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FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the fiscal year ended July 31, 2001
OR

(BOX)           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




|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 86-0619668                          
|                                                              
|                                                              
|                                                              
|                                                              
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)

|                                         |  |           
|---------------------------------------- |  | ----------
|5227 North 7th Street, Phoenix, Arizona  |  | 85014-2800
|                                        
|                                        
|                                        
|                                        
|(Address of Principal Executive Offices) |  | (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)

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes (CHECKBOX) No (BOX)

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. (BOX)

At September 28, 2001, the aggregate market value of common stock held by
non-affiliates of the registrant was $ 77,267,000.

APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes (BOX) No (BOX) N/A

APPLICABLE ONLY TO CORPORATE REGISTRANTS

Indicate the number of shares outstanding of each of the registrants
classes of common stock, as of the latest practicable date.

At September 28, 2001, the number of shares of common stock outstanding
was 43,653,727.

DOCUMENTS INCORPORATED BY REFERENCE

Materials from the Registrants 2001 Proxy Statement have been
incorporated by reference into Part III, Items 10, 11, 12 and 13.

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|                             |                                                                                               |  |  |  |  |  |  | 
|---------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|ZILA, INC.                  
|PART I                      
|                             | Item 1. BUSINESS                                                                             
|                             | Item 2.                                                                                      
|                             | Item 3. LEGAL PROCEEDINGS                                                                    
|                             | Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|PART II                     
|                             | Item 5. MARKET FOR THE COMPANYS COMMON STOCK AND RELATED STOCKHOLDER MATTERS                
|                             | Item 6. SELECTED FINANCIAL DATA                                                              
|                             | Item 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                             | Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                          
|                             | Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 
|PART III                    
|PART IV                     
|                             | Item 14. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES, AND REPORTS ON FORM 8-K               
|SIGNATURES                  
|INDEPENDENT AUDITORS REPORT
|                             | CONSOLIDATED BALANCE SHEETS                                                                  
|                             | CONSOLIDATED STATEMENTS OF OPERATIONS                                                        
|                             | CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY                                              
|                             | CONSOLIDATED STATEMENTS OF CASH FLOW                                                         
|                             | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                   
|EX-3.D                      
|EX-23                       



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TABLE OF CONTENTS

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|           | Item 1.  | BUSINESS                                                                              |      | 3  | 
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|           | Item 2.  | PROPERTIES                                                                            |      | 19 | 
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|           | Item 3.  | LEGAL PROCEEDINGS                                                                     |      | 20 | 
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|           | Item 4.  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                   |      | 20 | 
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|PART II    |          |                                                                                       | 21   |   
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|           | Item 5.  | MARKET FOR THE COMPANYS COMMON STOCK AND RELATED
STOCKHOLDER MATTERS                 |      | 21 | 
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|           | Item 6.  | SELECTED FINANCIAL DATA                                                               |      | 22 | 
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|           | Item 7.  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS |      | 22 | 
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|           | Item 8.  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                           |      | 28 | 
|          
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|           | Item 9.  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE  |      | 29 | 
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|PART III   |          |                                                                                       | 29   |   
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|PART IV    |          |                                                                                       | 29   |   
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|           | Item 14. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                      |      | 29 | 
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|SIGNATURES |          |                                                                                       | 31   |   





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This Form 10-K contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The Companys actual results could differ materially
from those set forth in the forward-looking statements. Certain factors that
might cause such a difference are discussed in the section entitled Cautionary
Factors that May Affect Future Results on page 15 of this Form 10-K.




PART I




Item 1.BUSINESS

General

Zila, Inc., a Delaware corporation, is an international manufacturer and
marketer of pharmaceutical, biomedical, dental, and nutraceutical products.
The Companys business is organized into four major product groups: Consumer
Pharmaceuticals, Professional Products, Dental Supplies and
Nutraceuticals. Unless the context otherwise indicates, the terms Zila and
Company as used herein refer to Zila, Inc. and each of its subsidiaries.

The Consumer Pharmaceuticals Group consists of over-the-counter products,
including the Zilactin® family of over-the-counter products. The Consumer
Pharmaceuticals Group operates under a wholly owned subsidiary of the Company,
Zila Pharmaceuticals, Inc., a Nevada corporation.

The Professional Products Group includes Peridex® prescription mouth
rinse, Pro-Ties, a bundling system for instrument sterilization, the
Pro-Series line of specialty products marketed directly to dentists, OraTest®, an oral cancer diagnostic system and the
plastic molded products from Zila Swab Technologies, Inc., dba Innovative Swab
Technologies (IST), a wholly owned subsidiary of the Company. The
Professional Products Group (excluding OraTest® and IST) operates under a wholly owned
subsidiary of the Company, Zila Pharmaceuticals, Inc., a Nevada
corporation. The OraTest®
product is sold in Europe under a wholly owned subsidiary of the
Company, Zila Limited, a United Kingdom company, and in other parts of the world
through Zila, Inc.

On February 5, 2001, the Company announced that it had acquired the patent
rights and the Antioch, Illinois manufacturing operations for swab products
from National Healthcare Manufacturing Corporation (NHMC), headquartered in
Winnipeg, Canada. Intellectual property, inventory, plus molding, labeling,
filling and sealing equipment were included in the acquisition. The business
unit is known as Innovative Swab Technologies. Zila paid approximately $2.3
million in a combination of cash and preferred stock for the unit.

The Dental Supply Group operates through the Companys wholly owned
subsidiaries Bio-Dental Technologies Corporation, a California corporation, and
Zila Technologies, Inc., formerly Cygnus Imaging Inc. (Cygnus), an Arizona
corporation. Bio-Dental Technologies Corporation has two subsidiaries, Ryker
Dental of Kentucky, Inc., a Kentucky corporation, which does business under the
name Zila Dental Supply (ZDS) and is a national distributor of professional
dental supplies, and Integrated Dental Technologies, Inc. (IDT), a California
corporation that distributed PracticeWorks dental practice management software
and is currently inactive.

On October 28, 1999, Cygnus, a manufacturer and marketer of dental imaging
products including digital x-ray systems and intraoral cameras, completed the
sale of substantially all of its assets and certain of its liabilities to
Procare Laboratories, Inc. (Procare), of Scottsdale, Arizona for
approximately $4.0 million.

On December 20, 1999, IDT completed the sale of substantially all of its
assets and liabilities related to its PracticeWorks division located in Gold
River, California to InfoCure Corporation (InfoCure), of Atlanta, Georgia for
approximately $4.65 million. InfoCure is a national provider of healthcare
practice management software products and services to targeted healthcare
practice specialties.

The Nutraceuticals Group includes Oxycal Laboratories, Inc., an Arizona
corporation (Oxycal), and its two subsidiaries, Inter-Cal Corporation, Inc,
(Inter-Cal), an Arizona corporation, and Oxycal Export, Inc., a U.S. Virgin
Islands corporation. Oxycal and its subsidiaries manufacture and distribute a
patented and unique form of Vitamin C under the trademark Ester-C® and a line
of botanical products that includes the Palmettx saw palmetto product.

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Financial information for each group or segment for each of the last three
fiscal years is included in the Audited Consolidated Financial Statements and
the notes thereto and have been restated to reflect the new segments.

The Companys principal executive offices are located at 5227 North
Seventh Street, Phoenix, Arizona 85014-2800, and its telephone number is (602)
266-6700.

Products

|                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                                                                                                                                                                                     
|------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Consumer Pharmaceuticals
|                        
|                        
|                        
|                        
|                        
|                         | The Zilactin® line includes six over-the-counter (OTC), non-prescription products: Zilactin®,
Zilactin®-B, Zilactin®-L, Zilactin®-Lip, Zilactin® Baby and Zilactin® Toothache & Oral Pain Swabs.
The Zilactin® products are used topically for the purposes described below:                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                        
|                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | Zilactin® a pain relieving gel that forms a protective film for treating cold sores.                                                                                                                                                                               
|                        
|                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | Zilactin®-B Zilactin®-B is a medicated gel for canker sores combining benzocaine with the
patented film-forming properties of Zilactin®. Zilactin®-B quickly controls the pain associated
with canker sores while shielding them from the environment of the mouth.
|                        
|                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | Zilactin®-L a liquid for treating cold sores.                                                                                                                                                                                                                      
|                        
|                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | Zilactin®-Lip Zilactin®-Lip is positioned to be a premium-priced, more effective alternative to
existing lip balms. Zilactin®-Lip prevents sun blisters and treats cold sores and dry, chapped
lips.                                                               
|                        
|                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | Zilactin®-Baby Zilactin®-Baby is a medication for teething pain. Zilactin®-Baby contains a
higher level of benzocaine than competing products, and has a cool grape flavor. Unlike other
teething gels, it does not contain saccharin or coloring dyes.            
|                        
|                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  | Zilactin® Toothache & Oral Pain Swabs- Zilactin® Toothache Swabs is a medication for toothaches,
sore gums and pain from dentures and braces. Each single use, dry handle swab applicator is
saturated with a unique formula containing 20 percent benzocaine.      
|                        
|                         | The Zilactin® treatment composition is covered by a patent owned by the Company. This patent covers
the composition and the film-forming properties of the product formula. See Business  Patents and
Trademarks. Zilactin® and Zilactin®-B formulas incorporate these proprietary treatment
compositions.                                                                                                                                                                                                                                                                                                                                                                                                                       
|                        
|                        
|                        
|                        
|                        
|                         | Zilactin® and Zilactin®-B are packaged as gels in .25 ounce plastic tubes. Zilactin®-L is a liquid
packaged in a .25 ounce plastic bottle. The products are applied directly to affected areas in
quantities large enough to cover the lesion with the gel or liquid. The gels contain an active
ingredient that forms a thin, transparent, pliable film, which holds the active ingredient against
the affected tissue and keeps the affected area clean. The film can last up to six hours inside the
mouth, a feature that makes the formulation suitable for a variety of dental applications.
Zilactin®-Baby is packed in a .33 ounce tube while the Zilactin® Toothache & Oral Pain Swabs
package contains 8 single use swabs.
|                        
|                        
|                        
|                        
|                        
|                         | In addition to its over-the-counter applications, Zilactin® is being used by dentists to treat
patients with canker sores and other oral mucosal ulcers or lesions, and has been evaluated in                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

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|                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |   |                                                                                                                                                                                                                                              
|--------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                     
|                     
|                     
|                     
|                      | Dental schools at selected major universities.
The Company believes that superior efficacy
and targeted marketing efforts are the reasons
that independent pharmacist research studies
reported that Zilactin® was the number one OTC
product pharmacists recommend for treating
canker sores and cold sores in fiscal year
2001. The Company is exploring the development
of new products, including the addition of
other medications into the dry handle swab
vehicle, and additional products in oral care.                                                                                                                                                                                                                                                                                                                                                                                                          
|                     
|Professional Products |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  
|                     
|                     
|                     
|                     
|- Peridex®            | Peridex® is a prescription antibacterial oral
rinse used between dental visits as part of a
professional program for the treatment of
gingivitis. The active ingredient in Peridex®
is 0.12% chlorhexidine gluconate. Peridex®
was the first rinse to receive the American
Dental Association seal for reduction of
plaque and gingivitis. Peridex® effectively
controls the oral bacteria associated with
periodontal disease, particularly in the first
and only completely reversible stage,
gingivitis. Controlling gum disease at its
earliest stage is important because, if left
untreated, gingivitis can progress to
periodontitis, resulting in destruction of the
periodontal structure and supporting bone.
The Company acquired the Peridex® product line
from The Procter & Gamble Company in November
1997.                                                                                               
|                     
|                     
|                     
|                     
|                     
|- Pro-Series          | The Pro-Series line includes five specialty
products marketed directly to medical and
dental professionals: Pro-Ties, Pro-Wash,
Pro-Scrub, Pro-Ester-C and Pro-Swab                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                     
|                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  | Pro-Ties a bundling system for instrument
sterilization. Made of medical grade silicon
that withstands all types of sterilizers and
are available in 4 attractive colors.                                                                  
|                     
|                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  | Pro-Wash a hand washing liquid for
healthcare professionals containing .75%
chlorhexidine gluconate. Available in
16-ounce pump containers and 1 gallon refills.                                                                           
|                     
|                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  | Pro-Scrub a hand washing liquid for
healthcare professionals containing 2.00%
chlorhexidine gluconate that provides more
protection against infection than gloves
alone. Available in 16-ounce pump containers
and 1 gallon refills.       
|                     
|                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  | Pro-Ester-C® a patented and unique form of
vitamin C used to promote healthy teeth and
gums. Sold in bottles containing 45 tablets,
each with 1000 mg of vitamin C with calcium,
Pro-Ester-C® is readily absorbed and gentle on
the stomach.
|                     
|                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  | Pro-Swabs a topical, anesthetic swab
medication used for pre-injection or
post-procedural pain relief. Each single use,
dry handle swab applicator is saturated with a
unique formula containing 20 percent
benzocaine and is alcohol free.
|                     
|                     
|                     
|                     
|                     
|- IST Products        | IST manufactures three sizes of dry handled
swab applicators for both OEM customers and
for divisions of the Company. In addition,
IST manufacturers it own brand of disposable
probe covers (plastic sheaths used with
electronic thermometers) sold into healthcare
distribution channels and manufactures custom
probe covers for OEM customers.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                     
|                     
|                     
|                     
|                     
|- OraTest®            | The OraTest® product, a diagnostic adjunct for
oral cancer and site delineation for biopsy
and surgical excision, is a chair-side oral
rinse or swab that can be administered by
either a medical practitioner or dentist.
OraTest® contains the active ingredient Zila®
Tolonium Chloride, a staining agent, that will
adhere to specific cell types within the mouth
that are abnormal and that may not be visible
to physicians or dentists. The product has
been approved for distribution in the United
Kingdom, Australia, Taiwan, Belgium, Holland,
Luxembourg, Finland, Greece, Portugal, China,
Bermuda and the Bahamas. Currently, OraTest®
is being marketed in the U.K., Greece,
Bahrain, China and Taiwan. The Company is
currently funding a Phase III clinical study
to support its application for approval of the
OraTest® product in the United States by the
Food and Drug Administration (the FDA).

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|                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |  | 
|--------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|               
|               
|               
|               
|                | According to the American Cancer Society,
30,100 new oral, nasopharyngeal and laryngeal
cancers will be diagnosed and approximately
7,800 oral cancer related deaths will occur in
the U.S. in 2001. Oral cancer remains one of
the most debilitating and disfiguring of all
malignancies. In most people diagnosed with
oral cancer, the disease has metastasized,
resulting in a poor prognosis because the
usual method of detecting the disease is a
visual examination. Those who do survive
frequently undergo significantly disfiguring
surgery. When oral cancer is detected early,
survival rates are as high as 80%; detected
late the survival rate plummets to 18%.                                                                                                                                                                                                        
|               
|               
|               
|               
|               
|Dental Supplies | Zila Dental Supply is a national distributor
of professional dental supplies and equipment,
carrying brand names such as Eastman Kodak,
Dentsply, Sybron/Kerr and 3M. Most of Zila
Dental Supplys sales are through direct mail,
an outside sales force, telemarketing and the
Internet.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|               
|               
|               
|               
|               
|                | Zila Dental Supply distributes over 29,000
consumable supplies and small equipment as
well as a select group of large items of
dental equipment, such as compressors,
sterilizers, dental lights and chairs in
limited geographical markets and represents
the products of over 600 dental manufacturers.
The Company believes that these products
constitute the vast majority of supplies used
in the day-to-day operations of a dental
practice. For example, Zila Dental Supply
carries a broad line of dental alloys, x-ray
film, composite filling materials, impression
materials, gloves, diamond and carbide cutting
instruments, anesthetics, asepsis and
infection control products, hygiene and
surgical instruments, and a variety of other
widely used items.                                                                                                            
|               
|               
|               
|               
|               
|                | Dentists have traditionally purchased their
supplies from local full-service supply
companies, or from mail-order firms.
Historically, Zila Dental Supply has operated
primarily as a direct mail distributor with
full-service operations in certain
geographical markets. The mail order
operation uses the efficiencies of direct mail
and telemarketing to provide service,
convenience and competitive prices. The full
service operation combines competitive prices
with an even higher level of service to the
dental customer, usually resulting in a higher
level of sales per customer.                                                                                                                                                                                                                                                                                     
|               
|               
|               
|               
|               
|Nutraceuticals  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         | 
|               
|               
|               
|               
|- Ester-C®      | Oxycal, located in Prescott, Arizona, manufactures a patented and unique form of Vitamin C under
the trademark Ester-C®. Inter-Cal Corporation, an Oxycal subsidiary, distributes its products.
Products manufactured with Ester-C®nutritional ingredients are sold throughout the U.S. and in
over 41 countries worldwide. Inter-Cal requires its customers to display the federally registered
Ester-C®logo on their packaging. Opportunities for Ester-C®nutritional ingredients exist among
topical applications (such as skin creams), chewable vitamins, nutrition bars, sport drinks, food
fortification, etc. Oxycal holds two patents on certain compositions and methods for administering
vitamin C and therapeutically active compounds and one patent on a stable liquid form of mineral
ascorbate. Sales of Ester-C® accounted for 19.1% of the Companys total revenues.
|               
|               
|               
|               
|               
|                | Ester-C® Topical Concentrate, a liquid formulation for skin care products, provides a stable form
of Vitamin C that penetrates to the collagen-producing layers of the skin without chemicals.
Ordinary Vitamin C is quite unstable in water, the basis of most health and beauty care products,
and does not last long enough for the skin to reap the benefits of Vitamin C. Ester-C® Topical
Concentrateis non-acidic and free of chemical esters. Ester-C®Chelated Mineral Blendprovides the
benefits of supplemental Vitamin C for animals. Ester-C®® Beverage Grademineral ascorbate is
characterized by a uniform particle size and shape that blends easily into formulations for vitamin
and sports drinks, chewable tablets and other products where delivery and dispersibility are
important.                                                                              

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|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  | 
|---------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|          
|          
|          
|          
|-Palmettx | Palmettx, a standardized extract of the saw palmetto plant that retains high concentrations of the
active phytosterol components and is extracted without chemicals, toxic solvents or excessive heat.
Saw Palmetto extract is used to reduce the symptoms associated with glandular swelling in patients
with Benign Prostatic Hyperplasia (BPH), a problem that affects as much as 50% of the male
population by the age of 60 years. Inter-Cal produces Palmettx using a proprietary supercritical
carbon dioxide (CO2) fluid bioprocess method, PureXtrax, which extracts botanicals naturally,
without solvents such as hexane and alcohol. The process is non-hazardous to the environment, and
the Company believes it assures the highest product integrity, superior storage stability and
virtual elimination of all enzymes, microorganisms, viruses, molds and spores. Inter-Cal currently
provides many forms of saw palmetto to its customers, from whole berries to high
phytosterol-content super critically extracted oils.

Marketing

|                                    |                                                                                                                                                                                                                                                                                                                                                              |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|----------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Consumer Pharmaceuticals            |                                                                                                                                                                                                                                                                                                                                                             
|                                   
|                                   
|                                   
|                                   
|- Strategy for         OTC Products | The Companys Pharmaceuticals Group employs three strategies to market its Zilactin® family of products:                                                                                                                                                                                                                                                    
|                                   
|                                    |                                                                                                                                                                                                                                                                                                                                                              |  | Build Consumer Awareness- build consumer awareness of the OTC products through focused efforts like targeted
advertising and direct mail sampling.                                                                                                                                                                                                                                                                                                                                                                                                        
|                                   
|                                    |                                                                                                                                                                                                                                                                                                                                                              |  | Professional Education- educate several key groups of health professionals on the uniqueness and effectiveness
of each of the products. Targeted efforts to build awareness of the product line are made by direct mailings and
attending medical conventions. During fiscal year 2001, the Company participated in over thirty meetings geared
to dental, pharmacy and medical professionals. At these meetings, Company representatives have an opportunity to
interact with and distribute information to thousands of interested health professionals.
|                                   
|                                    |                                                                                                                                                                                                                                                                                                                                                              |  | Trade Participation- participate in retailer-driven activities designed to make its OTC products available at
more outlets and to offer value to consumers at the retail store level.                                                                                                                                                                                                                                                                                                                                                                     
|                                   
|Professional Products               |                                                                                                                                                                                                                                                                                                                                                              |  
|                                   
|                                   
|                                   
|                                   
|- Peridex®                          | During fiscal year 2001, Peridex® was marketed to healthcare
professionals and pharmacists with extensive support from Omnii Products
of Palm Beach, Inc., (Omnii), a national dental profession sales and
distribution organization. Omnii has a growing national network of field
sales representatives with excellent coverage of dental professionals.
|                                   
|                                   
|                                   
|                                   
|                                   
|                                    | Additionally, Omnii representatives call upon the
nations 54 dental and 200 hygiene schools, as well as
managed care organizations, pharmacists and
wholesalers, to reinforce support for Peridex® and
Zilas other brands.                                                                                                                                
|                                   
|                                   
|                                   
|                                   
|                                   
|- Pro-Series                        | In April 2001, the Company signed a contract with the
Lanmark Group for telemarketing and fulfillment
services for its new Pro-Series line of products.
Lanmark markets the products directly to dental
professionals.                                                                                                                                      

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|                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |  | 
|--------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|               
|               
|               
|               
|- OraTest®      | During fiscal 2001, the Company, through its wholly
owned subsidiary, Zila Limited, contracted with Quedos
Dental (Sales) Ltd. to provide a sales force to sell
OraTest® products under the OraTest® name in the U.K.
Additionally, Zila Limited has contracted with CPG
Holdings Ltd, a third party fulfillment organization,
to warehouse and ship OraTest® products throughout the
European Union and other selected countries. The
Company currently sells OraTest® through distributors
in China, Taiwan and Greece.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|               
|               
|               
|               
|               
|- IST Products  | IST markets its swab products to a variety of OEM
accounts in the dental, medical and cosmetic industries
using independent sales representatives and its own
in-house employees. Probe covers are sold through
local, regional and national distributors and buying
groups.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|               
|               
|               
|               
|               
|Dental Supplies |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | 
|               
|               
|               
|               
|                | Zila Dental Supply markets its products directly to the
end user primarily by direct mail, an outside sales
force, trade shows, telemarketing and its website. Zila
Dental Supply believes it delivers to its customers the
best value in the dental supply business by providing
competitive prices on dental supplies while providing
excellent customer service. Its award-winning catalog
provides a comprehensive reference of the top-selling
products available to the dentist. Every month
customers receive a special sale flyer that offers
significant savings and highlights many manufacturers
specials.                                                                                                                                                                                                                                                                                                                                                                                        
|               
|               
|               
|               
|               
|Nutraceuticals  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | 
|               
|               
|               
|               
|                | Oxycals manufacturing and marketing division,
Inter-Cal Corporation, supports its value-added
Ester-C® products and its Palmettx branded saw
palmetto products with a multi-million dollar
advertising program designed to increase brand
awareness among consumers, provide consumer education,
and support its customer base of marketers and
manufacturers. Inter-Cal promotes the patented
Ester-C® ingredient on behalf of more than one hundred
manufacturers and marketers of finished Ester-C®
products. National radio advertising with targeted
print advertising is utilized in the United States,
Canada and the United Kingdom. With the help of the
advertising, Ester-C® is transitioning from being a
product sold primarily in natural food outlets to one
with more name recognition and with more broad-based
availability in mass market, food and chain stores.
International sales activities are managed by local
distributors and are encouraged by advertising
assistance programs.

