
                
                
                --
                
                
                58,021Capital
                    expenditures
                
                
                216,714
                
                
                29,585
                
                
                42,864
                
                
                --
                
                
                289,163Total
                    assets at March 31, 2006
                
                
                20,967,951
                
                
                3,404,987
                
                
                87,141
                
                
                (3,036,695
                )
                
                21,423,384
  **Three-Months
                    Ended March 31, 2005****U.S.
                    Operating Segment**
                
                **Asian
                    Operating Segment**
                
                **Netherlands
                    Operating Segment**
                
                **Eliminations**
                
                **Totals**Net
                    Sales:External
                    customers
                
                $
                2,390,543
                
                $
                1,343,817
                
                $
                --
                
                $
                --
                
                $
                3,734,360Intersegment
                
                
                133,620
                
                
                --
                
                
                --
                
                
                (133,620
                )
                
                --Total
                    net sales
                
                
                2,524,163
                
                
                1,343,817
                
                
                --
                
                
                (133,620
                )
                
                3,734,360(Loss)
                    income from operations
                
                
                (2,671,307
                )
                
                65,493
                
                
                (203,571
                )
                
                33,492
                
                
                (2,775,893
                )Interest
                    expense (a)
                
                
                (132,655
                )
                
                (13,894
                )
                
                (37,428
                )
                
                10,575
                
                
                (173,402
                )Investment
                    (loss) income, net
                
                
                (60,823
                )
                
                131
                
                
                8
                
                
                (10,575
                )
                
                (71,259
                )Depreciation
                    and amortization
                
                
                18,929
                
                
                8,995
                
                
                93,030
                
                
                --
                
                
                120,954Capital
                    expenditures
                
                
                24,526
                
                
                9,929
                
                
                --
                
                
                --
                
                
                34,455Total
                    assets at March 31, 2005
                
                
                27,882,307
                
                
                3,156,639
                
                
                286,710
                
                
                (1,770,082
                )
                
                29,555,574
  (a)
        Interest expense relating to the purchase by the U.S. operating segment of
        manufacturing equipment was allocated
        to the Netherlands operating segment.
  **14**
 *Table
            of Contents*
  **6.
          Subsequent Events**
 
 During
          April and through May 15, 2006, the Company has received an aggregate of
          approximately $3,500,000 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 228,334 shares of common stock for an exercise price of $5.50
          per
          share, (iii) stock options to purchase an aggregate of 91,500 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 50,000
          shares of common stock, granted prior to the Equity Plan, with an exercise
          price
          of $4.50 per share.
  On
        May 1,
        2006, the Company’s two largest stockholders, the Emalfarb Trust and the
        Francisco Trust U/A/D dated 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.
        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.
 
 On
        April
        30, 2006, the maturity date of the revolving note held by the Mark A. Emalfarb
        Trust U/A/D October 1, 1987 (the “Emalfarb Trust”) (see Note 2) was extended
        from January 1, 2007 to January 1, 2008, by a third amendment to the revolving
        note. The revolving note was not otherwise modified by the third amendment.
        The
        Emalfarb Trust has as its beneficiary Mark A. Emalfarb, the Chief Executive
        Officer, President and Chairman of the Company.
 
 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, restricted common stock of the Company
        in consideration for: (i) the transfer of all of the minority shareholder’s
        shares (representing 17.5% of the Asian Subsidiary’s outstanding shares) to the
        Company, bringing the Company’s ownership in the Asian Subsidiary to 100%; (ii)
        a release of the Company for, among other things, the 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 to the
        minority shareholders in the aggregate amount of $171,986 of principal and
        $69,868 of accrued interest, as of the effective date.
 
               
 
  **15**
 *Table
            of Contents*
  ***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 achievement 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 two
        categories of applications:
  ·
            enzymes
                and other biological products for a variety of industrial and commercial
                applications, which we refer to as our Enzyme Business; and 
 ·
            human
                therapeutic protein candidates 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.  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 legacy
        materials, 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
        and
        other biomaterials, 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, as its host production organism. A host production organism
        is an
        organism which has been genetically altered to express 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.
  **16**
 *Table
            of Contents*
  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 proteins 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.
 
