##### Table of Contents









SECURITIES AND EXCHANGE COMMISSION


Washington, DC 20549





Form 10-K


FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF 1934


|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended July 31, 2005                                                     
|          
|OR        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the transition period
    from           to          .                                  

Commission file number 0-17521


Zila, Inc.


(Exact Name of Registrant as Specified in its Charter)


|                                                                                    |  |                                         
|----------------------------------------------------------------------------------- |  | ----------------------------------------
|Delaware                                                                            |  | 86-0619668                              
|(State or Other Jurisdiction of
    Incorporation or Organization)                  |  | (I.R.S. Employer
    Identification No.)
|                                                                                   
|5227 North 7th Street,
    Phoenix, Arizona(Address of Principal Executive Offices) |  | 85014-2800(Zip Code)                    

Registrants telephone number, including area code


(602) 266-6700


Securities registered pursuant to Section 12(b) of the
Act:


|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of Each Class |  | Name of Each Exchange on Which Registered
|                    |  |                                          
|None                |  | N/A                                      

Securities registered pursuant to Section 12(g) of the
Act:


Common Stock, $.001 par value


(Title of Class)


þ o


o


o þ


þ o




DOCUMENTS INCORPORATED BY REFERENCE












---










TABLE OF CONTENTS


|              |  |                                                                                                                          |    |      |    |  |  | 
|------------- |  | ------------------------------------------------------------------------------------------------------------------------ | -- | ---- | -- |  |  | 
|              |  |                                                                                                                          |    | Page |   
|              |  |                                                                                                                          |    |      |   
|PART I       
|Item 1.       |  | Business                                                                                                                 |    |      | 3  | 
|Item 2.       |  | Properties                                                                                                               |    |      | 22 | 
|Item 3.       |  | Legal Proceedings                                                                                                        |    |      | 22 | 
|Item 4.       |  | Submission of Matters to a Vote of Security
    Holders                                                                  |    |      | 23 | 
|             
|PART II      
|Item 5.       |  | Market for the Registrants Common
    Equity, Related Stockholder Matters and Issuer Purchases of
    Equity Securities |    |      | 23 | 
|Item 6.       |  | Selected Financial Data                                                                                                  |    |      | 25 | 
|Item 7.       |  | Managements Discussion and Analysis
    of Financial Condition and Results of Operations                                |    |      | 25 | 
|Item 7A.      |  | Quantitative and Qualitative Disclosures
    about Market Risk                                                           |    |      | 45 | 
|Item 8.       |  | Financial Statements and Supplementary
    Data                                                                          |    |      | 46 | 
|Item 9.       |  | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure                                 |    |      | 46 | 
|Item 9A.      |  | Controls and Procedures                                                                                                  |    |      | 46 | 
|Item 9B.      |  | Other Information                                                                                                        |    |      | 49 | 
|             
|PART III     
|Item 10.      |  | Directors and Executive Officers of the
    Registrant                                                                   |    |      | 49 | 
|Item 11.      |  | Executive Compensation                                                                                                   |    |      | 49 | 
|Item 12.      |  | Security Ownership and Certain Beneficial
    Owners and Management and Related Stockholder Matter                       |    |      | 49 | 
|Item 13.      |  | Certain Relationships and Related
    Transactions                                                                       |    |      | 49 | 
|Item 14.      |  | Principal Accounting Fees and Services                                                                                   |    |      | 49 | 
|             
|PART IV      
|Item 15.      |  | Exhibits and Financial Statement
    Schedules                                                                           |    |      | 50 | 
|SIGNATURES    |  |                                                                                                                          | 53 |     
|Exhibit 3-B  
|Exhibit 10-Z 
|Exhibit 10-Aa
|Exhibit 10-Ab
|Exhibit 10-Ac
|Exhibit 21   
|Exhibit 23.1 
|Exhibit 23.2 
|Exhibit 31.1 
|Exhibit 31.2 
|Exhibit 32.1 
|Exhibit 32.2 



2



---



##### Table of Contents






PART I







|        |         
|------- | --------
|Item 1. | Business





630tm




Recent Developments








630tm


3



---



##### Table of Contents









Our Products




| |               
| | --------------
| | Nutraceuticals



| |         
| | --------
| | Ester-C®









| |         
| | --------
| | Ester-E®



4



---



##### Table of Contents









| |                
| | ---------------
| | Pharmaceuticals



| |          
| | ---------
| | ViziLite®



630tm 630tm tm




| |         
| | --------
| | Peridex®





| |             
| | ------------
| | IST Products





| |              
| | -------------
| | Biotechnology



| |         
| | --------
| | OraTest®

tm tm


5



---



##### Table of Contents



tm


tm tm








Sales and Marketing




| |               
| | --------------
| | Nutraceuticals



| |                      
| | ---------------------
| | Ester-C® and Ester-E®





| |                
| | ---------------
| | Pharmaceuticals



| |         
| | --------
| | Peridex®



6



---



##### Table of Contents







| |          
| | ---------
| | ViziLite®

630tm




| |             
| | ------------
| | IST Products





| |              
| | -------------
| | Biotechnology



| |         
| | --------
| | OraTest®



Manufacturing and Supply




| |               
| | --------------
| | Nutraceuticals







7



---



##### Table of Contents





| |                
| | ---------------
| | Pharmaceuticals



| |          
| | ---------
| | ViziLite®





| |         
| | --------
| | Peridex®





| |             
| | ------------
| | IST Products





| |              
| | -------------
| | Biotechnology



| |         
| | --------
| | OraTest®

tm tm


Competition






| |               
| | --------------
| | Nutraceuticals



| |         
| | --------
| | Ester-C®







8



---



##### Table of Contents







| |         
| | --------
| | Ester-E®





| |                
| | ---------------
| | Pharmaceuticals



| |         
| | --------
| | Peridex®





| |          
| | ---------
| | ViziLite®





| |             
| | ------------
| | IST Products





| |              
| | -------------
| | Biotechnology



| |         
| | --------
| | OraTest®



9



---



##### Table of Contents



tm


Licensing




| |               
| | --------------
| | Nutraceuticals



| |         
| | --------
| | Ester-E®





| |                
| | ---------------
| | Pharmaceuticals



| |         
| | --------
| | Peridex®





| |          
| | ---------
| | ViziLite®

630tm




| |              
| | -------------
| | Biotechnology



| |         
| | --------
| | OraTest®





10



---



##### Table of Contents



Governmental Regulation




| |        
| | -------
| | General













11



---



##### Table of Contents





| |                      
| | ---------------------
| | Ester-C® and Ester-E®















12



---



##### Table of Contents





| |         
| | --------
| | OraTest®





630tm


Patents and Trademarks




| |         
| | --------
| | Ester-C®













13



---



##### Table of Contents







| |         
| | --------
| | Ester-E®











| |         
| | --------
| | Peridex®







| |          
| | ---------
| | ViziLite®





14



---



##### Table of Contents





| |             
| | ------------
| | IST Products





| |         
| | --------
| | OraTest®

tm tm tm tm tm tm tm tm




Employees




Available Information






Cautionary Factors That May Affect Future Results and
Financial Condition




15



---



##### Table of Contents







| |                                                                                       
| | --------------------------------------------------------------------------------------
| | Obtaining regulatory approvals for our products is costly
    and full of uncertainty.







| |                                                                                                              
| | -------------------------------------------------------------------------------------------------------------
| | We may be unable to obtain FDA approval, or to establish a
    market, for OraTest® in the United
    States.





16



---



##### Table of Contents







tm




| |                                                                                                           
| | ----------------------------------------------------------------------------------------------------------
| | We are dependent on a few key products and our growth is
    dependent on the development of new products.









17



---



##### Table of Contents







| |                                         
| | ----------------------------------------
| | We are dependent on a few key customers.







| |                                                                       
| | ----------------------------------------------------------------------
| | We are dependent on our senior management and other key
    personnel.





| |                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------
| | We and our products are subject to regulatory oversight
    that could substantially interfere with our ability to do
    business.





| |                                                             
| | ------------------------------------------------------------
| | We are at risk with respect to product liability
    claims.



18



---



##### Table of Contents





| |                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------
| | We face significant competition that could adversely
    affect our results of operation and financial condition.





| |                                                                                                                                                                                                                                                                         
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we fail to secure and then enforce patents and other
    intellectual property rights underlying our technologies, or if
    the use of our technology is determined to infringe on the
    intellectual property rights of others, our business could be
    harmed.







19



---



##### Table of Contents





| |                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------
| | We require certain raw materials for our manufacturing
    processes that may only be acquired through limited
    sources.





| |                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------
| | If we are unable to obtain adequate funds, we may not be
    able to develop and market our present and potential
    products.









20



---



##### Table of Contents





| |                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------
| | In the past, we have experienced volatility in the market
    price of our common stock and we may experience such volatility
    in the future.





| |                                                                                                                                                     
| | ----------------------------------------------------------------------------------------------------------------------------------------------------
| | Our Board of Directors may unilaterally issue Preferred
    Stock which could dilute our ownership and prevent or delay a
    change in our control.





| |                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------
| | If we use environmentally hazardous materials in a manner
    that causes injury, we may be liable for damages.





| |                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------
| | We have, in the past, received minor deficiencies from
    regulatory agencies related to our manufacturing
    facilities.



21



---



##### Table of Contents








|        |           
|------- | ----------
|Item 2. | Properties



| |                       
| | ----------------------
| | Corporate Headquarters





| |                         
| | ------------------------
| | Manufacturing Facilities

tm











|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings







22



---



##### Table of Contents












|        |                                                    
|------- | ---------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security Holders






PART II







|        |                                                                                                                           
|------- | --------------------------------------------------------------------------------------------------------------------------
|Item 5. | Market for the Registrants Common Equity, Related
    Stockholder Matters and Issuer Repurchases of Equity
    Securities



|                                |                |      |   |      |     |  |   |      | 
|------------------------------- | -------------- | ---- | - | ---- | --- |  | - | ---- | 
|                                |                | High |   |      | Low | 
|                                |                |      |   |      |     | 
|Fiscal Year Ended July 31, 2005 |                |      |   |      |     |  |   |     
|                                | First quarter  |      | $ | 4.59 |     |  | $ | 3.31 | 
|                                | Second quarter |      |   | 5.00 |     |  |   | 3.42 | 
|                                | Third quarter  |      |   | 5.09 |     |  |   | 2.99 | 
|                                | Fourth quarter |      |   | 3.80 |     |  |   | 2.55 | 
|Fiscal Year Ended July 31, 2004 |                |      |   |      |     |  |   |     
|                                | First quarter  |      | $ | 4.01 |     |  | $ | 2.43 | 
|                                | Second quarter |      |   | 4.97 |     |  |   | 3.50 | 
|                                | Third quarter  |      |   | 5.53 |     |  |   | 3.87 | 
|                                | Fourth quarter |      |   | 5.28 |     |  |   | 3.81 | 





Preferred Stock




23



---



##### Table of Contents



Restricted Stock  Rule 144




Warrants










Issuer Repurchase of Equity Securities




24



---



##### Table of Contents








|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data



|                                                                                      |                                                                           |                             |        |        |      |   |        |        |   |   |        |        |     |      |        |         |   |   |        |         |  
|------------------------------------------------------------------------------------- | ------------------------------------------------------------------------- | --------------------------- | ------ | ------ | ---- | - | ------ | ------ | - | - | ------ | ------ | --- | ---- | ------ | ------- | - | - | ------ | ------- | -
|                                                                                      |                                                                           | Fiscal Years Ended July 31, |       
|                                                                                      |                                                                           |                             |       
|Statement of Operations Data:                                                         |                                                                           | 2005                        |        |        | 2004 |   |        | 2003   |   |   | 2002   |        |     | 2001 |       
|                                                                                      |                                                                           |                             |        |        |      |   |        |        |   |   |        |        |     |      |       
|Net revenues                                                                          |                                                                           | $                           | 44,325 |        |      | $ | 41,405 |        |   | $ | 39,210 |        |     | $    | 24,521 |         |   | $ | 19,163 |        
|                                                                                      | Net income (loss) from continuing operations before accounting
    change |                             |        | (9,030 | )    |   |        | (4,375 | ) |   |        | 11,611 | (1) |      |        | (13,519 | ) |   |        | (10,219 | )
|                                                                                      | Net income (loss) attributable to common shareholders                     |                             |        | 1,060  |      |   |        | (4,376 | ) |   |        | 7,246  | (2) |      |        | (12,069 | ) |   |        | (6,390  | )
|Basic and diluted net income (loss) per share attributable to
    common shareholders |                                                                           | $                           | 0.02   |        |      | $ | (0.10  | )      |   | $ | 0.16   |        |     | $    | (0.27  | )       |   | $ | (0.15  | )      

|                                     |  |             |        |  |      |   |        |      |  |   |        |  |  |        |        |  |  |   |        | 
|------------------------------------ |  | ----------- | ------ |  | ---- | - | ------ | ---- |  | - | ------ |  |  | ------ | ------ |  |  | - | ------ | 
|                                     |  | At July 31, |       
|                                     |  |             |       
|Balance Sheet Data:                  |  | 2005        |        |  | 2004 |   |        | 2003 |  |   | 2002   |  |  | 2001 _ |       
|                                     |  |             |        |  |      |   |        |      |  |   |        |  |  |        |       
|Current assets                       |  | $           | 32,639 |  |      | $ | 30,123 |      |  | $ | 35,326 |  |  | $      | 20,810 |  |  | $ | 34,090 | 
|Total assets                         |  |             | 65,418 |  |      |   | 62,109 |      |  |   | 69,020 |  |  |        | 57,361 |  |  |   | 75,603 | 
|Current liabilities                  |  |             | 9,815  |  |      |   | 7,581  |      |  |   | 11,519 |  |  |        | 7,427  |  |  |   | 15,803 | 
|Long-term debt                       |  |             | 3,328  |  |      |   | 3,650  |      |  |   | 3,728  |  |  |        | 3,610  |  |  |   | 4,153  | 
|Total liabilities                    |  |             | 13,696 |  |      |   | 11,880 |      |  |   | 15,272 |  |  |        | 11,038 |  |  |   | 19,956 | 
|Series B convertible preferred stock |  |             | 463    |  |      |   | 463    |      |  |   | 463    |  |  |        | 463    |  |  |   | 463    | 
|Total shareholders equity           |  |             | 51,722 |  |      |   | 50,228 |      |  |   | 53,748 |  |  |        | 46,323 |  |  |   | 55,646 | 






|    |                                                                                                                                                                                                                                                            
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes $14.8 million contract settlement gain from our
    former contract research organization (see Note 6 of Notes
    to Consolidated Financial Statements).                                                                                         
|   
|(2) | Includes adoption of SFAS No. 142, Goodwill and
    Other Intangibles Assets, in which we recorded a charge of
    $4.1 million reported under the caption Cumulative
    effect of accounting change on our Consolidated Statements
    of Operations.






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of Financial
    Condition and Results of Operations

Overview








| |   |                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Zila Nutraceuticals, manufacturer and marketer of Advanced
    Protection Ester-C® and Ester-E®, proprietary,
    branded, highly effective forms of vitamins C and E.                                                                                                                                                                                                                                                        
|
| |  | Zila Pharmaceuticals, manufacturer and marketer of superior
    products to promote oral health and prevent oral disease,
    including the ViziLite® chemiluminescent light for
    illumination of oral mucosal abnormalities and its adjunct
    product ViziLite® Plus with
    T-Blue630tm,
    Peridex® prescription periodontal rinse, and the plastic
    molded products of Zila Swab Technologies, Inc.
    (IST).

25



---



##### Table of Contents





| |   |                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Zila Biotechnology, a research, development and licensing
    business specializing in pre-cancer/cancer detection through its
    patented
    ZTCtm
    and OraTest® technologies.