Manufacturing and Supply

|                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |  | 
|------------------------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|Consumer Pharmaceuticals
|                        
|                        
|                        
|                        
|- Zilactin®              | The Company employs a network of manufacturers to
produce and package all of its products within the Group. The following is
a breakdown by product line.                                                                                                                                                                                                                                                                                                                                                                                     
|                        
|                        
|                        
|                        
|                        
|                         | Arizona Natural Resources of Phoenix, Arizona manufactures
the Zilactin® line of products, and Ivers Lee Corporation,
dba Sharp of West Caldwell, New Jersey manufactures all
Zilactin® sample packets. The Company, through IST,
manufactures the Zilactin® Toothache and Oral Pain Swabs.
The Company places orders with each supplier based on its
anticipated needs for the products. Secondary suppliers are
maintained as alternate supply sources, and are an integral
part of the Companys strategy to maintain its product
pipeline.

8



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##### Table of Contents



|                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  | 
|--------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|                     
|                     
|                     
|                     
|Professional Products |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | 
|                     
|                     
|                     
|                     
|- Peridex®            | Xttrium Laboratories, Inc. (Xttrium) of
Chicago, Illinois is the primary manufacturer of
Peridex®. Peridex® was manufactured by Procter
& Gamble through June 1998.                                                                                                                                                                                                                                                                                                                                                                      
|                     
|                     
|                     
|                     
|                     
|- Pro-Series          | Hi-Tech Rubber, Inc. of Anaheim, California,
manufactures Pro-Ties. Xttrium manufactures
Pro-Scrub and Pro-Wash . Pro-Ester-C® is
encapsulated and bottled by Natrol, Inc. of
Chatsworth, California. The Company, through
IST, produces and packages Pro-Swabs.                                                                                                                                                                                                                                                                      
|                     
|                     
|                     
|                     
|                     
|- OraTest®            | Fleet Laboratories Ltd. of Watford, Herts,
United Kingdom (Fleet), produces and packages
the OraTest® product for distribution in the
U.K. and for sale to other selected countries.
The Company has identified a U.S. location with
the capacity to manufacture the OraTest® rinse
kits and swabs domestically.                                                                                                                                                                                                                         
|                     
|                     
|                     
|                     
|                     
|                      | In order to ensure an available and stable
supply of Zila® Tolonium Chloride, the worlds
only pharmaceutical grade tolonium chloride and
the active ingredient in the OraTest® product,
the Company established its own manufacturing
facility as no other pharmaceutical grade of
tolonium chloride existed. The facility is
certified as an approved facility for the
manufacture of Zila® Tolonium Chloride under
federally regulated Good Manufacturing Practices
(GMP) standards, assuring the
pharmaceutical-grade quality required.
|                     
|                     
|                     
|                     
|                     
|-IST Products         | All IST products are manufactured at its Antioch, Illinois location.                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                     
|                     
|                     
|                     
|                     
|Dental Supplies       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | 
|                     
|                     
|                     
|                     
|                     
|                      | Zila Dental Supply distributes products from over 600 manufacturers.                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                     
|                     
|                     
|                     
|                     
|Nutraceuticals        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | 
|                     
|                     
|                     
|                     
|                      | Ester C®products are manufactured at Oxycals
Prescott, Arizona location. Palmettx oil
products are manufactured by John I. Haas, Inc.
in Yakima, Washington. Saw Palmetto Products
Inc. of Indiantown, Florida provides the
Palmettx powder products.                                                                                                                                                                                                                                                                                   

Competition

All industries in which the Company sells its products are highly competitive.
A number of companies, many of which have greater financial resources,
marketing capabilities and research and development capacities than the
Company, are actively engaged in the development of products that may compete
with the Companys products. The pharmaceutical industry is characterized by
extensive and ongoing research efforts that may result in development by other
companies of products comparable or superior to any that are now on the market,
including those sold by the Company.

|                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |  | 
|------------------------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|Consumer Pharmaceuticals |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | 
|                        
|                        
|                        
|                        
|- Zilactin®              | Numerous products exist for treatment of cold sores and canker
sores, including the following products: Orajel by Del
Pharmaceuticals, Inc., Abreva by GlaxoSmithKline, Anbesol by
Whitehall Labs, Herpecin-L by Chattem, Inc., and Carmex by
Carma Lab, Inc. Based upon clinical studies, consumer research
and comments received by the Company from physicians and
dentists, management believes that its products provide more
effective symptomatic relief of cold sores and canker sores
than the treatments of the Companys current competitors.

9



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|                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  | 
|--------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | 
|                     
|                     
|                     
|                     
|Professional Products
|                     
|                     
|                     
|                     
|                     
|- Peridex®            | Peridex® competitors include generic versions and name
brands such as Periogard, made by Colgate Oral
Pharmaceuticals. Many of the competitors possess greater
financial resources than the Company. However, the Company
believes that Peridexs® reputation as the gold standard
of prescription antibacterial oral rinse within the dental
profession and its relationship with Omnii Products as its
distributor to professionals should allow the Company to
continue to compete effectively in the healthcare
professional marketplace.                                                                                                                                                                                                                                                                                                                                                                                                 
|                     
|                     
|                     
|                     
|                     
|- Pro-Series          | Pro-Ties is a proprietary product with no known
significant competition. The other Pro-Series products
have category specific competition coming from other
healthcare organizations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|                     
|                     
|                     
|                     
|                     
|- OraTest®            | Because of the special chemicals required to manufacture an
oral cancer detection product such as OraTest®, there are
no known competitors to the OraTest® product. The
conventional method of using visual examinations by medical
personnel to detect oral cancer is still a widely accepted
practice.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                     
|                     
|                     
|                     
|                     
|                      | Zila® Tolonium Chloride is the active ingredient in
OraTest®. Zila® Tolonium Chloride is the worlds only
pharmaceutical grade tolonium chloride produced in
compliance with FDA current GMP regulations. Zila® Tolonium Chloride
and its technology are protected by issued and pending patents.
See also Item 1. Business  Patents and Trademarks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                     
|                     
|                     
|                     
|                     
|- IST Products        | The swab products compete with a variety of other
product delivery systems, including some that utilize swabs as part of their
configuration. The unique IST dry handle swab product provides a clean and
convenient product that is patented and is supported by a fusion plastic
molding process allowing low cost production of the key molded components.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                     
|Dental Supplies       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | 
|                     
|                     
|                     
|                     
|                      | Zila Dental Supply competes with approximately 200 dental
supply dealers and mail order supply houses in the United
States, some of which have significantly greater financial
resources than the Company. Zila Dental Supplys sales make
up less than 2% of the total domestic market for dental
supplies. Zila Dental Supplys position with respect to its
competitors is difficult to determine since most of the
companies are privately-held and do not disclose financial
information. However, the Company believes that
approximately 60 percent of the market is dominated by two
public companies: Patterson Dental Company and Henry
Schein, Inc.                                                                                                                                                                                                                                                                                  
|                     
|Nutraceuticals        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | 
|                     
|                     
|                     
|                     
|- Ester-C®            | Within the Vitamin C market, the Companys competitors
include all other Vitamin C manufacturers, such as Roche
and Takeda. Many of the Companys competitors,
particularly those in markets other than the health food
and vitamin store market, have substantially greater
financial resources than the Company. The Company believes
that the growing number of health food and vitamin
distributors and retailers are increasingly likely to align
themselves with producers that offer a wide variety of high
quality products, have a loyal customer base, support their
brands with strong marketing and advertising programs and
provide consistently high levels of customer service. The
Company believes that it competes favorably with other
producers of Vitamin C because of the positive attributes
of its Ester-C®product, high customer-order fill rate,
strong distribution network, and advertising and
promotional support.

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|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  | 
|----------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|           
|           
|           
|           
|           
|           
|           
|           
|- Palmettx | The major competitor for supercritical carbon dioxide (CO2)
extracted saw palmetto products is Indena, an Italian based
company. Other competitors include US Nutraceuticals, Saw
Palmetto Berry Coop and Bio-Botanicals. The Company
believes that Oxycals commitment to its customer base
through its large saw palmetto product offerings and
consistently high levels of customer service, commitment to
quality and providing safe, efficacious products that
instill consumer confidence keeps it competitive in an
extremely dynamic marketplace.

Licensing

|                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |  | 
|--------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|Professional Products |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | 
|- Peridex®            | On January 30, 2001, the Company signed an agreement with
Xttrium whereby the Company granted Xttrium the right to
use its technology related to chlorhexidine gluconate, the
active ingredient in Peridex®, to produce a generic form of
the product for distribution. In addition, the Company
granted Xttrium the right to use its technology related to
chlorhexidine gluconate to produce Pro-Scrub and
Pro-Wash.                                                                                                                                                                                                                                                                                                                                                                                  
|                     
|                     
|                     
|                     
|                     
|- OraTest®            | In 1991, the Company acquired ownership of certain
exclusive rights to the patents, technology and process
embodying the formulation and the application of the
OraTest® product. The Company is obligated to pay
royalties to the National Technical Information Service
based upon certain usages of the OraTest® product. During
the 1995 fiscal year, the Company entered into a licensing
agreement pursuant to which Stafford-Miller Ltd. (a
division of Block Drug Company, Inc.) (Block) was given
the right to distribute the OraTest® product under the name
OraScreen in certain markets not previously pursued by the
Company. The Company received royalties from Block equal
to a set percentage of the net sales of OraScreen by
Block. This agreement was terminated in December 1999.
|                     
|                     
|                     
|                     
|                     
|                      | In August 1998, the Company entered into a five year
distribution and manufacturing license agreement with
Nippon Shoji Kaishi, Ltd. (now known as Azwell, Inc.) to
obtain regulatory approval, market and manufacture the
OraTest® product in Japan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                     
|                     
|                     
|                     
|                     
|                      | In June 2001, the Company contracted to supply Zila®
Tolonium Chloride to Denfotex Limited of the United
Kingdom, for worldwide use in photo-activated disinfections
in the tooth structure. Denfotex will sell, directly and
through third party dental product distributors, both a
unit dose of Zila® Tolonium Chloride and a laser delivery
system. Zila will charge Denfotex for the material
supplied and will receive a royalty on each laser unit
sold.                                                                                                                                                                                                                                                                                                                                           

Governmental Regulation

|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |  | 
|------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|General | The Companys operations are subject to extensive
regulation by governmental authorities in the United States
and other countries with respect to the testing, approval,
manufacture, labeling, marketing, distribution and sale of
its products. The Company devotes significant time, effort
and expense addressing the extensive government regulations
applicable to its business, and in general, the trend is
towards more stringent regulation. On an ongoing basis, the
FDA reviews the safety and efficacy of marketed
pharmaceutical products and monitors labeling, advertising
and other matters related to the promotion of such
products. The FDA also regulates the facilities and
procedures used to manufacture pharmaceutical products in
the United States or for sale in the United States. Such
facilities must be registered with the FDA and all products
made in such facilities must be manufactured in accordance
with current good manufacturing practices established by
the FDA. Compliance with current good manufacturing
practices requires the dedication of substantial resources
and requires significant costs. The FDA periodically
inspects

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|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  | 
|----------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|           
|           
|           
|           
|            | both the Companys manufacturing facilities and its
contract manufacturing plants and laboratories to assure
compliance. The FDA may request a recall or withdraw
product approvals if regulatory standards are not
maintained. FDA approval to manufacture a drug is site
specific. In the event an approved manufacturing facility
for a particular drug becomes inoperable, obtaining the
required FDA approval to manufacture such drug at a
different manufacturing site could result in production
delays, which could adversely affect the Companys business
and results of operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|           
|           
|           
|           
|           
|            | In connection with its activities outside the United
States, the Company is also subject to regulatory
requirements governing the testing, approval, manufacture,
labeling, marketing, distribution and sale of its products,
which requirements vary from country to country. Whether or
not FDA approval has been obtained for a product, approval
of the product by comparable regulatory authorities of
foreign countries may need to be obtained prior to
marketing the product in those countries. The approval
process may be more or less rigorous from country to
country, and the time required for approval may be longer
or shorter than that required in the United States. No
assurance can be given that any clinical studies conducted
outside of any country will be accepted by such country,
and the approval of any pharmaceutical product in one
country does not assure that such product will be approved
in another country. The Company is also subject to
worldwide governmental regulations and controls relating to
product safety, efficacy, packaging, labeling and
distribution. While not all of the products that the
Company plans to introduce into the market are new drugs
or new devices, those fitting the regulatory definitions
are subject to a stringent premarket approval process in
most countries. Submission of a substantial amount of
preclinical and clinical information prior to market
introduction significantly increases the amount of time and
related costs incurred for preparing such products for
market.
|           
|            | The federal and state governments in the United States, as
well as many foreign governments, from time to time explore
ways to reduce medical care costs through health care
reform. These efforts have resulted in, among other things,
government policies that encourage the use of generic drugs
rather than brand name drugs to reduce drug reimbursement
costs. Virtually every state in the United States has a
generic substitution law, which permits the dispensing
pharmacist to substitute a generic drug, if available for
the prescribed brand name product.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|           
|           
|           
|           
|           
|            | As a responsible manufacturer, the Company is alert to the
possibility that the final monographs to be issued in the
foreseeable future may require formula modifications of
certain of its OTC products to maintain compliance with
these regulations, a possibility facing competitive
products as well.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|           
|           
|           
|           
|           
|            | Manufacturing companies, especially those engaged in health
care related fields, are subject to a wide range of
federal, state and local laws and regulations. Concern for
maintaining compliance with federal, state, local and
foreign regulations on environmental protection, hazardous
waste management, occupational safety and industrial
hygiene has also increased substantially. The Company
cannot predict what additional legislation or governmental
action, if any, will be enacted or taken with respect to
the above matters and what its effect, if any, will be on
the Companys consolidated financial position, results of
operations or cash flows.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|           
|           
|           
|           
|           
|- Zilactin® | Zilactin® is marketed by the Company as a treatment for the
symptomatic relief of canker sores (oral mucosal ulcers and
lesions) and cold sores. The Company is not required to
file a New Drug Application (NDA) covering these uses of
Zilactin®.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|           
|           
|           
|           
|           
|            | The FDAs regulation of most of the OTC drug products in
the United States (such as Zilas Zilactin® family of
products) has not been finalized. In addition, the FTC
continually monitors the advertising practices of consumer
products companies with respect to claims made relating to
product functionality and efficacy.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

12



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|           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  | 
|---------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|          
|          
|          
|          
|- OraTest® | In 1994, the FDA approved an Investigational New Drug
Application (IND) for the Companys OraTest® product. In
November 1998, the FDA notified the Company that the
OraTest® NDA was being given priority review, which
targeted agency review within six months from September 3,
1998, the date when the Company provided additional data to
the FDA. On January 13, 1999, the FDAs Oncologic Drugs
Advisory Committee (the Committee) met to review the
OraTest® NDA and recommended, among other things, that the
FDA not approve the NDA as submitted. Subsequent to the
Committee meeting, Company representatives engaged in a
dialog with the FDA, culminating in several meetings at the
agency in 1999 and 2000.
|          
|          
|          
|          
|          
|           | On March 3, 1999, the Company received an action letter
from the FDA outlining certain deficiencies in the OraTest®
NDA that prevented the FDA from approving the product at
that time. The FDAs letter detailed a procedure for
amending the NDA to rectify those matters. In November
1999, the Company contracted with ILEX Oncology Services,
Inc. (ILEX), a wholly-owned subsidiary of ILEX Oncology,
Inc. of San Antonio, Texas, for management of clinical
research and liaison with the FDA related to the Companys
pursuit of regulatory approval for the OraTest® product. In
August 2000, the Company received FDA authorization to
proceed with a new Phase III clinical study.                                
|          
|          
|          
|          
|          
|           | The Company received regulatory approval to market the
OraTest® product in Australia in 1993. Approval to market
the OraTest® product in certain Caribbean countries and
Hungary has also been received. The Medicines Control
Agency (MCA), which is the regulatory authority in the
U.K., has also granted approval for the OraTest® rinse
product to be marketed in the U.K.                                                                                                                                                                                                                                                                                                                                                
|          
|           | In January 1998, Zila submitted a Mutual Recognition
Procedure (MRP) application through the MCA for
regulatory approval of OraTest® in the European Union
(EU). In April 1998, Belgium, the Netherlands,
Luxembourg, Portugal, Finland and Greece gave their
regulatory approval through this application. Zila has
also received licenses to sell in Greece, Luxembourg,
Finland, Belgium, Portugal, Bahrain, Oman and the
Netherlands and is finalizing the license procedure for the
remaining EU member nations.                                                                                                                                                                                                        

Patents and Trademarks

|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |  | 
|----------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|- Zilactin® | A comprehensive U.S. patent covering present film-forming
Zilactin® products was issued in February 1991. Two applications for
United States patents and corresponding foreign patent applications have
been filed covering additional topical film-forming products. The Company
has registered the trademarks Zila® and Zilactin® in the United States,
Canada and in several important foreign countries and has applications
pending to register these trademarks in others. The Company believes
that widespread use of the Zila® and Zilactin® trademark alone and as the
dominant features of other marks, e.g., Zilactin®-B, Zilactin®-L, etc.,
affords reasonable protection for the family of trademarks in which Zila®
is the dominant feature.
|           
|           
|           
|           
|           
|-Peridex®   | Peridex® as a brand name has become the gold standard
within the dental industry for prescription oral rinses in both the U.S.
and Canada. Concurrent with the purchase of the Peridex® brand from
Procter & Gamble in November 1997, Zila Pharmaceuticals purchased the
trademark rights to Peridex®. Accordingly, Procter & Gamble has assigned
the Peridex® trademark to the Company for each country where it has been
previously registered, except for certain countries in Western Europe.
The Company recorded its trademark assignment for Peridex® with the U.S.
Patent and Trademark office in June 1998 and with the Canadian Registrar
of Trademarks in July 1998.                                                                           

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|               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |  | 
|-------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|              
|              
|              
|              
|- OraTest®     | Concurrent with the purchase of the shares of CTM
Associates, Inc. in June 1996, the Company acquired
certain technology rights and U. S. patent rights
related to the OraTest® product. The Company is the
exclusive licensee of the National Institutes of Health
under its U.S. and Canadian patents covering a protocol
for the use of toluidine blue for detection of oral
cancer. Three U.S. patents were issued in March 1999,
July 2000 and February 2001. The Company has filed applications
in many foreign countries covering the process that the
Company developed for manufacturing its Zila® Tolonium
Chloride drug substance, the drug substance itself and
methods of using the drug substance in detecting
epithelial cancer and covering other dyes which are
chemically related to toluidine blue for use in
detecting epithelial cancer.
|              
|              
|              
|              
|              
|               | The Company registered the OraTest® trademark in the
United States in June 1998 and has either pending
applications for registrations or issued registrations
of this trademark in major foreign countries in which
this mark is being used or in which it will be used.
Australia has issued the first patent specifically
protecting the concept of using the OraTest® kit to
screen for oral cancer. The Company licensed the use
of the trademark OraScreen in Europe and certain other
foreign countries and has obtained registrations of the
OraScreen trademark in all major European countries
and in Pacific Rim countries important to its marketing
and distribution strategy.                                                                                                                                                                 
|              
|              
|              
|              
|              
|- IST Products | Concurrent with the February 1, 2001 purchase of the
assets from NHMC, the Company purchased the patent
rights related to the Dry Handle Swab Assembly and
Unit. Accordingly, NHMC has assigned the patent rights
to the Company. Since then, the Company has filed a
new patent application covering an improved version of
the swab assembly. An application to register the
Innovative trademark has been approved by the United
States Patent & Trademark Office.                                                                                                                                                                                                                                                                                                                                                                                      
|              
|              
|              
|              
|              
|- Pro-Ties    | The Company has filed applications of patents in the
United States and major foreign countries covering the
method of cleaning and sterilizing medical instruments
using Pro-Ties. An application for registration of
the Pro-Ties trademark has been filed in the United
States and Canada.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|              
|              
|              
|              
|              
|- Ester-C®     | In 1989, 1990 and 1991, three U.S. patents were issued
in connection with Ester-C®nutritional ingredients.
All three patents expire in the year 2007. The first
patent covers compositions for administering Vitamin C
that contains mineral theonates or other Vitamin C
metabolites. The second and third patents cover the
metabolite technology, which improved the absorption of
Vitamin C from the Ester-C®formulation and is
applicable to a wide variety of other non-prescription
and prescription drugs. Oxycal has filed and is
currently pursuing corresponding
patent applications in all foreign countries important
to its marketing and distribution strategy.                                                                                                                                                                               
|              
|              
|              
|              
|              
|               | Oxycal has filed a new international patent application
covering improved Vitamin C compositions that may have
the effect of extending protection of the improved
Ester-C®product for several additional years.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|              
|              
|              
|              
|              
|               | Ester-C®Topical Concentrate, a stable form of Vitamin
C that penetrates the skin to help produce collagen and
supporting structures, was awarded a U. S. patent in
March 2001 for Stable Liquid Mineral Ascorbate
Composition and Methods of Manufacturing and Use.
Corresponding patent applications are pending in
several foreign countries.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|              
|              
|              
|              
|              
|               | The Company has four major and several other trademarks
issued by the United States Patent and Trademark office
in the United States. The Ester-C®trademark was
issued in August 1985; the EC® logo trademark was
issued in August 1990; the CV-Flex® trademark was
issued in August 1990; and the Palmettx trademark was
issued in September 2001. The Company also has
trademarks issued in 36 foreign countries with
trademarks pending in other countries.                                                                                                                                                                                                                                                                                                                                                                                              

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##### Table of Contents



Product Liability Insurance

The Company faces an inherent risk of exposure to product liability claims
if the use of one or more of its products is alleged to have resulted in
adverse effects. Such risk exists even with respect to those products that are
manufactured in licensed and regulated facilities or that otherwise received
regulatory approval for commercial sale. There can be no assurance that the
Company will not be subject to significant product liability claims. Many of
the Companys customers require the Company to maintain product liability
insurance coverage as a condition of their conducting business with the
Company. As the loss of such insurance coverage could result in a loss of such
customers, the Company intends to take all reasonable steps necessary to
maintain such insurance coverage. There can be no assurance that insurance
coverage will be available in the future on commercially reasonable terms, or
at all, or that such insurance will be adequate to cover potential product
liability claims. The loss of insurance coverage or the assertion of a product
liability claim or claims could have a material adverse effect on the Companys
business, financial condition and results of operations.

Employees

As of July 31, 2001, the Company and its operating subsidiaries had 266
employees in the following categories:

|                              |  |                     |    |  |  |  |  | 
|----------------------------- |  | ------------------- | -- |  |  |  |  | 
|Categories                    |  | Number of Employees
|                              |  |                    
|Executive Officers            |  |                     | 3  | 
|                             
|                             
|                             
|                             
|Sales and Service             |  |                     | 83 | 
|                             
|                             
|                             
|                             
|Accounting and Administration |  |                     | 76 | 
|                             
|                             
|                             
|                             
|Purchasing and Distribution   |  |                     | 47 | 
|                             
|                             
|                             
|                             
|Manufacturing                 |  |                     | 57 | 

No employees are represented by a labor union, nor are there any current
labor relations complaints on file with any agency. The Company believes its
relationship with its employees is good.