 Using
        the
        C1 Expression System, as well as other biological systems, our Enzyme Business
        develops and produces commercial quantities of enzymes for sale to textile,
        pulp
        and paper, food, animal feed, chemical, agricultural, and other industries.
        These industries, in turn, use our products to enhance their own products
        or to
        improve production efficiency. We currently sell more than 45 liquid and
        dry
        enzyme products to more than 200 industrial customers in approximately 50
        countries.
  We
        believe, however, even larger market opportunities will exist for our C1
        Expression System when the technology is 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 waste products (lignocellulosic substrates)
        into fermentable sugars, which in turn can be used to produce ethanol and
        other
        chemicals that have historically been petroleum-derived. We have a stable
        of
        fungal 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 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 is
        required.
 
 Although
        this 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 this unique fungus to make even larger quantities of 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 proteins and enzymes of commercial interest to potential business
        partners in sectors such as, agriculture, food and animal feed. We continue
        to
        mine the C1 genome and have identified a number of enzymes that have the
        potential to become new products for several industries, such as pulp and
        paper,
        energy, food and animal feed. Still in the development stage, we refer to
        these
        activites as our Biosciences Business.
  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 our purchase of state-of-the-art robotics equipment,
        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
 **17**
 *Table
            of Contents*
  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 development efficiency, economy and speed to market. 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 U.S. patents, 26 issued International patents and 49 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*
 
 In
        the
        first half of 2001, we raised capital of approximately $13,635,000, prior
        to
        expenses of approximately $200,000, largely to fund the development of our
        C1
        Screening System. At that time, we thought we were within one year of being
        able
        to find collaboration partners to help us complete its development, though
        we
        continued to develop our C1 Expression System. However, between 2001 and
        2003,
        even as our Enzyme Business began to grow rapidly, we experienced a major
        shift
        in market demand for our C1 Screening System. First, we found that large
        pharmaceutical companies, frustrated by lack of success with some of their
        investments in unproven screening technologies like our C1 Screening System,
        began requiring unprecedented levels of accumulated scientific data as a
        pre-condition to partnering with us. Second, we found that the interest of
        these
        large pharmaceutical companies had moved away from gene discovery and screening
        applications, to an interest in the expression of therapeutic proteins for
        pre-clinical testing, clinical trials and drug commercialization.
 
 We
        adjusted our strategy accordingly, and 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 and related HTS hardware and 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
        April and through May 12, 2006, we have received an aggregate of approximately
        $3.36 million in proceeds from exercises of warrants and stock options. The
        proceeds to date have exceeded the net amount of cash the Company used during
        the first quarter 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
        intend to conduct an increasing number of new customer plant trials and
        convert a host 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.  **18**
 *Table
                of Contents*
 
 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 waste products (lignocellulosic substrates) into
        fermentable sugars, which in turn can be used to produce ethanol and other
        chemicals that have historically been petroleum-derived. We believe we have
        a
        stable of fungal strains from which we have identified and characterized
        a
        number of these activities. Accordingly, we believe our C1 Host Technology,
        coupled with our R&D efforts, 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 its 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 waste products
        such as dry distillers grain (DDG), corn stover, wheat straw and sugar cane
        bagasse into fermentable sugars, which in turn can be used to produce ethanol
        and other chemicals historically derived from petroleum.
 
 Currently,
        ethanol producers sell DDG, the corn mash byproduct from ethanol, for use
        as
        animal feed.  We are applying our C1 Host 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 will
        be 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 intend 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 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 the conduct of our Enzyme Business, and have
        thus
        far generated only nominal sales from our conduct of our BioSciences Business.
        We have an accumulated deficit at March 31, 2006 of approximately $36,355,000.
        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 generate income from the conduct of our
        BioSciences Business, either directly or through potential future license
        agreements and collaborative partnerships with drug companies.
 *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 Expression and Screening Systems, making
          them
          more robust and versatile. Those improvements would likely enable these
          Systems
          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.
 
  **19**
 *Table
              of Contents*
 With
          petroleum prices around $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 waste 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
            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
            3% - 6% 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.
 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 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.
 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 Distiller Dried
                Grain
                and/or other agricultural feestocks 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 parties, other strategic relationship, or
                a combination
                of one or more of the above. 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 and our
                C1 Screening
                System .
                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 an exceptional 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 & 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 mid-2006 or later. For the first quarter of 2006,
                  pulp and paper
                  sales increased to 13% of net sales as compared to 6% for the comparable
                  period
                  in 2005.
 