26



---



##### Table of Contents





Results of Operations




| |                                                                                
| | -------------------------------------------------------------------------------
| | Fiscal Year Ended July 31, 2005 Compared to Fiscal
    Year Ended July 31, 2004



|                                                                              |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |     |    |     |   |      |      |    | 
|----------------------------------------------------------------------------- | ----------------------------- | --------------------------- | ------ | ---------- | -------- | - | --- | ---- | ---------- | - | -------- | ------ | ------ | ------ | --- | -- | --- | - | ---- | ---- | -- | 
|                                                                              |                               | Fiscal Years Ended July 31, |       
|                                                                              |                               |                             |       
|                                                                              |                               |                             |        | Percent of |          |   |     |      | Percent of |   |          |       
|                                                                              |                               |                             |        | Net        |          |   |     |      | Net        |   |          | %      |       
|                                                                              |                               | 2005                        |        |            | Revenues |   |     | 2004 |            |   | Revenues |        |        | Change |    
|                                                                              |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |    
|Net revenues                                                                  |                               | $                           | 44,325 |            |          |   | 100 | %    |            | $ | 41,405   |        |        |        | 100 | %  |     |   | 7    |     
|                                                                              | Cost of products sold         |                             |        | 15,385     |          |   |     | 35   |            |   |          | 16,120 |        |        |     | 39 |     |   |      | (5   | ) 
|                                                                              |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |    
|                                                                              |                               | Gross profit                |        |            | 28,940   |   |     |      | 65         |   |          |        | 25,285 |        |     |    | 61  |   |      |      | 14 | 
|                                                                              |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |    
|Operating expenses:                                                           |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |     |    |     |   |      |     
|                                                                              | Marketing & selling           |                             |        | 15,939     |          |   |     | 36   |            |   |          | 9,552  |        |        |     | 23 |     |   |      | 67   |   
|                                                                              | General & administrative      |                             |        | 11,538     |          |   |     | 26   |            |   |          | 11,149 |        |        |     | 27 |     |   |      | 3    |   
|                                                                              | Severance and related charges |                             |        | 192        |          |   |     |     |            |   |          | 350    |        |        |     | 1  |     |   |      | (45  | ) 
|                                                                              | Other operating costs         |                             |        | 296        |          |   |     | 1    |            |   |          |       |        |        |     |   |     |   |      |     |   
|                                                                              | Research & development        |                             |        | 7,181      |          |   |     | 16   |            |   |          | 5,933  |        |        |     | 14 |     |   |      | 21   |   
|                                                                              | Impairment of assets          |                             |        |           |          |   |     |     |            |   |          | 289    |        |        |     | 1  |     |   |      | (100 | ) 
|                                                                              | Depreciation & amortization   |                             |        | 2,688      |          |   |     | 6    |            |   |          | 2,483  |        |        |     | 6  |     |   |      | 8    |   
|                                                                              |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |    
|                                                                              |                               |                             | 37,834 |            |          |   | 85  |      |            |   | 29,756   |        |        |        | 72  |    |     |   | 27   |     
|                                                                              |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |    
|                                                                              |                               | Loss from operations        |        |            | (8,894   | ) |     |      | (20        | ) |          |        | (4,471 | )      |     |    | (11 | ) |      |      | 99 | 
|Other income (expense), net                                                   |                               |                             | (128   | )          |          |   |    |      |            |   | 99       |        |        |        |    |    |     |   | (229 | )   
|                                                                              |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |    
|Loss from continuing operations before income taxes and
    accounting change |                               | $                           | (9,022 | )          |          |   | (20 | )    |            | $ | (4,372   | )      |        |        | (11 | )  |     |   | 106  |     
|                                                                              |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |    



| |             
| | ------------
| | Consolidated







27



---



##### Table of Contents









tm








Nutraceuticals




|                                           |                |                             |        |     |      |   |        |          |   |  |    |  | 
|------------------------------------------ | -------------- | --------------------------- | ------ | --- | ---- | - | ------ | -------- | - |  | -- |  | 
|                                           |                | Fiscal Years Ended July 31, |       
|                                           |                |                             |       
|                                           |                | 2005                        |        |     | 2004 |   |        | % Change |  
|                                           |                |                             |        |     |      |   |        |          |  
|Net revenues                               |                | $                           | 38,471 |     |      | $ | 32,432 |          |   |  | 19 | 
|Gross profit                               |                |                             | 25,994 |     |      |   | 20,286 |          |   |  | 28 | 
|                                           | Gross profit % |                             |        | 68% |      |   |        | 63       | % |  |    |  | 
|Income from operations before income taxes |                |                             | 9,022  |     |      |   | 8,300  |          |   |  | 9  | 

28



---



##### Table of Contents







| |   |                                                                                                                                                                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Growing consumer awareness and trial of Ester-C® in
    response to increased media and promotion investment and
    improved advertising methods;                                                                                                                                                                                                   
|
| |  | Improved gross profits through purchase of ascorbic acid under
    supply agreements that provided a substantial portion of our
    annual requirements at prices equivalent to historical averages,
    providing cost predictability for our Ester-C® products;                                                                                    
|
| |  | The commercial introduction of our Ester-E® tocopheryl
    phosphates, an enhanced form of natural vitamin E and the first
    line extension under our successful Ester umbrella
    of products, was made much more difficult and ultimately
    unprofitable to date by unprecedented and unexpected negative
    publicity regarding vitamin E;
|
| |  | Increased capacity and efficiency through upgrading our
    Ester-C® production facility in Prescott, Arizona;                                                                                                                                                                                                                                       
|
| |  | Consolidation amongst our customer base that has increased the
    percentage of our total revenues that is attributable to one of
    our largest customers, NBTY, Inc.                                                                                                                                                                             





®


29



---



##### Table of Contents





| |                
| | ---------------
| | Pharmaceuticals



|                                    |                                   |                                          |   |        |        |   |   |          |       |   |  |      |     |  
|----------------------------------- | --------------------------------- | ---------------------------------------- | - | ------ | ------ | - | - | -------- | ----- | - |  | ---- | --- | -
|                                    |                                   | Fiscal Years Ended July 31,              |  
|                                    |                                   |                                          |  
|                                    |                                   | 2005                                     |   |        | 2004   |   |   | % Change |      
|                                    |                                   |                                          |   |        |        |   |   |          |      
|Net revenues:                       |                                   |                                          |   |        |        |   |   |          |       |   |  |     
|                                    | Core Pharmaceuticals products     |                                          | $ | 5,010  |        |   | $ | 4,248    |       |   |  | 18   |    
|                                    | IST*                              |                                          |   | 836    |        |   |   | 4,723    |       |   |  | (82  | )  
|                                    |                                   |                                          |   |        |        |   |   |          |      
|                                    |                                   | Total net revenues                       |   |        | 5,846  |   |   |          | 8,971 |   |  |      | (35 | )
|Gross profit:                       |                                   |                                          |   |        |        |   |   |          |       |   |  |     
|                                    | Core Pharmaceuticals gross profit |                                          |   | 3,228  |        |   |   | 2,898    |       |   |  | 11   |    
|                                    | Gross profit %                    |                                          |   | 64     | %      |   |   | 68       | %     |   |  |      |    
|                                    | IST*                              |                                          |   | (276   | )      |   |   | 2,088    |       |   |  | (113 | )  
|                                    | Gross profit %                    |                                          |   | (33    | )%     |   |   | 44       | %     |   |  |      |    
|                                    |                                   | Total gross profit                       |   |        | 2,952  |   |   |          | 4,986 |   |  |      | (41 | )
|                                    |                                   | Total gross profit %                     |   |        | 51     | % |   |          | 56    | % |  |      |     |  
|Operating loss before income taxes: |                                   |                                          |   |        |        |   |   |          |       |   |  |     
|                                    | Core Pharmaceuticals              |                                          |   | (857   | )      |   |   | (566     | )     |   |  | 51   |    
|                                    | IST*                              |                                          |   | (1,757 | )      |   |   | (199     | )     |   |  | 783  |    
|                                    |                                   |                                          |   |        |        |   |   |          |      
|                                    |                                   | Total operating loss before income taxes |   |        | (2,614 | ) |   |          | (765  | ) |  |      | 242 |  






|  |                                 
|- | --------------------------------
|* | Net of intercompany eliminations





| |   |                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | A continued product rollout of ViziLite® with emphasis in
    key markets that resulted in improving sales trends;                                              
|
| |  | Strengthening the position of Peridex® in the direct to
    dental market via competitive new advertising and new packaging
    forms;                          
|
| |  | Increased marketing and selling investment to increase
    Peridex® brand value and to support the ViziLite®
    rollout;                                       
|
| |  | Loss of a major IST customer late in fiscal 2004 which continued
    to negatively impacted net revenues, gross profit and operating
    results in fiscal 2005.



30



---



##### Table of Contents







Biotechnology




|                                                    |  |                             |        |   |      |   |        |          |  |  |     | 
|--------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------ | -------- |  |  | --- | 
|                                                    |  | Fiscal Years Ended July 31, |       
|                                                    |  |                             |       
|                                                    |  | 2005                        |        |   | 2004 |   |        | % Change | 
|                                                    |  |                             |        |   |      |   |        |          | 
|Net revenues                                        |  | $                           | 8      |   |      | $ | 2      |          |  |  | 300 | 
|Research and development                            |  |                             | 6,696  |   |      |   | 5,476  |          |  |  | 22  | 
|Loss from continuing operations before income taxes |  |                             | (8,694 | ) |      |   | (7,195 | )        |  |  | 21  | 





| |   |                                                                                                                                                                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Increased spending for the OraTest® product regulatory
    program;                                                                                                                                                                                                                                                                                             
|
| |  | Continued development of a commercialization strategy for the
    OraTest® product;                                                                                                                                                                                                                                                                             
|
| |  | Approval of modifications to the current OraTest®
    regulatory program submitted to the FDA and aimed at reducing
    the programs overall duration and total cost;                                                                                                                                                                                          
|
| |  | Re-commissioning of our
    ZTCtm
    manufacturing facility to support our regulatory program and the
    production of ViziLite® Plus with
    TBlue630tm,
    the first commercialized use of our
    ZTCtm
    technology;                                                                                                                                  
|
| |  | Renegotiation of the General Services Agreement with Quintiles
    Transnational Corp. (Quintiles), our contract
    research organization, to support the modifications to our
    regulatory program;                                                                                                                                                       
|
| |  | Expanded use of our Medical Advisory Board, whose members are
    some of the worlds leading researchers studying cancers
    located in the head and neck, to assist in development of our
    regulatory strategy to reduce the cost and duration of our
    current regulatory program and in development of our product
    commercialization strategy; and
|
| |  | Evaluation of other
    ZTCtm
    pre-cancer and cancer detection applications.                                                                                                                                                                                                                                                                                 





31



---



##### Table of Contents



Results of Operations




| |                                                                                
| | -------------------------------------------------------------------------------
| | Fiscal Year Ended July 31, 2004 Compared to Fiscal
    Year Ended July 31, 2003



|                                                                                       |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |     |    |    |   |      |     |    | 
|-------------------------------------------------------------------------------------- | ----------------------------- | --------------------------- | ------ | ---------- | -------- | - | --- | ---- | ---------- | - | -------- | ------ | ------ | ------ | --- | -- | -- | - | ---- | --- | -- | 
|                                                                                       |                               | Fiscal Years Ended July 31, |       
|                                                                                       |                               |                             |       
|                                                                                       |                               |                             |        | Percent of |          |   |     |      | Percent of |   |          |       
|                                                                                       |                               |                             |        | Net        |          |   |     |      | Net        |   |          | %      |       
|                                                                                       |                               | 2004                        |        |            | Revenues |   |     | 2003 |            |   | Revenues |        |        | Change |    
|                                                                                       |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |    
|Net revenues                                                                           |                               | $                           | 41,405 |            |          |   | 100 | %    |            | $ | 39,210   |        |        |        | 100 | %  |    |   | 6    |    
|                                                                                       | Cost of products sold         |                             |        | 16,120     |          |   |     | 39   |            |   |          | 16,772 |        |        |     | 43 |    |   |      | (4  | ) 
|                                                                                       |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |    
|                                                                                       |                               | Gross profit                |        |            | 25,285   |   |     |      | 61         |   |          |        | 22,438 |        |     |    | 57 |   |      |     | 13 | 
|                                                                                       |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |    
|Operating Expenses:                                                                    |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |     |    |    |   |      |    
|                                                                                       | Marketing & selling           |                             |        | 9,552      |          |   |     | 23   |            |   |          | 7,225  |        |        |     | 18 |    |   |      | 32  |   
|                                                                                       | General & administrative      |                             |        | 11,149     |          |   |     | 27   |            |   |          | 10,363 |        |        |     | 26 |    |   |      | 8   |   
|                                                                                       | Severance and related charges |                             |        | 350        |          |   |     | 1    |            |   |          | 1,322  |        |        |     | 3  |    |   |      | (74 | ) 
|                                                                                       | Research & development        |                             |        | 5,933      |          |   |     | 14   |            |   |          | 4,137  |        |        |     | 11 |    |   |      | 43  |   
|                                                                                       | Impairment of assets          |                             |        | 289        |          |   |     | 1    |            |   |          | 141    |        |        |     | 1  |    |   |      | 105 |   
|                                                                                       | Depreciation & amortization   |                             |        | 2,483      |          |   |     | 6    |            |   |          | 2,346  |        |        |     | 6  |    |   |      | 6   |   
|                                                                                       |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |    
|                                                                                       |                               |                             | 29,756 |            |          |   | 72  |      |            |   | 25,534   |        |        |        | 65  |    |    |   | 17   |    
|                                                                                       |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |    
|                                                                                       |                               | Loss from operations        |        |            | (4,471   | ) |     |      | (11        | ) |          |        | (3,096 | )      |     |    | (8 | ) |      |     | 44 | 
|Contract settlement gain, net of related expenses                                      |                               |                             |       |            |          |   |    |      |            |   | 14,844   |        |        |        | 38  |    |    |   | (100 | )  
|Other income (expense), net                                                            |                               |                             | 99     |            |          |   |    |      |            |   | 51       |        |        |        |    |    |    |   | 94   |    
|                                                                                       |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |    
|Income (loss) from continuing operations before income taxes and
    accounting change |                               | $                           | (4,372 | )          |          |   | (11 | )    |            | $ | 11,799   |        |        |        | 30  |    |    |   | (137 | )  
|                                                                                       |                               |                             |        |            |          |   |     |      |            |   |          |        |        |        |    



| |             
| | ------------
| | Consolidated







32



---



##### Table of Contents

















| |               
| | --------------
| | Nutraceuticals



|                                           |                       |                             |        |        |        |  |        |          |        |  |    |     |    | 
|------------------------------------------ | --------------------- | --------------------------- | ------ | ------ | ------ |  | ------ | -------- | ------ |  | -- | --- | -- | 
|                                           |                       | Fiscal Years Ended July 31, |       
|                                           |                       |                             |       
|                                           |                       | 2004                        |        |        | 2003   |  |        | % Change |       
|                                           |                       |                             |        |        |        |  |        |          |       
|Net revenues:                              |                       |                             |        |        |        |  |        |          |        |  |    |    
|                                           | Ester products        |                             | $      | 32,305 |        |  | $      | 26,077   |        |  |    | 24  |   
|                                           | Saw palmetto products |                             |        | 127    |        |  |        | 3,346    |        |  |    | (96 | ) 
|                                           |                       |                             |        |        |        |  |        |          |       
|                                           |                       | Total net revenues          |        |        | 32,432 |  |        |          | 29,423 |  |    |     | 10 | 
|Gross profit                               |                       |                             | 20,286 |        |        |  | 17,482 |          |        |  | 16 |    
|Gross profit %                             |                       |                             | 63     | %      |        |  | 59     | %        |        |  |    |    
|Income from operations before income taxes |                       |                             | 8,300  |        |        |  | 7,733  |          |        |  | 7  |    

33



---



##### Table of Contents







| |   |                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Growing consumer awareness and trial of Ester-C® in
    response to increased media and promotion investment and
    improved advertising;                                                                                             
|
| |  | The commercial introduction of our Ester-E® tocopheryl
    phosphates, an enhanced form of natural vitamin E and the first
    line extension under our successful Ester umbrella
    of products;                                   
|
| |  | Negotiation of supply agreements for ascorbic acid that will
    provide a substantial portion of our annual requirements at
    prices equivalent to historical averages, providing cost
    predictability for our Ester-C® products;
|
| |  | A controlled exit from the saw palmetto market, liquidating all
    remaining inventory at pricing that offsets our carrying
    value; and                                                                                            
|
| |  | Reducing general and administrative costs from fiscal year 2003
    despite significant volume growth.                                                                                                                                 









®




34



---



##### Table of Contents







| |                
| | ---------------
| | Pharmaceuticals



|                                                                       |                                            |                             |   |       |       |   |   |          |       |   |  |      |      |  
|---------------------------------------------------------------------- | ------------------------------------------ | --------------------------- | - | ----- | ----- | - | - | -------- | ----- | - |  | ---- | ---- | -
|                                                                       |                                            | Fiscal Years Ended July 31, |  
|                                                                       |                                            |                             |  
|                                                                       |                                            | 2004                        |   |       | 2003  |   |   | % Change |      
|                                                                       |                                            |                             |   |       |       |   |   |          |      
|Net revenues:                                                          |                                            |                             |   |       |       |   |   |          |       |   |  |     
|                                                                       | Core Pharmaceuticals products              |                             | $ | 4,248 |       |   | $ | 4,866    |       |   |  | (13  | )   
|                                                                       | IST*                                       |                             |   | 4,723 |       |   |   | 4,901    |       |   |  | (4   | )   
|                                                                       |                                            |                             |   |       |       |   |   |          |      
|                                                                       |                                            | Total net revenues          |   |       | 8,971 |   |   |          | 9,767 |   |  |      | (8   | )
|Gross profit:                                                          |                                            |                             |   |       |       |   |   |          |       |   |  |     
|                                                                       | Core Pharmaceuticals products gross profit |                             |   | 2,898 |       |   |   | 3,640    |       |   |  | (20  | )   
|                                                                       | Core Pharmaceuticals gross margin %        |                             |   | 68    | %     |   |   | 75       | %     |   |  |      |     
|                                                                       | IST gross profit*                          |                             |   | 2,088 |       |   |   | 1,427    |       |   |  | 46   |     
|                                                                       | IST gross margin %                         |                             |   | 44    | %     |   |   | 29       | %     |   |  |      |     
|                                                                       |                                            | Total gross profit          |   |       | 4,986 |   |   |          | 5,067 |   |  |      | (2   | )
|                                                                       |                                            | Total gross margin %        |   |       | 56    | % |   |          | 52    | % |  |      |      |  
|Operating income (loss) before income taxes and accounting
    change: |                                            |                             |   |       |       |   |   |          |       |   |  |     
|                                                                       | Core Pharmaceuticals products              |                             |   | (566  | )     |   |   | 522      |       |   |  | (208 | )   
|                                                                       | IST*                                       |                             |   | (199  | )     |   |   | (116     | )     |   |  | (72  | )   
|                                                                       |                                            |                             |   |       |       |   |   |          |      
|                                                                       |                                            | Total                       |   |       | (765  | ) |   |          | 406   |   |  |      | (288 | )




Net of intercompany eliminations






| |   |                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------
| |  | Strengthening the position of Peridex® in the direct to
    dental market through the introduction of new dispensing
    offerings;
|
| |  | A disciplined product rollout of ViziLite® that resulted in
    improving sales trends;                                            
|
| |  | Cost of goods increases for production due to supplier changes
    and an increase in regulatory compliance; and                   
|
| |  | Loss of a major IST customer.                                                                                                      



35



---



##### Table of Contents













| |              
| | -------------
| | Biotechnology



|                                                             |  |                             |        |   |      |   |       |          |  |  |      |  
|------------------------------------------------------------ |  | --------------------------- | ------ | - | ---- | - | ----- | -------- |  |  | ---- | -
|                                                             |  | Fiscal Years Ended July 31, |       
|                                                             |  |                             |       
|                                                             |  | 2004                        |        |   | 2003 |   |       | % Change | 
|                                                             |  |                             |        |   |      |   |       |          | 
|Net revenues                                                 |  | $                           | 2      |   |      | $ | 20    |          |  |  | (90  | )
|Research and development                                     |  |                             | 5,476  |   |      |   | 3,610 |          |  |  | 52   |  
|Income (loss) from continuing operations before income taxes |  |                             | (7,195 | ) |      |   | 3,474 |          |  |  | (307 | )





| |   |                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Increased spending for the OraTest® product regulatory
    program;                                                                                  
|
| |  | Selecting new regulatory consultants and continued development
    of a commercialization strategy for the OraTest® product;                         
|
| |  | Proposed modifications to the current OraTest® regulatory
    program submitted to the FDA aimed at reducing its overall
    duration and total cost;