Cautionary Factors that May Affect Future Results

The disclosure and analysis in this report
and in the Companys other reports, press
releases and public statements of our
officers contain some forward-looking
statements. Forward-looking statements give
the Companys current expectations or
forecasts of future events, and may be
identified by the fact that they do not
relate strictly to historical or current
facts. In particular, forward-looking
statements include statements relating to
future actions, prospective products or
product approvals, future performance or
results of current and anticipated products,
sales efforts, expenses, the outcome of
contingencies such as legal proceedings, and
financial results. Many factors discussed
in Part I of this report, for example
government regulation, competition, and the
supply of raw materials, will be important
in determining future results.

Any or all forward-looking statements in
this report, any other report, and in any
other public statements may turn out to be
wrong. They can be affected by inaccurate
assumptions or by known or unknown
uncertainties. No forward-looking statement
can be guaranteed, and actual results may
differ materially.

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|                                                  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                 
|                                                 
|                                                 
|                                                 
|                                                  |  | The Company undertakes no obligation to
publicly update forward-looking statements.
Shareholders are advised to consult further
disclosures on related subjects in the
Companys other reports to the Securities
and Exchange Commission. The following
cautionary discussion of risks,
uncertainties and possible inaccurate
assumptions are factors that the Companys
management believes could cause actual
results to differ materially from expected
and historical results. Factors other than
those included below could also adversely
affect the Companys business results. The
following discussion is provided pursuant to
the Private Securities Litigation Reform Act
of 1995.                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                 
|                                                 
|                                                 
|                                                 
|                                                 
|- Uncertainties of
Regulatory Approval            |  | The rigorous clinical testing and an
extensive regulatory approval process
mandated by the FDA and equivalent foreign
authorities before the Company can market
any new drug 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. The Company may also
decide to replace the compounds in testing
with modified or optimized compounds, thus
extending the testing process. In addition,
delays or rejections may be encountered
based upon changes in FDA policy during the
period of product development and FDA
regulatory review of each submitted new drug
application or product license application.
Similar delays may also be encountered in
other countries. There can be no assurance
that even after such time and expenditures,
regulatory approval will be obtained for any
products developed by the Company.
|                                                 
|                                                 
|                                                 
|                                                 
|                                                 
|                                                  |  | A marketed product, its manufacturer and its
manufacturing facilities are also subject to
continual review and periodic inspections,
and later discovery of previously unknown
problems with a product, manufacturer or
facility may result in restrictions on such
product or manufacturer, potentially
including withdrawal of the product from the
market.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                 
|                                                 
|                                                 
|                                                 
|                                                 
|- Introduction of
OraTest® in the   United
States |  | Zila has not received final FDA approval for
OraTest® and is conducting a Phase III
clinical trial to include in an amended NDA.
As of July 31, 2001, Zila expensed
approximately $24.4 million for OraTest®
including a significant financial investment
towards obtaining FDA approval of OraTest®,
to build its manufacturing facility and to
prepare for the introduction of OraTest® to
the United States market. There can be no
assurance that the FDA will issue a final
approval of OraTest®, and the failure of the
FDA to approve OraTest® would make it
impossible for Zila to recoup its investment
through sales of OraTest® in the United
States. The failure of the FDA to finally
approve OraTest® will have a material
adverse effect on the Companys results of
operations. If regulatory approval is
granted, such approval may entail
limitations on the indicated uses for which
the product may be marketed. Further, even
if such regulatory approval is obtained, the
FDA will require post-marketing reporting,
and may require surveillance programs to
monitor the usage or side effects of
OraTest®.                                    
|                                                 
|                                                 
|                                                 
|                                                 
|                                                 
|                                                  |  | If FDA approval of OraTest® is received, the
Company must establish a marketing and sales
force with technical expertise to market
directly to the dental profession or it must
obtain the assistance of a pharmaceutical
company or a distributor with a large sales
force. There is no assurance that the
Company will be successful in gaining market
acceptance of OraTest®.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                 
|                                                 
|                                                 
|                                                 
|                                                 
|- Dependence on Key Products                      |  | A large percentage of the Companys revenues
result from sales of Ester-C®, Peridex®, and
the Zilactin® family of products. If any of
these major products were to become subject
to a problem such as loss of patent
protection, unexpected side effects,
regulatory proceedings, publicity affecting
user confidence, or pressure from competing
products, or if a new, more effective
treatment should be introduced, the impact
on the Companys revenues could be
significant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

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|                                        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                       
|                                       
|                                       
|                                       
|- Possible Claims Relating
to Products  |  | The Company could be exposed to possible
claims for personal injury resulting from
allegedly defective products manufactured by
the Company and third parties with whom it
has entered into manufacturing agreements.
The Company maintains product liability
insurance coverage for claims arising from
the use of all its products. However, the
Company could be subject to product
liability claims in excess of its insurance
coverage. Any significant product liability
claims not within the scope of the Companys
insurance coverage could have a material
adverse effect on the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                       
|                                       
|                                       
|                                       
|                                       
|- Competition;
Research and
Development |  | The pharmaceutical industry is highly
competitive. A number of companies, many of
which have greater financial resources,
marketing capabilities and research and
development capacities than the Company, are
actively engaged in the development of
products similar to those products produced
and marketed by the Company. The
pharmaceutical industry is characterized by
extensive and ongoing research efforts.
Other companies may succeed in developing
products superior to those marketed by the
Company. Such companies may even succeed in
developing a cure for herpes simplex virus,
which would substantially reduce the
potential market for symptomatic treatments
such as Zilactin®. In addition, Zila Dental
Supply faces significant competition,
primarily from a various number of dental
supply dealers and mail order supply houses
in the United States. It may be difficult
for the Company to maintain or increase
sales volume and market share due to such
competition.                                                                                                                                                                                                                                                                                                                                 
|                                       
|                                       
|                                       
|                                       
|                                       
|- Generic Competition                   |  | In the U.S., competition with producers of
generic products is a major challenge. The
Companys loss of any of its products
patent protection could lead to a dramatic
loss in sales of the product in the U.S.
market.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                       
|                                       
|                                       
|                                       
|                                       
|- Dependence on Proprietary Rights      |  | Zila relies on a combination of patent,
copyright, trademark and trade secret
protection, nondisclosure agreements and
licensing arrangements to establish and
protect its proprietary rights. Zila owns
and has exclusive licenses to a number of
United States and foreign patents and patent
applications, and intends to seek additional
patent applications, as it deems
appropriate. Whether patents will issue from
any of these pending applications or, if
patents do issue, that any claims allowed
will be sufficiently broad to cover Zilas
products or to effectively limit competition
against Zila is uncertain. Furthermore, any
patents that may be issued to Zila may be
challenged, invalidated or circumvented.
Litigation may result from the Companys use
of registered trademarks or common law marks
and, if litigation against Zila were
successful, a resulting loss of the right to
use a trademark could reduce sales of Zilas
products and could result in a significant
damages award. Although Zila intends to
defend the proprietary rights, policing
unauthorized use of proprietary technology
and products is difficult. International
operations may be affected by changes in
intellectual property legal protections and
remedies in foreign countries in which in
the Company does business.
|                                       
|                                       
|                                       
|                                       
|                                       
|- Raw Materials                         |  | Raw materials essential to the Companys
business are generally readily available.
However, certain raw materials and
components used in the manufacture of the
pharmaceutical products are available from
limited sources, and in some cases, a single
source. Any curtailment in the availability
of such raw materials could be accompanied
by production delays, and in the case of
products for which only one raw material
supplier exists, could result in a material
loss of sales. In addition, because raw
material sources for pharmaceutical products
must generally be approved by regulatory
authorities, changes in raw material
suppliers could result in production delays,
higher raw material costs and loss of sales
and customers.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

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|                                                                  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|----------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|- Future Capital
Requirements and
  Uncertainty of Future
Funding |  | The development of the Companys products
will require the commitment of substantial
resources to conduct the time-consuming
research and development, clinical studies
and regulatory activities necessary to bring
any potential product to market and to
establish production, marketing and sales
capabilities. The Company may need to raise
substantial additional funds for these
purposes. The Company may seek such
additional funding through collaborative
arrangements and through public or private
financings. The inability to obtain
sufficient funds may require the Company to
delay, scale back or eliminate some or all
of its research and product development
programs, to limit the marketing of its
products or to license third parties the
rights to commercialize products or
technologies that the Company would
otherwise seek to develop and market itself.                                                                                        
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|- Possible
Volatility of Common
Stock Price                       |  | The market price for the Companys common
stock has fluctuated significantly in the
past. Management of Zila believes that
announcements of new products, quarterly
fluctuations in the results of operations
and other factors, including changes in
conditions of the pharmaceutical industry in
general, and developments in regulatory
arenas may have caused such fluctuations.
Stock markets have experienced extreme price
volatility in recent years. This volatility
has had a substantial effect on the market
prices of securities issued by Zila and
other pharmaceutical and health care
companies, often for reasons unrelated to
the operating performance of the specific
companies. Zila anticipates that the market
price for its common stock may continue to
be volatile.                                                                                                                                                                                    
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|- Issuance of
Preferred Stock                                     |  | The Companys Board of Directors has the
authority, without any further vote by the
Companys stockholders, to issue up to
2,500,000 shares of Preferred Stock in one
or more series and to determine the
designations, powers, preferences and
relative, participating, optional or other
rights thereof, including without
limitation, the dividend rate (and whether
dividends are cumulative), conversion
rights, voting rights, rights and terms of
redemption, redemption price and liquidation
preference. On February 1, 2001, the Company
issued 100,000 shares of its Series B
Convertible Preferred Stock related to the
IST acquisition. As of July 31, 2001, all of
the shares of the Series B Preferred Stock
remained outstanding.                                                                                                                                                                                                                                
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|- Environmental and
Controlled Use of
  Hazardous
Materials       |  | The Company is subject to federal, state and
local laws and regulations governing the
use, generation, manufacture, storage,
discharge, handling and disposal of certain
materials and wastes used in its operations,
some of which are classified as hazardous.
The Company could be required to incur
significant costs to comply with
environmental laws and regulations as its
research activities are increased, and the
operations, business and future
profitability of the Company could be
adversely affected by current or future
environmental laws and regulations. Although
the Company believes that its safety
procedures for handling and disposing
materials comply with such laws and
regulations, the risk of accidental
contamination or injury from these materials
cannot be eliminated. In the event of such
an accident, the Company could be held
liable for any damages that result and any
such liability could exceed the resources of
the Company.

18



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##### Table of Contents



|                            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|--------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                           
|                           
|                           
|                           
|- Interest rates            |  | The Company is exposed to the risk of
interest rate fluctuations in connection
with its revolving line of credit and the
Industrial Development Authority (IDA)
Bonds outstanding. At July 31, 2001, the
carrying values of the revolving line of
credit and the IDA Bonds approximated fair
value.                                                                                                                                                                                                                                                                                                                                                                
|                           
|                           
|                           
|                           
|                           
|- Introduction of
Palmettx |  | The Company entered the saw palmetto
business with its Palmettx line of products
during the current fiscal year. During the
year the Company purchased a large amount of
saw palmetto inventory in order to take
advantage of bulk purchase discounts and to
establish a reputation as a reliable
supplier to its customers. At July 31,
2001, the Company had approximately $4.5
million of saw palmetto inventory on hand.
The ultimate probable future economic
benefit associated with such inventory is
contingent on the Companys ability to
continue to sell its line of saw palmetto
products for a price greater than the
carrying value of the inventory.
|                           
|                           
|                           
|                           
|                           
|- Foreign Currency          |  | The Company transacts business in various
foreign countries. Foreign currency
exposures are primarily related to, but not
limited to, vendor and customer payments and
inter-company balances in currencies other
than the functional currency. Fluctuations
in foreign currencies are not expected to
have a material adverse effect on the
Companys results of operations.                                                                                                                                                                                                                                                                                        




Item 2.

PROPERTIES

|                           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|- Corporate Headquarters   |  | On January 4, 1991, the
Company purchased a 16,000
square foot building located
at 5227 North Seventh
Street, Phoenix, Arizona
85014-2800. The Company
moved its corporate
headquarters to this
location on February 8,
1991. The purchase price of
the building was
approximately $600,000. The
Company paid 25% of the
purchase price in cash and
obtained a loan for the
balance of the purchase
price. The Company
refinanced the mortgage with
Bank One, Arizona. The terms
of the refinancing included
interest to be payable
monthly on the unpaid
balance at an interest rate
of 9.00%. The refinanced
mortgage loan was amortized
over 20 years and was paid
in full on August 23, 2001.
|                          
|                          
|                          
|                          
|                          
|- Manufacturing Facilities |  | The Company leases 11,262
square feet for a
manufacturing facility in
Phoenix, Arizona. This
facility produces Zila®
Tolonium Chloride, which is
the active ingredient in
OraTest®. The facility is
leased under a 56-month
agreement, which expires
December 31, 2005. Monthly
lease payments are $7,374.
Together with the Companys
laboratory facilities, the
Company believes that its
current manufacturers are
capable of performing all
necessary production
functions. See Item 1.
Business  Manufacturing
and Distribution.                                                                                                                                                         
|                          
|                          
|                          
|                          
|                          
|                           |  | The Companys Oxycal
subsidiary owns 2.79 acres
and occupies a new 65,000
square foot facility located
at 6735 Inter-Cal Way,
Prescott, Arizona 86301.
The building features
production, laboratory,
packaging, storage and
shipping areas, as well as a
controlled environment, and
was financed by Yavapai
County Industrial
Development Authority Bond
proceeds. The construction
and move to the new facility
was completed in the fall of
2000.                                                                                                                                                                                                                                             
|                          
|                          
|                          
|                          
|                          
|                           |  | IST leases 14,400 square
feet for a manufacturing
facility in Antioch,
Illinois for the manufacture
and distribution of dry
handled swab products and
probe covers. The facility
is leased under a 7-year
agreement, which expires
January 31, 2008. The lease
has an option to renew for
an additional 3 years.
Monthly lease payments are
$5,667. The Company does
not currently intend to
invest in any other plants
or manufacturing facilities
related to this business.                                                                                                                                                                                                                    

19



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##### Table of Contents



|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       
|       
|       
|       
|- Other |  | The Companys subsidiaries
hold additional leases on
five separate facilities.
Bio-Dental leases 25,000
square feet of
office/warehouse space in a
concrete building located at
11291 Sunrise Park Drive,
Rancho Cordova, California.
The current lease rate for
the Rancho Cordova facility
is $9,837 per month, and is
constant for the duration of
the lease. The lease for the
Rancho Cordova facility
expires on December 31,
2005. Bio-Dentals
administrative offices are
located in the Rancho
Cordova facility.                                                                                                                                                                                                                                                                                                                                                    
|       
|       
|       
|       
|       
|        |  | Zila Dental Supply leases
19,200 square feet in an
office/warehouse complex at
172 Lisle Industrial Avenue,
Lexington, Kentucky. The
current lease rate is $3,024
per month, and expires on
December 31, 2004. Zila
Dental Supply leases 7,708
square feet in an office
building at 125 Lisle
Industrial Avenue,
Lexington, Kentucky. The
current lease rate is $9,603
per month, and expires on
December 31, 2004. On
December 1, 1998, Zila
Dental Supply entered into a
three-year lease for 3,915
square feet at 4544 South
Pinemont, Suite 204,
Houston, Texas for their
Houston branch office. The
current lease rate is $2,145
per month. On November 19,
1999, Zila Dental Supply
entered into a five-year
lease for 4,761 square feet
at 555 Menlo Drive, Suite B,
Rocklin, California for
their Rocklin branch office.
The current lease rate is
$4,047 per month.




Item 3.LEGAL PROCEEDINGS

The Company and certain officers of the Company were named as defendants
in a consolidated First Amended Class Action Complaint filed July 6, 1999 in
the United States District Court for the District of Arizona under the caption
In re Zila Securities Litigation, No. CIV 99 0115 PHX EHC. The First Amended Class
Action Complaint sought damages in an unspecified amount on behalf of a class
consisting of purchasers of the Companys securities for alleged violations of
the federal securities laws. During the fourth quarter 2001, the parties
settled this matter without a material impact on the Companys financial
statements.

On September 8, 1999, the Securities and Exchange Commission (the
Commission) entered an order directing an investigation entitled In the Matter
of Zila, Inc.At that time, the Commission stated it was investigating, inter
alia, whether there were false and misleading statements in press releases,
filings with the Commission, or elsewhere concerning the prospects that the
Oncologic Drugs Advisory Committee for the FDA would recommend approval of the
OraTest® NDA and whether the FDA would subsequently approve the NDA. The
Company has cooperated with the Commission in its investigation. The
Company and Mr. Hines, its President, are engaged in settlement
discussions with the staff of the Commission.

In September 2000, counsel advised Zila that its obligation to pay
royalties to Dr. James E. Tinnell, (Tinnell) under a 1980 agreement ceased as
of August 25, 1998 when the patents on the invention expired. In September
2000, Zila gave notice to Tinnell that it would not continue paying such
royalties and requested reimbursement of royalties paid since August 1998.
After attempts to settle the matter failed, Zila filed suit in the Federal
District Court for the District of Nevada (Zila, Inc. v. James E. Tinnell, No.
CV-S-00-1344), requesting a declaratory judgment that it had no royalty
obligations to Tinnell after August 1998 and judgment for the overpaid
royalties.

Tinnell asserted a counterclaim for royalties since the last payment in
August 2000 and several additional counterclaims based on transactions between
Tinnell and Zila in the 1980s. Counsel have advised Zila that, based on their
investigations and discovery to date, that (i) the counterclaim for royalties
is without merit and (ii) the additional counterclaims are meritless and, in
any event, are time-barred by the applicable statutes of limitation.




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

The Company did not submit any matter to a vote of its security holders
during the fourth quarter of the fiscal year covered by this report.

20



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##### Table of Contents






PART II




Item 5.MARKET FOR THE COMPANYS COMMON STOCK AND RELATED STOCKHOLDER MATTERS

Information regarding the market for Zilas Common Stock and related
stockholder matters is set forth below. The following table sets forth, for the
fiscal periods shown, the high and low quotations in dollars per share for the
Common Stock as reported by the National Association of Securities Dealers
Automated Quotation System (NASDAQ).

|                                |                |  |      |       |     |  |  |       | 
|------------------------------- | -------------- |  | ---- | ----- | --- |  |  | ----- | 
|                                |                |  | High |       | Low
|                                |                |  |      |       |    
|Fiscal Year Ended July 31, 2001 |                |  |      |       |     |  | 
|                                | First Quarter  |  |      | 4.000 |     |  |  | 2.844 | 
|                               
|                               
|                               
|                               
|                                | Second Quarter |  |      | 3.625 |     |  |  | 1.875 | 
|                               
|                               
|                               
|                               
|                                | Third Quarter  |  |      | 3.125 |     |  |  | 2.000 | 
|                               
|                               
|                               
|                               
|                                | Fourth Quarter |  |      | 3.020 |     |  |  | 2.050 | 
|                               
|Fiscal Year Ended July 31, 2000 |                |  |      |       |     |  | 
|                                | First Quarter  |  |      | 3.688 |     |  |  | 3.000 | 
|                               
|                               
|                               
|                               
|                                | Second Quarter |  |      | 5.375 |     |  |  | 2.625 | 
|                               
|                               
|                               
|                               
|                                | Third Quarter  |  |      | 8.000 |     |  |  | 3.094 | 
|                               
|                               
|                               
|                               
|                                | Fourth Quarter |  |      | 4.938 |     |  |  | 3.125 | 

The number of stockholders of record of the Common Stock as of July 31,
2001 and September 28, 2001 were approximately 3,170 and 3,163, respectively.
As of July 31, 2001 there are 100,000 shares of the Companys Series B
Preferred Stock outstanding.

The Company has not paid dividends on the Common Stock. It is the policy
of the Companys Board of Directors to retain future earnings to finance the
growth and development of the Companys business. Any future dividends will be
at the discretion of the Companys Board of Directors and will depend upon the
financial condition, capital requirements, earnings and liquidity of the
Company, as well as other factors the Companys Board of Directors may deem
relevant.

On March 23, 2000, the Company issued a warrant to purchase 10,000 shares
of the Companys common stock, to a financial advisor. The warrant was issued
pursuant to the terms of an engagement agreement, and the exercise price is
$4.906 per share. The warrant was issued pursuant to the exemption set forth
in Section 4(2) of the Securities Act of 1933, as amended.

On December 21, 2000, the Company issued a warrant to purchase 15,000
shares of the Companys common stock, to a financial advisor. The warrant was
issued pursuant to the terms of a consulting agreement and 7,500 of the shares
underlying the warrant have an exercise price of $4.00 per share and 7,500 of
the shares have an exercise price of $5.00 per share. The warrant was issued
pursuant to the exemption set forth in Section 4(2) of the Securities Act of
1933, as amended.

On February 1, 2001, the Company issued 100,000 shares of Series B
convertible preferred stock to National Healthcare Manufacturing Corporation,
U.S. as part of the acquisition of the patent rights and the Antioch, Illinois
manufacturing operations for swab products. The preferred stock is convertible
into shares of the Companys common stock at any time at a conversion ratio of
one to one. The holders of the preferred stock are entitled to receive
cumulative quarterly dividends at a rate of $0.0975 per share per fiscal
quarter, payable in arrears. Holders of the preferred shares have no voting
rights except as required by applicable law.