 During
                  2006, we are continuing to expand our pulp and paper sales and marketing
                  infrastructure, 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 by training the sales forces
                  of our
                  distributors around the world. 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.
 **20**
  We
                  have
                  worked with several existing
                  pulp and paper customers who have allowed us 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 nine months .
 
 Our
                  marketing and field efforts were recently recognized by recording
                  our first
                  North American 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 the paper
                  mills have 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 Enzymes
                  Business net
                  sales
                  in 2005 and 2004, respectively. For
                  the
                  first quarter of 2006, animal feed sales increased to 8% of net
                  sales as compared
                  to 5% 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 March 31, 2006 Compared
                  to the
                  Three-Months Ended March 31, 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 for the three-months ended March 31, 2006 and 2005 (in
                  thousands):


**Three-Months
                  Ended March 31,**(In
                  thousands)
              
              **2006**
              
              **2005**
              
              **Increase
                  (Decrease)**Net
                  sales
              
              $
              3,826
              
              $
              3,734
              
              $
              92Cost
                  of goods sold
              
              
              2,940
              
              
              2,985
              
              
              (45
              )Gross
                  profit
              
              
              886
              
              
              749
              
              
              137Operating
                  expenses:Research
                  and development
              
              
              908
              
              
              1,568
              
              
              (660
              )Selling
                  and marketing
              
              
              803
              
              
              569
              
              
              234General
                  and administrative
              
              
              1,335
              
              
              1,449
              
              
              (114
              )Foreign
                  currency exchange losses (gains), net
              
              
              31
              
              
              (61
              )
              
              923,077
              
              
              3,525
              
              
              (448
              )Loss
                  from operations
              
              
              (2,191
              )
              
              (2,776
              )
              
              585Other
                  income (expense):Interest
                  expense
              
              
              (174
              )
              
              (173
              )
              
              (1
              )Investment
                  (loss) income, net
              
              
              102
              
              
              (71
              )
              
              173Minority
                  interest
              
              
              (1
              )
              
              (8
              )
              
              7Other
                  expense, net
              
              
              (58
              )
              
              (68
              )
              
              10Total
                  other expense
              
              
              (131
              )
              
              (320
              )
              
              189Loss
                  before income taxes
              
              
              (2,322
              )
              
              (3,096
              )
              
              774Provision
                  for income taxes
              
              
              25
              
              
              12
              
              
              13Net
                  loss
              
              $
              (2,347
              )
              $
              (3,108
              )
              $
              761
 **21**


**Net
      Sales**


The
        following table reflects the Company’s net sales by industry for the three-month
        periods ended March 31, 2006 and 2005 (in thousands):


**Three-Months
                    Ended March 31,**(In
                    thousands)
                
                2006
                
                %
                  of Net Sales
                
                2005
                
                %
                  of Net Sales
                
                Increase
                    / (Decrease)
                
                %Textile*
                
                $
                2,719
                
                
                71
                %
                $
                3,074
                
                
                82
                %
                $
                (355
                )
                
                (12
                %)Animal
                    Feed*
                
                
                310
                
                
                8
                %
                
                189
                
                
                5
                %
                
                121
                
                
                64
                %Pulp
                    & Paper*
                
                
                479
                
                
                13
                %
                
                228
                
                
                6
                %
                
                251
                
                
                110
                %Others
                    (5 industries)*
                
                
                318
                
                
                8
                %
                
                243
                
                
                7
                %
                
                75
                
                
                31
                %Bioscience
                
                
                --
                
                
                0
                %
                
                --
                
                
                0
                %
                
                --
                
                
                0
                %Net
                  Sales
                
                $
                3,826
                
                
                100
                %
                $
                3,734
                
                
                100
                %
                $
                92
                
                
                2
                %
  *
            Industrial Enzyme Industries
  For
            the
            three-months ended March 31, 2006, we generated net sales of approximately
            $3,826,000, compared to net sales of approximately $3,734,000 for the
            three-months ended March 31, 2005, an increase of approximately $92,000.
            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, food and animal feed industries, which
            represents an increase in net sales in these three industries of 68%
            over sales
            for the three-months ended March 31, 2005 (or 29% of net sales versus
            18%). 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 (71% vs. 82% for the three-months ended March 31,
            2006 and
            2005, respectively, as a percentage of net sales).
  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, on our success
            in
            developing new products and our ability to lower our production costs.  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.
            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), 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 March 31, 2006, cost of goods sold was approximately
            $2,940,000, or 77% of net sales, as compared to approximately $2,985,000,
            or 80%
            of net sales for the three-months ended March 31, 2005. The slight improvement
            in cost of goods sold is a result of increased sales of higher margin
            products.
 