36



---



##### Table of Contents





| |   |                                                                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Renegotiation of the General Services Agreement with Quintiles
    Transnational Corp. (Quintiles), our contract
    research organization, to support the modifications to our
    regulatory program;                                                                                                                                          
|
| |  | Expanded use of our Medical Advisory Board, whose members are
    some of the worlds leading researchers in the field of
    head and neck cancer, to assist in development of our regulatory
    strategy to reduce the cost and duration of our current
    regulatory program and in development of our product
    commercialization strategy;
|
| |  | Emphasizing the United States domestic market sales potential
    and de-emphasizing European and Asian marketing efforts; and                                                                                                                                                                                                                     
|
| |  | Evaluation of other Tolonium Chloride pre-cancer and cancer
    detection applications.                                                                                                                                                                                                                                                            









| |                          
| | -------------------------
| | Inflation and Seasonality



Liquidity and Capital Resources




| |         
| | --------
| | Overview





|                                                    |  |                    |        |   |      |   |        |  
|--------------------------------------------------- |  | ------------------ | ------ | - | ---- | - | ------ | -
|                                                    |  | Fiscal Years Ended |       
|                                                    |  | July 31,           |       
|                                                    |  |                    |       
|                                                    |  | 2005               |        |   | 2004 |  
|                                                    |  |                    |        |   |      |  
|Net cash used in operating activities               |  | $                  | (7,387 | ) |      | $ | (3,629 | )
|Net cash provided by (used in) investing activities |  |                    | 16,588 |   |      |   | (8,796 | )
|Net cash provided by (used in) financing activities |  |                    | 57     |   |      |   | (56    | )

|                                                  |  |          |        |  |          |   |        | 
|------------------------------------------------- |  | -------- | ------ |  | -------- | - | ------ | 
|                                                  |  | July 31, |        |  | July 31, |  
|                                                  |  | 2005     |        |  | 2004     |  
|                                                  |  |          |        |  |          |  
|Cash, cash equivalents and short-term investments |  | $        | 12,938 |  |          | $ | 11,680 | 
|Working capital                                   |  |          | 22,824 |  |          |   | 22,542 | 
|Current ratio                                     |  |          | 3.33   |  |          |   | 3.97   | 

37



---



##### Table of Contents









| |                     
| | --------------------
| | Operating Activities







| |                     
| | --------------------
| | Investing Activities



tm




| |                     
| | --------------------
| | Financing Activities



38



---



##### Table of Contents





| |             
| | ------------
| | Income Taxes





| |                  
| | -----------------
| | Credit Facilities











39



---



##### Table of Contents





| |                    
| | -------------------
| | Supply Arrangements





| |                
| | ---------------
| | Preferred Stock





| |                         
| | ------------------------
| | Stock Repurchase Program





| |       
| | ------
| | EBITDA





40



---



##### Table of Contents



Reconciliation of GAAP Measures to Non-GAAP Measures


|                              |                   |                             |        |       |      |   |        |        |   |   |        |       |    
|----------------------------- | ----------------- | --------------------------- | ------ | ----- | ---- | - | ------ | ------ | - | - | ------ | ----- | ---
|                              |                   | Fiscal Years Ended July 31, |       
|                              |                   |                             |       
|                              |                   | 2005                        |        |       | 2004 |   |        | 2003   |  
|                              |                   |                             |        |       |      |   |        |        |  
|                              |                   | Unaudited                   |       
|                              |                   | (In thousands)              |       
|EBITDA                        |                   | $                           | 3,939  |       |      | $ | (1,431 | )      |   | $ | 10,264 |      
|Interest income               |                   |                             | 188    |       |      |   | 109    |        |   |   | 15     |      
|Interest expense              |                   |                             | (196   | )     |      |   | (342   | )      |   |   | (389   | )    
|Depreciation and amortization |                   |                             | (2,746 | )     |      |   | (2,671 | )      |   |   | (2,417 | )    
|Income tax expense            |                   |                             | (86    | )     |      |   | (2     | )      |   |   | (188   | )    
|                              |                   |                             |        |       |      |   |        |        |  
|                              | Net income (loss) |                             | $      | 1,099 |      |   | $      | (4,337 | ) |   | $      | 7,285 | (a)
|                              |                   |                             |        |       |      |   |        |        |  






|    |                                                                                                                                                                                                                                                              
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Fiscal 2003 net income includes a $14.8 million net
    contract settlement gain from our former contract research
    organization and goodwill impairment charge of $4.1 million
    (see Notes 6 and 9 of Notes to Consolidated Financial
    Statements).



| |                        
| | -----------------------
| | Contractual Obligations



|                          |       |      |       |        |             |   |        |             |  |   |            |       |  |       |       |       |  |   |        |        | 
|------------------------- | ----- | ---- | ----- | ------ | ----------- | - | ------ | ----------- |  | - | ---------- | ----- |  | ----- | ----- | ----- |  | - | ------ | ------ | 
|                          |       | 2006 |       |        | 2007 & 2008 |   |        | 2009 & 2010 |  |   | Thereafter |       |  | Total |      
|                          |       |      |       |        |             |   |        |             |  |   |            |       |  |       |      
|Long-term debt            |       | $    | 274   |        |             | $ | 491    |             |  | $ | 991        |       |  | $     | 1,740 |       |  | $ | 3,496  |       
|Operating leases          |       |      | 476   |        |             |   | 887    |             |  |   | 488        |       |  |       | 69    |       |  |   | 1,920  |       
|Capital lease obligations |       |      | 54    |        |             |   | 98     |             |  |   | 13         |       |  |       |      |       |  |   | 165    |       
|Purchase obligations      |       |      | 9,208 |        |             |   | 11,801 |             |  |   |           |       |  |       |      |       |  |   | 21,009 |       
|                          |       |      |       |        |             |   |        |             |  |   |            |       |  |       |      
|                          | Total |      | $     | 10,012 |             |   | $      | 13,277      |  |   | $          | 1,492 |  |       | $     | 1,809 |  |   | $      | 26,590 | 
|                          |       |      |       |        |             |   |        |             |  |   |            |       |  |       |      





Critical Accounting Policies and Estimates






| |                                                                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Revenue Recognition  Revenue from sales of
    products is recognized when earned; that is, when the risks and
    rewards of ownership have transferred to the customer, which is
    considered to have occurred

41



---



##### Table of Contents



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | when delivery to the designated location or carrier has
    occurred. Cash discounts, sales incentives, and returns are
    estimated and recognized as a reduction of revenue at the time
    of sale based upon historical activity and current customer
    commitments. We evaluate these estimates on a quarterly basis
    and revise them as necessary.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| | We provide for allowances for doubtful accounts and sales
    returns based on historical experience and a review of our
    receivables. Receivables are presented net of allowances for
    doubtful accounts and for sales returns of $150,000 at
    July 31, 2005 and $272,000 at July 31, 2004. We
    evaluate these estimates on a quarterly basis and revise them as
    necessary.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | On occasion, we enter into arrangements to license our
    technology on specifically approved products. For those
    arrangements where we have continuing involvement with the
    licensee, nonrefundable, upfront license fees are recognized
    systematically as they are earned over the life of the
    agreement. Fees associated with substantive, at risk,
    performance milestones are recognized as revenue upon their
    completion, as defined in the respective agreements. For
    perpetual licenses or manufacturing rights agreements, where:
    (i) we have no further continuing involvement with the
    licensee; (ii) the fees are nonrefundable; and
    (iii) the fees are not a prepayment of future royalties, we
    recognize the fees as revenue at the time the arrangement
    becomes effective. The assessment of existence or extent of
    continuing involvement requires significant judgment and
    analysis of the contractual requirements and other factors
    relating to the business relationship between the parties.

Use of Estimates










| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The cash flows used to measure long-lived assets related to the
    OraTest® product are dependent upon obtaining FDA approval
    and generating sufficient revenues from sales of the
    OraTest® product. The rigorous clinical testing and an
    extensive regulatory approval process mandated by the FDA and
    equivalent foreign authorities before any new drug can be
    marketed by us can take a number of years and require the
    expenditure of substantial resources. Obtaining such approvals
    and completing such testing is a costly and time-consuming
    process, and approval may not be ultimately obtained. The length
    of the FDA review period varies considerably, as does the amount
    of clinical data required to demonstrate the safety and efficacy
    of a specific product. Net long-lived assets related to the
    OraTest® product as of July 31, 2005 of
    $5.8 million have been capitalized.
|
| | The cash flows used to measure long-lived assets related to the
    ViziLite® products are dependent upon our ability to
    properly market the products to a sufficient number of dentists
    so they become integrated within their practice. ViziLite®
    is a chemiluminescent light technology used in combination with
    traditional oral screening to increase identification,
    evaluation and monitoring of oral mucosal                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

42



---



##### Table of Contents



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | abnormalities. Achieving our sales goals requires significant
    training and education about the products attributes to
    the dental professionals. As a result of organizational and
    sales strategy changes in 2003 and 2004, we have revised our
    business model with current sales and costs assumptions. We have
    added significant marketing, sales and educational costs
    targeted towards achieving market acceptance within a reasonable
    timeframe. Net long-lived assets related to the ViziLite®
    products as of July 31, 2005 of $1.8 million have been
    capitalized.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| | Goodwill, Intangibles and Other Long-Lived
    Assets  We have made acquisitions of products and
    businesses that include goodwill, license agreements, patents
    and trademarks, product rights and other intangible and
    long-lived assets. We assess the impairment of goodwill,
    intangibles and other long-lived assets whenever events or
    changes in circumstances indicate that the carrying value of any
    of these assets may not be recoverable. Such events or
    circumstances might include a significant decline in market
    share and/or significant negative industry or economic trends, a
    significant decline in profits and/or significant
    underperformance relative to expected historical or projected
    operating results, significant changes in the manner of our use
    of the acquired assets or the strategy for our overall business,
    rapid changes in technology, significant litigation or other
    items. In evaluating the recoverability of goodwill, intangibles
    and other long-lived assets, our policy is to compare the
    carrying amounts of such assets with the estimated undiscounted
    future operating cash flows. If we have changes in events or
    circumstances, including reductions in anticipated cash flows
    generated by our operations or determinations to divest of
    certain assets, certain assets could be impaired which would
    result in a charge to earnings.
|
| | In accordance with SFAS No. 142 
    Goodwill and Other Intangibles, our policy is to
    review the carrying amounts of goodwill and certain intangible
    assets with indefinite lives at least annually as of May 1
    or, as described above, whenever events or changes in
    circumstances indicate that the carrying amount of the asset may
    be impaired.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| | The following is a summary of the significant components of our
    goodwill and intangible assets and our impairment methodology
    for each.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | Zila Pharmaceuticals Goodwill  Goodwill is
    related to the Peridex® product which was acquired from
    Procter & Gamble in November 1997 and to the IST
    acquisition in February 2001. As part of the implementation for
    SFAS No. 142, Goodwill and Other Intangible
    Assets on August 1, 2002, the Company retained an
    independent financial advisor who compared the fair values and
    corresponding carrying values of the Peridex® and IST
    assets as of the adoption date for SFAS No. 142. Based
    upon the financial advisors findings, we determined that
    approximately $3.0 million of the Peridex® goodwill
    and the entire $1.1 million of IST goodwill was impaired
    thus reducing goodwill to approximately $4.1 million. This
    transitional impairment charge of $4.1 million was recorded
    as a change in accounting principle and retroactively restated
    to August 1, 2002, the beginning of our fiscal year. We
    review the carrying value of Zila Pharmaceuticals goodwill at
    least annually as of May 1 or, as described above, whenever
    events or changes in circumstances indicate that the carrying
    amount of the asset may be impaired.                                                                                                                                                                                                                                                  
|
| | Zila Nutraceuticals Goodwill  Goodwill and
    trademarks totaling approximately $10.6 million (net of
    accumulated amortization of $4.3 million) are related to
    the Ester-C® group of products. These assets were acquired
    by merger in 1997 and are combined for purposes of testing for
    impairment. We review the carrying value of Zila Nutraceuticals
    goodwill at least annually as of May 1 or, as described
    above, whenever events or changes in circumstances indicate that
    the carrying amount of the asset may be impaired.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| | OraTest®  The purchase of CTM eliminated
    our obligation to pay royalties to CTM on future sales of the
    OraTest® product. The recoverability of the
    $3.0 million net purchased technology rights is dependent
    upon obtaining FDA approval and generating sufficient revenues
    from future sales of the OraTest® products. For purposes of
    testing recoverability, the following are grouped with purchased
    technology rights: (i) fixed assets of approximately
    $1.2 million (primarily related to our manufacturing
    facility); (ii) patents and patents pending of
    $1.6 million; and (iii) $482,000 of OraTest®
    clinical rinse and swab inventory,
    ZTCtm
    drug substance, the active ingredient in the OraTest®
    product, and its related                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

43



---



##### Table of Contents



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | components. We have prepared a probability-weighted analysis of
    potential future cash flows under various possible outcomes.
    Significant assumptions in the analysis include the expected
    date and overall likelihood of FDA approval, cost of the
    remaining regulatory program, cost of the marketing roll out,
    future net cash flows associated with sales of the products and
    the probabilities assigned to each possible outcome. The
    assumptions included in the analysis are updated whenever events
    or changes in circumstances indicate that the carrying amount
    may be impaired.

Recent Accounting Pronouncements




Stock Options




44



---



##### Table of Contents














|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures about Market
    Risk









45



---



##### Table of Contents








|        |                                            
|------- | -------------------------------------------
|Item 8. | Financial Statements and Supplementary Data








|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure








|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Evaluation of Disclosure Controls and Procedures.






Changes in Internal Control over Financial Reporting.




Managements Annual Report on Internal Control Over
Financial Reporting.






| |                                                                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (i) pertain to the maintenance of records that, in
    reasonable detail, accurately and fairly reflect the
    transactions and dispositions of our assets;                                                                                                                                                                                                   
|
| | (ii) provide reasonable assurance that transactions are
    recorded as necessary to permit preparation of our financial
    statements in accordance with generally accepted accounting
    principles, and that our receipts and expenditures are being
    made only in accordance with the authorizations of our
    management and board of directors; and
|
| | (iii) provide reasonable assurance regarding prevention or
    timely detection of unauthorized acquisition, use or disposition
    of our assets that could have a material effect on the financial
    statements.                                                                                                                                           

46



---



##### Table of Contents









47



---



##### Table of Contents



Report of Independent Registered Public Accounting Firm On
Internal Control Over Financial Reporting.








Internal
Control  Integrated Framework








Internal
Control  Integrated Framework Internal Control  Integrated
Framework






| |                     
| | --------------------
| | /s/ BDO Seidman, LLP





48



---



##### Table of Contents








|         |                  
|-------- | -----------------
|Item 9B. | Other Information






PART III







|         |                                                   
|-------- | --------------------------------------------------
|Item 10. | Directors and Executive Officers of the Registrant












|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation








|         |                                                                                                   
|-------- | --------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial Owners and
    Management and Related Stockholder Matters








|         |                                               
|-------- | ----------------------------------------------
|Item 13. | Certain Relationships and Related Transactions








|         |                                       
|-------- | --------------------------------------
|Item 14. | Principal Accountant Fees and Services



49



---



##### Table of Contents






PART IV







|         |                                           
|-------- | ------------------------------------------
|Item 15. | Exhibits and Financial Statement Schedules

| |        |  |  |                                                                                                                                                                                                                                                                                                                                                                                                 
| | ------ |  |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (a)(1) |  |  | Financial Statements. Reference is made to the financial
    statements list in Section 1 of the Index to Consolidated
    Financial Statements and Schedules in this Report.                                                                                                                                                                                                                   
| | (a)(2) |  |  | Financial Statement Schedule. Reference is made to the financial
    statement schedule listed in Section 2 of the Index to
    Consolidated Financial Statements and Schedules in this Report.
    All other schedules have been omitted as not required, not
    applicable or because the information required to be presented
    is included in the financial statements and related notes.
| | (a)(3) |  |  | The exhibits listed in the accompanying Index to Exhibits filed
    as part of this Report are incorporated herein by reference.                                                                                                                                                                                                                                                                

INDEX TO EXHIBITS


|        |      |  |             |                                                                                                                                                                                                                                                                            |           |  |   | 
|------- | ---- |  | ----------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------- |  | - | 
|Exhibit |      |  |             |                                                                                                                                                                                                                                                                            | Method    | 
|Number  |      |  | Description |                                                                                                                                                                                                                                                                            | of Filing | 
|        |      |  |             |                                                                                                                                                                                                                                                                            |           | 
|        | 3-A  |  |             | Certificate of Incorporation, as amended                                                                                                                                                                                                                                   |           |  | A | 
|        | 3-B  |  |             | Certificate of Amendment to Certificate of Incorporation                                                                                                                                                                                                                   |           |  | * | 
|        | 3-C  |  |             | Amended and Restated Bylaws (as amended through
    September 26, 2002)                                                                                                                                                                                                    |           |  | B | 
|       
|        | 4-A  |  |             | Specimen Stock Certificate                                                                                                                                                                                                                                                 |           |  | A | 
|       
|        | 10-A |  |             | Asset Purchase Agreement dated October 28, 1999 between
    Zila, Inc., and Cygnus Imaging, Inc. and Procare Laboratories,
    Inc.                                                                                                                                        |           |  | A | 
|       
|        | 10-B |  |             | Secured Note dated October 28, 1999 between Zila, Inc. and
    Procare Laboratories, Inc.                                                                                                                                                                                  |           |  | A | 
|       
|        | 10-C |  |             | Asset Purchase agreement dated as of November 30, 1999 by
    and among Zila, Inc., Integrated Dental Technologies, Inc.,
    InfoCure Systems, Inc., and InfoCure Corporation                                                                                             |           |  | C | 
|       
|        | 10-D |  |             | Engagement Letter dated March 15, 2001 between Zila, Inc.
    and Douglas, Curtis and Allyn, LLC                                                                                                                                                                           |           |  | D | 
|       
|        | 10-E |  |             | Employee Stock Purchase Plan(1)                                                                                                                                                                                                                                            |           |  | E | 
|       
|        | 10-F |  |             | Asset Purchase Agreement, dated as of November 1, 2001, by
    and between Ryker Dental of Kentucky, Inc. and HSI Ryker, Inc.                                                                                                                                              |           |  | F | 
|       
|        | 10-G |  |             | Amended and Restated Asset Purchase Agreement dated as of
    December 4, 2001 by and among Zila, Inc., Ryker Dental of
    Kentucky, Inc. and PracticeWares, Inc.                                                                                                         |           |  | F | 
|       
|        | 10-H |  |             | First Amendment to Engagement Letter dated as of June 6,
    2002 between Zila, Inc. and Douglas, Curtis & Allyn, LLC                                                                                                                                                      |           |  | G | 
|       
|        | 10-I |  |             | Fourth Extension and Modification Agreement dated as of
    June 6, 2002 between Ryker Dental of Kentucky, Inc.,
    PracticeWares, Inc. and Practice Works, Inc. and Gregory A. Jones                                                                                     |           |  | G | 
|       
|        | 10-J |  |             | First Amendment to Amended and Restated Asset Purchase Agreement
    dated as of June 18, 2002 between Ryker Dental of Kentucky,
    Inc., PracticeWares, Inc. and Zila, Inc                                                                                               |           |  | G | 
|       
|        | 10-K |  |             | Stockholders Agreement dated as of June 18, 2002, among
    PracticeWorks, Inc., Gregory A Jones, Ryker Dental of Kentucky,
    Inc. and PracticeWares, Inc                                                                                                                |           |  | G | 
|       
|        | 10-L |  |             | Investment Agreement between Zila, Inc. and PharmaBio
    Development, Inc. dated December 18, 2002                                                                                                                                                                        |           |  | H | 
|       
|        | 10-M |  |             | Credit and Security Agreement between Zila Nutraceuticals, Inc.,
    Zila Biotechnology, Inc., Zila Pharmaceuticals, Inc., Zila
    Swab Technologies, Inc., Oxycal Laboratories, Incorporated, and
    Wells Fargo Business Credit, Inc., date as of February 6,
    2004 |           |  | I | 