21



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##### Table of Contents






Item 6.SELECTED FINANCIAL DATA

The following tables summarize selected financial information derived from
the Companys audited financial statements. The information set forth below is
not necessarily indicative of results of future operations and should be read in conjunction with the Companys Consolidated Financial Statements and related
Notes and with Managements Discussion and Analysis of Financial Condition and
Results of Operations included elsewhere in this Form 10-K.

|                                                                                  |  |                            |            |      |  |      |            |      |  |      |            |   |  |   |            |   |  |   |            |  
|--------------------------------------------------------------------------------- |  | -------------------------- | ---------- | ---- |  | ---- | ---------- | ---- |  | ---- | ---------- | - |  | - | ---------- | - |  | - | ---------- | -
|                                                                                  |  | Fiscal Year Ended July 31,
|                                                                                  |  |                           
|Statement of Operations Data:                                                     |  | 2001                       |            | 2000 |  | 1999 |            | 1998 |  | 1997
|                                                                                  |  |                            |            |      |  |      |            |      |  |     
|Net Revenues                                                                      |  | $                          | 73,724,923 |      |  | $    | 77,580,908 |      |  | $    | 71,294,751 |   |  | $ | 62,107,110 |   |  | $ | 38,664,892 |  
|                                                                                 
|                                                                                 
|                                                                                 
|                                                                                 
|Net (Loss) Income                                                                 |  |                            | (6,313,823 | )    |  |      | 2,932,027  |      |  |      | (1,966,982 | ) |  |   | 2,301,068  |   |  |   | (6,458,377 | )
|                                                                                 
|                                                                                 
|                                                                                 
|                                                                                 
|Net (Loss) Income Attributable to Common Shareholders                             |  |                            | (6,313,823 | )    |  |      | 2,932,027  |      |  |      | (1,966,982 | ) |  |   | (5,013,532 | ) |  |   | (6,458,377 | )
|                                                                                 
|                                                                                 
|                                                                                 
|                                                                                 
|Basic and Diluted Net (Loss) Income Per Share Attributable
To Common Shareholders |  |                            | (0.15      | )    |  |      | 0.07       |      |  |      | (0.05      | ) |  |   | (0.15      | ) |  |   | (0.20      | )

|                                                |  |             |            |      |  |      |            |      |  |      |            |  |  |   |            |  |  |   |            | 
|----------------------------------------------- |  | ----------- | ---------- | ---- |  | ---- | ---------- | ---- |  | ---- | ---------- |  |  | - | ---------- |  |  | - | ---------- | 
|                                                |  | At July 31,
|                                                |  |            
|Balance Sheet Data:                             |  | 2001        |            | 2000 |  | 1999 |            | 1998 |  | 1997
|                                                |  |             |            |      |  |      |            |      |  |     
|Current Assets                                  |  | $           | 32,069,550 |      |  | $    | 31,380,071 |      |  | $    | 30,750,624 |  |  | $ | 27,992,138 |  |  | $ | 10,779,049 | 
|                                               
|                                               
|                                               
|                                               
|Total Assets                                    |  |             | 76,557,129 |      |  |      | 77,711,459 |      |  |      | 76,555,933 |  |  |   | 69,863,877 |  |  |   | 23,604,032 | 
|                                               
|                                               
|                                               
|                                               
|Current Liabilities                             |  |             | 15,683,253 |      |  |      | 11,050,668 |      |  |      | 8,704,760  |  |  |   | 8,777,242  |  |  |   | 5,804,965  | 
|                                               
|                                               
|                                               
|                                               
|Long-Term Debt                                  |  |             | 4,153,271  |      |  |      | 4,548,953  |      |  |      | 9,577,755  |  |  |   | 1,355,547  |  |  |   | 375,908    | 
|                                               
|                                               
|                                               
|                                               
|Total Liabilities                               |  |             | 19,836,524 |      |  |      | 15,599,621 |      |  |      | 18,282,515 |  |  |   | 10,132,789 |  |  |   | 6,180,873  | 
|                                               
|                                               
|                                               
|                                               
|Series A Convertible Redeemable Preferred Stock |  |             |            |      |  |      |            |      |  |      | 8,787,191  |  |  |   | 33,801,930 |  |  |   |            | 
|                                               
|                                               
|                                               
|                                               
|Series B Convertible Preferred Stock            |  |             | 462,500    |      |  |      |            |      |  |      |            |  |  |   |            |  |  |   |            | 
|                                               
|                                               
|                                               
|                                               
|Shareholders Equity                            |  |             | 56,720,605 |      |  |      | 62,111,838 |      |  |      | 49,486,227 |  |  |   | 25,929,158 |  |  |   | 17,423,159 | 




Item 7.MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Form 10-K contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The words believe, expect, anticipate, intend,
estimate and other expressions which are predictions of or indicate future
events and trends and which do not relate to historical matters, identify
forward-looking statements. These forward-looking statements are based largely
on the Companys expectations or forecasts of future events, can be affected by
inaccurate assumptions and are subject to various business risks and known and
unknown uncertainties, a number of which are beyond the Companys control.
Therefore, actual results could differ materially from the forward-looking
statements contained in this document, and readers are cautioned not to place
undue reliance on such forward-looking statements. The Company undertakes no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise. There can be no
assurance that the forward-looking statements contained in this document will,
in fact, transpire or prove to be accurate.

Company Overview

The following discussion and analysis should be read in conjunction with
Selected Financial Data and the audited Consolidated Financial Statements and
Notes thereto.

Zila is a worldwide manufacturer and marketer of pharmaceutical,
biomedical, dental and nutritional products. The Company has four major
product groups: Consumer Pharmaceuticals, Professional Products, Dental Supplies and Nutraceuticals. The Consumer Pharmaceuticals
Group consists of over-the-counter products, including the Zilactin® family of
over-the-counter products. The Professional Products Group includes Peridex®
prescription mouth rinse, the Pro-Series family of products including
Pro-Ties, the bundling system of instrument sterilization, OraTest®, an oral cancer detection system, and the plastic
molded products from IST. The Dental Supply Group includes Zila Dental Supply, a national distributor of
professional dental supplies. The Nutraceuticals Group is comprised of Oxycal
Laboratories, Inc. (Oxycal) and its Inter-Cal subsidiary (Inter-Cal), a
manufacturer and distributor of mineral and botanical products including a
patented and unique form of Vitamin C under the trademark Ester-C® and the
Palmettx botanical line of products.

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On October 28, 1999, Cygnus completed the sale of substantially all of its
assets and certain liabilities to Procare Laboratories, Inc. (Procare), of
Scottsdale, Arizona for approximately $4.0 million. Procare is controlled by
the former owner and President of Cygnus.

On December 20, 1999, IDT completed the sale of substantially all of its
assets and liabilities related to its PracticeWorks division located in Gold
River, California to InfoCure Corporation (InfoCure), of Atlanta, Georgia for
approximately $4.65 million. InfoCure is a national provider of healthcare
practice management software products and services to targeted healthcare
practice specialties.

On February 5, 2001, the Company announced it had acquired the patent
rights and the Antioch, Illinois manufacturing operations for swab products
from National Healthcare Manufacturing Corporation (NHMC), headquartered in
Winnipeg, Canada. Intellectual property, inventory, plus molding, labeling,
filling and sealing equipment were included in the acquisition. The business
unit is known as Innovative Swab Technologies (IST) and is a wholly owned
subsidiary of the Company. Zila paid approximately $2.3 million in a
combination of cash and preferred stock for the unit.

Operating Results

Fiscal year ended July 31, 2001.Net revenues declined 5.0% to $73.7
million for fiscal year 2001, compared to revenues of $77.6 million for the
2000 fiscal year.

Net revenues in 2001 for the Dental Supply Group increased 4.6% to $41.6
million compared to $39.8 million for the previous fiscal year. This increase
was primarily attributable to an increase in both full-service supplies and
equipment revenue due to the contribution of the branch offices opened in
fiscal 1999 and increases in Internet sales. The Consumer Pharmaceuticals Group
had net revenues of $11.8 million for fiscal year 2001, a slight increase from
the $11.7 million recorded during the corresponding period last year. Sales of
the three Zilactin® canker and cold sore medicines for fiscal
2001 were approximately equal to those in fiscal 2000. Sales of the Zilactin® Toothache
for fiscal 2001 increased 13.9% over the previous year while sales of the
Zilactin® Baby declined 25% over the previous fiscal year. International sales
for fiscal 2001 increased 3.9% when compared to fiscal year 2000.

The Professional Products Group had revenues
of $4.8 million in fiscal 2001, a 6.9% decrease from the $5.2 million recorded
in 2000. The decrease was due primarily to lower sales of Peridex®, which
declined 32.9% from $5.1 million in 2000 to $3.4 million in 2001 due to
increased pricing pressures and substitutions of generic equivalents. In
addition, the current year revenues include (i) a one-time licensing fee of
$499,000 generated from an agreement executed during the second fiscal quarter,
whereby the Company granted a customer the right to use its technology related
to chlorhexidine gluconate, the active ingredient in Peridex®, to produce a
generic form of the product for distribution, and (ii) revenues for IST of
$521,000 (excluding $425,000 of intercompany sales) for the partial year. In
order to stimulate sales of its Professional Products, in April 2001, the
Company signed a contract with the Lanmark Group for telemarketing and
fulfillment services for its new Pro-Series line of products that are being
marketed directly to dental professionals.

Net revenues for the Nutraceuticals Group for fiscal year 2001 were $15.4
million, a 19.4% decrease when compared to $19.1 million for fiscal year 2000.
The decrease was largely attributable to an overall slowdown in the domestic
and foreign vitamin and food supplement market during the first nine months of
the fiscal year and the effects of promotional discounting that occurred in
prior year periods. International sales for the Nutraceuticals Group for 2001
declined approximately 26.0% when compared to the previous fiscal year.

Cost of products sold was $41.4 million for the fiscal year ended July 31,
2001, a 3.6% increase from $40.0 million for the previous fiscal year. Cost of
products sold as a percentage of net revenues increased to 56.2% in fiscal year
2001 from 51.6% in the corresponding 2000 period. The increase for the period
reflects the growth of the Dental Supply Group as a percentage of total
revenues, 56.5% for fiscal 2001 compared to 51.3% for same period of the
previous fiscal year. The gross profit margin for the Dental Supply Group is
lower as compared to the other operating groups resulting in a higher cost of
products sold as a percentage of revenues.

Cost of products sold as a percentage of net revenues for the Dental
Supply Group increased slightly to 75.1% in fiscal year 2001 from 74.3% in
fiscal year 2000 primarily due to a change in product mix. In addition, the
Dental Supply Group had no increase in prices to customers until the fourth
quarter of the year even though the cost of products increased from the
manufacturers. Cost of products sold as a percentage of net revenues for
Consumer Pharmaceuticals increased to 24.5% in fiscal year 2001, compared to
22.5% for the corresponding period in fiscal 2000. The increase for the period
is a result of a change in the mix of products sold as the toothache product
has a higher cost than the other Zilactin® products.

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Cost of products sold as a percentage of net revenue for the Professional
Products Group increased to 32.6% from 26.1% in the prior fiscal year due
primarily to the addition of IST to the group during the year. IST had a cost
of products sold of 70.6% of net revenue for the current fiscal year. Cost of
products sold as a percentage of net revenues for the Nutraceuticals Group
increased to 35.6% for the current fiscal year from 27.2% The increase was
caused by costs associated with the manufacturing of the new Palmettx
botanical line of products as well as the duplicate overhead, moving and
equipment validation costs related to the relocation of the manufacturing
equipment to the new facility during the current fiscal year.

The Company incurred selling, general and administrative expenses of $31.9
million in fiscal year 2001, a 1.8% decrease when compared to $32.4 million in
fiscal year 2000. The decrease is primarily attributable to the elimination of
the costs related to the Cygnus and PracticeWorks businesses partially offset
by increased costs related to the expansion of the sales force and service
department at Zila Dental Supplys full service branches, increased marketing
and advertising expenses at Inter-Cal and the inclusion of the costs at IST.
Selling, general and administrative expenses as a percentage of net sales in
fiscal 2001 increased to 43.2% from 41.8% in fiscal 2000 as a result of lower
net revenues.

Research and development expenses increased $1.4 million, or 86.5%, from
$1.6 million incurred in fiscal year 2000 to $3.0 million for fiscal year 2001.
The increase was primarily due to an increase in expenses related to research
and clinical activities associated with the OraTest® clinical study, partially
offset by a reduction of expenses related to seeking international approval of
OraTest® and a reduction of costs resulting from the sale of the Cygnus and
PracticeWorks
businesses.

Depreciation and amortization expenses increased $47,000 when compared to
fiscal year 2000. The increase was mainly related to the increase in
depreciation of assets associated with Inter-Cals new manufacturing facility
that were placed in service during fiscal 2001.

The Company recorded interest expense of $597,000 for the year ended July
31, 2001 compared to $213,000 in the prior fiscal year, an increase of
$384,000. The increase was attributable to an increase in bank borrowings
during fiscal year 2001 as compared to the previous year period.

In the year ended July 31, 2001, the Company recorded income tax benefit
of $335,000 compared to an income tax expense of $1.8 million in fiscal 2000.
The Company offset most of its deferred tax asset generated in the current year
with a valuation allowance.

For the fiscal year ended July 31, 2001, the Company had a net loss of
$6.3 million compared to a net income of $2.9 million for 2000. The loss is
due primarily to decreased profitability in the Companys businesses during the
year and increased spending on OraTest®.

Fiscal year ended July 31, 2000.Total net revenues grew 8.8% to $77.6
million for the 2000 fiscal year, compared to revenues of $71.3 million for the
prior fiscal year.

Net revenues in 2000 for the Dental Supply Group increased 26.3% to $39.8
million compared to $31.5 million for the previous fiscal year. This increase
was primarily attributable to an increase in full-service operations due to the
contribution of the two additional branch offices opened in fiscal 1999 and
increases in Internet sales. Consumer Pharmaceuticals had net revenues of $11.7
million for the 2000 fiscal year, a 28.4% increase from the $9.1 million
recorded during the corresponding period last year. Over-the-counter sales of
the Zilactin® family of products increased primarily due to higher sales of the
Zilactin® Toothache Swab and Zilactin-L product lines. Net revenues for the
Professional Products Group were $5.2 million in
2000, a decrease of 44.3% from the $9.3 million recorded in fiscal year 1999.
The decrease was due primarily to a decline in sales of Peridex® due to
increased pricing pressures from generic equivalents. In order to increase
sales of Peridex, the Company signed a distribution agreement with Omnii
Products, a national marketer and detailer of dental products that targets
dispensing dentist professionals in the United States.

Net revenues for the Nutraceuticals Group for fiscal year 2000 were $19.1
million, a 27.5% increase when compared to $15.0 million for fiscal year 1999.
International sales for the group increased 104% to $6.1 million during the
current fiscal year as compared to the previous year due to improved economic
conditions in foreign markets, primarily in the Pacific Rim region. In
addition, Inter-Cal had increased demand for all of its major domestic product
lines in fiscal 2000 when compared to the fiscal 1999 year.

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Cost of products sold were $40.0 million for the fiscal year ended July
31, 2000, a 16.5% increase from $34.3 million for the previous fiscal year.
Cost of products sold as a percentage of net revenues increased to 51.6% in
fiscal year 2000 from 48.2% in the corresponding 1999 period. The increase for
the period reflects the growth of the Dental Supply Group as a percentage of
total revenues, 51.3% for fiscal 2000 compared to 44.2% for same period of the
previous fiscal year. The gross profit margin for the Dental Supply Group is
lower as compared to the other operating groups resulting in a higher cost of
products sold as a percentage of revenues.

Cost of products sold as a percentage of net revenues for the Dental
Supply Group decreased slightly to 74.3% in fiscal year 2000 from 74.6% in
fiscal year 1999 primarily due to an increase in vendor rebate programs in the
first quarter of fiscal 2000. Cost of products sold as a percentage of net
revenues for the Consumer Pharmaceuticals Group increased to 22.5% in fiscal
year 2000, compared to 19.3% for the corresponding period in fiscal 1999. The
increase for the period is a result of a change in the mix of products sold
during 2000. Cost of products sold as a percentage of net revenue for the
Professional Products Group increased to 26.1% from 16.7% in the prior fiscal
year due primarily to a promotional program for Peridex® that offered the
product at reduced pricing during the second half of the year. Cost of
products sold as a percentage of net revenues for the Nutraceuticals Group
decreased slightly to 27.2% for the current fiscal year from 27.9% due
primarily to favorable raw material contracts in effect for fiscal year 2000 as
compared to fiscal year 1999.

The Company incurred selling, general and administrative expenses of $32.4
million, or 41.8% of net revenues during the fiscal year ended July 31, 2000
compared to $31.9 million, or 44.7% of net revenue in fiscal year 1999. The
decrease in
selling, general and administrative expenses as a percentage of revenue is
attributable to a reduction in costs related to the Cygnus and PracticeWorks
businesses partially offset by increased costs related to the expansion of the
sales force and service department at Zila Dental Supplys full service
branches, increased selling and administrative costs related to the OraTest®
international product launches, increased marketing and selling expenses at
Inter-Cal and increased corporate legal, professional and insurance expenses.

Research and development expenses decreased $2.4 million, or 59.2%, from
$4.0 million incurred in fiscal year 1999 to $1.6 million for the same period
in fiscal year 2000. The decrease was primarily due to reduced expenses
related to research and clinical activities associated with the OraTest®
product, and reduced expenses related to seeking international approval of
OraTest® and a reduction of costs incurred in the Cygnus and PracticeWorks
businesses which were sold in fiscal year 2000.

Depreciation and amortization expenses decreased $104,000 from $3.6
million in fiscal year 1999 to $3.5 million in fiscal year 2000. The decrease
was mainly related to the sale of the Cygnus and PracticeWorks businesses.

The Company recorded interest expense of $212,000 for the year ended July
31, 2000 compared to $393,000 in the prior fiscal year, a decrease of $181,000.
The decrease was attributable to decreases in debt obligations incurred during
fiscal year 2000 as compared to the previous year period.

In the year ended July 31, 2000, the Company recorded income tax expense
of $1.8 million which is net of $2.9 million in income tax benefit resulting
from the reversal of a valuation allowance ($1 million of which was
attributable to the exercise of common stock options and therefore credited to
capital in excess of par value) as compared to an income tax benefit of
$846,000 ($250,000 of which was attributable to the exercise of common stock
options and therefore credited to capital in excess of par value) for the
fiscal year ended July 31, 1999. The reversal of the valuation allowance was
based on the Companys estimate that it is more likely than not that certain
net operating losses of prior years will be realized. Excluding the effects of
the reversal of the valuation allowance, the Companys effective tax rate for
the current fiscal year is higher than the statutory rate due primarily to the
amortization of intangible assets that is not deductible for tax purposes and
the non-deductibility of the Companys foreign operating losses. Additionally,
approximately $1.7 million of goodwill related to the sale of Cygnus was not
deductible for tax purposes.

For the fiscal year ended July 31, 2000, the Company had net income of
$2.9 million compared to a net loss of $2.0 for 1999. The increase in
profitability is due primarily to the increased profitability in the
Nutraceuticals Group, the sale of the PracticeWorks business and the
elimination of losses associated with the Cygnus business.

Inflation and Seasonality

Inflation has had no material effect on the operations or financial
condition of the Company. The Companys consolidated operations are not
considered seasonal in nature.

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##### Table of Contents



Liquidity and Capital Resources

At July 31, 2001, the Company had cash and cash equivalents of $1.6
million compared to $5.6 million at July 31, 2000. Excess cash and cash
equivalents are invested primarily in money market accounts. The Companys
working capital was $16.4 million at July 31, 2001 as compared to $20.3 million
at July 31, 2000. Working capital decreased primarily due to an increase in
bank borrowings during the year. The Companys current ratio was 2.0 at July
31, 2001, compared to 2.8 at July 31, 2000.

During the year ended July 31, 2001, cash used in operating activities
totaled $8.7 million primarily related to the net loss of $6.3 million plus
changes in operating assets and liabilities totaling $5.9 million offset by
non-cash depreciation and amortization of $3.5 million. Significant changes in
operating assets and liabilities were comprised of (i) an increase in
inventories of $4.3 million related primarily to the new Palmettx botanical
line of products at Inter-Cal and purchases of Pro-Series products and (ii) a
decrease in accounts payable and accrued expenses of $1.6 million primarily due
to vendor payments made during the year for inventory purchases.

The Company used cash in investing activities of $4.3 million during the
year ended July 31, 2001, primarily due to (i) the purchase of property and
equipment of $2.6 million, consisting of manufacturing additions for the new
Inter-Cal facility,
(ii) the purchase of assets related to IST of $1.8 million, (iii) the
purchase of intangible assets of $833,000 related to the Pro-Ties product and patent filings for Oxycal products. Additionally, financing activities
during the 2001 fiscal year provided approximately $9.0 million. The Company
(i) borrowed $6.1 million against its line of credit with Bank One, (ii)
received $476,000 from the exercise of warrants and options, and (iii) received
$2.9 million from the trustee for reimbursement for equipment and constructions
costs related to the new Inter-Cal facility. The Company used $125,370 to
repurchase 60,000 shares of Zila common stock on the open market and made debt
payments of $361,000.

At July 31, 2001, the Company had federal income tax net operating loss
carryforwards of approximately $14.4 million, which expire in years 2007
through 2022.

In December 2000, the Company renewed its $9.0 million line of credit with
Bank One for an additional 12 months under similar terms and conditions,
including a variable interest rate equal to the prime rate (the Index), which
was 6.75% at July 31, 2001. Under the line of credit loan agreement, the
Company was required to comply with financial covenants based on certain
financial ratios. As of April 30, 2001, the Company was in default under the
debt service coverage ratio. On May 7, 2001, the Company and Bank One entered
into the First Loan Modification Agreement whereby the line of credit was
reduced to $7.25 million, the interest rate was raised to 3.0% over the Index,
the Company agreed to cross-defaulting and cross-collateralizing of all Bank
One loans and obligations and Bank One agreed to forebear in exercising any
remedy with respect to the default through May 31, 2001. On June 14, 2001, the
forbearance period contained in the First Loan Modification Agreement, and the
Agreement were amended and the forbearance period was extended to June 29,
2001.

On July 3, 2001 and effective June 29, 2001, the Company and Bank One
entered into a Second Extension to the First Loan Modification Agreement.
Under this Agreement, the line of credit was reduced to $6.9 million and Bank
One agreed to forebear in exercising any remedy with respect to certain
covenant defaults under the line of credit through July 31, 2001 and agreed to
extend the maturity date of the building loan for the Companys 7th Street
location until July 31, 2001.

The Company entered into a Third Extension to First Loan Modification
Agreement effective July 31, 2001. Under this agreement, Bank One agreed to
forebear in exercising any remedy with respect to certain covenant defaults
under the line of credit through August 31, 2001 and agreed to extend the
maturity date of the building loan for the Companys 7th Street location until
August 31, 2001.

On August 27, 2001, the Company and Congress Financial Corporation
(Congress) entered into a Loan and Security Agreement (the Agreement)
whereby Congress will provide a $12 million revolving line of credit to the
Company at an interest rate equal to the prime rate plus 3/4 percent. The
amount of funds available to the Company from the line of credit is based upon
a percentage of the value of eligible receivables and inventory (excluding the
inventory of Zila Dental) and was $7.7 million at August 27, 2001. The
obligations under the Agreement are collateralized by various assets,
including, but not limited to, trade accounts receivable, inventories,
equipment and intangible assets of the Company and of certain of its operating
subsidiaries. Zila, Inc. and all of its direct and indirect operating
subsidiaries guarantee the obligations under the Agreement. The Agreement
expires August 17, 2004; however the line of credit is classified as current
because of certain provisions required by Congress. Under the Agreement, the
Company is required to comply with a financial covenant based on an adjusted
tangible net worth calculation. A portion of the available funds from the
new line of credit were used to pay off in full the line of credit and building
loan due to Bank One, totaling approximately $6.4 million.

26



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##### Table of Contents



During October 2000, Inter-Cal moved into its new manufacturing and
laboratory facility in Prescott, Arizona. The facility was financed through a
transaction with The Industrial Development Authority of the County of Yavapai
(the Authority) in which the Authority issued $5.0 million in Industrial
Development Revenue Bonds (the Bonds), the proceeds of which were loaned to
Inter-Cal for the construction of the facility. The Bond proceeds were held by
the trustee, Bank One, Arizona, until such time as invoices for building
construction costs and new equipment were submitted for payment. As of July 31,
2001, the trustee had released all the Bond proceeds. As of July 31, 2001, the
Bonds outstanding consisted of $3.9 million Series A and $675,000 Taxable
Series B which carried interest rates of 3.0% and 3.9%, respectively. The
Bonds were marketed and sold by Banc One Capital Markets and carry a maturity
of 20 years. In connection with the issuance of the Bonds, the Authority
required that Oxycal obtain, for the benefit of the Bondholders, an irrevocable
direct-pay letter of credit to secure payment of principal and interest. The
letter of credit was issued by Bank One and is guaranteed by Zila.