 **Research
            and Development**
  For
            the
            three-months ended March 31, 2006, research and development expenses
            were
            approximately $908,000, or 24% of net sales, as compared to approximately
            $1,568,000, or 42% of net sales for the three-months ended March 31,
            2005,
            representing a decrease of approximately $660,000. 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
            three-month period ended March 31, 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.
 **22**
 *Table
                of Contents*
  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 will allow Dyadic 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.
  Other
            contributing factors to our decrease in R&D expense are the reduction in
            depreciation expense due to the full depreciation of certain R&D equipment
            at the end of 2005 which contributed approximately $115,000 of the
            decrease.
 
 Research
            and development costs incurred by type of project were as
            follows:
 **Three-Months
                    Ended March 31,****2006**
                
                **2005**Internal
                    development
                
                $
                392,849
                
                $
                469,384Collaborations
                
                
                514,830
                
                
                1,098,622$
                907,679
                
                $
                1,568,006
  Research
            and development costs based upon type of cost were as
            follows:
 **Three-Months
                    Ended March 31,****2006**
                
                **2005**Personnel
                    related
                
                $
                198,800
                
                $
                267,876Laboratory
                    and supplies
                
                
                29,573
                
                
                34,758Outside
                    services
                
                
                514,830
                
                
                1,098,622Equipment
                    and depreciation
                
                
                8,512
                
                
                118,298Facilities,
                    overhead and other
                
                
                155,964
                
                
                48,452$
                907,679
                
                $
                1,568,006
  **Selling
            and Marketing**
 
 For
            the
            three-months ended March 31, 2006, selling and marketing expenses were
            approximately $803,000, or 21% of net sales, compared to approximately
            $569,000,
            or 15% of net sales for the three-months ended March 31, 2005, representing
            an
            increase of approximately $234,000. This increase is attributable to
            several
            factors, including an increase in salaries and wages of approximately
            $145,000,
            and increased travel expense of approximately $60,000, due to the addition
            of
            nine employees in 2005 including a Vice President - Pulp and Paper and
            a Vice
            President of Sales & Marketing - Enzymes, and additional contract labor as
            well as additional 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 March 31, 2006, general and administrative expenses
              were
              approximately $1,335,000, or 35% of net sales, compared to approximately
              $1,449,000, or 39% of net sales for the three-months ended March 31,
              2005,
              representing a decrease of approximately $114,000. The decrease is
              primarily
              attributable to expense incurred during the three-months ended March
              31, 2005 of
              approximately $114,000, related to new patent applications for
              which
              there were no comparable applications made during the three-month period
              ended
              March 31, 2006. The Company applies for new patent applications as
              the need
              arises and it is determined by management to be a beneficial
              effort.
 **23**
 *Table
                  of Contents*
  **Foreign
            Currency Exchange Gains (Losses), Net**
  For
            the
            three-months ended March 31, 2006, the Company incurred a net foreign
            currency
            exchange loss of approximately $31,000 as compared to a net gain of
            approximately $61,000 for the three-months ended March 31, 2005. The
            $92,000
            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 March 31, 2006, interest expense was approximately
            $174,000
            as compared to approximately $173,000 for the three-months ended March
            31, 2005.
            Interest expense consists primarily of the amortization of beneficial
            conversion
            features related to stockholders notes payable of approximately $93,000,
            and
            interest from notes payable to stockholders of approximately $74,000.
  *Investment Income, Net*
  For
            the
            three-months ended March 31, 2006, income from investments in money market
            funds
            was approximately $102,000. During the three-months ended March 31, 2005,
            all
            then remaining private placement proceeds were placed in short-term investments,
            which were subsequently sold, resulting in a net loss of approximately
            $71,000,
            and then reinvested in money market funds as of March 31, 2005.
 