50



---



##### Table of Contents



|        |       |  |             |                                                                                                                                                                                                                                                                                                                             |           |  |    | 
|------- | ----- |  | ----------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------- |  | -- | 
|Exhibit |       |  |             |                                                                                                                                                                                                                                                                                                                             | Method    | 
|Number  |       |  | Description |                                                                                                                                                                                                                                                                                                                             | of Filing | 
|        |       |  |             |                                                                                                                                                                                                                                                                                                                             |           | 
|       
|        | 10-N  |  |             | Reimbursement Agreement between Oxycal Laboratories,
    Incorporated, an Arizona Corporation, and Wells Fargo Business
    Credit, Inc. relating to $3,900,000  The Industrial
    Development Authority Revenue Bonds (Oxycal Laboratories,
    Incorporated Project) Series 1999A, dated as of
    February 6, 2004     |           |  | I  | 
|       
|        | 10-O  |  |             | Employment Agreement between Zila, Inc. and Douglas D.
    Burkett, Ph.D., dated as of October 21, 2003(1)                                                                                                                                                                                                                  |           |  | I  | 
|       
|        | 10-P  |  |             | Purchase Agreement between Zila, Inc. and Gary and Janet Hedge,
    dated as of November 7, 2003                                                                                                                                                                                                                            |           |  | I  | 
|       
|        | 10-Q  |  |             | Lease between Zila, Inc. and Phoenix 7 LLC, dated
    January 30, 2004                                                                                                                                                                                                                                                      |           |  | I  | 
|       
|        | 10-R  |  |             | Offer letter between Zila, Inc. and Andrew A. Stevens dated
    January 15, 2004(1)                                                                                                                                                                                                                                         |           |  | J  | 
|       
|        | 10-S  |  |             | First Amendment dated August 17, 2004 to the Credit and
    Security Agreement dated February 6, 2004 by and between Wells
    Fargo Business Credit, Inc. and Zila Nutraceuticals, Inc., Zila
    Biotechnology, Inc., Zila Pharmaceuticals, Inc., Zila Swab
    Technologies, Inc., and Oxycal Laboratories, Incorporated |           |  | J  | 
|       
|        | 10-T  |  |             | 1997 Stock Award Plan, as amended effective December 16,
    2004(1)                                                                                                                                                                                                                                                        |           |  | K  | 
|       
|        | 10-U  |  |             | Second Amendment to the Credit and Security Agreement with Wells
    Fargo Business Credit, Inc. and Zila Nutraceuticals, Inc., Zila
    Biotechnology, Inc., Zila Pharmaceuticals, Inc., Zila Swab
    Technologies, Inc., and Oxycal Laboratories, Incorporated                                                           |           |  | L  | 
|        | 10-V  |  |             | Offer letter between Zila, Inc. and Gary V. Klinefelter dated
    November 16, 2004(1)                                                                                                                                                                                                                                      |           |  | M  | 
|       
|        | 10-W  |  |             | Retention Agreement with Andrew A. Stevens effective
    March 7, 2005(1)                                                                                                                                                                                                                                                   |           |  | M  | 
|       
|        | 10-X  |  |             | Retention Agreement with Betty J. Pecha effective March 7,
    2005(1)                                                                                                                                                                                                                                                      |           |  | M  | 
|       
|        | 10-Y  |  |             | Retention Agreement with Diane E. Klein effective March 7,
    2005(1)                                                                                                                                                                                                                                                      |           |  | M  | 
|       
|        | 10-Z  |  |             | Agreement of Purchase and Sale of Assets dated June 27,
    2005 with Blairex Laboratories, Inc.                                                                                                                                                                                                                            |           |  | *  | 
|       
|        | 10-Aa |  |             | 2006 Executive Incentive Bonus Plan(1)                                                                                                                                                                                                                                                                                      |           |  | *  | 
|       
|        | 10-Ab |  |             | 2006 Employees Incentive Bonus Plan(1)                                                                                                                                                                                                                                                                                      |           |  | *  | 
|       
|        | 10-Ac |  |             | Form of Option Agreement                                                                                                                                                                                                                                                                                                    |           |  | *  | 
|       
|        | 21    |  |             | Subsidiaries of Registrant                                                                                                                                                                                                                                                                                                  |           |  | *  | 
|       
|        | 23.1  |  |             | Consent of BDO Seidman, LLP, Independent Registered Public
    Accounting Firm                                                                                                                                                                                                                                              |           |  | *  | 
|       
|        | 23.2  |  |             | Consent of Deloitte & Touche LLP, Independent
    Registered Public Accounting Firm                                                                                                                                                                                                                                         |           |  | *  | 
|       
|        | 24.1  |  |             | Power of Attorney (included on page 53 of this Annual
    Report on Form 10-K)                                                                                                                                                                                                                                              |           |  | *  | 
|       
|        | 31.1  |  |             | Sarbanes-Oxley Section 302 Certification of the Chief
    Executive Officer                                                                                                                                                                                                                                                 |           |  | *  | 
|       
|        | 31.2  |  |             | Sarbanes-Oxley Section 302 Certification of the Chief
    Financial Officer                                                                                                                                                                                                                                                 |           |  | *  | 
|       
|        | 32.1  |  |             | Sarbanes-Oxley Section 906 Certification of the Chief
    Executive Officer                                                                                                                                                                                                                                                 |           |  | ** | 
|       
|        | 32.2  |  |             | Sarbanes-Oxley Section 906 Certification of the Chief
    Financial Officer                                                                                                                                                                                                                                                 |           |  | ** | 






|    |                                                        
|--- | -------------------------------------------------------
|(1) | Management contract or compensatory plan or arrangement



| |   |               
| | - | --------------
| | * | Filed herewith



|   |                                                                                                                               
|-- | ------------------------------------------------------------------------------------------------------------------------------
|** | Furnished herewith                                                                                                            
|  
|A  | Incorporated by reference to the Companys Annual Report on
    Form 10-K for fiscal year ended July 31, 1999                 
|  
|B  | Incorporated by reference to the Companys Annual Report on
    Form 10-K for fiscal year ended July 31, 2002                 
|  
|C  | Incorporated by reference to the Companys Current Report
    on Form 8-K dated January 3, 2000                               
|  
|D  | Incorporated by reference to the Companys Quarterly Report
    on Form 10-Q for the quarterly period ended April 30,
    2001

51



---



##### Table of Contents





|  |                                                                                                                                 
|- | --------------------------------------------------------------------------------------------------------------------------------
|E | Incorporated by reference to the Companys Proxy Statement
    on Schedule 14A filed November 7, 2000                           
| 
|F | Incorporated by reference to the Companys Quarterly Report
    on Form 10-Q for the quarterly period ended
    October 31, 2001
| 
|G | Incorporated by reference to the Companys Current Report
    on Form 8-K dated July 3, 2002                                    
| 
|H | Incorporated by reference to the Companys Quarterly Report
    on Form 10-Q for the quarterly period ended
    January 31, 2003



|  |                                                                                                                                 
|- | --------------------------------------------------------------------------------------------------------------------------------
|I | Incorporated by reference to the Companys Quarterly Report
    on Form 10-Q for the quarterly period ended
    January 31, 2004
| 
|J | Incorporated by reference to the Companys Annual Report on
    Form 10-K for fiscal year ended July 31, 2004                   



|  |                                                                                                                                 
|- | --------------------------------------------------------------------------------------------------------------------------------
|K | Incorporated by reference to the Companys Proxy Statement
    on Schedule 14A filed November 8, 2004                           
| 
|L | Incorporated by reference to the Companys Current Report
    on Form 8-K dated January 25, 2005                                
| 
|M | Incorporated by reference to the Companys Quarterly Report
    on Form 10-Q for the quarterly period ended
    January 31, 2005

52



---



##### Table of Contents






SIGNATURES






| |                                   
| | ----------------------------------
| | ZILA, INC., a Delaware corporation



| |    |                      
| | -- | ---------------------
| | By | /s/ ANDREW A. STEVENS

| |                                           
| | ------------------------------------------
| |                                           
| | Andrew A. Stevens                         
| | Vice President and Chief Financial Officer
| | (Principal Financial Officer)             

POWER OF ATTORNEY






|                                                               |  |                                                               |  |                  |  | 
|-------------------------------------------------------------- |  | ------------------------------------------------------------- |  | ---------------- |  | 
|Signature                                                      |  | Title                                                         |  | Date            
|                                                               |  |                                                               |  |                 
|                                                              
|/s/ DOUGLAS D. BURKETT,
    PH.D.Douglas
    D. Burkett, Ph.D. |  | Chairman of the Board, President, and Chief Executive Officer |  | October 12, 2005
|                                                              
|/s/ MORRIS C. AARONMorris
    C. Aaron                         |  | Director                                                      |  | October 12, 2005
|                                                              
|/s/ LESLIE GREENLeslie
    Green                               |  | Director                                                      |  | October 12, 2005
|                                                              
|/s/ CHRISTOPHER D.
    JOHNSONChristopher
    D. Johnson       |  | Director                                                      |  | October 12, 2005
|                                                              
|/s/ MICHAEL S. LESSERMichael
    S. Lesser                     |  | Director                                                      |  | October 12, 2005

53



---



##### Table of Contents



|                                             |  |          |  |                  |  | 
|-------------------------------------------- |  | -------- |  | ---------------- |  | 
|Signature                                    |  | Title    |  | Date            
|                                             |  |          |  |                 
|                                            
|/s/ JOHN EDWARD PORTERJohn
    Edward Porter |  | Director |  | October 12, 2005
|                                            
|/s/ S. TIMOTHY ROSES.
    Timothy Rose       |  | Director |  | October 12, 2005

54



---



##### Table of Contents



APPENDIX F


ZILA, INC. AND SUBSIDIARIES


INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND


FINANCIAL STATEMENT SCHEDULE


| |    |  |  |                                                                                                                 |  |  |      | 
| | -- |  |  | --------------------------------------------------------------------------------------------------------------- |  |  | ---- | 
| |    |  |  | Page                                                                                                            | 
| |    |  |  |                                                                                                                 | 
| | 1. |  |  | Financial Statements                                                                                            |  |  |      | 
| |    |  |  | Report of Independent Registered Public
    Accounting Firm  BDO Seidman LLP                                   |  |  | F-2  | 
| |    |  |  | Report of Independent Registered Public
    Accounting Firm  Deloitte & Touche LLP                             |  |  | F-3  | 
| |    |  |  | Consolidated Balance Sheets as of
    July 31, 2005 and 2004                                                    |  |  | F-4  | 
| |    |  |  | Consolidated Statements of Operations for
    the Years Ended July 31, 2005, 2004 and 2003                      |  |  | F-5  | 
| |    |  |  | Consolidated Statements of Comprehensive
    Income (Loss) for the Years Ended July 31, 2005, 2004 and
    2003 |  |  | F-6  | 
| |    |  |  | Consolidated Statements of
    Shareholders Equity for the Years Ended July 31,
    2005, 2004 and 2003        |  |  | F-7  | 
| |    |  |  | Consolidated Statements of Cash Flows for
    the Years Ended July 31, 2005, 2004 and 2003                      |  |  | F-8  | 
| |    |  |  | Notes to Consolidated Financial
    Statements                                                                  |  |  | F-9  | 
| | 2. |  |  | Financial Statement Schedule                                                                                    |  |  |      | 
| |    |  |  | Schedule II  Valuation and
    Qualifying Accounts                                                             |  |  | F-34 | 

F-1



---



##### Table of Contents






Report of Independent Registered Public Accounting Firm
















Goodwill and Other Intangible
Assets


Internal Control  Integrated
Framework




| |                     
| | --------------------
| | /s/ BDO Seidman, LLP





F-2



---



##### Table of Contents






Report of Independent Registered Public Accounting Firm




















| |                          
| | -------------------------
| | /s/ DELOITTE & TOUCHE LLP





F-3



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES





CONSOLIDATED BALANCE SHEETS


July 31, 2005 and 2004


|                                                                          |                                                                                                                                      |                            |                                            |             |            |            |            |             |            |            | 
|------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------ | -------------------------- | ------------------------------------------ | ----------- | ---------- | ---------- | ---------- | ----------- | ---------- | ---------- | 
|                                                                          |                                                                                                                                      | 2005                       |                                            |             | 2004       |           
|                                                                          |                                                                                                                                      |                            |                                            |             |            |           
|ASSETS                                                                   
|CURRENT ASSETS:                                                           |                                                                                                                                      |                            |                                            |             |            |            |            |            
|                                                                          | Cash and cash equivalents                                                                                                            |                            | $                                          | 12,937,517  |            |            | $          | 3,679,915   |           
|                                                                          | Short-term investments                                                                                                               |                            |                                            |            |            |            |            | 8,000,000   |           
|                                                                          | Restricted cash collateral                                                                                                           |                            |                                            | 527,783     |            |            |            | 517,353     |           
|                                                                          | Trade receivables  net of allowances of $150,000 and
    $272,000                                                                   |                            |                                            | 11,422,743  |            |            |            | 8,027,341   |           
|                                                                          | Inventories  net                                                                                                                    |                            |                                            | 6,024,266   |            |            |            | 6,579,235   |           
|                                                                          | Prepaid expenses and other current assets                                                                                            |                            |                                            | 1,726,778   |            |            |            | 1,813,133   |           
|                                                                          | Assets held for sale                                                                                                                 |                            |                                            |            |            |            |            | 1,505,658   |           
|                                                                          |                                                                                                                                      |                            |                                            |             |            |           
|                                                                          |                                                                                                                                      | Total current assets       |                                            |             | 32,639,087 |            |            |             | 30,122,635 |           
|PROPERTY AND EQUIPMENT  net                                              |                                                                                                                                      |                            | 9,691,686                                  |             |            |            | 8,116,177  |            
|PURCHASED TECHNOLOGY RIGHTS  net                                         |                                                                                                                                      |                            | 3,031,613                                  |             |            |            | 3,510,288  |            
|GOODWILL  net                                                            |                                                                                                                                      |                            | 6,930,192                                  |             |            |            | 6,930,192  |            
|TRADEMARKS AND OTHER INTANGIBLE ASSETS  net                              |                                                                                                                                      |                            | 12,652,564                                 |             |            |            | 13,023,566 |            
|OTHER ASSETS                                                              |                                                                                                                                      |                            | 473,095                                    |             |            |            | 405,785    |            
|                                                                          |                                                                                                                                      |                            |                                            |             |            |           
|                                                                          |                                                                                                                                      |                            | TOTAL ASSETS                               |             | $          | 65,418,237 |            |             | $          | 62,108,643 | 
|                                                                          |                                                                                                                                      |                            |                                            |             |            |           
|LIABILITIES AND SHAREHOLDERS EQUITY                                     
|CURRENT LIABILITIES:                                                      |                                                                                                                                      |                            |                                            |             |            |            |            |            
|                                                                          | Accounts payable                                                                                                                     |                            | $                                          | 5,397,213   |            |            | $          | 4,159,242   |           
|                                                                          | Accrued liabilities                                                                                                                  |                            |                                            | 3,717,630   |            |            |            | 2,620,913   |           
|                                                                          | Short-term borrowings                                                                                                                |                            |                                            | 154,335     |            |            |            |            |           
|                                                                          | Deferred revenue and deferred gain on sale leaseback                                                                                 |                            |                                            | 221,726     |            |            |            | 223,524     |           
|                                                                          | Current portion of long-term debt and capital lease obligations                                                                      |                            |                                            | 323,758     |            |            |            | 343,403     |           
|                                                                          | Liabilities related to assets held for sale                                                                                          |                            |                                            |            |            |            |            | 233,446     |           
|                                                                          |                                                                                                                                      |                            |                                            |             |            |           
|                                                                          |                                                                                                                                      | Total current liabilities  |                                            |             | 9,814,662  |            |            |             | 7,580,528  |           
|Deferred revenue and deferred gain on sale leaseback                      |                                                                                                                                      |                            | 553,486                                    |             |            |            | 650,212    |            
|Long-term debt and capital lease obligations  net of
    current portion |                                                                                                                                      |                            | 3,328,139                                  |             |            |            | 3,649,733  |            
|                                                                          |                                                                                                                                      |                            |                                            |             |            |           
|                                                                          |                                                                                                                                      | Total liabilities          |                                            |             | 13,696,287 |            |            |             | 11,880,473 |           
|                                                                          |                                                                                                                                      |                            |                                            |             |            |           
|COMMITMENTS AND CONTINGENCIES (Note 17)                                   |                                                                                                                                      |                            |                                            |             |            |            |            |            
|SHAREHOLDERS EQUITY:                                                     |                                                                                                                                      |                            |                                            |             |            |            |            |            
|                                                                          | Preferred stock  Series B, $.001 par
    value  2,500,000 shares authorized,
    100,000 shares issued and outstanding             |                            |                                            | 462,500     |            |            |            | 462,500     |           
|                                                                          | Common stock, $.001 par value 
    65,000,000 shares authorized, 45,864,050 shares and
    45,723,296 shares issued and outstanding |                            |                                            | 45,864      |            |            |            | 45,723      |           
|                                                                          | Capital in excess of par value                                                                                                       |                            |                                            | 84,372,257  |            |            |            | 83,968,913  |           
|                                                                          | Accumulated other comprehensive loss                                                                                                 |                            |                                            | (63,924     | )          |            |            | (73,453     | )         
|                                                                          | Accumulated deficit                                                                                                                  |                            |                                            | (32,543,676 | )          |            |            | (33,604,140 | )         
|                                                                          | Common stock in treasury, at cost, 218,411 shares and
    225,100 shares                                                             |                            |                                            | (551,071    | )          |            |            | (571,373    | )         
|                                                                          |                                                                                                                                      |                            |                                            |             |            |           
|                                                                          |                                                                                                                                      | Total shareholders equity |                                            |             | 51,721,950 |            |            |             | 50,228,170 |           
|                                                                          |                                                                                                                                      |                            |                                            |             |            |           
|                                                                          |                                                                                                                                      |                            | TOTAL LIABILITIES AND SHAREHOLDERS EQUITY |             | $          | 65,418,237 |            |             | $          | 62,108,643 | 
|                                                                          |                                                                                                                                      |                            |                                            |             |            |           