On December 20, 1999, IDT completed the sale of substantially all of its
assets and liabilities related to its PracticeWorks division located in Gold
River, California to InfoCure of Atlanta, Georgia for approximately $4.65
million. InfoCure is a national provider of healthcare practice management software
products and services to targeted healthcare practice specialties.

In November 1999, the Company contracted with ILEX Oncology Services,
Inc. (ILEX), a wholly owned subsidiary of ILEX Oncology, Inc. of San
Antonio, Texas, for management of clinical research and liaison with the U.S.
Food and Drug Administration (FDA) related to the Companys pursuit of
regulatory approval for the OraTest® oral cancer detection product. In March
2000, the Company paid approximately $792,000 to ILEX as a deposit on estimated
expenses related to an FDA-required clinical study associated with the
Companys ongoing efforts to obtain FDA approval of OraTest®. Current
commitments under the ILEX agreement include a monthly installment payment of
$76,000 plus reimbursement for out of pocket expenses as they occur during the
course of the study. Zila may terminate the contract or any work plan at any
time upon not less than 90 days prior written notice of termination to ILEX.
If the agreement is so terminated, Zila shall pay ILEX any amount owed, but not
yet paid, for work performed prior to the date of termination.

On November 10, 1999, the Company announced that the Companys Board of
Directors authorized the repurchase of up to one million shares of Zila common
stock. Purchases will be made on the open market depending on market
conditions and other factors. As of July 31, 2001, 195,000 shares had been
repurchased for $535,120.

On February 5, 2001, the Company issued 100,000 shares of Series B
Convertible Preferred Stock as part of the IST acquisition. The holders of the
preferred stock are entitled to receive cumulative quarterly dividends at a
rate of $0.0975 per share per fiscal quarter, payable in arrears.

The Company believes that cash generated from its operations, its
investing activities and the availability of cash under its line of credit are
sufficient to finance its level of operations, anticipated capital expenditures
and stock repurchase program through the next 12 months. The Company may
require additional financing to support the production and future OraTest®
clinical, regulatory, manufacturing and marketing costs or to make any
significant acquisitions. There can be no assurances that such funds will be
available on terms acceptable to the Company.

New Accounting Pronouncements

The Securities and Exchange Commission released Staff Accounting Bulletin
(SAB) No. 101 Revenue Recognition in Financial Statements on December 3,
1999, SAB No. 101A on March 24, 2000 and SAB No. 101B on June 26, 2000. SAB
No. 101 sets forth revenue recognition issues, including conceptual issues as
well as certain industry specific guidance. The Company adopted SAB 101 during
the fourth quarter of fiscal 2001, and its adoption did not have a material
impact on the operating results or the financial condition of the Company.

Statement of Financial Accounting Standards No. 133, Accounting for
Derivative Instruments and Hedging Activities, (SFAS 133), establishes
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts, and for hedging
activities. SFAS No. 133 requires that an enterprise recognize all derivatives
as either assets or liabilities in the balance sheet and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as a hedge. The accounting for changes in the fair
value of a derivative instrument depends on the intended use of the derivative
and resulting designation. The Company adopted SFAS No. 133 effective August
1, 2000 and the adoption did not have a material impact on the Companys
results of operations as the Company has no derivative financial instruments or
hedging activities.

27



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##### Table of Contents



In May 2000, the Financial Accounting Standards Boards EITF issued Issue
No. 00-14, Accounting for Certain Sales Incentives. The Issue addresses the
recognition, measurement, and income statement classification for certain sales
incentives including coupons, rebates and free products. The consensus on EITF
00-14 will be effective for the Company in the third quarter of 2002. The
implementation of this consensus will require the Company to change the way it
classifies certain sales incentives, which are currently recorded as selling,
general and administrative expenses. The cost of coupons and rebates will be
recorded as a reduction of net sales. The cost of free products will be
recorded as a reduction of products sold. The Company is in the process of
analyzing the impact that this statement will have on the financial statements.

In April 2001, the EITF issued Issue No. 00-25, Vendor Income Statement
Characterization of Consideration from a Vendor to a Retailer. The issue
discusses accounting and income statement classification of costs, other than
those directly addressed in Issue 00-14, that are incurred by a vendor
(typically a manufacturer or distributor) to or on behalf of a customer
(typically a retailer) in connection with the customers purchase or promotion
of the vendors products. Such costs include
consideration given to retailers for space in their stores (slotting
fees), consideration given to obtain favorable display positions in the
retailers stores and other promotional activity (cooperative advertising).
The issue addresses the recognition and measurement of such costs and whether a
vendor should classify such costs in its income statement when incurred as a
reduction of revenues or as an expense item. The consensus on EITF 00-25 will
be effective for the Company in the third quarter of 2002. The Company is in
the process of analyzing the impact that this statement will have on the
financial statements.

In June 2001, the Financial Accounting Standards Board issued SFAS No.
141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible
Assets. The statements will change the accounting for business combinations
and goodwill in two significant ways. SFAS No. 141 requires that the purchase
method of accounting be used for all business combinations initiated after June
30, 2001. Use of the pooling-of-interests method will be prohibited. SFAS No.
142 changes the accounting for goodwill from an amortization method to an
impairment-only approach. Thus, amortization of goodwill, including goodwill
recorded in past business combinations, will cease upon adoption of that
statement. The Company will adopt SFAS 142 effective August 1, 2002, as
required. The Company expects that the adoption of SFAS No. 142 will reduce
annual amortization expense by approximately $1.2 million annually pre-tax.
The Company is in the process of analyzing the impact that the impairment
analyses will have on the Companys recorded intangibles.

In August 2001, the Financial Accounting Standards Board issued SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets. This
Statement supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and
reporting provisions of APB Opinion No. 30, Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for
the disposal of a
segment of a business (as previously defined in that
Opinion). The Company will adopt SFAS 144 effective August 1, 2002, as
required. The Company has not completed its evaluation of the impact of
implementing SFAS No. 144.

Item 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to market risk primarily from interest rates and,
to a lesser extent, from changes in foreign currency exchange rates. The
Company is exposed to interest rate fluctuations on its revolving line of
credit and the Industrial Development Revenue Bonds. The Company has
operations in the United Kingdom and, therefore, has risk to changes in foreign
currencies.




Item 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Consolidated financial statements, together with the related notes and the
report of Deloitte & Touche LLP, independent certified public accountants, are
set forth hereafter. Other required financial information and schedules are set
forth herein, as more fully described in Item 14 hereof.

28



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##### Table of Contents






Item 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.




PART III

The information called for by this Part III is, in accordance with General
Instruction G (3) to Form 10-K, incorporated herein by reference to the
information contained in the Companys definitive proxy statement for the
annual meeting of stockholders of Zila to be held December 20, 2001, which will
be filed with the SEC not later than 120 days after July 31, 2001.




PART IV




Item 14.EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES, AND REPORTS ON FORM 8-K

|    |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |  |                 
|--- | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------
|    |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |  | Method of Filing
|    |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |  |                 
|(a) |     | Financial Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |  |                 
|   
|   
|   
|   
|    | (1) | Report of Deloitte & Touche LLP                                                                                                                                                                                                                                                                                                                                                                                                                                                          |  | Filed herewith  
|   
|   
|   
|   
|    | (2) | Consolidated Financial Statements and Notes thereto of the
Company including Consolidated Balance Sheets as of July 31, 2001
and 2000 and related Consolidated Statements of Operations, and
Shareholders
Equity, and Cash Flows for each of the years in the three-year period
ended July 31, 2001                                                                                                                                                                                     |  | Filed herewith  
|   
|(b) |     | Reports on Form 8-K for the quarter ended July 31, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                 |  |                 
|   
|   
|   
|   
|    |     | During the quarter ended July 31, 2001, the Company filed Current Reports
on Form 8-K containing information pursuant to Item 5 (Other Events)
dated June 29, 2001, announcing a second extension to the First Loan
Modification Agreement related to its line of credit with Bank One,
Arizona to July 31, 2001 and dated July 31, 2001 announcing a third
extension to the First Loan Modification Agreement related to its line of
credit with Bank One, Arizona to August 31, 2001 |  |                 

29



---



##### Table of Contents



|(c) |  | Exhibits. |  | 
|--- |  | --------- |  | 

|        |  |                                                                                                                                                                                                           |  |                  |  
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | -
|Exhibit |  |                                                                                                                                                                                                           |  |                 
|Number  |  | Description                                                                                                                                                                                               |  | Method of Filing
|        |  |                                                                                                                                                                                                           |  |                 
|3-A     |  | Certificate of Incorporation, as amended                                                                                                                                                                  |  |                  | A
|       
|       
|       
|       
|3-B     |  | Bylaws                                                                                                                                                                                                    |  |                  | A
|       
|       
|       
|       
|3-C     |  | Certificate of Designations, Preferences and Rights of Series A
Convertible Preferred Stock                                                                                                               |  |                  | C
|       
|       
|       
|       
|3-D     |  | Certificate of Designations, Preferences and Rights of Series B
Convertible Preferred Stock                                                                                                               |  |                  | *
|       
|       
|       
|       
|4-A     |  | Specimen Stock Certificate                                                                                                                                                                                |  |                  | A
|       
|       
|       
|       
|10-A    |  | Revolving Line of Credit Loan Agreement dated February 1, 1999 between
Zila, Inc. and Bank One, Arizona                                                                                                   |  |                  | A
|       
|       
|       
|       
|10-B    |  | Stock Option Award Plan (as amended through April 10, 1991)                                                                                                                                               |  |                  | B
|       
|       
|       
|       
|10-C    |  | Non-Employee Directors Stock Option Plan (as amended through April 10, 1991)                                                                                                                              |  |                  | B
|       
|       
|       
|       
|10-L    |  | Asset Purchase Agreement dated October 28, 1999 between Zila, Inc., Cygnus
Imaging, Inc. and Procare Laboratories, Inc.                                                                                   |  |                  | A
|       
|       
|       
|       
|10-M    |  | Secured Note dated October 28, 1999 between Zila, Inc. and Procare Laboratories, Inc.                                                                                                                     |  |                  | A
|       
|       
|       
|       
|10-N    |  | Asset Purchase agreement dated as of November 30, 1999 by and among Zila, Inc.,
Integrated Dental Technologies, Inc., InfoCure Systems, Inc., and InfoCure Corporation                                    |  |                  | E
|       
|       
|       
|       
|10-O    |  | Revolving Line of Credit Loan Agreement dated December 1, 2000 between Zila, Inc.
and Bank One, Arizona, NA.                                                                                              |  |                  | H
|       
|       
|       
|       
|10-P    |  | First Loan Modification Agreement dated May 7, 2001 between Zila, Inc.
and Bank One Arizona, NA.                                                                                                          |  |                  | H
|       
|       
|       
|       
|10-Q    |  | Engagement Letter dated March 15, 2001 between Zila, Inc. and
Douglas, Curtis and Allyn, LLC                                                                                                              |  |                  | H
|       
|       
|       
|       
|10-R    |  | Extension to First Loan Modification Agreement dated effective May 31, 2001
between Zila, Inc. and Bank One Arizona, NA.                                                                                  |  |                  | H
|       
|       
|       
|       
|10-S    |  | Second Extension to First Loan Modification Agreement dated effective June 29, 2001
between Zila, Inc. and Bank One Arizona, NA.                                                                          |  |                  | I
|       
|       
|       
|       
|10-T    |  | Third Extension to First Loan Modification Agreement dated effective July 31, 2001
between Zila, Inc. and Bank One Arizona, NA.                                                                           |  |                  | J
|       
|       
|       
|       
|10-U    |  | 1997 Stock Option Award Plan (as amended through September 13, 2001)                                                                                                                                      |  |                  | G
|       
|       
|       
|       
|10-V    |  | Employee Stock Purchase Plan                                                                                                                                                                              |  |                  | F
|       
|       
|       
|       
|10-W    |  | Loan and Security Agreement dated August 17, 2001 by and between Congress Financial
Corporation and Zila, Inc., Zila Pharmaceuticals, Inc. Ryker Dental of Kentucky, Inc. and
Inter-Cal Corporation, Inc. |  |                  | K
|       
|       
|       
|       
|21      |  | Subsidiaries of Registrant                                                                                                                                                                                |  |                  | D
|       
|       
|       
|       
|23      |  | Consent of Deloitte & Touche LLP (regarding Form S-8 Registration Statements)                                                                                                                             |  |                  | *
|       
|       
|       
|       
|24-A    |  | Power of Attorney of Joseph Hines                                                                                                                                                                         |  |                  | L
|       
|       
|       
|       
|24-B    |  | Power of Attorney of Bradley C. Anderson                                                                                                                                                                  |  |                  | L
|       
|       
|       
|       
|24-C    |  | Power of Attorney of Carl A. Schroeder                                                                                                                                                                    |  |                  | L
|       
|       
|       
|       
|24-D    |  | Power of Attorney of Michael S. Lesser                                                                                                                                                                    |  |                  | L
|       
|       
|       
|       
|24-E    |  | Power of Attorney of Curtis M. Rocca                                                                                                                                                                      |  |                  | L
|       
|       
|       
|       
|24-F    |  | Power of Attorney of Christopher D. Johnson                                                                                                                                                               |  |                  | L
|       
|       
|       
|       
|24-G    |  | Power of Attorney of Kevin J. Tourek                                                                                                                                                                      |  |                  | L



---

|* |  | Filed 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 Quarterly Report on Form 10-Q for the
quarterly period ended January 31, 1996, as amended
| 
|C |  | Incorporated by reference to the Companys Annual Report on Form 10-K for fiscal
year ended July 31, 1997                           
| 
|D |  | Incorporated by reference to the Companys Annual Report on Form 10-K for fiscal
year ended July 31, 1998                           
| 
|E |  | Incorporated by reference to the Companys Current Report on Form 8-K dated January 3, 2000                                         
| 
|F |  | Incorporated by reference to the Companys Form S-8 Registration Statement No. 333-54958
dated February 5, 2001                     
| 
|G |  | Incorporated by reference to the Companys Form S-8 Registration Statement No. 333-54960
dated February 5, 2001                     
| 
|H |  | Incorporated by reference to the Companys Quarterly Report on Form 10-Q for the
quarterly period ended April 30, 2001              
| 
|I |  | Incorporated by reference to the Companys Current Report on Form 8-K dated June 29, 2001                                           
| 
|J |  | Incorporated by reference to the Companys Current Report on Form 8-K dated July 31, 2001                                           
| 
|K |  | Incorporated by reference to the Companys Current Report on Form 8-K dated August 17, 2001                                         
| 
|L |  | Incorporated by reference to
the Companys Annual Report on Form 10-K for fiscal year ended July 31, 2001 located on signature page.

30



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report on Form 10-K
to be signed on its behalf by the undersigned, thereunto duly authorized, this
23rd day of October 2001.



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



| | By | /s/ BRADLEY C. ANDERSON                                                                                    
| | -- | -----------------------------------------------------------------------------------------------------------
| |    |                                                                                                            
| |    | Bradley C. Anderson
Vice President
and Chief Financial Officer (Principal
Financial and Accounting Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report on Form 10-K has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated:

|                                                                   |  |                                                           |  |                 
|------------------------------------------------------------------ |  | --------------------------------------------------------- |  | ----------------
|Signature                                                          |  | Title                                                     |  | Date            
|                                                                   |  |                                                           |  |                 
|                                                                  
|/s/     JOSEPH HINESJoseph Hines                                   |  | Chairman of the
Board, President,
Chief Executive
Officer |  | October 23, 2001
|                                                                  
|/s/     BRADLEY C. ANDERSONBradley C. Anderson                     |  | Vice President and
Chief Financial
Officer                |  | October 23, 2001
|                                                                  
|*                                                                  |  | Director                                                  |  | October 23, 2001
|Carl A. Schroeder                                                 
|                                                                  
|*                                                                  |  | Director                                                  |  | October 23, 2001
|Michael S. Lesser                                                 
|                                                                  
|*                                                                  |  | Director                                                  |  | October 23, 2001
|Curtis M. Rocca III                                               
|                                                                  
|*                                                                  |  | Director                                                  |  | October 23, 2001
|Christopher D. Johnson                                            
|                                                                  
|*                                                                  |  | Director                                                  |  | October 23, 2001
|Kevin J. Tourek                                                   
|                                                                  
|*By /s/ BRADLEY C. ANDERSONBradley C. Anderson
   Attorney-in-Fact |  |                                                           |  | October 23, 2001

31



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##### Table of Contents






INDEPENDENT AUDITORS REPORT

Board of Directors and Shareholders
Zila, Inc.
Phoenix, Arizona

We have audited the consolidated balance sheets of Zila, Inc. and subsidiaries
(the Company) as of July 31, 2001 and 2000, and the related consolidated
statements of operations, shareholders equity, and cash flows for each of the
three years in the period ended July 31, 2001. These financial statements are
the responsibility of the Companys management. Our responsibility is to
express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Zila, Inc. and subsidiaries at
July 31, 2001 and 2000, and the results of their operations and their cash
flows for each of the three years in the period ended July 31, 2001 in
conformity with accounting principles generally accepted in the United States
of America.

DELOITTE & TOUCHE LLP
Phoenix, Arizona
October 15, 2001

F-1



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##### Table of Contents






ZILA, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
JULY 31, 2001 AND 2000

|                                             |                                                                                                                                                             |                            |                           |                   |            |            |            |             |            |            |            | 
|-------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ------------------------- | ----------------- | ---------- | ---------- | ---------- | ----------- | ---------- | ---------- | ---------- | 
|                                             |                                                                                                                                                             |                            |                           |                   |            | 2001       |            | 2000       
|                                             |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|ASSETS                                       |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|                                            
|                                            
|                                            
|                                            
|CURRENT ASSETS:                              |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|                                            
|                                            
|                                            
|                                            
|                                             | Cash and cash equivalents                                                                                                                                   |                            | $                         | 1,651,266         |            |            | $          | 5,558,487   |           
|                                            
|                                            
|                                            
|                                            
|                                             | Trade receivables, less allowance for doubtful accounts
of $312,061 (2001) and $345,857 (2000)                                                              |                            |                           | 10,412,372        |            |            |            | 9,893,587   |           
|                                            
|                                            
|                                            
|                                            
|                                             | Inventories  net                                                                                                                                           |                            |                           | 17,751,148        |            |            |            | 13,204,137  |           
|                                            
|                                            
|                                            
|                                            
|                                             | Prepaid expenses and other current assets                                                                                                                   |                            |                           | 2,254,764         |            |            |            | 2,723,860   |           
|                                             |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|                                             |                                                                                                                                                             |                            | Total current assets      |                   |            | 32,069,550 |            |             |            | 31,380,071 |           
|                                             |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|PROPERTY AND EQUIPMENT  net                 |                                                                                                                                                             |                            | 9,843,103                 |                   |            |            | 9,442,278  |            
|                                            
|                                            
|                                            
|                                            
|PURCHASED TECHNOLOGY RIGHTS  net            |                                                                                                                                                             |                            | 5,164,535                 |                   |            |            | 5,600,975  |            
|                                            
|                                            
|                                            
|                                            
|GOODWILL  net                               |                                                                                                                                                             |                            | 12,894,874                |                   |            |            | 12,725,978 |            
|                                            
|                                            
|                                            
|                                            
|TRADEMARKS AND OTHER INTANGIBLE ASSETS  net |                                                                                                                                                             |                            | 12,721,567                |                   |            |            | 12,423,632 |            
|                                            
|                                            
|                                            
|                                            
|CASH HELD BY TRUSTEE                         |                                                                                                                                                             |                            |                           |                   |            |            | 2,928,001  |            
|                                            
|                                            
|                                            
|                                            
|OTHER ASSETS                                 |                                                                                                                                                             |                            | 3,863,500                 |                   |            |            | 3,210,524  |            
|                                             |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|TOTAL                                        |                                                                                                                                                             | $                          | 76,557,129                |                   |            | $          | 77,711,459 |            
|                                             |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|LIABILITIES AND SHAREHOLDERS EQUITY         |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|                                            
|                                            
|                                            
|                                            
|CURRENT LIABILITIES:                         |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|                                            
|                                            
|                                            
|                                            
|                                             | Accounts payable                                                                                                                                            |                            | $                         | 5,331,668         |            |            | $          | 6,599,702   |           
|                                            
|                                            
|                                            
|                                            
|                                             | Accrued liabilities                                                                                                                                         |                            |                           | 3,379,472         |            |            |            | 3,622,330   |           
|                                            
|                                            
|                                            
|                                            
|                                             | Short-term borrowings                                                                                                                                       |                            |                           | 6,160,947         |            |            |            | 51,770      |           
|                                            
|                                            
|                                            
|                                            
|                                             | Current portion of long-term debt                                                                                                                           |                            |                           | 811,166           |            |            |            | 776,866     |           
|                                             |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|                                             |                                                                                                                                                             |                            | Total current liabilities |                   |            | 15,683,253 |            |             |            | 11,050,668 |           
|                                            
|LONG-TERM DEBT  net of current portion      |                                                                                                                                                             |                            | 4,153,271                 |                   |            |            | 4,548,953  |            
|                                             |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|                                             |                                                                                                                                                             |                            |                           | Total liabilities |            |            | 19,836,524 |             |            |            | 15,599,621 | 
|                                             |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|COMMITMENTS AND CONTINGENCIES (Note 13)      |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|                                            
|                                            
|                                            
|                                            
|SHAREHOLDERS EQUITY:                        |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|                                            
|                                            
|                                            
|                                            
|                                             | Preferred stock, $.001 par value  authorized 2,500,000 shares,
issued 100,000 shares Series B Preferred Stock (July 31, 2001)
and 0 shares (July 31, 2000) |                            |                           | 462,500           |            |            |            |             |           
|                                            
|                                            
|                                            
|                                            
|                                             | Common stock, $.001 par value  authorized 65,000,000 shares, issued
43,653,727 shares (July 31, 2001) and 43,362,658 shares (July 31, 2000)                |                            |                           | 43,654            |            |            |            | 43,363      |           
|                                            
|                                            
|                                            
|                                            
|                                             | Capital in excess of par value                                                                                                                              |                            |                           | 79,930,094        |            |            |            | 79,424,235  |           
|                                            
|                                            
|                                            
|                                            
|                                             | Accumulated other comprehensive income                                                                                                                      |                            |                           | 150,976           |            |            |            | 71,666      |           
|                                            
|                                            
|                                            
|                                            
|                                             | Accumulated deficit                                                                                                                                         |                            |                           | (23,331,499       | )          |            |            | (17,017,676 | )         
|                                            
|                                            
|                                            
|                                            
|                                             | Less: 195,000 shares (July 31, 2001) and 135,000 shares (July 31, 2000)
of common stock in treasury, at cost                                                |                            |                           | (535,120          | )          |            |            | (409,750    | )         
|                                             |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|                                             |                                                                                                                                                             | Total shareholders equity |                           |                   | 56,720,605 |            |            |             | 62,111,838 |           
|                                             |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|TOTAL                                        |                                                                                                                                                             | $                          | 76,557,129                |                   |            | $          | 77,711,459 |            
|                                             |                                                                                                                                                             |                            |                           |                   |            |            |            |            

See notes to condensed consolidated financial statements.