 *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 March 31, 2006, we had a foreign
            income
            tax provision of approximately $25,000 compared to approximately $12,000
            for the
            three-months ended March 31, 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
            for Stock Issued to Employees* ,
            and its
            related interpretations. Under the provisions of APB No. 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 approximately $131,000 and $8,000 in
            share-based compensation expense for our share-based awards during the
            three-month periods ended March 31, 2006 and 2005, 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 March 31****2006**
                      
                      **2005**Research
                          and development
                      
                      $
                      78,789
                      
                      $
                      1,104Selling
                          and marketing
                      
                      
                      144
                      
                      
                      --General
                          and administrative
                      
                      
                      52,360
                      
                      
                      6,576$
                      131,293
                      
                      $
                      7,680
 **24**
 *Table
                of Contents*
  Under
            the
            modified prospective method of transition under SFAS No. 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 ended March 31, 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 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 123R. 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 123R 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,
            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. 
 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 will be amortized to interest expense
              through
              the new maturity date.  **25**
 *Table
                    of Contents*
  *Cash
              Flow*
  *Operating
            Activities*
  As
            reflected in our condensed consolidated financial statements, we have
            incurred
            losses from operations during the three-month periods ending March 31,
            2006 and
            2005, resulting in net cash used in operating activities of approximately
            $2,756,000 and $2,941,000, respectively. The decrease in net cash used
            in
            operating activities was primarily due to the decrease in net loss for
            the
            three-months ended March 31, 2006 of approximately $761,000 which was
            partially
            offset by working capital increases.
 
 *Investing
            Activities*
 
 For
            the
            three-months ended March 31, 2006, net cash used in investing activities
            was
            approximately $289,000 as compared to approximately $34,000 for the three-months
            ended March 31, 2005, which relates to purchases of fixed assets. 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.
 
 *Financing
            Activities*
  For
            the
            three-month periods ended March 31, 2005, our net cash used in financing
            activities was approximately $98,000, for payment of issuance costs related
            to
            the October 2004 private offering. No cash was used in financing activities
            for
            the three-months ended March 31, 2006.
 
 *Financial
            Condition and Liquidity at March 31, 2006*
 
 As
            of
            March 31, 2006, stockholders' equity was approximately $13,219,000 and
            we had a
            total of approximately $9,104,000 in cash and cash equivalents and restricted
            cash of approximately $35,000. Our outstanding indebtedness was approximately
            $4,144,000 as of March 31, 2006, and consisted of notes payable to certain
            stockholders, notes payable for Letter of Credit advances, and the Bridge
            Loan
            including related accrued interest payable.
 
 During
            April and through May 15, 2006, the Company has received an aggregate
            of
            approximately $3,500,000 in proceeds related to 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 228,334 shares of common stock for an exercise price of
            $5.50 per
            share, (iii) stock options to purchase an aggregate of 91,500 shares
            of common
            stock, granted under the Dyadic 2001 Equity Compensation Plan, with exercise
            prices ranging from $2.08 to $4.50 per share, and (iv) stock options
            to purchase
            an aggregate of 50,000 shares of common stock, granted prior to the Equity
            Compensation Plan, with an exercise price of $4.50 per share.
 On
              May 1,
              2006, the Company’s two largest stockholders, the Emalfarb Trust and the
              Francisco Trust U/A/D dated 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.
              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 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. 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 March 31, 2006,
              42,922
              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.  **26**
 *Table
                    of Contents*
  *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. We have established a number of flexible
            partnerships 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. There can be no assurance, however, that we will achieve
            decreased cash outflows as a result of these factors, or achieve them
            in the
            timeframe outlined. It is possible that we will seek additional financing
            within
            this timeframe. We may raise additional funds through public or private
            financings, 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 favorable 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 March 31,
            2006.
 
 (b)
            Changes in Internal Controls
 
 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
            March 31, 2006 that have materially affected, or are reasonably likely
            to
            materially affect, the Company's internal control over financial
            reporting.
   **27**
 *Table
              of Contents*
 **PART** **II. OTHER INFORMATION**
  ITEM
            6. EXHIBITS
 
 **A)**
                **Index
                    to Exhibits**
 Exhibits
              Description
                  of Documents10.22
              Satisfaction
                  and Purchase Agreement dated April 28, 2006 with an effective date
                  of
                  January 1, 2006 between Dyadic International, Inc., Geneva Investment
                  Holdings Limited, Puridet (Asia), Limited, Robert Albert Smeaton
                  and
                  Raymond Tsang (1)31.1
              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:
                    May 15, 2006
                By:
                    /s/ Mark A. EmalfarbMark
                    A. EmalfarbChief
                    Executive OfficerDate:
                    May 15, 2006
                By:
                    /s/ Wayne MoorWayne
                    MoorChief
                    Financial Officer
 
 **28**