F-4



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF OPERATIONS


Years Ended July 31, 2005, 2004 and 2003


|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |            |        |            |            |            |            |  
|-------------------------------------------------------------------------------------- | ------------------------------------------ | ------------------------------------------------ | -------------------------------------- | ---------- | ---------- | ------ | ---------- | ---------- | ---------- | ------ | ---------- | ---------- | ---------- | ---------- | -
|                                                                                       |                                            | 2005                                             |                                        |            | 2004       |        |            | 2003       |           
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Net revenues                                                                           |                                            | $                                                | 44,324,845                             |            |            | $      | 41,404,805 |            |            | $      | 39,210,412 |           
|Cost of products sold                                                                  |                                            |                                                  | 15,385,266                             |            |            |        | 16,120,121 |            |            |        | 16,772,674 |           
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Gross profit                                                                           |                                            |                                                  | 28,939,579                             |            |            |        | 25,284,684 |            |            |        | 22,437,738 |           
|Operating costs and expenses:                                                          |                                            |                                                  |                                        |            |            |        |            |            |            |        |            |           
|                                                                                       |                                            | Marketing and selling                            |                                        |            | 15,938,675 |        |            |            | 9,552,462  |        |            |            | 7,224,855  |           
|                                                                                       |                                            | General and administrative                       |                                        |            | 11,537,357 |        |            |            | 11,149,629 |        |            |            | 10,362,767 |           
|                                                                                       |                                            | Severance and related charges                    |                                        |            | 191,957    |        |            |            | 349,533    |        |            |            | 1,322,147  |           
|                                                                                       |                                            | Other operating costs                            |                                        |            | 296,118    |        |            |            |           |        |            |            |           |           
|                                                                                       |                                            | Research and development                         |                                        |            | 7,181,206  |        |            |            | 5,932,870  |        |            |            | 4,137,215  |           
|                                                                                       |                                            | Impairment of assets                             |                                        |            |           |        |            |            | 288,940    |        |            |            | 140,794    |           
|                                                                                       |                                            | Depreciation and amortization                    |                                        |            | 2,688,141  |        |            |            | 2,482,514  |        |            |            | 2,346,315  |           
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|                                                                                       |                                            |                                                  | 37,833,454                             |            |            |        | 29,755,948 |            |            |        | 25,534,093 |           
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Loss from operations                                                                   |                                            |                                                  | (8,893,875                             | )          |            |        | (4,471,264 | )          |            |        | (3,096,355 | )         
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Other income (expense):                                                                |                                            |                                                  |                                        |            |            |        |            |            |            |        |            |           
|                                                                                       |                                            | Interest income                                  |                                        |            | 187,712    |        |            |            | 109,245    |        |            |            | 15,132     |           
|                                                                                       |                                            | Interest expense                                 |                                        |            | (195,508   | )      |            |            | (342,114   | )      |            |            | (389,628   | )         
|                                                                                       |                                            | Contract settlement gain, net of related expense |                                        |            |           |        |            |            |           |        |            |            | 14,844,093 |           
|                                                                                       |                                            | Gain on sale of assets                           |                                        |            | (6,202     | )      |            |            | 470,462    |        |            |            | 530,756    |           
|                                                                                       |                                            | Other expense                                    |                                        |            | (114,017   | )      |            |            | (138,727   | )      |            |            | (105,249   | )         
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|                                                                                       |                                            |                                                  | (128,015                               | )          |            |        | 98,866     |            |            |        | 14,895,104 |           
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Income (loss) from continuing operations before income taxes and
    accounting change |                                            |                                                  | (9,021,890                             | )          |            |        | (4,372,398 | )          |            |        | 11,798,749 |           
|Income tax expense                                                                     |                                            |                                                  | (8,300                                 | )          |            |        | (2,106     | )          |            |        | (188,126   | )         
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Income (loss) from continuing operations before accounting change                      |                                            |                                                  | (9,030,190                             | )          |            |        | (4,374,504 | )          |            |        | 11,610,623 |           
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Discontinued operations:                                                               |                                            |                                                  |                                        |            |            |        |            |            |            |        |            |           
|                                                                                       |                                            | Income (loss) from operations                    |                                        |            | 426,625    |        |            |            | 37,693     |        |            |            | (251,071   | )         
|                                                                                       |                                            | Net gain on disposal                             |                                        |            | 9,781,029  |        |            |            |           |        |            |            | 10,000     |           
|                                                                                       |                                            | Income tax expense                               |                                        |            | (78,000    | )      |            |            |           |        |            |            |           |           
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Income (loss) from discontinued operations                                             |                                            |                                                  | 10,129,654                             |            |            |        | 37,693     |            |            |        | (241,071   | )         
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Income (loss) before accounting change                                                 |                                            |                                                  | 1,099,464                              |            |            |        | (4,336,811 | )          |            |        | 11,369,552 |           
|                                                                                       |                                            |                                                  | Cumulative effect of accounting change |            |            |       |            |            |            |       |            |            |            | (4,084,193 | )
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Net income (loss)                                                                      |                                            |                                                  | 1,099,464                              |            |            |        | (4,336,811 | )          |            |        | 7,285,359  |           
|                                                                                       |                                            |                                                  | Preferred stock dividends              |            |            | 39,000 |            |            |            | 39,000 |            |            |            | 39,000     |  
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Net income (loss) attributable to common shareholders                                  |                                            | $                                                | 1,060,464                              |            |            | $      | (4,375,811 | )          |            | $      | 7,246,359  |           
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Basic net income (loss) per common share:                                              |                                            |                                                  |                                        |            |            |        |            |            |            |        |            |           
|                                                                                       |                                            | Income (loss) from continuing operations         |                                        | $          | (0.20      | )      |            | $          | (0.10      | )      |            | $          | 0.26       |           
|                                                                                       |                                            | Income (loss) from discontinued operations       |                                        |            | 0.22       |        |            |            |           |        |            |            | (0.01      | )         
|                                                                                       |                                            | Accounting change                                |                                        |            |           |        |            |            |           |        |            |            | (0.09      | )         
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Net income (loss)                                                                      |                                            | $                                                | 0.02                                   |            |            | $      | (0.10      | )          |            | $      | 0.16       |           
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|                                                                                       | Weighted average shares outstanding        |                                                  |                                        | 45,564,562 |            |        |            | 45,333,794 |            |        |            | 45,115,111 |           
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Diluted net income (loss) per common share:                                            |                                            |                                                  |                                        |            |            |        |            |            |            |        |            |           
|                                                                                       | Income (loss) from continuing operations   |                                                  | $                                      | (0.20      | )          |        | $          | (0.10      | )          |        | $          | 0.26       |           
|                                                                                       | Income (loss) from discontinued operations |                                                  |                                        | 0.22       |            |        |            |           |            |        |            | (0.01      | )         
|                                                                                       | Accounting change                          |                                                  |                                        |           |            |        |            |           |            |        |            | (0.09      | )         
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|Net income (loss)                                                                      |                                            | $                                                | 0.02                                   |            |            | $      | (0.10      | )          |            | $      | 0.16       |           
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           
|                                                                                       | Weighted average shares outstanding        |                                                  |                                        | 45,564,562 |            |        |            | 45,333,794 |            |        |            | 45,390,939 |           
|                                                                                       |                                            |                                                  |                                        |            |            |        |            |            |           



F-5



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)


Years Ended July 31, 2005, 2004 and 2003


|                                  |                                         |      |           |       |      |   |            |       |  |   |           |      |  
|--------------------------------- | --------------------------------------- | ---- | --------- | ----- | ---- | - | ---------- | ----- |  | - | --------- | ---- | -
|                                  |                                         | 2005 |           |       | 2004 |   |            | 2003  | 
|                                  |                                         |      |           |       |      |   |            |       | 
|Net income (loss)                 |                                         | $    | 1,099,464 |       |      | $ | (4,336,811 | )     |  | $ | 7,285,359 |     
|Other comprehensive income (loss) |                                         |      |           |       |      |   |            |       |  |   |           |     
|                                  | Foreign currency translation adjustment |      |           | 9,529 |      |   |            | 2,191 |  |   |           | (268 | )
|                                  |                                         |      |           |       |      |   |            |       | 
|Comprehensive income (loss)       |                                         | $    | 1,108,993 |       |      | $ | (4,334,620 | )     |  | $ | 7,285,091 |     
|                                  |                                         |      |           |       |      |   |            |       | 

|                         |                            |             |         |       |               |   |         |       | 
|------------------------ | -------------------------- | ----------- | ------- | ----- | ------------- | - | ------- | ----- | 
|                         |                            | Foreign     |         |       | Accumulated   |  
|                         |                            | Currency    |         |       | Other         |  
|                         |                            | Translation |         |       | Comprehensive |  
|                         |                            | Adjustments |         |       | Loss          |  
|                         |                            |             |         |       |               |  
|Balance at July 31, 2003 |                            | $           | (75,644 | )     |               | $ | (75,644 | )    
|                         | Other comprehensive income |             |         | 2,191 |               |   |         | 2,191 | 
|                         |                            |             |         |       |               |  
|Balance at July 31, 2004 |                            |             | (73,453 | )     |               |   | (73,453 | )    
|                         | Other comprehensive income |             |         | 9,529 |               |   |         | 9,529 | 
|                         |                            |             |         |       |               |  
|Balance at July 31, 2005 |                            | $           | (63,924 | )     |               | $ | (63,924 | )    
|                         |                            |             |         |       |               |  



F-6



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY


Years Ended July 31, 2005, 2004 and 2003


|                                                            |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               |               |   |  |        |          |   |  |   |         |   |  |   |            |  
|----------------------------------------------------------- |  | -------------------- | ------- | ------------ | ------ | - | ---------- | ------ | ----------- | --------- | ---------- | ----- | ----------- | --------- | ------ | -------- | ------- | - | ------------- | ----- |  | ------------- | ------------- | - |  | ------ | -------- | - |  | - | ------- | - |  | - | ---------- | -
|                                                            |  | Shareholders Equity |        
|                                                            |  |                      |        
|                                                            |  |                      |         | Common Stock |        |   |           
|                                                            |  |                      |         |              |        |   |            |        | Accumulated |           |            |      
|                                                            |  | Preferred Stock      |         |              |        |   | Capital in |        |             |           |            | Other |             |           | Total  |         
|                                                            |  |                      |         |              |        |   | Par        |        |             | Excess of |            |       | Accumulated |           |        | Treasury |         |   | Comprehensive |       |  | Shareholders |              
|                                                            |  | Shares               |         |              | Amount |   |            | Shares |             |           | Value      |       |             | Par Value |        |          | Deficit |   |               | Stock |  |               | Income (Loss) |   |  | Equity |         
|                                                            |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               |               |   |  |        |         
|BALANCE, JULY 31, 2002                                      |  |                      | 100,000 |              |        | $ | 462,500    |        |             |           | 45,291,160 |       |             | $         | 45,291 |          |         | $ | 82,900,342    |       |  | $             | (36,474,688   | ) |  | $      | (535,120 | ) |  | $ | (75,376 | ) |  | $ | 46,322,949 |  
|Warrants issued for services provided                       |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   | 70,569        |       |  |               |               |   |  |        |          |   |  |   |         |   |  |   | 70,569     |  
|Dividends on preferred stock                                |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               | (39,000       | ) |  |        |          |   |  |   |         |   |  |   | (39,000    | )
|Purchase of common stock for treasury                       |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               |               |   |  |        | (36,253  | ) |  |   |         |   |  |   | (36,253    | )
|Issuance of common stock under employee stock purchase plan |  |                      |         |              |        |   |            |        |             |           | 143,733    |       |             |           | 144    |          |         |   | 139,377       |       |  |               |               |   |  |        |          |   |  |   |         |   |  |   | 139,521    |  
|Exercise of common stock options and warrants               |  |                      |         |              |        |   |            |        |             |           | 5,000      |       |             |           | 5      |          |         |   | 5,245         |       |  |               |               |   |  |        |          |   |  |   |         |   |  |   | 5,250      |  
|Foreign currency translation                                |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               |               |   |  |        |          |   |  |   | (268    | ) |  |   | (268       | )
|Net income                                                  |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               | 7,285,359     |   |  |        |          |   |  |   |         |   |  |   | 7,285,359  |  
|                                                            |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               |               |   |  |        |         
|BALANCE, JULY 31, 2003                                      |  |                      | 100,000 |              |        |   | 462,500    |        |             |           | 45,439,893 |       |             |           | 45,440 |          |         |   | 83,115,533    |       |  |               | (29,228,329   | ) |  |        | (571,373 | ) |  |   | (75,644 | ) |  |   | 53,748,127 |  
|Warrants issued for services provided                       |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   | 28,028        |       |  |               |               |   |  |        |          |   |  |   |         |   |  |   | 28,028     |  
|Dividends on preferred stock                                |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               | (39,000       | ) |  |        |          |   |  |   |         |   |  |   | (39,000    | )
|Issuance of common stock under employee stock purchase plan |  |                      |         |              |        |   |            |        |             |           | 76,803     |       |             |           | 77     |          |         |   | 249,883       |       |  |               |               |   |  |        |          |   |  |   |         |   |  |   | 249,960    |  
|Exercise of common stock options and warrants               |  |                      |         |              |        |   |            |        |             |           | 206,600    |       |             |           | 206    |          |         |   | 440,001       |       |  |               |               |   |  |        |          |   |  |   |         |   |  |   | 440,207    |  
|Trylon shares adjustment to market value                    |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   | 135,468       |       |  |               |               |   |  |        |          |   |  |   |         |   |  |   | 135,468    |  
|Foreign currency translation                                |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               |               |   |  |        |          |   |  |   | 2,191   |   |  |   | 2,191      |  
|Net loss                                                    |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               | (4,336,811    | ) |  |        |          |   |  |   |         |   |  |   | (4,336,811 | )
|                                                            |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               |               |   |  |        |         
|BALANCE, JULY 31, 2004                                      |  |                      | 100,000 |              |        |   | 462,500    |        |             |           | 45,723,296 |       |             |           | 45,723 |          |         |   | 83,968,913    |       |  |               | (33,604,140   | ) |  |        | (571,373 | ) |  |   | (73,453 | ) |  |   | 50,228,170 |  
|Dividends on preferred stock                                |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               | (39,000       | ) |  |        |          |   |  |   |         |   |  |   | (39,000    | )
|Issuance of common stock under employee stock purchase plan |  |                      |         |              |        |   |            |        |             |           | 66,519     |       |             |           | 67     |          |         |   | 223,017       |       |  |               |               |   |  |        |          |   |  |   |         |   |  |   | 223,084    |  
|Exercise of common stock options and warrants               |  |                      |         |              |        |   |            |        |             |           | 74,235     |       |             |           | 74     |          |         |   | 127,882       |       |  |               |               |   |  |        |          |   |  |   |         |   |  |   | 127,956    |  
|Issuance of common stock from treasury                      |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   | 3,445         |       |  |               |               |   |  |        | 20,302   |   |  |   |         |   |  |   | 23,747     |  
|Trylon shares adjustment to market value                    |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   | 49,000        |       |  |               |               |   |  |        |          |   |  |   |         |   |  |   | 49,000     |  
|Foreign currency translation                                |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               |               |   |  |        |          |   |  |   | 9,529   |   |  |   | 9,529      |  
|Net income                                                  |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               | 1,099,464     |   |  |        |          |   |  |   |         |   |  |   | 1,099,464  |  
|                                                            |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               |               |   |  |        |         
|BALANCE, JULY 31, 2005                                      |  |                      | 100,000 |              |        | $ | 462,500    |        |             |           | 45,864,050 |       |             | $         | 45,864 |          |         | $ | 84,372,257    |       |  | $             | (32,543,676   | ) |  | $      | (551,071 | ) |  | $ | (63,924 | ) |  | $ | 51,721,950 |  
|                                                            |  |                      |         |              |        |   |            |        |             |           |            |       |             |           |        |          |         |   |               |       |  |               |               |   |  |        |         