F-2



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##### Table of Contents






ZILA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended July 31, 2001, 2000 and 1999

|                                  |                               |                                     |            |            |            |            |            |        |            |            |            |            |            |            |  
|--------------------------------- | ----------------------------- | ----------------------------------- | ---------- | ---------- | ---------- | ---------- | ---------- | ------ | ---------- | ---------- | ---------- | ---------- | ---------- | ---------- | -
|                                  |                               |                                     |            |            | 2001       |            | 2000       |        | 1999      
|                                  |                               |                                     |            |            |            |            |            |        |           
|NET REVENUES                      |                               | $                                   | 73,724,923 |            |            | $          | 77,580,908 |        |            | $          | 71,294,751 |           
|                                  |                               |                                     |            |            |            |            |            |        |            |            |            |           
|OPERATING COSTS AND EXPENSES:     |                               |                                     |            |            |            |            |            |        |            |            |            |           
|                                 
|                                 
|                                 
|                                 
|                                  |                               | Cost of products sold               |            |            | 41,425,083 |            |            |        | 40,004,391 |            |            |            | 34,335,344 |           
|                                 
|                                 
|                                 
|                                 
|                                  |                               | Selling, general and administrative |            |            | 31,864,041 |            |            |        | 32,449,161 |            |            |            | 31,853,421 |           
|                                 
|                                 
|                                 
|                                 
|                                  |                               | Research and development            |            |            | 3,036,896  |            |            |        | 1,628,580  |            |            |            | 3,988,028  |           
|                                 
|                                 
|                                 
|                                 
|                                  |                               | Depreciation and amortization       |            |            | 3,524,707  |            |            |        | 3,478,120  |            |            |            | 3,581,768  |           
|                                  |                               |                                     |            |            |            |            |            |        |            |            |            |           
|                                  |                               |                                     | 79,850,727 |            |            |            | 77,560,252 |        |            |            | 73,758,561 |           
|                                  |                               |                                     |            |            |            |            |            |        |            |            |            |           
|                                  | (LOSS) INCOME FROM OPERATIONS |                                     |            | (6,125,804 | )          |            |            | 20,656 |            |            |            | (2,463,810 | )         
|                                  |                               |                                     |            |            |            |            |            |        |            |            |            |           
|OTHER INCOME (EXPENSE):           |                               |                                     |            |            |            |            |            |        |            |            |            |           
|                                 
|                                 
|                                 
|                                 
|                                  |                               | Interest income                     |            |            | 274,073    |            |            |        | 388,773    |            |            |            | 288,918    |           
|                                 
|                                 
|                                 
|                                 
|                                  |                               | Interest expense                    |            |            | (596,870   | )          |            |        | (212,671   | )          |            |            | (392,805   | )         
|                                 
|                                 
|                                 
|                                 
|                                  |                               | Other (expense) income              |            |            | (200,222   | )          |            |        | (182,921   | )          |            |            | 4,715      |           
|                                 
|                                 
|                                 
|                                 
|                                  |                               | Gain on sale of assets              |            |            |            |            |            |        | 4,677,860  |            |            |            |            |           
|                                  |                               |                                     |            |            |            |            |            |        |            |            |            |           
|                                  |                               |                                     | (523,019   | )          |            |            | 4,671,041  |        |            |            | (99,172    | )         
|                                  |                               |                                     |            |            |            |            |            |        |            |            |            |           
|(LOSS) INCOME BEFORE INCOME TAXES |                               |                                     | (6,648,823 | )          |            |            | 4,691,697  |        |            |            | (2,562,982 | )         
|                                 
|                                 
|                                 
|                                 
|INCOME TAX BENEFIT (EXPENSE)      |                               |                                     | 335,000    |            |            |            | (1,759,670 | )      |            |            | 596,000    |           
|                                  |                               |                                     |            |            |            |            |            |        |            |            |            |           
|NET (LOSS) INCOME                 |                               | $                                   | (6,313,823 | )          |            | $          | 2,932,027  |        |            | $          | (1,966,982 | )         
|                                  |                               |                                     |            |            |            |            |            |        |            |            |            |           
|NET (LOSS) INCOME PER SHARE:      |                               |                                     |            |            |            |            |            |        |            |            |            |           
|                                 
|                                 
|                                 
|                                 
|                                  |                               |                                     | BASIC      |            | $          | (0.15      | )          |        | $          | 0.07       |            |            | $          | (0.05      | )
|                                  |                               |                                     |            |            |            |            |            |        |            |            |            |           
|                                  |                               |                                     | DILUTED    |            | $          | (0.15      | )          |        | $          | 0.07       |            |            | $          | (0.05      | )
|                                  |                               |                                     |            |            |            |            |            |        |            |            |            |           
|
|                                 
|                                 
|                                 
|                                 
|                                 
|                                  |                               |                                     | BASIC      |            |            | 43,412,786 |            |        |            | 42,180,236 |            |            |            | 38,013,058 |  
|                                 
|                                 
|                                 
|                                 
|                                  |                               |                                     | DILUTED    |            |            | 43,412,786 |            |        |            | 43,576,180 |            |            |            | 38,013,058 |  

See notes to consolidated financial statements.

F-3



---



##### Table of Contents






ZILA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
Years Ended July 31, 2001, 2000 and 1999

|                        |                                                      |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            |            |  
|----------------------- | ---------------------------------------------------- |  | --------------- | ------- | ------------ | - | ---------- | ----------- | ----- |  | -------------------- | --------- | ------- | - | ------ | ----- | ------------- | - | ----------- | ---------- | -------- | - | ------------- | ---------- | ------------- | - | -------- | -------- | - | - | ------- | ------ | - | - | ---------- | ---------- | -
|                        |                                                      |  |                 |         |              |   |            |             |       |  | Shareholders' Equity
|                        |                                                      |  |                 |         |              |   |            |             |       |  |                     
|                        |                                                      |  | Preferred Stock |         | Common Stock |   |            |             |       |  |                      |           |         |   |        |       |               |   | Accumulated |            | Total   
|                        |                                                      |  |                 |         |              |   | Capital in |             |       |  |                      |           |         |   |        |       | Other         |   | Common     
|                        |                                                      |  |                 |         |              |   |            |             |       |  |                      |           |         |   | Par    |       | Excess of     |   | Accumulated |            | Treasury |   | Comprehensive |            | Shareholders'
|                        |                                                      |  | Shares          |         | Amount       |   | Shares     |             | Value |  | Par Value            |           | Deficit |   | Stock  |       | Income (Loss) |   | Equity     
|                        |                                                      |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |            
|BALANCE, AUGUST 1, 1998 |                                                      |  | 28,800          |         |              | $ | 33,801,930 |             |       |  | 34,743,575           |           |         | $ | 34,744 |       |               | $ | 43,877,135  |            |          | $ | (17,982,721   | )          |               |   |         |          |   |   |        |        |   | $ | 25,929,158 |           
|                       
|                       
|                       
|                       
|                        | Conversion of preferred stock into
common stock      |  |                 | (21,318 | )            |   |            | (25,014,739 | )     |  |                      | 5,483,371 |         |   |        | 5,483 |               |   |             | 25,009,256 |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            | 25,014,739 |  
|                       
|                       
|                       
|                       
|                        | Exercise of common stock warrants                    |  |                 |         |              |   |            |             |       |  |                      | 35,975    |         |   |        | 36    |               |   |             | 107,889    |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            | 107,925    |  
|                       
|                       
|                       
|                       
|                        | Exercise of common stock options                     |  |                 |         |              |   |            |             |       |  |                      | 115,667   |         |   |        | 116   |               |   |             | 151,271    |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            | 151,387    |  
|                       
|                       
|                       
|                       
|                        | Income tax benefit  stock options                   |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             | 250,000    |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            | 250,000    |  
|                       
|                       
|                       
|                       
|                        | Net loss                                             |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               | (1,966,982 | )             |   |          |          |   |   |         |        |   |   |            | (1,966,982 | )
|                        |                                                      |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            |           
|BALANCE, JULY 31, 1999  |                                                      |  | 7,482           |         |              |   | 8,787,191  |             |       |  | 40,378,588           |           |         |   | 40,379 |       |               |   | 69,395,551  |            |          |   | (19,949,703   | )          |               |   |         |          |   |   |        |        |   |   | 49,486,227 |           
|                       
|                       
|                       
|                       
|                        | Conversion of preferred stock into
common stock      |  |                 | (7,482  | )            |   |            | (8,787,191  | )     |  |                      | 2,904,472 |         |   |        | 2,904 |               |   |             | 8,784,287  |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            | 8,787,191  |  
|                       
|                       
|                       
|                       
|                        | Warrants issued for services provided                |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             | 30,000     |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            | 30,000     |  
|                       
|                       
|                       
|                       
|                        | Purchase of common stock for treasury                |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               |            |               |   | $        | (409,750 | ) |   |         |        |   |   |            | (409,750   | )
|                       
|                       
|                       
|                       
|                        | Exercise of common stock warrants                    |  |                 |         |              |   |            |             |       |  |                      | 49,074    |         |   |        | 49    |               |   |             | 76,280     |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            | 76,329     |  
|                       
|                       
|                       
|                       
|                        | Exercise of common stock options                     |  |                 |         |              |   |            |             |       |  |                      | 30,524    |         |   |        | 31    |               |   |             | 148,117    |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            | 148,148    |  
|                       
|                       
|                       
|                       
|                        | Income tax benefit  stock options                   |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             | 990,000    |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            | 990,000    |  
|                       
|                       
|                       
|                       
|                        | Foreign currency translation                         |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               |            |               |   |          |          |   |   | $       | 75,166 |   |   |            | 75,166     |  
|                       
|                       
|                       
|                       
|                        | Net unrealized loss on available-for-sale securities |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               |            |               |   |          |          |   |   |         | (3,500 | ) |   |            | (3,500     | )
|                       
|                       
|                       
|                       
|                        | Net income                                           |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               | 2,932,027  |               |   |          |          |   |   |         |        |   |   |            | 2,932,027  |  
|                        |                                                      |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            |           
|BALANCE, JULY 31, 2000  |                                                      |  |                |         |              |   |           |             |       |  | 43,362,658           |           |         |   | 43,363 |       |               |   | 79,424,235  |            |          |   | (17,017,676   | )          |               |   | (409,750 | )        |   |   | 71,666  |        |   |   | 62,111,838 |           
|                       
|                       
|                       
|                       
|                        | Warrants issued for services provided                |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             | 30,000     |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            | 30,000     |  
|                       
|                       
|                       
|                       
|                        | Purchase of common stock for treasury                |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               |            |               |   |          | (125,370 | ) |   |         |        |   |   |            | (125,370   | )
|                       
|                       
|                       
|                       
|                        | Exercise of common stock warrants                    |  |                 |         |              |   |            |             |       |  |                      | 149,870   |         |   |        | 150   |               |   |             | 449,460    |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            | 449,610    |  
|                       
|                       
|                       
|                       
|                        | Exercise of common stock options                     |  |                 |         |              |   |            |             |       |  |                      | 128,622   |         |   |        | 129   |               |   |             | 2,871      |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            | 3,000      |  
|                       
|                       
|                       
|                       
|                        | Issuance of common stock                             |  |                 |         |              |   |            |             |       |  |                      | 12,577    |         |   |        | 12    |               |   |             | 23,528     |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            | 23,540     |  
|                       
|                       
|                       
|                       
|                        | Issuance of preferred stock                          |  |                 | 100,000 |              |   |            | 462,500     |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            | 462,500    |  
|                       
|                       
|                       
|                       
|                        | Foreign currency translation                         |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               |            |               |   |          |          |   |   |         | 75,810 |   |   |            | 75,810     |  
|                       
|                       
|                       
|                       
|                        | Net unrealized gain on available-for-sale securities |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               |            |               |   |          |          |   |   |         | 3,500  |   |   |            | 3,500      |  
|                       
|                       
|                       
|                       
|                        | Net loss                                             |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               | (6,313,823 | )             |   |          |          |   |   |         |        |   |   |            | (6,313,823 | )
|                        |                                                      |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            |           
|BALANCE, JULY 31, 2001  |                                                      |  | 100,000         |         |              | $ | 462,500    |             |       |  | 43,653,727           |           |         | $ | 43,654 |       |               | $ | 79,930,094  |            |          | $ | (23,331,499   | )          |               | $ | (535,120 | )        |   | $ | 150,976 |        |   | $ | 56,720,605 |           
|                        |                                                      |  |                 |         |              |   |            |             |       |  |                      |           |         |   |        |       |               |   |             |            |          |   |               |            |               |   |          |          |   |   |         |        |   |   |            |           

See notes to consolidated financial statements.

F-4



---



##### Table of Contents






ZILA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JULY 31, 2001, 2000 AND 1999

|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |            |           |            |          |  
|------------------------------------------------------------------------ | ------------------------------------------------------------------------------------ | --------------------------------- | --------------------------------------------------- | --------------------------------------------------- | --------- | ---------- | ---------- | ---------- | ---------- | ---------- | --------- | ---------- | --------- | ---------- | -------- | -
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           | 2001       |            | 2000       |            | 1999      
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |           
|OPERATING ACTIVITIES:                                                    |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Net (loss) income                                                                    |                                   | $                                                   | (6,313,823                                          | )         |            | $          | 2,932,027  |            |            | $         | (1,966,982 | )        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Adjustments to reconcile net (loss) income to net cash used in operating activities: |                                   |                                                     |                                                     |           |            |            |            |            |            |           |            |          
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                                      | Depreciation and amortization     |                                                     |                                                     | 3,524,707 |            |            |            | 3,478,120  |            |           |            | 3,581,768 |           
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                                      | Gain on sale of assets            |                                                     |                                                     | (17,116   | )          |            |            | (4,677,860 | )          |           |            |           |           
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                                      | Impairment of asset               |                                                     |                                                     | 310,000   |            |            |            |            |            |           |            |           |           
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                                      | Warrants issued for services      |                                                     |                                                     | 30,000    |            |            |            | 30,000     |            |           |            |           |           
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                                      | Deferred income taxes and other   |                                                     |                                                     | (264,005  | )          |            |            | 1,667,567  |            |           |            | (553,239  | )         
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                                      | Change in assets and liabilities: |                                                     |                                                     |           |            |            |            |            |            |           |            |           |           
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                                      |                                   | Receivables  net                                   |                                                     |           | (208,785   | )          |            |            | (1,983,531 | )         |            |           | (1,580,043 | )       
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                                      |                                   | Inventories                                         |                                                     |           | (4,339,867 | )          |            |            | (2,871,820 | )         |            |           | 144,126    |         
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                                      |                                   | Prepaid expenses and other assets                   |                                                     |           | 161,275    |            |            |            | (1,140,726 | )         |            |           | (103,935   | )       
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                                      |                                   | Accounts payable and accrued liabilities            |                                                     |           | (1,565,893 | )          |            |            | 3,618,248  |           |            |           | (727,357   | )       
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         |                                                                                      |                                   | Deferred revenue                                    |                                                     |           |           |            |            |            | 83,281     |           |            |           | 414,081    |         
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|                                                                         |                                                                                      |                                   |                                                     | Net cash (used in) provided by operating activities |           |            | (8,683,507 | )          |            |            | 1,135,306 |            |           |            | (791,581 | )
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|INVESTING ACTIVITIES:                                                    |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Purchases of property and equipment                                                  |                                   |                                                     | (2,597,690                                          | )         |            |            | (5,198,064 | )          |            |           | (1,762,927 | )        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Net proceeds from sale of assets                                                     |                                   |                                                     | 1,030,662                                           |           |            |            | 7,749,927  |            |            |           |            |          
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Net cash paid for acquisition                                                        |                                   |                                                     | (1,849,418                                          | )         |            |            |            |            |            |           |            |          
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Purchases of intangible assets                                                       |                                   |                                                     | (833,844                                            | )         |            |            | (159,210   | )          |            |           | (686,236   | )        
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|                                                                         |                                                                                      |                                   | Net cash (used in) provided by investing activities |                                                     |           | (4,250,290 | )          |            |            | 2,392,653  |           |            |           | (2,449,163 | )       
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|FINANCING ACTIVITIES:                                                    |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Net proceeds (repayments) from short-term borrowings                                 |                                   |                                                     | 6,109,177                                           |           |            |            | (20,999    | )          |            |           | 29,352     |          
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Net proceeds from issuance of common stock                                           |                                   |                                                     | 476,150                                             |           |            |            | 224,477    |            |            |           | 259,312    |          
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Net proceeds from issuance of long-term debt                                         |                                   |                                                     |                                                     |           |            |            |            |            |            |           | 9,209,486  |          
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Purchase of common stock for treasury                                                |                                   |                                                     | (125,370                                            | )         |            |            | (409,750   | )          |            |           |            |          
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Cash released (held) by trustee                                                      |                                   |                                                     | 2,928,001                                           |           |            |            | 1,906,754  |            |            |           | (4,834,755 | )        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Principal payments on long-term debt                                                 |                                   |                                                     | (361,382                                            | )         |            |            | (5,440,924 | )          |            |           | (892,882   | )        
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|                                                                         |                                                                                      |                                   | Net cash provided by (used in) financing activities |                                                     |           | 9,026,576  |            |            |            | (3,740,442 | )         |            |           | 3,770,513  |         
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                     |                                                                                      |                                   | (3,907,221                                          | )                                                   |           |            | (212,483   | )          |            |            | 529,769   |           
|                                                                        
|CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                           |                                                                                      |                                   | 5,558,487                                           |                                                     |           |            | 5,770,970  |            |            |            | 5,241,201 |           
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|CASH AND CASH EQUIVALENTS, END OF PERIOD                                 |                                                                                      | $                                 | 1,651,266                                           |                                                     |           | $          | 5,558,487  |            |            | $          | 5,770,970 |           
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|                                                                        
|CASH PAID FOR INTEREST                                                   |                                                                                      | $                                 | 505,898                                             |                                                     |           | $          | 172,813    |            |            | $          | 229,318   |           
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|CASH PAID FOR INCOME TAXES                                               |                                                                                      | $                                 | 136,636                                             |                                                     |           | $          | 128,074    |            |            | $          |          |           
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND
FINANCING ACTIVITIES: |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Issuance of Series B Convertible Preferred Stock for acquisition                     |                                   | $                                                   | 462,500                                             |           |            |            |            |            |            |           |            |          
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|                                                                         | Income tax benefit attributable to exercise of common stock options                  |                                   |                                                     |                                                     |           |            | $          | 990,000    |            |            | $         | 250,000    |          
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           
|                                                                         | Conversion of Series A Convertible Redeemable Preferred stock
to common stock        |                                   |                                                     |                                                     |           |            | $          | 8,787,191  |            |            | $         | 25,014,739 |          
|                                                                         |                                                                                      |                                   |                                                     |                                                     |           |            |            |            |            |            |           |           

F-5



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##### Table of Contents






ZILA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended July 31, 2001, 2000 and 1999

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

Nature of Business Activities Zila, Inc. and subsidiaries (Zila or the
Company), a Delaware corporation, is a worldwide manufacturer and marketer of
pharmaceutical, biomedical, dental and nutritional products. The Company has
four major operating groups: Consumer Pharmaceuticals, Professional Products,
Dental Supplies and Nutraceuticals. The Consumer
Pharmaceuticals Group consists of over-the-counter products, including the
Zilactin® family of products. The Professional Products Group includes Peridex®
prescription mouth rinse, Pro-Ties, a bundling system for instrument
sterilization, the Pro-Series line of specialty products marketed directly to
dentists, OraTest®, an oral cancer diagnostic system, and the plastic molded products from Innovative Swab Technologies
(IST). The Dental
Supply Group includes Zila Dental Supply (Zila Dental), a national
distributor of professional dental supplies. The Nutraceuticals Group is
presently comprised of Oxycal Laboratories, Inc. (Oxycal) and its Inter-Cal
subsidiary, a manufacturer and distributor of mineral and botanical products
including a patented and unique form of vitamin C under the trademark Ester-C®
and the Palmettx botanical line of products.

On October 28, 1999, Cygnus completed the sale of substantially all of its
assets and certain liabilities to Procare Laboratories, Inc. (Procare), of
Scottsdale, Arizona for approximately $4.0 million. Procare is controlled by
the former owner and President of Cygnus.

On December 20, 1999, the Company, through IDT, completed the sale of
substantially all of IDTs assets and liabilities related to its PracticeWorks
division located in Gold River, California to InfoCure Corporation
(InfoCure), of Atlanta, Georgia for approximately $4.65 million. InfoCure is
a national provider of healthcare practice management software products and
services to targeted healthcare practice specialties. Under the terms of the
agreement, 10% of the sales price was held in escrow for one year in order to
secure the representations, warranties, and covenants made by the Company to
InfoCure. The trustee released the entire escrow amount in fiscal 2001.

On February 5, 2001, the Company announced it had acquired the patent
rights and the Antioch, Illinois manufacturing operations for swab products
from National Healthcare Manufacturing Corporation, headquartered in Winnipeg,
Canada. Intellectual property, inventory, plus molding, labeling, filling and
sealing equipment were included in the acquisition. The business unit is known
as Innovative Swab Technologies. Zila paid approximately $2.3 million in a
combination of cash and preferred stock for the unit (See Note 10).

The Company prepares its financial statements in accordance with
accounting principles generally accepted in the United States of America.
Significant accounting policies are as follows:

Principles of Consolidation The consolidated financial statements
include the accounts of Zila, Inc. and its wholly owned subsidiaries, Zila
Pharmaceuticals, Inc., Zila International Inc., Zila Ltd., Bio-Dental
Technologies Corporation (Bio-Dental), Zila Technologies, Inc, Zila Swab
Technologies, Inc. and Oxycal Laboratories, Inc. Zila International Inc. has no
operations. All significant intercompany balances and transactions are
eliminated in consolidation.

F-6



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##### Table of Contents



Use of Estimates The preparation of financial statements in conformity
with generally accepted accounting principles necessarily requires management
to make estimates and assumptions that affect the reported amounts of assets
and liabilities, disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses
during the reporting period. Actual results could differ from those estimates.
Significant estimates include estimated cash flows used to measure long-lived
assets for impairment and the estimated net realizable value of inventories.

The cash flows used to measure long-lived assets related to OraTest® are
dependent upon obtaining FDA approval and generating sufficient revenues from
sales of OraTest®. The rigorous clinical testing and an extensive regulatory
approval process mandated by the FDA and equivalent foreign authorities before
the Company can market any new drug 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. The company currently has net intangible assets
related to OraTest® recorded as of July 31, 2001, of $6.6 million.

The Nutraceuticals Group entered the saw palmetto business with its
Palmettx line of products during the current fiscal year. In order to take
advantage of bulk purchase discounts and to establish a reputation as a
reliable supplier, the Company purchased a large amount of inventory of which
$4.5 million remains as of July 31, 2001. The ultimate probable future
economic benefit associated with such inventory is contingent on the Companys
ability to continue to sell its line of saw palmetto products for a price
greater than the carrying value of the inventory.

Cash Equivalents The Company considers highly liquid investments
purchased with original maturities of three months or less to be cash
equivalents.

Inventories, which consist of finished goods and raw materials, are stated
at the lower of cost (first-in, first-out method) or market.

Property and equipmentare stated at cost and are depreciated using
straight-line methods over their respective estimated useful lives, ranging
from 2 to 40 years. Leasehold improvements are depreciated over the lease term
or the estimated useful life, whichever is shorter.

Goodwill, purchase technology rights, trademarks and other intangible
assetsare being amortized on a straight-line basis. Goodwill is amortized
over estimated useful lives ranging from 15 to 40 years; trademarks are
amortized over their legal or estimated useful lives, whichever is shorter (not
exceeding 17 years). Other intangible assets consist of deferred patent and licensing costs and
software rights. Deferred patent and licensing costs incurred in connection
with the acquisition of patent rights, obtaining Food and Drug Administration
(FDA) regulatory approvals and obtaining other licensing rights for treatment
compositions are capitalized and amortized over the estimated benefit period
not exceeding 17 years. Research and development costs totaling approximately
$3,037,000, $1,629,000 and $3,988,000 in 2001, 2000 and 1999, respectively,
were expensed.

The Companys policy is to review the carrying amounts of goodwill and
other intangibles whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Such events or
circumstances might include a significant decline in market share, a
significant decline in profits, rapid changes in technology, significant
litigation or other items. In evaluating the recoverability of goodwill and
other intangible assets, managements policy is to compare the carrying amounts
of such assets with the estimated undiscounted future operating cash flows. In
the event impairment exists, an impairment charge would be determined by
comparing the carrying amounts of the asset to the applicable estimated future
cash flows, discounted at a risk-adjusted rate. In addition, the remaining
amortization period for the impaired asset would be reassessed and revised if
necessary.

F-7



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##### Table of Contents



Net income (loss) per common share Basic net income (loss) per common
share is computed by dividing net income (loss) available to common
shareholders by the weighted average number of common shares outstanding during
the year before giving effect to stock options and warrants considered to be
dilutive common stock equivalents. Diluted net income per common share is
computed by dividing net income (loss) available to common shareholders by the
weighted average number of common shares outstanding during the year after
giving effect to convertible preferred stock, stock options and warrants
considered to be dilutive common stock equivalents. For the years ended July
31, 2001 and 1999, convertible preferred stock, options and warrants that would
otherwise qualify as common stock equivalents are excluded because their
inclusion would have the effect of decreasing the loss per share.

Financial instrumentsThe carrying amounts and estimated fair value of
the Companys financial instruments are as follows:

The carrying values of cash and cash equivalents, 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 the Company to credit
risk, consist principally of trade receivables. The Company provides credit, in
the normal course of business, to pharmaceutical wholesalers and chains, food
wholesalers and chains, rack jobbers, convenience stores, and dentists. The
Company performs ongoing credit evaluations of its customers and maintains an
allowance for credit losses. Amounts included in selling, general and
administrative expenses related to increases in the allowance for doubtful
accounts receivable during fiscal 2001, 2000 and 1999 were $260,000, $178,000
and $371,000, respectively.

Comprehensive incomeconsists of net income and other gains and losses
affecting shareholders equity that, under generally accepted accounting
principles are excluded from net income. For the Company, such items consist
primarily of unrealized gains and losses on marketable equity investments and
foreign currency translation gains and losses.

Certain reclassificationshave been made to the 1999 financial statements
to conform to the classifications used in 2000 and 2001.

Shipping costsCosts of shipping products to customers are included in the
cost of products sold.

Accounting for Derivative Instruments and Hedging Activities Statement
of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities, (SFAS No. 133), establishes accounting
and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
SFAS No. 133 requires that an enterprise recognize all derivatives as either
assets or liabilities in the balance sheet and measure those instruments at
fair value. If certain conditions are met, a derivative may be specifically
designated as a hedge. The accounting for changes in the fair value of a
derivative instrument depends on the intended use of the derivative and
resulting designation. The Company adopted SFAS No. 133 effective August 1,
2000, and the adoption did not have a material impact on the Companys results
of operations as the Company has no derivative financial instruments or hedging
activities.

F-8



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##### Table of Contents



New Accounting Pronouncements In December 1999, the Securities and
Exchange Commission released Staff Accounting Bulletin No. 101 (SAB 101),
which provides the Staffs views in applying generally accepted accounting
principles to selected revenue recognition issues. The Company adopted SAB 101
during the fourth quarter of fiscal 2001, and its adoption did not have a
material impact on the operating results or the financial condition of the
Company.

In May 2000, the Financial Accounting Standards Boards Emerging Issues
Task Force (EITF) issued Issue No. 00-14, Accounting for Certain Sales
Incentives. The Issue addresses the recognition, measurement, and income
statement classification for certain sales incentives including coupons,
rebates and free products. The consensus on EITF 00-14 will be effective for
the Company in the third quarter of 2002. The implementation of this consensus
will require the Company to change the way it classifies certain sales
incentives, which are currently recorded as selling, general and administrative
expenses. The cost of coupons and rebates will be recorded as a reduction of
net sales. The cost of free products will be recorded as a reduction of
products sold. The Company is in the process of analyzing the impact that this
statement will have on the financial statements.

In April 2001, the EITF issued Issue No. 00-25, Vendor Income Statement
Characterization of Consideration from a Vendor to a Retailer. The issue
discusses accounting and income statement classification of costs, other than
those directly addressed in Issue 00-14, that are incurred by a vendor
(typically a manufacturer or distributor) to or on behalf of a customer
(typically a retailer) in connection with the customers purchase or promotion
of the vendors products. Such costs include consideration given to retailers
for space in their stores (slotting fees), consideration given to obtain
favorable display positions in the retailers stores and other promotional
activity (cooperative advertising). The issue addresses the recognition and
measurement of such costs and whether a vendor should classify such costs in
its income statement when incurred as a reduction of revenues or as an expense
item. The consensus on EITF 00-25 will be effective for the Company in the
third quarter of 2002. The Company is in the process of analyzing the impact
that this statement will have on the financial statements.

In June 2001, the Financial Accounting Standards Board issued SFAS No.
141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible
Assets. The statements will change the accounting for business combinations
and goodwill in two significant ways. SFAS No. 141 requires that the purchase
method of accounting be used for all business combinations initiated after June
30, 2001. Use of the pooling-of-interests method will be prohibited. SFAS No.
142 changes the accounting for goodwill from an amortization method to an
impairment-only approach. Thus, amortization of goodwill, including goodwill
recorded in past business combinations, will cease upon adoption of that
statement. The Company will adopt SFAS 142 effective August 1, 2002, as
required. The Company expects that the adoption of SFAS No. 142 will reduce
annual amortization expense by approximately $1.2 million annually pre-tax.
The Company is in the process of analyzing the impact that the impairment
analyses will have on the Companys recorded intangibles.

In August 2001, the Financial Accounting Standards Board issued SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets. This
Statement supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and
reporting provisions of APB Opinion No. 30, Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for
the disposal of a segment of a business (as previously defined in that
Opinion). The Company will adopt SFAS 144 effective August 1, 2002, as
required. The Company has not completed its evaluation of the impact of
implementing the provisions of SFAS No. 144.

F-9



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##### Table of Contents



2. Acquisitions

On February 5, 2001, the Company announced it had acquired the patent
rights and the Antioch, Illinois manufacturing operations for swab products
from National Healthcare Manufacturing Corporation, headquartered in Winnipeg,
Canada. Intellectual property, inventory, plus molding, labeling, filling and
sealing equipment were included in the acquisition. The business unit is known
as Innovative Swab Technologies. Zila paid approximately $2.3 million in a
combination of cash and preferred stock for the unit (See Note 10).

3. Sale of Assets

As described in Note 1, on October 28, 1999, Cygnus completed the sale of
substantially all of its assets and certain liabilities and on December 20,
1999, the Company completed the sale of substantially all of IDTs assets and
liabilities related to its PracticeWorks division.

The following unaudited pro forma condensed statement of operations data
for the year ended July 31, 2000, present historical statement of operations
data for the Company, Cygnus and IDT as if the Cygnus and IDT transactions had
occurred as of August 1, 1999. The pro forma data are not necessarily
indicative of the results of operations that would actually have been reported
had the transactions been consummated at the date mentioned above or which may
be reported in the future.

Unaudited Pro Forma Condensed Statement of Operations

|                                             |  |              |        |           |  |        |      |                |  |           |       |           |  |  |        |   |  |   |        |  
|-------------------------------------------- |  | ------------ | ------ | --------- |  | ------ | ---- | -------------- |  | --------- | ----- | --------- |  |  | ------ | - |  | - | ------ | -
|                                             |  | Historical   |        |           |  |        |      |                |  |          
|                                             |  |              |        |           |  |        |      |                |  |          
|Year ended July 31, 2000                     |  | Zila         |        |           |  |        |      |                |  |           |       | Pro forma |  |  |        |  
|(in thousands except per share data)         |  | Consolidated |        | Cygnus(a) |  | IDT(a) |      | Adjustments(b) |  | Pro Forma
|                                             |  |              |        |           |  |        |      |                |  |          
|Net revenues                                 |  | $            | 77,581 |           |  | $      | 193  |                |  | $         | 1,515 |           |  |  |        |   |  | $ | 75,873 |  
|                                            
|                                            
|                                            
|                                            
|Cost of products sold                        |  |              | 40,004 |           |  |        | 110  |                |  |           | 69    |           |  |  |        |   |  |   | 39,825 |  
|                                            
|                                            
|                                            
|                                            
|Selling, general and administrative
expenses |  |              | 32,449 |           |  |        | 491  |                |  |           | 1,188 |           |  |  |        |   |  |   | 30,770 |  
|                                            
|                                            
|                                            
|                                            
|Research and development expenses            |  |              | 1,629  |           |  |        | 155  |                |  |           | 120   |           |  |  |        |   |  |   | 1,354  |  
|                                            
|                                            
|                                            
|                                            
|Depreciation and amortization                |  |              | 3,478  |           |  |        | 110  |                |  |           | 35    |           |  |  |        |   |  |   | 3,333  |  
|                                            
|                                            
|                                            
|                                            
|Income (loss) from operations                |  |              | 21     |           |  |        | (673 | )              |  |           | 103   |           |  |  |        |   |  |   | 591    |  
|                                            
|                                            
|                                            
|                                            
|Other income (expense)                       |  |              | 4,671  |           |  |        |      |                |  |           |       |           |  |  | (4,678 | ) |  |   | (7     | )
|                                            
|                                            
|                                            
|                                            
|Income tax (expense) benefit                 |  |              | (1,760 | )         |  |        |      |                |  |           |       |           |  |  | (2,761 | ) |  |   | 1,001  |  
|                                            
|                                            
|                                            
|                                            
|Net income (loss)                            |  |              | 2,932  |           |  |        | (673 | )              |  |           | 103   |           |  |  | (1,917 | ) |  |   | 1,585  |  
|                                            
|                                            
|                                            
|                                            
|Net income per share (basic)                 |  | $            | 0.07   |           |  |        |      |                |  |           |       |           |  |  |        |   |  | $ | 0.04   |  
|                                            
|                                            
|                                            
|                                            
|Basic shares outstanding                     |  |              | 42,180 |           |  |        |      |                |  |           |       |           |  |  |        |   |  |   | 42,180 |  
|                                            
|                                            
|                                            
|                                            
|Net income per share (diluted)               |  | $            | 0.07   |           |  |        |      |                |  |           |       |           |  |  |        |   |  | $ | 0.04   |  
|                                            
|                                            
|                                            
|                                            
|Diluted shares outstanding                   |  |              | 43,576 |           |  |        |      |                |  |           |       |           |  |  |        |   |  |   | 43,576 |  



---

|(a) |  | Represents Cygnus and IDT balances for the year ended July 31,
2000. These amounts are removed to reflect the sale of assets and
the corresponding revenue and expenses thereby reducing the
consolidated balances for pro forma purposes.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(b) |  | The Company believes that no pro forma adjustments are required
other than the elimination of the gain on the sale of the assets and
the resulting income tax effect recorded in the consolidated
statement of operations.                

F-10



---



##### Table of Contents



4. Inventories

Inventories consist of the following at July 31:

|                   |  |      |            |      |  |   |            |  
|------------------ |  | ---- | ---------- | ---- |  | - | ---------- | -
|                   |  | 2001 |            | 2000
|                   |  |      |            |     
|Finished goods     |  | $    | 10,965,370 |      |  | $ | 9,219,343  |  
|                  
|                  
|                  
|                  
|Raw materials      |  |      | 7,052,981  |      |  |   | 4,168,834  |  
|                  
|                  
|                  
|                  
|Inventory reserves |  |      | (267,203   | )    |  |   | (184,040   | )
|                   |  |      |            |      |  |   |            |  
|Total inventories  |  | $    | 17,751,148 |      |  | $ | 13,204,137 |  
|                   |  |      |            |      |  |   |            |  

Amounts included in cost of products sold related to increases in
inventory reserves during fiscal 2001, 2000 and 1999 were $145,000, $33,000,
and $0, respectively.

5. Property and Equipment

Property and equipment consists of the following at July 31:

|                                               |  |      |            |      |  |   |            | 
|---------------------------------------------- |  | ---- | ---------- | ---- |  | - | ---------- | 
|                                               |  | 2001 |            | 2000
|                                               |  |      |            |     
|Land                                           |  | $    | 619,917    |      |  | $ | 1,221,097  | 
|                                              
|                                              
|                                              
|                                              
|Construction in progress                       |  |      |            |      |  |   | 3,618,340  | 
|                                              
|                                              
|                                              
|                                              
|Building and improvements                      |  |      | 5,789,948  |      |  |   | 2,174,869  | 
|                                              
|                                              
|                                              
|                                              
|Furniture and equipment                        |  |      | 3,553,339  |      |  |   | 2,995,821  | 
|                                              
|                                              
|                                              
|                                              
|Leasehold improvements and other assets        |  |      | 489,472    |      |  |   | 475,941    | 
|                                              
|                                              
|                                              
|                                              
|Production and warehouse equipment             |  |      | 4,644,277  |      |  |   | 3,470,101  | 
|                                               |  |      |            |      |  |   |            | 
|Total property and equipment                   |  |      | 15,096,953 |      |  |   | 13,956,169 | 
|                                              
|                                              
|                                              
|                                              
|Less accumulated depreciation and amortization |  |      | 5,253,850  |      |  |   | 4,513,891  | 
|                                               |  |      |            |      |  |   |            | 
|Property and equipment  net                   |  | $    | 9,843,103  |      |  | $ | 9,442,278  | 
|                                               |  |      |            |      |  |   |            | 

Depreciation and amortization expense related to property and equipment
for 2001, 2000 and 1999 was $1,191,815, $1,112,995 and $1,038,507,
respectively.

6. Intangible Assets

Intangible assets consist of the following at July 31:

|                                                                                                         |                                              |                                              |            |            |            |      |            |            |            | 
|-------------------------------------------------------------------------------------------------------- | -------------------------------------------- | -------------------------------------------- | ---------- | ---------- | ---------- | ---- | ---------- | ---------- | ---------- | 
|                                                                                                         |                                              |                                              |            | 2001       |            | 2000
|                                                                                                         |                                              |                                              |            |            |            |     
|Purchased technology rights  net of accumulated
amortization of $2,254,938 (2001) and
$1,818,498 (2000) |                                              | $                                            | 5,164,535  |            |            | $    | 5,600,975  |           
|                                                                                                         |                                              |                                              |            |            |            |      |            |           
|Goodwill  net of accumulated amortization of
$4,591,983 (2001) and $3,385,783 (2000)                    |                                              | $                                            | 12,894,874 |            |            | $    | 12,725,978 |           
|                                                                                                         |                                              |                                              |            |            |            |      |            |           
|Trademarks and other intangible assets:                                                                  |                                              |                                              |            |            |            |      |            |           
|                                                                                                        
|                                                                                                        
|                                                                                                        
|                                                                                                        
|                                                                                                         |                                              | Trademarks                                   |            | $          | 11,520,889 |      |            | $          | 11,514,218 | 
|                                                                                                        
|                                                                                                        
|                                                                                                        
|                                                                                                        
|                                                                                                         |                                              | Patents                                      |            |            | 2,188,507  |      |            |            | 1,494,021  | 
|                                                                                                        
|                                                                                                        
|                                                                                                        
|                                                                                                        
|                                                                                                         |                                              | Licensing costs                              |            |            | 1,548,818  |      |            |            | 1,548,818  | 
|                                                                                                        
|                                                                                                        
|                                                                                                        
|                                                                                                        
|                                                                                                         |                                              | Other                                        |            |            | 633,358    |      |            |            | 472,736    | 
|                                                                                                         |                                              |                                              |            |            |            |      |            |           
|                                                                                                         |                                              | Total trademarks and other intangible assets |            |            | 15,891,572 |      |            |            | 15,029,793 | 
|                                                                                                        
|                                                                                                        
|                                                                                                        
|                                                                                                        
|                                                                                                         |                                              | Less accumulated amortization                |            |            | 3,170,005  |      |            |            | 2,606,161  | 
|                                                                                                         |                                              |                                              |            |            |            |      |            |           
|                                                                                                         | Trademarks and other intangible assets  net |                                              | $          | 12,721,567 |            |      | $          | 12,423,632 |           
|                                                                                                         |                                              |                                              |            |            |            |      |            |           

F-11



---



##### Table of Contents



Licensing costs consist primarily of professional fees associated with
seeking FDA approval for a new product, OraTest®. Purchased technology rights
relate to the acquisition of CTM, Inc in fiscal year 1996. The recoverability
of the $6.6 million net deferred licensing costs and purchased technology
rights is dependent upon obtaining FDA approval and generating sufficient
revenues from sales of OraTest® (see Note 13).

Amortization of the Companys intangible assets during fiscal 2001, 2000
and 1999 was $ 2,332,892, $2,365,125, and $2,543,261, respectively.

7. Short-term Borrowings and Long-Term Debt

Short-term borrowings at July 31, 2001 consisted of $6.1 million for the
revolving line of credit with Bank One, Arizona, NA (Bank One) and $60,947 at
6.99% for installments due on the Companys various insurance policies.
Short-term borrowings were $51,770 at 7.12% at July 31, 2000 for installments
due on the Companys various insurance policies.

In December 2000, the Company renewed its $9 million line of credit with
Bank One for an additional 12 months under similar terms and conditions,
including a variable interest rate equal to the prime rate (the Index), which
was 6.75% at July 31, 2001. Under the line of credit loan agreement, the
Company is required to comply with financial covenants based on certain
financial ratios. As of April 30, 2001, the Company was in default of the debt
service coverage ratio. On May 7, 2001, the Company and Bank One entered into
the First Loan Modification Agreement whereby the line of credit was reduced to
$7.25 million, the interest rate was raised to 3.0% over the Index, the Company
agreed to cross-defaulting and cross-collateralizing of all Bank One loans and
obligations and Bank One agreed to forebear in exercising any remedy with
respect to the default through May 31, 2001. On June 14, 2001, the forbearance
period contained in the First Loan Modification Agreement ended May 31, 2001,
and the Agreement were amended and the forbearance period was extended to June
29, 2001.

On July 3, 2001 and effective June 29, 2001, the Company and Bank One
entered into a Second Extension to First Loan Modification Agreement. Under
this agreement, the line of credit was reduced to $6.9 million and Bank One
agreed to forebear in exercising any remedy with respect to certain defaults
under the line of credit through July 31, 2001 and agreed to extend the
maturity date of the building loan for the Companys 7th Street location until
July 31, 2001.

The Company entered into a Third Extension to First Loan Modification
Agreement effective July 31, 2001. Under this agreement, Bank One agreed to
forebear in exercising any remedy with respect to certain defaults under the
line of credit through August 31, 2001 and agreed to extend the maturity date
of the building loan for the Companys 7th Street location until August 31,
2001.

On August 27, 2001, the Company and Congress Financial Corporation
(Congress) entered into a Loan and Security Agreement (the Agreement)
whereby Congress will provide a $12 million revolving line of credit to the
Company at an interest rate equal to the prime rate plus 3/4 percent. The
amount of funds available to the Company from the line of credit is based upon
a percentage of the value of eligible receivables and inventory (excluding the
inventory of Zila Dental) and was $7.7 million at August 27, 2001. The
obligations under the Agreement are collateralized by various assets,
including, but not limited to, trade accounts receivable, inventories,
equipment and intangible assets of the Company and of certain of its operating
subsidiaries. Zila and all of its direct and indirect operating subsidiaries
guarantee the obligations under the Agreement. The Agreement expires August
17, 2004; however the line of credit is classified as current because of
certain provisions required by Congress. Under the Agreement, the Company is
required to comply with a financial covenant based on an adjusted tangible net
worth calculation. A portion of the available funds from the new line of
credit were used to pay off in full the line of credit and building loan due to Bank One, totaling approximately $6.4
million. The obligations of Oxycal Laboratories, Incorporated, an operating
subsidiary of Zila, Inc., to Bank One with respect to the 1999 Industrial
Revenue Development Bonds have not changed.

F-12



---



##### Table of Contents



|                                                                                                            |  |      |           |      |  |   |           | 
|----------------------------------------------------------------------------------------------------------- |  | ---- | --------- | ---- |  | - | --------- | 
|Long-term debt consisted of the following at July 31:                                                       |  | 2001 |           | 2000
|                                                                                                            |  |      |           |     
|IDA bond payable, Series A, (1)                                                                             |  | $    | 3,900,000 |      |  | $ | 3,900,000 | 
|                                                                                                           
|                                                                                                           
|                                                                                                           
|                                                                                                           
|IDA bond payable, Series B, (1)                                                                             |  |      | 532,288   |      |  |   | 958,072   | 
|                                                                                                           
|                                                                                                           
|                                                                                                           
|                                                                                                           
|Mortgage note payable, interest at 9%,
monthly payments of $2,315 with a balloon due
August 31, 2001        |  |      | 277,821   |      |  |   | 298,659   | 
|                                                                                                           
|                                                                                                           
|                                                                                                           
|                                                                                                           
|Notes payable for equipment with interest
rates between 6.34% and 12.25% with
maturities no later than 2004 |  |      | 254,328   |      |  |   | 169,088   | 
|                                                                                                            |  |      |           |      |  |   |           | 
|                                                                                                            |  |      | 4,964,437 |      |  |   | 5,325,819 | 
|                                                                                                           
|                                                                                                           
|                                                                                                           
|                                                                                                           
|Less current portion                                                                                        |  |      | 811,166   |      |  |   | 776,866   | 
|                                                                                                            |  |      |           |      |  |   |           | 
|Long-term portion                                                                                           |  | $    | 4,153,271 |      |  | $ | 4,548,953 | 
|                                                                                                            |  |      |           |      |  |   |           | 



---

|(1) |  | In April 1999, Oxycal entered into a transaction with The Industrial
Development Authority of the County of Yavapai (the Authority) in which the
Authority issued $5.0 million in Industrial Development Revenue Bonds (the
Bonds), the proceeds of which were loaned to Oxycal for the construction of a
new manufacturing and laboratory facility. The Bond proceeds were held by the
trustee, Bank One, Arizona until such time as invoices for building
construction and new equipment were submitted for payment. As of July 31,
2001, the trustee had released all the Bond proceeds. The Bonds consist of $3.9
million Series A and $675,000 Taxable Series B which, as of July 31, 2001,
carried interest rates of 3.0 % and 3.9 %, respectively. The Bonds were
marketed and sold by Banc One Capital Markets and carry a maturity of 20 years.
In connection with the issuance of the Bonds, the Authority required that
Oxycal obtain, for the benefit of the Bondholders, an irrevocable direct-pay
letter of credit to secure payment of principal and interest. The letter of
credit is guaranteed by the Company.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Aggregate annual maturities of long-term debt for the years ending July 31
are as follows:

|                     |  |   |           | 
|-------------------- |  | - | --------- | 
|2002                 |  | $ | 811,166   | 
|                    
|                    
|                    
|                    
|2003                 |  |   | 538,805   | 
|                    
|                    
|                    
|                    
|2004                 |  |   | 459,530   | 
|                    
|                    
|                    
|                    
|2005                 |  |   | 425,784   | 
|                    
|                    
|                    
|                    
|2006                 |  |   | 425,784   | 
|                    
|                    
|                    
|                    
|2007 and beyond      |  |   | 2,303,368 | 
|                     |  |   |           | 
|Total                |  |   | 4,964,437 | 
|                    
|                    
|                    
|                    
|Less current portion |  |   | 811,166   | 
|                     |  |   |           | 
|Long-term portion    |  | $ | 4,153,271 | 
|                     |  |   |           | 

8. Stock Options and Warrants

a.     Options The Company adopted the 1997 Stock Option Award Plan, which
became effective on February 5, 1997, authorizing the Board of Directors to
grant options to employees and certain employee directors of the Company to
purchase up to 1,000,000 shares of the Companys common stock. On December 7,
2000, the plan was amended to increase the authorized number of shares to
3,000,000. The options are issuable at an exercise price no less than market
value at the date of grant. Options may be exercised up to five to ten years
from the date of grant. In fiscal 1999, 2000 and 2001, the Company granted
74,900, 285,000 and 354,800 options, respectively, to employees. At July 31, 2001, 1,470,400
shares were available for grant under this plan.