F-7



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF CASH FLOWS


Years Ended July 31, 2005, 2004, 2003


|                                                     |                                                                                                        |                                                       |                                                     |            |            |            |             |             |            |            |            |          |            |            |  
|---------------------------------------------------- | ------------------------------------------------------------------------------------------------------ | ----------------------------------------------------- | --------------------------------------------------- | ---------- | ---------- | ---------- | ----------- | ----------- | ---------- | ---------- | ---------- | -------- | ---------- | ---------- | -
|                                                     |                                                                                                        | 2005                                                  |                                                     |            | 2004       |            |             | 2003        |           
|                                                     |                                                                                                        |                                                       |                                                     |            |            |            |             |             |           
|OPERATING ACTIVITIES:                                |                                                                                                        |                                                       |                                                     |            |            |            |             |             |            |            |            |         
|Net income (loss)                                    |                                                                                                        | $                                                     | 1,099,464                                           |            |            | $          | (4,336,811  | )           |            | $          | 7,285,359  |         
|                                                     | Adjustments to reconcile net income (loss) to net cash provided
    by (used in) operating activities: |                                                       |                                                     |            |            |            |             |             |            |            |            |          |           
|                                                     |                                                                                                        | Depreciation and amortization continuing operations   |                                                     |            | 2,688,141  |            |             |             | 2,482,514  |            |            |          | 2,346,315  |           
|                                                     |                                                                                                        | Depreciation and amortization discontinued operations |                                                     |            | 57,345     |            |             |             | 188,426    |            |            |          | 70,270     |           
|                                                     |                                                                                                        | Effect of change in accounting principle              |                                                     |            |           |            |             |             |           |            |            |          | 4,084,193  |           
|                                                     |                                                                                                        | Amortization of deferred financing costs              |                                                     |            | 36,418     |            |             |             | 186,086    |            |            |          | 183,519    |           
|                                                     |                                                                                                        | Gain on sale of assets                                |                                                     |            |           |            |             |             | (470,462   | )          |            |          | (530,756   | )         
|                                                     |                                                                                                        | Gain from sale of discontinued operations             |                                                     |            | (9,781,029 | )          |             |             |           |            |            |          | (10,000    | )         
|                                                     |                                                                                                        | Impairment of assets                                  |                                                     |            |           |            |             |             | 288,940    |            |            |          | 140,794    |           
|                                                     |                                                                                                        | Noncash research and development expense              |                                                     |            | 49,000     |            |             |             | 72,187     |            |            |          |           |           
|                                                     |                                                                                                        | Noncash stock-based compensation expense              |                                                     |            | 42,860     |            |             |             | 65,827     |            |            |          | 18,191     |           
|                                                     |                                                                                                        | Warrants issued for services                          |                                                     |            |           |            |             |             |           |            |            |          | 70,569     |           
|                                                     |                                                                                                        | Other                                                 |                                                     |            | (1,710     | )          |             |             | (23,400    | )          |            |          | (66,873    | )         
|                                                     | Change in assets and liabilities:                                                                      |                                                       |                                                     |            |            |            |             |             |            |            |            |          |           
|                                                     |                                                                                                        | Receivables  net                                     |                                                     |            | (3,395,402 | )          |             |             | (1,272,570 | )          |            |          | (1,417,526 | )         
|                                                     |                                                                                                        | Inventories                                           |                                                     |            | (200,796   | )          |             |             | 1,268,369  |            |            |          | 586,216    |           
|                                                     |                                                                                                        | Prepaid expenses and other assets                     |                                                     |            | 68,567     |            |             |             | 1,576,773  |            |            |          | (1,912,060 | )         
|                                                     |                                                                                                        | Accounts payable and accrued liabilities              |                                                     |            | 1,949,787  |            |             |             | (3,654,487 | )          |            |          | 4,100,271  |           
|                                                     |                                                                                                        |                                                       |                                                     |            |            |            |             |             |           
|                                                     |                                                                                                        |                                                       | Net cash provided by (used in) operating activities |            |            | (7,387,355 | )           |             |            | (3,628,608 | )          |          |            | 14,948,482 |  
|                                                     |                                                                                                        |                                                       |                                                     |            |            |            |             |             |           
|INVESTING ACTIVITIES:                                |                                                                                                        |                                                       |                                                     |            |            |            |             |             |            |            |            |         
|                                                     | Additions to property and equipment                                                                    |                                                       |                                                     | (1,871,230 | )          |            |             | (1,276,811  | )          |            |            | (932,396 | )         
|                                                     | Additions to intangible assets                                                                         |                                                       |                                                     | (553,122   | )          |            |             | (723,967    | )          |            |            | (195,815 | )         
|                                                     | Net proceeds from sale of assets                                                                       |                                                       |                                                     | 500        |            |            |             | 1,721,876   |            |            |            | 531,966  |           
|                                                     | Net proceeds from disposition of discontinued operations                                               |                                                       |                                                     | 11,022,608 |            |            |             |            |            |            |            | 10,000   |           
|                                                     | Proceeds from sale of short-term investments                                                           |                                                       |                                                     | 8,000,000  |            |            |             | 3,950,000   |            |            |            |         |           
|                                                     | Purchases of short-term investments                                                                    |                                                       |                                                     |           |            |            |             | (11,950,000 | )          |            |            |         |           
|                                                     | Restricted cash deposited to collateralize letter of credit                                            |                                                       |                                                     | (10,430    | )          |            |             | (517,353    | )          |            |            |         |           
|                                                     |                                                                                                        |                                                       |                                                     |            |            |            |             |             |           
|                                                     |                                                                                                        |                                                       | Net cash provided by (used in) investing activities |            |            | 16,588,326 |             |             |            | (8,796,255 | )          |          |            | (586,245   | )
|                                                     |                                                                                                        |                                                       |                                                     |            |            |            |             |             |           
|FINANCING ACTIVITIES:                                |                                                                                                        |                                                       |                                                     |            |            |            |             |             |            |            |            |         
|                                                     | Net (repayments) proceeds from short-term borrowings                                                   |                                                       |                                                     | 154,335    |            |            |             | (154,793    | )          |            |            | 55,009   |           
|                                                     | Proceeds from issuance of common stock                                                                 |                                                       |                                                     | 317,580    |            |            |             | 652,757     |            |            |            | 126,561  |           
|                                                     | Acquisition of treasury stock                                                                          |                                                       |                                                     |           |            |            |             |            |            |            |            | (36,253  | )         
|                                                     | Dividends paid to preferred stockholders                                                               |                                                       |                                                     | (68,250    | )          |            |             | (19,500     | )          |            |            | (49,000  | )         
|                                                     | Financing costs                                                                                        |                                                       |                                                     |           |            |            |             | (91,531     | )          |            |            | (18,206  | )         
|                                                     | Proceeds from long-term borrowings                                                                     |                                                       |                                                     |           |            |            |             |            |            |            |            | 641,515  |           
|                                                     | Principal payments on long-term debt                                                                   |                                                       |                                                     | (347,034   | )          |            |             | (442,639    | )          |            |            | (525,584 | )         
|                                                     |                                                                                                        |                                                       |                                                     |            |            |            |             |             |           
|                                                     |                                                                                                        |                                                       | Net cash provided by (used in) financing activities |            |            | 56,631     |             |             |            | (55,706    | )          |          |            | 194,042    |  
|                                                     |                                                                                                        |                                                       |                                                     |            |            |            |             |             |           
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS |                                                                                                        |                                                       | 9,257,602                                           |            |            |            | (12,480,569 | )           |            |            | 14,556,279 |         
|CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR         |                                                                                                        |                                                       | 3,679,915                                           |            |            |            | 16,160,484  |             |            |            | 1,604,205  |         
|                                                     |                                                                                                        |                                                       |                                                     |            |            |            |             |             |           
|CASH AND CASH EQUIVALENTS, END OF YEAR               |                                                                                                        | $                                                     | 12,937,517                                          |            |            | $          | 3,679,915   |             |            | $          | 16,160,484 |         
|                                                     |                                                                                                        |                                                       |                                                     |            |            |            |             |             |           



F-8



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Years Ended July 31, 2005, 2004 and 2003




|   |                                                                                 
|-- | --------------------------------------------------------------------------------
|1. | Nature of Business Activities and Summary of Significant
    Accounting Policies



| |                              
| | -----------------------------
| | Nature of Business Activities



Advanced Protection








| |                                           
| | ------------------------------------------
| | Summary of Significant Accounting Policies

Principles of Consolidation


Use of Estimates and Risks and Uncertainties




F-9



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




Reclassifications 


Revisions 


Business Concentration




Revenue Recognition




Cash and Cash Equivalents


Restricted Cash


Allowances for Doubtful Accounts and Sales
Returns


F-10



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




Inventories


Property and Equipment




|                                               |  |  |             | 
|---------------------------------------------- |  |  | ----------- | 
|Building                                       |  |  | 40 years    | 
|Building improvements                          |  |  | 15 years    | 
|Leasehold improvements                         |  |  | 5-7 years   | 
|Furniture and equipment                        |  |  | 3-7 years   | 
|Production, laboratory and warehouse equipment |  |  | 7-10  years | 

Long-Lived Assets and Long-Lived Assets to be Disposed
of


tm


Goodwill and Other Intangible Assets






F-11



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








| |                                                                                                                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Pharmaceuticals Goodwill  Goodwill
    totaling approximately $4.0 million (net of accumulated
    amortization of $4.6 million) related to the Peridex®
    product which was acquired from The Procter & Gamble
    Company in November 1997.
|
| | Zila Nutraceuticals  Goodwill totaling
    approximately $2.9 million (net of accumulated amortization
    of $890,000) is related to the Ester-C® group of
    products which were acquired in 1997.                                          





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Purchased Technology Rights  In 1996,
    we acquired CTM Associates, Inc. (CTM). The purchase
    of CTM perfected our interest in the OraTest® technology
    and eliminated our obligation to pay royalties to CTM on future
    sales of the OraTest® product. The recoverability of the
    $3.0 million net purchased technology rights is dependent
    upon obtaining FDA approval and generating sufficient revenues
    from future sales of the OraTest® products. Fixed assets of
    approximately $1.2 million (primarily related to our
    manufacturing facility), patents and patents pending of
    $1.6 million and inventory, drug substance and related
    components of $482,000 are also associated with the
    OraTest® products and are grouped with the purchased
    technology rights for the purpose of testing recoverability. The
    purchased technology rights are amortized on a straight-line
    basis over the expected period of benefit, which was based on
    the estimated remaining life of the related patents, which will
    expire in 2011.
|
| | Trademarks and Other Intangible Assets 
    Trademarks are amortized on a straight-line basis over the
    lesser of their legal or expected lives, which range from 8 to
    30 years. Other intangible assets include deferred patent
    costs, which represent legal costs associated with filing patent
    applications, and licensing costs related primarily to the
    ViziLite® and Ester-E® products. Other intangible
    assets are amortized on a straight-line basis over the lesser of
    their legal or expected lives, which range from 4 to
    17 years.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

Research and Development


Stock Options


F-12



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                                                                         |                                                                                                                                           |                    |   |        |      |  |   |        |   |  |   |       | 
|---------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------- | ------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ----- | 
|                                                                                         |                                                                                                                                           | Fiscal Years Ended |  
|                                                                                         |                                                                                                                                           | July 31,           |  
|                                                                                         |                                                                                                                                           |                    |  
|                                                                                         |                                                                                                                                           | 2005               |   |        | 2004 |  |   | 2003   |  
|                                                                                         |                                                                                                                                           |                    |   |        |      |  |   |        |  
|Net income (loss) attributable to common shareholders:                                   |                                                                                                                                           |                    |   |        |      |  |   |        |   |  |   |      
|                                                                                         | As reported                                                                                                                               |                    | $ | 1,060  |      |  | $ | (4,376 | ) |  | $ | 7,246 | 
|                                                                                         | Add: Compensation expense for equity awards recorded at fair
    value included in the determination of net income (loss) as
    reported |                    |   | 43     |      |  |   | 66     |   |  |   | 18    | 
|                                                                                         | Less: Compensation expense for equity awards determined by the
    fair value based method                                                |                    |   | 3,915  |      |  |   | 1,079  |   |  |   | 321   | 
|                                                                                         |                                                                                                                                           |                    |   |        |      |  |   |        |  
|                                                                                         | Pro forma                                                                                                                                 |                    | $ | (2,812 | )    |  | $ | (5,389 | ) |  | $ | 6,943 | 
|                                                                                         |                                                                                                                                           |                    |   |        |      |  |   |        |  
|Net income (loss) attributable to common shareholders per basic
    share outstanding:   |                                                                                                                                           |                    |   |        |      |  |   |        |   |  |   |      
|                                                                                         | As reported                                                                                                                               |                    | $ | 0.02   |      |  | $ | (0.10  | ) |  | $ | 0.16  | 
|                                                                                         | Pro forma                                                                                                                                 |                    | $ | (0.06  | )    |  | $ | (0.12  | ) |  | $ | 0.15  | 
|Net income (loss) attributable to common shareholders per
    diluted share outstanding: |                                                                                                                                           |                    |   |        |      |  |   |        |   |  |   |      
|                                                                                         | As reported                                                                                                                               |                    | $ | 0.02   |      |  | $ | (0.10  | ) |  | $ | 0.16  | 
|                                                                                         | Pro form                                                                                                                                  |                    | $ | (0.06  | )    |  | $ | (0.12  | ) |  | $ | 0.15  | 



|                                 |                          |                    |  |     |      |  |  |      |   |  |  |     |  
|-------------------------------- | ------------------------ | ------------------ |  | --- | ---- |  |  | ---- | - |  |  | --- | -
|                                 |                          | Fiscal Years Ended | 
|                                 |                          | July 31,           | 
|                                 |                          |                    | 
|                                 |                          | 2005               |  |     | 2004 |  |  | 2003 |  
|                                 |                          |                    |  |     |      |  |  |      |  
|Black-Scholes model assumptions: |                          |                    |  |     |      |  |  |      |   |  |  |    
|                                 | Risk-free interest rate  |                    |  | 4   | %    |  |  | 4    | % |  |  | 3   | %
|                                 | Expected volatility      |                    |  | 75  | %    |  |  | 75   | % |  |  | 80  | %
|                                 | Expected term (in years) |                    |  | 6.4 |      |  |  | 5.7  |   |  |  | 5.6 |  
|                                 | Dividend yield           |                    |  | 0   | %    |  |  | 0    | % |  |  | 0   | %



Net Income (Loss) Per Common Share


F-13



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                                           |                             |   |        |     | 
|---------------------------------------------------------- | --------------------------- | - | ------ | --- | 
|Income attributable to common shareholders                 |                             | $ | 7,246  |    
|                                                           |                             |   |       
|Average outstanding common shares                          |                             |   | 45,115 |    
|Effect of dilutive securities:                             |                             |   |        |    
|                                                           | Options                     |   |        | 162 | 
|                                                           | Warrants                    |   |        | 14  | 
|                                                           | Convertible preferred stock |   |        | 100 | 
|                                                           |                             |   |       
|Average outstanding and potentially dilutive common shares |                             |   | 45,391 |    
|                                                           |                             |   |       
|Basic income                                               |                             | $ | 0.16   |    
|Diluted income                                             |                             | $ | 0.16   |    

Financial Instruments




| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The carrying values of cash and cash equivalents, restricted
    cash, receivables, accounts payable and accrued expenses
    approximate fair values due to the short-term maturities of
    these instruments.                                                                                                                                                                                                                                                                                                                             
|
| | The carrying amount of long-term debt and short-term borrowings
    are estimated to approximate fair value as the actual interest
    rate is consistent with the rate estimated to be currently
    available for debt of similar term and remaining maturity.                                                                                                                                                                                                                                                                             
|
| | Financial instruments, which potentially subject us to credit
    risk, consist principally of trade receivables. In the normal
    course of business, we provide credit primarily to
    pharmaceutical wholesalers and nutraceutical manufacturers.
    Ongoing credit evaluations are performed of customers to
    determine an appropriate allowance for credit losses.                                                                                                                                                                
|
| | Estimates of fair value are subjective in nature and involve
    uncertainties and significant matters of judgment and do not
    include tax considerations. Therefore, results cannot be
    determined with precision and cannot be substantiated by
    comparison to independent market values and may not be realized
    in actual sale or settlement of the instruments. There may be
    inherent weaknesses in any calculation technique, and changes in
    the underlying assumptions could significantly affect the
    results.

Comprehensive Income


Advertising


Shipping Costs


Recently Issued Accounting Pronouncements


F-14



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




Stock Options






F-15



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




2.     ViziLite® Acquisition










F-16



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)










|   |                       
|-- | ----------------------
|3. | Discontinued Operation







|                              |  |                             |       |  |      |   |       |      |  |   |       |  
|----------------------------- |  | --------------------------- | ----- |  | ---- | - | ----- | ---- |  | - | ----- | -
|                              |  | Fiscal Years Ended July 31, |      
|                              |  |                             |      
|                              |  | 2005                        |       |  | 2004 |   |       | 2003 | 
|                              |  |                             |       |  |      |   |       |      | 
|Net revenues                  |  | $                           | 6,398 |  |      | $ | 7,106 |      |  | $ | 7,071 |  
|Income (loss) from operations |  | $                           | 427   |  |      | $ | 38    |      |  | $ | (251  | )



|   |                     
|-- | --------------------
|4. | Assets Held for Sale



F-17



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








|                                   |                                                   |   |       |       | 
|---------------------------------- | ------------------------------------------------- | - | ----- | ----- | 
|Current assets                     |                                                   | $ | 250   |      
|Property, plant and equipment, net |                                                   |   | 1,026 |      
|Patents, net                       |                                                   |   | 217   |      
|Other                              |                                                   |   | 13    |      
|                                   |                                                   |   |      
|                                   | Total assets held for sale                        |   | $     | 1,506 | 
|                                   |                                                   |   |      
|Current liabilities                |                                                   |   | 233   |      
|                                   |                                                   |   |      
|                                   | Total liabilities related to assets held for sale |   | $     | 233   | 
|                                   |                                                   |   |      



|   |               
|-- | --------------
|5. | Sale of Assets







|   |                              
|-- | -----------------------------
|6. | Gain from Contract Settlement



F-18



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|   |            
|-- | -----------
|7. | Inventories



|                   |  |      |       |   |      |   |       |  
|------------------ |  | ---- | ----- | - | ---- | - | ----- | -
|                   |  | 2005 |       |   | 2004 |  
|                   |  |      |       |   |      |  
|Finished goods     |  | $    | 732   |   |      | $ | 2,161 |  
|Work in process    |  |      | 579   |   |      |   | 295   |  
|Raw materials      |  |      | 4,853 |   |      |   | 4,320 |  
|Inventory reserves |  |      | (140  | ) |      |   | (197  | )
|                   |  |      |       |   |      |  
|Total inventories  |  | $    | 6,024 |   |      | $ | 6,579 |  
|                   |  |      |       |   |      |  



|   |                       
|-- | ----------------------
|8. | Property and Equipment



|                                               |  |      |        |   |      |   |        |  
|---------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | -
|                                               |  | 2005 |        |   | 2004 |  
|                                               |  |      |        |   |      |  
|Land                                           |  | $    | 403    |   |      | $ | 403    |  
|Building and improvements                      |  |      | 5,135  |   |      |   | 4,872  |  
|Furniture and equipment                        |  |      | 2,856  |   |      |   | 2,306  |  
|Leasehold improvements and other assets        |  |      | 707    |   |      |   | 382    |  
|Production and warehouse equipment             |  |      | 7,821  |   |      |   | 5,833  |  
|                                               |  |      |        |   |      |  
|Total property and equipment                   |  |      | 16,922 |   |      |   | 13,796 |  
|Less accumulated depreciation and amortization |  |      | (7,230 | ) |      |   | (5,680 | )
|                                               |  |      |        |   |      |  
|Property and equipment  net                   |  | $    | 9,692  |   |      | $ | 8,116  |  
|                                               |  |      |        |   |      |  



F-19



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|   |                  
|-- | -----------------
|9. | Intangible Assets



|                                |                                         |                 |                                              |                                     |              |        |        |          |       |       |          |       |       |              |        |        |          |        |        |       |       |       |        |       |       |        |        | 
|------------------------------- | --------------------------------------- | --------------- | -------------------------------------------- | ----------------------------------- | ------------ | ------ | ------ | -------- | ----- | ----- | -------- | ----- | ----- | ------------ | ------ | ------ | -------- | ------ | ------ | ----- | ----- | ----- | ------ | ----- | ----- | ------ | ------ | 
|                                |                                         | 2005            |                                              |                                     | 2004         |       
|                                |                                         |                 |                                              |                                     |              |       
|                                |                                         | Gross           |                                              |                                     |              |        | Net    |          |       | Gross |          |       |       |              | Net    |       
|                                |                                         | Carrying        |                                              |                                     | Accumulated  |        |        | Carrying |       |       | Carrying |       |       | Accumulated  |        |        | Carrying |       
|                                |                                         | Amount          |                                              |                                     | Amortization |        |        | Amount   |       |       | Amount   |       |       | Amortization |        |        | Amount   |       
|                                |                                         |                 |                                              |                                     |              |        |        |          |       |       |          |       |       |              |        |        |          |       
|Amortizable intangibles:        |                                         |                 |                                              |                                     |              |        |        |          |       |       |          |       |       |              |        |        |          |        |        |       |       |       |        |      
|                                | Purchased technology rights             |                 | $                                            | 7,419                               |              |        | $      | 4,387    |       |       | $        | 3,032 |       |              | $      | 7,419  |          |        | $      | 3,909 |       |       | $      | 3,510 |      
|                                | Trademarks and other intangible assets: |                 |                                              |                                     |              |        |        |          |       |       |          |       |       |              |        |        |          |        |        |       |       |       |        |       |      
|                                |                                         | Trademarks      |                                              |                                     | 11,657       |        |        |          | 3,602 |       |          |       | 8,055 |              |        |        | 11,627   |        |        |       | 3,119 |       |        |       | 8,508 |       
|                                |                                         | Patents         |                                              |                                     | 3,168        |        |        |          | 624   |       |          |       | 2,544 |              |        |        | 3,189    |        |        |       | 947   |       |        |       | 2,242 |       
|                                |                                         | Licensing costs |                                              |                                     | 3,162        |        |        |          | 1,108 |       |          |       | 2,054 |              |        |        | 3,100    |        |        |       | 826   |       |        |       | 2,274 |       
|                                |                                         |                 |                                              |                                     |              |        |        |          |       |       |          |       |       |              |        |        |          |       
|                                |                                         |                 | Total trademarks and other intangible assets |                                     |              | 17,987 |        |          |       | 5,334 |          |       |       | 12,653       |        |        |          | 17,916 |        |       |       | 4,892 |        |       |       | 13,024 |       
|                                |                                         |                 |                                              |                                     |              |        |        |          |       |       |          |       |       |              |        |        |          |       
|                                |                                         |                 |                                              | Total amortizable intangible assets |              |        | 25,406 |          |       |       | 9,721    |       |       |              | 15,685 |        |          |        | 25,335 |       |       |       | 8,801  |       |       |        | 16,534 | 
|                                |                                         |                 |                                              |                                     |              |        |        |          |       |       |          |       |       |              |        |        |          |       
|Unamortizable intangible asset: |                                         |                 |                                              |                                     |              |        |        |          |       |       |          |       |       |              |        |        |          |        |        |       |       |       |        |      
|                                | Goodwill                                |                 |                                              | 12,401                              |              |        |        | 5,471    |       |       |          | 6,930 |       |              |        | 12,401 |          |        |        | 5,471 |       |       |        | 6,930 |      
|                                |                                         |                 |                                              |                                     |              |        |        |          |       |       |          |       |       |              |        |        |          |       
|                                |                                         |                 |                                              | Total intangible assets             |              | $      | 37,807 |          |       | $     | 15,192   |       |       | $            | 22,615 |        |          | $      | 37,736 |       |       | $     | 14,272 |       |       | $      | 23,464 | 
|                                |                                         |                 |                                              |                                     |              |        |        |          |       |       |          |       |       |              |        |        |          |       







F-20



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |     
|--- | ----
|10. | Debt



|                                   |                                                |                                         |   |       |       |  |   |       |       | 
|---------------------------------- | ---------------------------------------------- | --------------------------------------- | - | ----- | ----- |  | - | ----- | ----- | 
|                                   |                                                | 2005                                    |   |       | 2004  | 
|                                   |                                                |                                         |   |       |       | 
|Short-term borrowings:             |                                                |                                         |   |       |       |  |   |      
|                                   | Installment note payable on insurance policies |                                         | $ | 154   |       |  | $ |      |      
|                                   |                                                |                                         |   |       |       | 
|Current portion of long-term debt: |                                                |                                         |   |       |       |  |   |      
|                                   | IDA bond payable, Series A, current portion    |                                         | $ | 245   |       |  | $ | 245   |      
|                                   | Capital lease obligations, current portion     |                                         |   | 50    |       |  |   | 47    |      
|                                   | Note payable for equipment                     |                                         |   | 29    |       |  |   | 51    |      
|                                   |                                                |                                         |   |       |       | 
|                                   |                                                | Total current portion of long-term debt |   | $     | 324   |  |   | $     | 343   | 
|                                   |                                                |                                         |   |       |       | 
|Long-term debt:                    |                                                |                                         |   |       |       |  |   |      
|                                   | IDA bond payable, Series A                     |                                         | $ | 2,967 |       |  | $ | 3,212 |      
|                                   | PharmaBio                                      |                                         |   | 500   |       |  |   | 500   |      
|                                   | Capital lease obligations                      |                                         |   | 156   |       |  |   | 201   |      
|                                   | Notes payable for equipment                    |                                         |   | 29    |       |  |   | 80    |      
|                                   |                                                |                                         |   |       |       | 
|                                   |                                                | Total long-term debt                    |   |       | 3,652 |  |   |       | 3,993 | 
|                                   |                                                | Less current portion                    |   |       | 324   |  |   |       | 343   | 
|                                   |                                                |                                         |   |       |       | 
|                                   |                                                | Long-term portion                       |   | $     | 3,328 |  |   | $     | 3,650 | 
|                                   |                                                |                                         |   |       |       | 









F-21



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)














|                     |  |           |       |  |         |   |      |       |  |   |       | 
|-------------------- |  | --------- | ----- |  | ------- | - | ---- | ----- |  | - | ----- | 
|                     |  | Long-term |       |  | Capital |   |      | Total | 
|                     |  | Debt      |       |  | Leases  |   |      | Debt  | 
|                     |  |           |       |  |         |   |      |       | 
|2006                 |  | $         | 274   |  |         | $ | 50   |       |  | $ | 324   | 
|2007                 |  |           | 246   |  |         |   | 51   |       |  |   | 297   | 
|2008                 |  |           | 245   |  |         |   | 43   |       |  |   | 288   | 
|2009                 |  |           | 746   |  |         |   | 12   |       |  |   | 758   | 
|2010                 |  |           | 245   |  |         |   |     |       |  |   | 245   | 
|2011 and thereafter  |  |           | 1,740 |  |         |   |     |       |  |   | 1,740 | 
|                     |  |           |       |  |         |   |      |       | 
|Total                |  |           | 3,496 |  |         |   | 156  |       |  |   | 3,652 | 
|Less current portion |  |           | 274   |  |         |   | 50   |       |  |   | 324   | 
|                     |  |           |       |  |         |   |      |       | 
|Long-term portion    |  | $         | 3,222 |  |         | $ | $106 |       |  | $ | 3,328 | 
|                     |  |           |       |  |         |   |      |       | 



|    |                           
|--- | --------------------------
|11. | Stock Options and Warrants

Stock Options


F-22



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)












F-23



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                  |  |        |       |          |       |   |      |        |          |  |       |   |  |          |      |  |       |  |        |   |  |   |      | 
|--------------------------------- |  | ------ | ----- | -------- | ----- | - | ---- | ------ | -------- |  | ----- | - |  | -------- | ---- |  | ----- |  | ------ | - |  | - | ---- | 
|                                  |  | 2005   |       |          | 2004  |   |      | 2003   |         
|                                  |  |        |       |          |       |   |      |        |         
|                                  |  |        |       | Weighted |       |   |      |        | Weighted |  |       |   |  | Weighted |     
|                                  |  |        |       | Average  |       |   |      |        | Average  |  |       |   |  | Average  |     
|                                  |  |        |       | Exercise |       |   |      |        | Exercise |  |       |   |  | Exercise |     
|                                  |  | Shares |       |          | Price |   |      | Shares |          |  | Price |   |  | Shares   |      |  | Price | 
|                                  |  |        |       |          |       |   |      |        |          |  |       |   |  |          |      |  |       | 
|Outstanding at beginning of year  |  |        | 1,660 |          |       | $ | 3.35 |        |          |  | 1,299 |   |  | $        | 2.69 |  |       |  | 2,196  |   |  | $ | 4.42 | 
|Granted                           |  |        | 983   |          |       |   | 4.11 |        |          |  | 689   |   |  |          | 3.93 |  |       |  | 580    |   |  |   | 1.59 | 
|Exercised                         |  |        | (73   | )        |       |   | 1.76 |        |          |  | (207  | ) |  |          | 2.13 |  |       |  | (5     | ) |  |   | 1.05 | 
|Forfeited/expired                 |  |        | (225  | )        |       |   | 4.79 |        |          |  | (121  | ) |  |          | 1.58 |  |       |  | (1,472 | ) |  |   | 4.84 | 
|                                  |  |        |       |          |       |   |      |        |          |  |       |   |  |          |      |  |       | 
|Outstanding at end of year        |  |        | 2,345 |          |       |   | 3.58 |        |          |  | 1,660 |   |  |          | 3.36 |  |       |  | 1,299  |   |  |   | 2.69 | 
|                                  |  |        |       |          |       |   |      |        |          |  |       |   |  |          |      |  |       | 
|Options exercisable at year-end   |  |        | 2,269 |          |       |   | 3.61 |        |          |  | 975   |   |  |          | 3.26 |  |       |  | 760    |   |  |   | 3.30 | 
|                                  |  |        |       |          |       |   |      |        |          |  |       |   |  |          |      |  |       | 
|Shares available for future grant |  |        | 2,394 |          |       |   |      |        |          |  |       |   |  |          |      |  |       |  |        |   |  |   |      | 
|                                  |  |        |       |          |       |   |      |        |          |  |       |   |  |          |      |  |       | 



|                         |  |                     |       |  |                     |  |     |          |  |   |             |  |  |          |       |  |  |   |      | 
|------------------------ |  | ------------------- | ----- |  | ------------------- |  | --- | -------- |  | - | ----------- |  |  | -------- | ----- |  |  | - | ---- | 
|                         |  | Options Outstanding |       |  | Options Exercisable | 
|                         |  |                     |       |  |                     | 
|                         |  | Number              |       |  | Weighted            |  |     | Weighted |  |   | Number      |  |  | Weighted |      
|                         |  | Outstanding         |       |  | Average             |  |     | Average  |  |   | Exercisable |  |  | Average  |      
|                         |  | at July 31,         |       |  | Remaining           |  |     | Exercise |  |   | at July 31, |  |  | Exercise |      
|Range of Exercise Prices |  | 2005                |       |  | Contractual Life    |  |     | Price    |  |   | 2005        |  |  | Price    |      
|                         |  |                     |       |  |                     |  |     |          |  |   |             |  |  |          |      
|$0.76-$2.95              |  |                     | 524   |  |                     |  | 5.9 |          |  | $ | 1.47        |  |  |          | 449   |  |  | $ | 1.29 | 
|$3.02-$3.55              |  |                     | 566   |  |                     |  | 6.4 |          |  |   | 3.36        |  |  |          | 566   |  |  |   | 3.36 | 
|$3.62-$4.12              |  |                     | 495   |  |                     |  | 9.0 |          |  |   | 4.07        |  |  |          | 494   |  |  |   | 4.07 | 
|$4.20-$4.65              |  |                     | 550   |  |                     |  | 8.0 |          |  |   | 4.37        |  |  |          | 550   |  |  |   | 4.37 | 
|$4.75-$9.88              |  |                     | 210   |  |                     |  | 6.1 |          |  |   | 6.23        |  |  |          | 210   |  |  |   | 6.23 | 
|                         |  |                     |       |  |                     |  |     |          |  |   |             |  |  |          |      
|Total                    |  |                     | 2,345 |  |                     |  | 7.2 |          |  |   | 3.58        |  |  |          | 2,269 |  |  |   | 3.61 | 
|                         |  |                     |       |  |                     |  |     |          |  |   |             |  |  |          |      

Warrants




|                           |                   |           |     |     |               |   |           |           | 
|-------------------------- | ----------------- | --------- | --- | --- | ------------- | - | --------- | --------- | 
|                           |                   | Number of |     |     | Warrant Price |  
|                           |                   | Shares    |     |     | per Share     |  
|                           |                   |           |     |     |               |  
|Outstanding, July 31, 2002 |                   |           | 25  |     |               | $ | 4.00-5.00 |          
|                           | Issued            |           |     | 104 |               |   |           | 0.98-4.00 | 
|                           |                   |           |     |     |               |  
|Outstanding, July 31, 2003 |                   |           | 129 |     |               |   | 0.98-5.00 |          
|                           | Issued            |           |     | 55  |               |   |           | 0.74-4.06 | 
|                           |                   |           |     |     |               |  
|Outstanding, July 31, 2004 |                   |           | 184 |     |               |   | 0.74-5.00 |          
|                           | Exercised         |           |     | (16 | )             |   |           | 0.74      | 
|                           | Forfeited/expired |           |     | (35 | )             |   |           | 4.06-4.91 | 
|                           |                   |           |     |     |               |  
|Outstanding, July 31, 2005 |                   |           | 133 |     |               |   | 0.74-5.00 |          
|                           |                   |           |     |     |               |  

F-24



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Stock Purchase Plan




|    |             
|--- | ------------
|12. | Income Taxes



|                                                  |         |      |    |    |      |   |    |      |   |   |      |     |  
|------------------------------------------------- | ------- | ---- | -- | -- | ---- | - | -- | ---- | - | - | ---- | --- | -
|                                                  |         | 2005 |    |    | 2004 |   |    | 2003 |  
|                                                  |         |      |    |    |      |   |    |      |  
|Current:                                          |         |      |    |    |      |   |    |      |   |   |      |    
|                                                  | Federal |      | $  |   |      |   | $  |     |   |   | $    | (95 | )
|                                                  | State   |      |    | (8 | )    |   |    | (2   | ) |   |      | (93 | )
|                                                  |         |      |    |    |      |   |    |      |  
|Total current                                     |         |      | (8 | )  |      |   | (2 | )    |   |   | (188 | )  
|                                                  |         |      |    |    |      |   |    |      |  
|Deferred:                                         |         |      |    |    |      |   |    |      |   |   |      |    
|                                                  | Federal |      |    |   |      |   |    |     |   |   |      |    |  
|                                                  | State   |      |    |   |      |   |    |     |   |   |      |    |  
|                                                  |         |      |    |    |      |   |    |      |  
|Total deferred                                    |         |      |   |    |      |   |   |      |   |   |     |    
|                                                  |         |      |    |    |      |   |    |      |  
|Total consolidated income tax (benefit) provision |         | $    | (8 | )  |      | $ | (2 | )    |   | $ | (188 | )  
|                                                  |         |      |    |    |      |   |    |      |  



|                       |                                                 |      |    |     |      |  |     |      |   |  |    |     |  
|---------------------- | ----------------------------------------------- | ---- | -- | --- | ---- |  | --- | ---- | - |  | -- | --- | -
|                       |                                                 | 2005 |    |     | 2004 |  |     | 2003 |  
|                       |                                                 |      |    |     |      |  |     |      |  
|Federal statutory rate |                                                 |      | 35 | %   |      |  | (35 | )%   |   |  | 35 | %  
|Adjustments:           |                                                 |      |    |     |      |  |     |      |   |  |    |    
|                       | State income taxes  net of federal tax effects |      |    | 4   |      |  |     |     |   |  |    | 5   |  
|                       | Non-deductible meal and entertainment expenses  |      |    | 2   |      |  |     | 1    |   |  |    | 1   |  
|                       | Non-deductible intangible amortization          |      |    | 13  |      |  |     | 4    |   |  |    | 4   |  
|                       | Increase (decrease) in valuation allowance      |      |    | (53 | )    |  |     | 30   |   |  |    | (43 | )
|                       |                                                 |      |    |     |      |  |     |      |  
|                       | Effective tax rate                              |      |    | 1   | %    |  |     | 0    | % |  |    | 2   | %
|                       |                                                 |      |    |     |      |  |     |      |  

F-25



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                 |                                               |                                       |        |       |       |   |        |       |       |  
|-------------------------------- | --------------------------------------------- | ------------------------------------- | ------ | ----- | ----- | - | ------ | ----- | ----- | -
|                                 |                                               | 2005                                  |        |       | 2004  |  
|                                 |                                               |                                       |        |       |       |  
|Deferred income tax assets:      |                                               |                                       |        |       |       |   |        |      
|                                 | Net operating loss carry forwards             |                                       | $      | 4,151 |       |   | $      | 4,078 |      
|                                 | Book basis versus tax basis differences       |                                       |        | 947   |       |   |        | 1,416 |      
|                                 | Alternative minimum tax credit                |                                       |        | 230   |       |   |        | 230   |      
|                                 | Miscellaneous reserves and accruals           |                                       |        | 637   |       |   |        | 797   |      
|                                 | Other                                         |                                       |        | 82    |       |   |        | 77    |      
|                                 |                                               |                                       |        |       |       |  
|                                 |                                               | Total deferred income tax assets      |        |       | 6,047 |   |        |       | 6,598 |  
|                                 |                                               |                                       |        |       |       |  
|Deferred income tax liabilities: |                                               |                                       |        |       |       |   |        |      
|                                 | Depreciation and amortization                 |                                       |        | (113  | )     |   |        | (174  | )    
|                                 | Federal income tax on state NOL carryforwards |                                       |        | (74   | )     |   |        | (73   | )    
|                                 | Other                                         |                                       |        | (254  | )     |   |        | (147  | )    
|                                 |                                               |                                       |        |       |       |  
|                                 |                                               | Total deferred income tax liabilities |        |       | (441  | ) |        |       | (394  | )
|                                 |                                               |                                       |        |       |       |  
|Valuation allowance              |                                               |                                       | (5,606 | )     |       |   | (6,204 | )    
|                                 |                                               |                                       |        |       |       |  
|                                 |                                               | Net deferred income tax assets        |        | $     |      |   |        | $     |      |  
|                                 |                                               |                                       |        |       |       |  









|    |                                               
|--- | ----------------------------------------------
|13. | Supplemental Schedule of Cash flow Information



|                                                                                 |  |      |     |  |      |   |     |      |  |   |     | 
|-------------------------------------------------------------------------------- |  | ---- | --- |  | ---- | - | --- | ---- |  | - | --- | 
|                                                                                 |  | 2005 |     |  | 2004 |   |     | 2003 | 
|                                                                                 |  |      |     |  |      |   |     |      | 
|Interest paid                                                                    |  | $    | 168 |  |      | $ | 158 |      |  | $ | 197 | 
|Income taxes paid                                                                |  |      | 14  |  |      |   | 193 |      |  |   |    | 
|Capital lease obligation for new equipment                                       |  |      | 6   |  |      |   | 232 |      |  |   |    | 
|Noncash effect of removal of contractual restrictions on issued
    common stock |  |      | 49  |  |      |   | 135 |      |  |   |    | 
|Liability satisfied through issuance of warrants                                 |  |      |    |  |      |   | 28  |      |  |   |    | 

F-26



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                            
|--- | ---------------------------
|14. | Convertible Preferred Stock





|    |               
|--- | --------------
|15. | Treasury Stock





|    |       
|--- | ------
|16. | Leases









F-27



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                                   |  |         |     |  |           |   |       |       |  |   |       | 
|-------------------------------------------------- |  | ------- | --- |  | --------- | - | ----- | ----- |  | - | ----- | 
|                                                   |  | Capital |     |  | Operating |   |       |      
|                                                   |  | Leases  |     |  | Leases    |   |       | Total | 
|                                                   |  |         |     |  |           |   |       |       | 
|2006                                               |  | $       | 54  |  |           | $ | 476   |       |  | $ | 530   | 
|2007                                               |  |         | 52  |  |           |   | 484   |       |  |   | 536   | 
|2008                                               |  |         | 46  |  |           |   | 403   |       |  |   | 449   | 
|2009                                               |  |         | 12  |  |           |   | 285   |       |  |   | 297   | 
|2010                                               |  |         | 1   |  |           |   | 203   |       |  |   | 204   | 
|Thereafter                                         |  |         |    |  |           |   | 69    |       |  |   | 69    | 
|                                                   |  |         |     |  |           |   |       |       | 
|Total minimum lease payments                       |  | $       | 165 |  |           | $ | 1,920 |       |  | $ | 2,085 | 
|                                                   |  |         |     |  |           |   |       |       | 
|Less: amounts representing interest                |  |         | 9   |  |           |   |       |       |  |   |       | 
|                                                   |  |         |     |  |           |   |       |       | 
|Present value of minimum lease payments            |  |         | 156 |  |           |   |       |       |  |   |       | 
|Less: Current portion of capital lease obligations |  |         | 50  |  |           |   |       |       |  |   |       | 
|                                                   |  |         |     |  |           |   |       |       | 
|Long-term portion of capital lease obligations     |  | $       | 106 |  |           |   |       |       |  |   |       | 
|                                                   |  |         |     |  |           |   |       |       | 



|    |                              
|--- | -----------------------------
|17. | Commitments and Contingencies



| |                                         
| | ----------------------------------------
| | FDA approval of the OraTest®
    product



tm




| |          
| | ---------
| | ViziLite®





| |           
| | ----------
| | Litigation



F-28



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)












| |                      
| | ---------------------
| | Employment Agreements





| |                 
| | ----------------
| | Daleco Agreement





| |                                             
| | --------------------------------------------
| | Vital Health Sciences Ltd. License Agreement



F-29



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |                    
| | -------------------
| | Supply Arrangements





| |                 
| | ----------------
| | Indemnifications





|    |                           
|--- | --------------------------
|18. | Related Party Transactions





|    |                      
|--- | ---------------------
|19. | Employee Benefit Plan

,


F-30



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                    
|--- | -------------------
|20. | Accrued Liabilities



|                                                |  |      |       |  |      |   |       | 
|----------------------------------------------- |  | ---- | ----- |  | ---- | - | ----- | 
|                                                |  | 2005 |       |  | 2004 |  
|                                                |  |      |       |  |      |  
|Accrued professional and consulting fees        |  | $    | 1,248 |  |      | $ | 964   | 
|Accrued royalties                               |  |      | 815   |  |      |   | 4     | 
|Accrued employee compensation and related taxes |  |      | 712   |  |      |   | 776   | 
|Other                                           |  |      | 943   |  |      |   | 877   | 
|                                                |  |      |       |  |      |  
|Total accrued liabilities                       |  | $    | 3,718 |  |      | $ | 2,621 | 
|                                                |  |      |       |  |      |  



|    |                    
|--- | -------------------
|21. | Segment Information

: Advanced Protection




F-31



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


):


|                                                                                        |      |                |   |        |                 |  |   |               |   |  |           |        |   |       |   |        |   |  |   |        |  
|--------------------------------------------------------------------------------------- | ---- | -------------- | - | ------ | --------------- |  | - | ------------- | - |  | --------- | ------ | - | ----- | - | ------ | - |  | - | ------ | -
|                                                                                        |      | Nutraceuticals |   |        | Pharmaceuticals |  |   | Biotechnology |   |  | Corporate |        |   | Total |  
|                                                                                        |      |                |   |        |                 |  |   |               |   |  |           |        |   |       |  
|Net revenues from continuing operations:                                                |      |                |   |        |                 |  |   |               |   |  |           |        |   |       |   |        |   |  |   |       
|                                                                                        | 2005 |                | $ | 38,471 |                 |  | $ | 5,846         |   |  | $         | 8      |   |       | $ |       |   |  | $ | 44,325 |  
|                                                                                        | 2004 |                |   | 32,432 |                 |  |   | 8,971         |   |  |           | 2      |   |       |   |       |   |  |   | 41,405 |  
|                                                                                        | 2003 |                |   | 29,423 |                 |  |   | 9,767         |   |  |           | 20     |   |       |   |       |   |  |   | 39,210 |  
|Income (loss) from continuing operations before income taxes and
    accounting change: |      |                |   |        |                 |  |   |               |   |  |           |        |   |       |   |        |   |  |   |       
|                                                                                        | 2005 |                |   | 9,022  |                 |  |   | (2,614        | ) |  |           | (8,694 | ) |       |   | (6,736 | ) |  |   | (9,022 | )
|                                                                                        | 2004 |                |   | 8,300  |                 |  |   | (765          | ) |  |           | (7,195 | ) |       |   | (4,712 | ) |  |   | (4,372 | )
|                                                                                        | 2003 |                |   | 7,733  |                 |  |   | 406           |   |  |           | 3,474  |   |       |   | 186    |   |  |   | 11,799 |  
|Identifiable assets from continuing operations:                                         |      |                |   |        |                 |  |   |               |   |  |           |        |   |       |   |        |   |  |   |       
|                                                                                        | 2005 |                |   | 34,083 |                 |  |   | 10,867        |   |  |           | 19,076 |   |       |   | 1,392  |   |  |   | 65,418 |  
|                                                                                        | 2004 |                |   | 31,469 |                 |  |   | 11,499        |   |  |           | 15,583 |   |       |   | 3,558  |   |  |   | 62,109 |  
|                                                                                        | 2003 |                |   | 29,290 |                 |  |   | 14,520        |   |  |           | 7,983  |   |       |   | 17,227 |   |  |   | 69,020 |  
|Capital expenditures:                                                                   |      |                |   |        |                 |  |   |               |   |  |           |        |   |       |   |        |   |  |   |       
|                                                                                        | 2005 |                |   | 735    |                 |  |   | 279           |   |  |           | 737    |   |       |   | 120    |   |  |   | 1,871  |  
|                                                                                        | 2004 |                |   | 759    |                 |  |   | 31            |   |  |           | 37     |   |       |   | 450    |   |  |   | 1,277  |  
|                                                                                        | 2003 |                |   | 175    |                 |  |   | 153           |   |  |           | 509    |   |       |   | 95     |   |  |   | 932    |  
|Depreciation and amortization:                                                          |      |                |   |        |                 |  |   |               |   |  |           |        |   |       |   |        |   |  |   |       
|                                                                                        | 2005 |                |   | 1,130  |                 |  |   | 619           |   |  |           | 732    |   |       |   | 207    |   |  |   | 2,688  |  
|                                                                                        | 2004 |                |   | 1,057  |                 |  |   | 644           |   |  |           | 683    |   |       |   | 99     |   |  |   | 2,483  |  
|                                                                                        | 2003 |                |   | 986    |                 |  |   | 525           |   |  |           | 715    |   |       |   | 120    |   |  |   | 2,346  |  



F-32



---



##### Table of Contents



ZILA, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                                     
|--- | ------------------------------------
|22. | Quarterly Financial Data (Unaudited)



|                                               |                                            |               |        |       |            |   |        |          |   |   |         |       |   |   |        |       |  
|---------------------------------------------- | ------------------------------------------ | ------------- | ------ | ----- | ---------- | - | ------ | -------- | - | - | ------- | ----- | - | - | ------ | ----- | -
|                                               |                                            | 2005          |       
|                                               |                                            | Quarter Ended |       
|                                               |                                            |               |       
|                                               |                                            | October 31    |        |       | January 31 |   |        | April 30 |   |   | July 31 |      
|                                               |                                            |               |        |       |            |   |        |          |   |   |         |      
|Net revenues                                   |                                            | $             | 9,876  |       |            | $ | 10,931 |          |   | $ | 12,020  |       |   | $ | 11,498 |      
|Gross profit                                   |                                            |               | 6,406  |       |            |   | 7,251  |          |   |   | 8,110   |       |   |   | 7,173  |      
|Loss from continuing operations                |                                            |               | (3,203 | )     |            |   | (2,744 | )        |   |   | (2,229  | )     |   |   | (854   | )    
|Income from discontinued operations            |                                            |               | 491    |       |            |   | 88     |          |   |   | 78      |       |   |   | 9,472  |      
|Net income (loss)                              |                                            | $             | (2,712 | )     |            | $ | (2,656 | )        |   | $ | (2,151  | )     |   | $ | 8,618  |      
|Basic and diluted net income (loss) per share: |                                            |               |        |       |            |   |        |          |   |   |         |       |   |   |        |      
|                                               | Loss from continuing operations            |               | $      | (0.07 | )          |   | $      | (0.06    | ) |   | $       | (0.05 | ) |   | $      | (0.02 | )
|                                               | Income (loss) from discontinued operations |               |        | 0.01  |            |   |        | 0.00     |   |   |         | 0.00  |   |   |        | 0.21  |  
|                                               |                                            |               |        |       |            |   |        |          |   |   |         |      
|                                               | Net loss                                   |               | $      | (0.06 | )          |   | $      | (0.06    | ) |   | $       | (0.05 | ) |   | $      | 0.19  |  
|                                               |                                            |               |        |       |            |   |        |          |   |   |         |      

|                                               |                                            |               |        |       |            |   |        |          |   |   |         |       |   |   |       |       |  
|---------------------------------------------- | ------------------------------------------ | ------------- | ------ | ----- | ---------- | - | ------ | -------- | - | - | ------- | ----- | - | - | ----- | ----- | -
|                                               |                                            | 2004          |       
|                                               |                                            | Quarter Ended |       
|                                               |                                            |               |       
|                                               |                                            | October 31    |        |       | January 31 |   |        | April 30 |   |   | July 31 |      
|                                               |                                            |               |        |       |            |   |        |          |   |   |         |      
|Net revenues                                   |                                            | $             | 9,811  |       |            | $ | 11,533 |          |   | $ | 10,802  |       |   | $ | 9,259 |      
|Gross profit                                   |                                            |               | 5,796  |       |            |   | 6,753  |          |   |   | 6,794   |       |   |   | 5,942 |      
|Loss from continuing operations                |                                            |               | (1,830 | )     |            |   | (795   | )        |   |   | (1,747  | )     |   |   | (3    | )    
|Income (loss) from discontinued operations     |                                            |               | 262    |       |            |   | (167   | )        |   |   | 180     |       |   |   | (237  | )    
|Net loss                                       |                                            | $             | (1,568 | )     |            | $ | (962   | )        |   | $ | (1,567  | )     |   | $ | (240  | )    
|Basic and diluted net income (loss) per share: |                                            |               |        |       |            |   |        |          |   |   |         |       |   |   |       |      
|                                               | Loss from continuing operations            |               | $      | (0.05 | )          |   | $      | (0.02    | ) |   | $       | (0.03 | ) |   | $     | 0.00  |  
|                                               | Income (loss) from discontinued operations |               |        | 0.01  |            |   |        | 0.00     |   |   |         | 0.00  |   |   |       | (0.01 | )
|                                               |                                            |               |        |       |            |   |        |          |   |   |         |      
|                                               | Net loss                                   |               | $      | (0.04 | )          |   | $      | (0.02    | ) |   | $       | (0.03 | ) |   | $     | (0.01 | )
|                                               |                                            |               |        |       |            |   |        |          |   |   |         |      

F-33



---



##### Table of Contents






SCHEDULE II


VALUATION AND QUALIFYING ACCOUNTS


|                                            |               |            |   |                |            |  |   |            |   |            |           |       |  |  |   |       | 
|------------------------------------------- | ------------- | ---------- | - | -------------- | ---------- |  | - | ---------- | - | ---------- | --------- | ----- |  |  | - | ----- | 
|                                            |               | Balance at |   |                | Charged to |  |   |            |   | Balance at |          
|                                            |               | Beginning  |   |                | Costs and  |  |   |            |   | End of     |          
|Description                                 |               | of Period  |   |                | Expenses   |  |   | Deductions |   |            | of Period |      
|                                            |               |            |   |                |            |  |   |            |   |            |           |      
|                                            |               |            |   | (In thousands) |            |  |  
|Allowance for doubtful accounts receivable: |               |            |   |                |            |  |   |            |   |            |           |       |  |  |   |      
|                                            | July 31, 2003 |            | $ | 133            |            |  | $ | 458        |   |            | $         | 274   |  |  | $ | 317   | 
|                                            | July 31, 2004 |            |   | 317            |            |  |   | (90        | ) |            |           | 168   |  |  |   | 59    | 
|                                            | July 31, 2005 |            |   | 59             |            |  |   | 37         |   |            |           | 54    |  |  |   | 42    | 
|Allowance for sales returns:                |               |            |   |                |            |  |   |            |   |            |           |       |  |  |   |      
|                                            | July 31, 2003 |            |   | 185            |            |  |   | 201        |   |            |           | 92    |  |  |   | 294   | 
|                                            | July 31, 2004 |            |   | 294            |            |  |   | 154        |   |            |           | 235   |  |  |   | 213   | 
|                                            | July 31, 2005 |            |   | 213            |            |  |   | 11         |   |            |           | 116   |  |  |   | 108   | 
|Inventory reserve:                          |               |            |   |                |            |  |   |            |   |            |           |       |  |  |   |      
|                                            | July 31, 2003 |            |   | 293            |            |  |   | 363        |   |            |           | 301   |  |  |   | 355   | 
|                                            | July 31, 2004 |            |   | 355            |            |  |   | 172        |   |            |           | 330   |  |  |   | 197   | 
|                                            | July 31, 2005 |            |   | 197            |            |  |   | 290        |   |            |           | 347   |  |  |   | 140   | 
|Deferred tax valuation allowance:           |               |            |   |                |            |  |   |            |   |            |           |       |  |  |   |      
|                                            | July 31, 2003 |            |   | 9,102          |            |  |   |           |   |            |           | 3,843 |  |  |   | 5,259 | 
|                                            | July 31, 2004 |            |   | 5,259          |            |  |   | 945        |   |            |           |      |  |  |   | 6,204 | 
|                                            | July 31, 2005 |            |   | 6,204          |            |  |   |           |   |            |           | 598   |  |  |   | 5,606 | 



|                                           |  |         |   |      |  |   |    | 
|------------------------------------------ |  | ------- | - | ---- |  | - | -- | 
|                                           |  | July 31 |  
|                                           |  |         |  
|                                           |  | 2004    |   | 2003 | 
|                                           |  |         |   |      | 
|Allowance for doubtful accounts receivable |  | $       |  |      |  | $ | 17 | 
|Allowance for sales returns                |  |         |  |      |  |   | 50 | 

F-34



---



##### Table of Contents



INDEX TO EXHIBITS


|        |       |             |  |                                                                                                 
|------- | ----- | ----------- |  | ------------------------------------------------------------------------------------------------
|Exhibit |       |            
|Number  |       | Description
|        |       |            
|        | 3-B   |             |  | Certificate of Amendment to Certificate of Incorporation                                        
|        | 10-Z  |             |  | Agreement of Purchase and Sale of Assets dated June 27,
    2005 with Blairex Laboratories, Inc.
|        | 10-Aa |             |  | 2006 Executive Incentive Bonus Plan                                                             
|        | 10-Ab |             |  | 2006 Employees Incentive Bonus Plan                                                             
|        | 10-Ac |             |  | Form of Option Agreement                                                                        
|        | 21    |             |  | Subsidiaries of Registrant                                                                      
|        | 23.1  |             |  | Consent of BDO Seidman, LLP, Independent Registered Public
    Accounting Firm                  
|        | 23.2  |             |  | Consent of Deloitte & Touche LLP, Independent
    Registered Public Accounting Firm             
|        | 24.1  |             |  | Power of Attorney (included on page 53 of this Annual
    Report on Form 10-K)                  
|        | 31.1  |             |  | Sarbanes-Oxley Section 302 Certification of the Chief
    Executive Officer                     
|        | 31.2  |             |  | Sarbanes-Oxley Section 302 Certification of the Chief
    Financial Officer                     
|        | 32.1  |             |  | Sarbanes-Oxley Section 906 Certification of the Chief
    Executive Officer                     
|        | 32.2  |             |  | Sarbanes-Oxley Section 906 Certification of the Chief
    Financial Officer