F-13



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##### Table of Contents



The Company adopted a Stock Option Award Plan that became effective on
September 1, 1988, authorizing the Board of Directors to grant options to
employees and certain employee-directors of the Company to purchase up to
4,000,000 shares of the Companys common stock. The plan was amended December
8, 1995 to increase the authorized number of shares to 5,000,000. The options
are issuable at an exercise price no less than the market value at the date of
grant. Options may be exercised at any time up to five to ten years from the
date of grant. At July 31, 2001, no shares were available for grant under this
plan.

The Company adopted a Non-Employee Directors Stock Option Plan that became
effective October 20, 1989, authorizing the Board of Directors to grant options
of 100,000 shares to non-employee members of the Board of Directors in
increments of 2,500 shares per director each year. The plan was amended
December 8, 1995 to increase the authorized number of shares to 200,000. The
options are issuable at an exercise price equal to the market value at the date
of grant. All options may be exercised at any time up to five years from the
date of grant. At July 31, 2001, 150,000 shares were available for grant under
this plan.

A summary of the status of the option plans as of July 31, 2001, 2000 and
1999 and changes during the years then ended is presented below:

|                                 |  |        |           |       |  |          |      |       |  |        |           |          |  |   |      |  |  |          |           |   |  |   |      | 
|-------------------------------- |  | ------ | --------- | ----- |  | -------- | ---- | ----- |  | ------ | --------- | -------- |  | - | ---- |  |  | -------- | --------- | - |  | - | ---- | 
|                                 |  | 2001   |           | 2000  |  | 1999    
|                                 |  |        |           |       |  |         
|                                 |  |        |           |       |  | Weighted |      |       |  |        |           | Weighted |  |   |      |  |  | Weighted
|                                 |  |        |           |       |  | Average  |      |       |  |        |           | Average  |  |   |      |  |  | Average 
|                                 |  |        |           |       |  | Exercise |      |       |  |        |           | Exercise |  |   |      |  |  | Exercise
|                                 |  | Shares |           | Price |  | Shares   |      | Price |  | Shares |           | Price   
|                                 |  |        |           |       |  |          |      |       |  |        |           |         
|Outstanding at beginning of year |  |        | 2,576,354 |       |  | $        | 5.07 |       |  |        | 2,306,678 |          |  | $ | 5.41 |  |  |          | 2,275,918 |   |  | $ | 5.25 | 
|                                
|                                
|                                
|                                
|Granted                          |  |        | 354,800   |       |  |          | 2.64 |       |  |        | 513,000   |          |  |   | 3.25 |  |  |          | 419,500   |   |  |   | 7.40 | 
|                                
|                                
|                                
|                                
|Exercised                        |  |        | (249,752  | )     |  |          | 1.19 |       |  |        | (30,524   | )        |  |   | 4.85 |  |  |          | (115,667  | ) |  |   | 2.61 | 
|                                
|                                
|                                
|                                
|Cancelled                        |  |        | (583,459  | )     |  |          | 5.27 |       |  |        | (212,800  | )        |  |   | 4.37 |  |  |          | (273,073  | ) |  |   | 6.34 | 
|                                 |  |        |           |       |  |          |      |       |  |        |           |          |  |   |      |  |  |          |           |   |  |   |      | 
|Outstanding at end of year       |  |        | 2,097,943 |       |  |          | 5.07 |       |  |        | 2,576,354 |          |  |   | 5.07 |  |  |          | 2,306,678 |   |  |   | 5.41 | 
|                                 |  |        |           |       |  |          |      |       |  |        |           |          |  |   |      |  |  |          |           |   |  |   |      | 
|Options exercisable at year-end  |  |        | 1,386,321 |       |  |          | 5.94 |       |  |        | 1,877,559 |          |  |   | 5.25 |  |  |          | 1,488,078 |   |  |   | 5.98 | 
|                                 |  |        |           |       |  |          |      |       |  |        |           |          |  |   |      |  |  |          |           |   |  |   |      | 

The following table summarizes information regarding stock options
outstanding as of July 31, 2001:

|                    |  |                     |             |                  |          |          |          |               |             |          |          |  |  |  |           |  |  |  |      |  | 
|------------------- |  | ------------------- | ----------- | ---------------- | -------- | -------- | -------- | ------------- | ----------- | -------- | -------- |  |  |  | --------- |  |  |  | ---- |  | 
|Options Outstanding |  | Options Exercisable
|                    |  |                    
|                    |  |                     | Number      |                  | Weighted |          | Weighted |               | Number      |          | Weighted
|                    |  |                     | Outstanding |                  | Average  |          | Average  |               | Exercisable |          | Average 
|Range of            |  | At                  |             | Remaining        |          | Exercise |          | at            |             | Exercise
|Exercise Prices     |  | July 31, 2001       |             | Contractual Life |          | Price    |          | July 31, 2001 |             | Price   
|                    |  |                     |             |                  |          |          |          |               |             |         
|2.24  3.00         |  |                     | 343,510     |                  |          |          | 8.5      |               |             |          | 2.61     |  |  |  | 36,710    |  |  |  | 2.78 | 
|                   
|                   
|                   
|                   
|3.01  4.50         |  |                     | 670,797     |                  |          |          | 7.3      |               |             |          | 3.29     |  |  |  | 309,474   |  |  |  | 3.35 | 
|                   
|                   
|                   
|                   
|4.51  6.00         |  |                     | 402,877     |                  |          |          | 5.8      |               |             |          | 5.58     |  |  |  | 401,377   |  |  |  | 5.58 | 
|                   
|                   
|                   
|                   
|6.01  8.00         |  |                     | 479,759     |                  |          |          | 4.9      |               |             |          | 6.84     |  |  |  | 479,759   |  |  |  | 6.84 | 
|                   
|                   
|                   
|                   
|8.01  9.92         |  |                     | 201,000     |                  |          |          | 7.4      |               |             |          | 9.88     |  |  |  | 159,001   |  |  |  | 9.88 | 
|                    |  |                     |             |                  |          |          |          |               |             |          |          |  |  |  |           |  |  |  |      | 
|2.24  9.92         |  |                     | 2,097,943   |                  |          |          | 6.7      |               |             |          | 5.07     |  |  |  | 1,386,321 |  |  |  | 5.94 | 
|                    |  |                     |             |                  |          |          |          |               |             |          |          |  |  |  |           |  |  |  |      | 

The Company applies APB Opinion No. 25 and related interpretations in
accounting for its stock-based employee compensation plans. Accordingly, no
compensation cost has been recognized for its stock-based employee compensation
plans. Had compensation cost been computed based on the fair value of awards on
the date of grant, utilizing the Black-Scholes option-pricing model, consistent
with the method stipulated by SFAS No. 123, the Companys net (loss) income
attributable to common shareholders and (loss) income per

F-14



---



##### Table of Contents



share attributable to common shareholders for the years ended July 31, 2001,
2000 and 1999 would have been (increased) reduced to the pro forma amounts
indicated below, followed by the model assumptions used:

|                                                                                   |                          |  |          |            |      |  |      |           |   |  |   |            |  
|---------------------------------------------------------------------------------- | ------------------------ |  | -------- | ---------- | ---- |  | ---- | --------- | - |  | - | ---------- | -
|                                                                                   |                          |  | July 31,
|                                                                                   |                          |  |         
|                                                                                   |                          |  | 2001     |            | 2000 |  | 1999
|                                                                                   |                          |  |          |            |      |  |     
|Net (loss) income attributable
to common shareholders:                             |                          |  |          |            |      |  |      |           |   |  |   |           
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | As reported              |  | $        | (6,314,000 | )    |  | $    | 2,932,000 |   |  | $ | (1,967,000 | )
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Pro forma                |  | $        | (6,920,000 | )    |  | $    | 2,210,000 |   |  | $ | (2,838,000 | )
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Net (loss) income attributable
to common shareholders per
basic share outstanding: |                          |  |          |            |      |  |      |           |   |  |   |           
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | As reported              |  | $        | (.15       | )    |  | $    | .07       |   |  | $ | (.05       | )
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Pro forma                |  | $        | (.16       | )    |  | $    | .05       |   |  | $ | (.07       | )
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Black-Scholes model assumptions:                                                   |                          |  |          |            |      |  |      |           |   |  |   |           
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Risk-free interest rate  |  |          | 4.8        | %    |  |      | 5.3       | % |  |   | 4.4 - 4.5  | %
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Expected volatility      |  |          | 74         | %    |  |      | 78        | % |  |   | 82         | %
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Expected term (in years) |  |          | 9.3        |      |  |      | 8.5       |   |  |   | 6.9        |  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Dividend yield           |  |          | 0          | %    |  |      | 0         | % |  |   | 0          | %

b.     Warrants The Company has issued warrants to various investors,
shareholders and other third parties in connection with services provided and
purchases of the Companys stock. Activity related to such warrants, which
expire at various dates through September 2005, is summarized as follows:

|                            |           |  |           |          |               |   |              |              | 
|--------------------------- | --------- |  | --------- | -------- | ------------- | - | ------------ | ------------ | 
|                            |           |  | Number of |          | Warrant Price
|                            |           |  | Shares    |          | Per Share    
|                            |           |  |           |          |              
|Outstanding, August 1, 1998 |           |  | 1,143,406 |          |               | $ | 3.00 - 9.915 |             
|                           
|                           
|                           
|                           
|                            | Exercised |  |           | (35,975  | )             |   | $            | 3.00         | 
|                            |           |  |           |          |               |   |              |             
|Outstanding, July 31, 1999  |           |  | 1,107,431 |          |               | $ | 3.00 - 9.915 |             
|                           
|                           
|                           
|                           
|                            | Exercised |  |           | (49,074  | )             |   |              | 3.00         | 
|                           
|                           
|                           
|                           
|                            | Issued    |  |           | 10,000   |               |   |              | 4.90         | 
|                            |           |  |           |          |               |   |              |             
|Outstanding, July 31, 2000  |           |  | 1,068,357 |          |               | $ | 3.00 - 9.915 |             
|                           
|                           
|                           
|                           
|                            | Issued    |  |           | 15,000   |               |   |              | 4.00 - 5.00  | 
|                           
|                           
|                           
|                           
|                            | Exercised |  |           | (149,870 | )             |   |              | 3.00         | 
|                           
|                           
|                           
|                           
|                            | Expired   |  |           | (908,487 | )             |   |              | 3.00 - 9.915 | 
|                            |           |  |           |          |               |   |              |             
|Outstanding, July 31, 2001  |           |  | 25,000    |          |               | $ | 4.00 - 5.00  |             
|                            |           |  |           |          |               |   |              |             

c.     Stock Purchase Plan During fiscal year 2001, the Company established
the Zila, Inc. Employee Stock Purchase Plan whereby it is authorized, as July
31, 2001, to issue up to 2 million shares of common stock to its employees,
nearly all of whom are eligible to participate. Eligible employees may have up
to 18% of eligible compensation deducted from their pay and applied to the
purchase of shares of common stock. The price the employee must pay for each
share of stock will be 85% of the lower of the fair market value of the common
stock at the beginning or the end of the purchase term. As of July 31, 2001,
the Company sold 12,577 shares to employees.

F-15



---



##### Table of Contents



9. Income Taxes

The consolidated income tax (benefit) provision consists of the following
for the years ended July 31:

|                                                  |         |   |          |          |      |   |           |           |  |   |          |          |  
|------------------------------------------------- | ------- | - | -------- | -------- | ---- | - | --------- | --------- |  | - | -------- | -------- | -
|                                                  |         |   | 2001     |          | 2000 |   | 1999     
|                                                  |         |   |          |          |      |   |          
|Current:                                          |         |   |          |          |      |   |           |           |  |   |          |         
|                                                 
|                                                 
|                                                 
|                                                 
|                                                  | Federal |   |          |          |      |   | $         | 154,000   |  |   | $        | 63,000   |  
|                                                 
|                                                 
|                                                 
|                                                 
|                                                  | State   |   |          |          |      |   |           | 60,000    |  |   |          | 11,000   |  
|                                                  |         |   |          |          |      |   |           |           |  |   |          |         
|Total current                                     |         |   |          |          |      |   | 214,000   |           |  |   | 74,000   |         
|                                                  |         |   |          |          |      |   |           |           |  |   |          |         
|Deferred:                                         |         |   |          |          |      |   |           |           |  |   |          |         
|                                                 
|                                                 
|                                                 
|                                                 
|                                                  | Federal |   | $        | (272,000 | )    |   |           | 1,314,000 |  |   |          | (570,000 | )
|                                                 
|                                                 
|                                                 
|                                                 
|                                                  | State   |   |          | (63,000  | )    |   |           | 232,000   |  |   |          | (100,000 | )
|                                                  |         |   |          |          |      |   |           |           |  |   |          |         
|Total deferred                                    |         |   | (335,000 | )        |      |   | 1,546,000 |           |  |   | (670,000 | )       
|                                                  |         |   |          |          |      |   |           |           |  |   |          |         
|Total consolidated income
tax (benefit) provision |         | $ | (335,000 | )        |      | $ | 1,760,000 |           |  | $ | (596,000 | )       
|                                                  |         |   |          |          |      |   |           |           |  |   |          |         

The reconciliation of the federal statutory rate to the effective income
tax rate for the years ended July 31 is as follows:

|                       |                                                   |  |      |    |      |  |      |     |   |  |     |     |   
|---------------------- | ------------------------------------------------- |  | ---- | -- | ---- |  | ---- | --- | - |  | --- | --- | --
|                       |                                                   |  | 2001 |    | 2000 |  | 1999
|                       |                                                   |  |      |    |      |  |     
|Federal statutory rate |                                                   |  | (34  | )% |      |  | 34   | %   |   |  | (34 | )% 
|                      
|                      
|                      
|                      
|Adjustments:           |                                                   |  |      |    |      |  |      |     |   |  |     |    
|                      
|                      
|                      
|                      
|                       | State income taxes  net of federal benefit       |  |      | (1 | )    |  |      | 10  |   |  |     | (6  | ) 
|                      
|                      
|                      
|                      
|                       | Effect of foreign tax rates                       |  |      | 1  |      |  |      | 2   |   |  |     |     |   
|                      
|                      
|                      
|                      
|                       | Non-deductible meal and entertainment expenses    |  |      | 1  |      |  |      | 1   |   |  |     | 4   |   
|                      
|                      
|                      
|                      
|                       | Non-deductible acquisition expenses and other     |  |      |    |      |  |      |     |   |  |     | 16  |   
|                      
|                      
|                      
|                      
|                       | Non-deductible intangible amortization            |  |      | 7  |      |  |      | 9   |   |  |     | 23  |   
|                      
|                      
|                      
|                      
|                       | Non-deductible goodwill related to sale of assets |  |      |    |      |  |      | 14  |   |  |     |     |   
|                      
|                      
|                      
|                      
|                       | Increase (decrease) in valuation allowance        |  |      | 21 |      |  |      | (32 | ) |  |     | (26 | ) 
|                       |                                                   |  |      |    |      |  |      |     |   |  |     |    
|                       | Effective tax rate                                |  |      | (5 | %)   |  |      | 38  | % |  |     | (23 | )%
|                       |                                                   |  |      |    |      |  |      |     |   |  |     |    

The components of the Companys deferred income tax assets and liabilities
for the years ended July 31 are shown below:

|                                 |                                                  |   |            |           |      |   |           |           |   |   |            |           | 
|-------------------------------- | ------------------------------------------------ | - | ---------- | --------- | ---- | - | --------- | --------- | - | - | ---------- | --------- | 
|                                 |                                                  |   | 2001       |           | 2000 |   | 1999     
|                                 |                                                  |   |            |           |      |   |          
|Deferred income tax assets:      |                                                  |   |            |           |      |   |           |           |   |   |            |          
|                                
|                                
|                                
|                                
|                                 | Net operating loss carryforwards                 |   | $          | 5,563,000 |      |   | $         | 3,767,000 |   |   | $          | 6,635,000 | 
|                                
|                                
|                                
|                                
|                                 | Allowance for obsolete or discontinued
inventory |   |            | 74,000    |      |   |           | 59,000    |   |   |            | 164,000   | 
|                                
|                                
|                                
|                                
|                                 | Alternative minimum tax credit                   |   |            | 154,000   |      |   |           | 154,000   |   |   |            |           | 
|                                
|                                
|                                
|                                
|                                 | Book basis vs. tax basis differences             |   |            | (392,000  | )    |   |           | (547,000  | ) |   |            | 370,000   | 
|                                
|                                
|                                
|                                
|                                 | Reserve for litigation                           |   |            | 40,000    |      |   |           | 16,000    |   |   |            | 29,000    | 
|                                
|                                
|                                
|                                
|                                 | Allowance for doubtful accounts                  |   |            | 123,000   |      |   |           | 136,000   |   |   |            | 151,000   | 
|                                
|                                
|                                
|                                
|                                 | Accrued vacation                                 |   |            | 143,000   |      |   |           | 93,000    |   |   |            | 78,000    | 
|                                
|                                
|                                
|                                
|                                 | Accrued bonus                                    |   |            |           |      |   |           | 264,000   |   |   |            | 32,000    | 
|                                
|                                
|                                
|                                
|                                 | Other                                            |   |            | 165,000   |      |   |           | 156,000   |   |   |            | 107,000   | 
|                                 |                                                  |   |            |           |      |   |           |           |   |   |            |          
|Total deferred income tax assets |                                                  |   | 5,870,000  |           |      |   | 4,098,000 |           |   |   | 7,566,000  |          
|                                
|                                
|                                
|                                
|Valuation allowance              |                                                  |   | (2,370,000 | )         |      |   | (948,000  | )         |   |   | (3,860,000 | )        
|                                 |                                                  |   |            |           |      |   |           |           |   |   |            |          
|Net deferred income tax assets   |                                                  | $ | 3,500,000  |           |      | $ | 3,150,000 |           |   | $ | 3,706,000  |          
|                                 |                                                  |   |            |           |      |   |           |           |   |   |            |          

F-16



---



##### Table of Contents



Deferred income taxes reflect the tax effect of temporary differences
between the amounts of assets and liabilities recognized for financial
reporting and tax purposes. The Company has offset its net deferred tax assets
with a valuation allowance due to the Companys lack of earnings history.
Management believes the valuation allowance reduces deferred tax assets to an
amount that represents managements best estimate of the amount of such
deferred tax assets that more likely than not will be realized.

At July 31, 2001, the Company recorded an income tax benefit of $335,000.
The Company recorded income tax expense of $1.8 million at July 31, 2000, which
is net of $2.9 million in income tax benefit resulting from the reversal of a
valuation allowance ($1 million of which was attributable to the exercise of
common stock options and therefore credited to capital in excess of par value).

At July 31, 2001, the Company had federal net operating loss carryforwards
totaling approximately $14,331,000 that expire, if not previously utilized,
from 2007 through 2022. Net operating loss carryforwards for state income tax
purposes, totaling approximately $4,733,000, must be utilized within five years
of the date of their origination, and expire from 2002 through 2006.

10. Convertible Preferred Stock

On February 1, 2001, the Company issued 100,000 shares of Series B
convertible preferred stock to National Healthcare Manufacturing Corporation,
U.S. as part of the acquisition of the patent rights and the Antioch, Illinois
manufacturing operations for swab products. The preferred stock is convertible
into shares of the Companys common stock at any time at a conversion ratio of
one to one. The holders of the preferred stock are entitled to receive
cumulative quarterly dividends at a rate of $0.0975 per share per fiscal
quarter, payable in arrears. Holders of the preferred shares have no voting
rights except as required by applicable law.

11. Treasury Stock

During the quarter ended January 31, 2000, the Company began acquiring
shares of its common stock in conjunction with a stock repurchase program
announced in November 1999. That program authorized the repurchase of up to
one million shares of Zila common stock from time to time on the open market
depending on market conditions and other factors. As of July 31, 2001, the
Company purchased 195,000 shares of common stock at an aggregate cost of
$535,120.

12. Other Comprehensive (Loss) Income

Statements of Comprehensive
(Loss) Income

|                                                                  |  |   |            |                      |  |      |           |      |  |   |            |   |  | 
|----------------------------------------------------------------- |  | - | ---------- | -------------------- |  | ---- | --------- | ---- |  | - | ---------- | - |  | 
|                                                                  |  |   |            | Years Ended
July 31,
|                                                                  |  |   |            |                     
|                                                                  |  |   |            | 2001                 |  | 2000 |           | 1999
|                                                                  |  |   |            |                      |  |      |           |     
|Net
(loss) income                                                 |  | $ | (6,313,823 | )                    |  | $    | 2,932,027 |      |  | $ | (1,966,982 | )
|Other
comprehensive income (loss), net of tax:                    |  |   |            |                      |  |      |           |      |  |   |            |  
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|Foreign
currency translation adjustment                           |  |   | 75,810     |                      |  |      | 75,166    |      |  |   |            |  
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|Unrealized
holding losses on securities arising during the period |  |   |           |                      |  |      | (3,500    | )    |  |   |           |  
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|Reclassification
of holdings losses included in net loss          |  |   | 3,500      |                      |  |      |          |      |  |   |           |  
|                                                                  |  |   |            |                      | 
|Other
comprehensive income                                        |  |   | 79,310     |                      |  |      | 71,666    |      |  |   |           |  
|                                                                  |  |   |            |                      | 
|                                                                 
|                                                                 
|                                                                 
|                                                                 
|Comprehensive
(loss) income                                       |  | $ | (6,234,513 | )                    |  | $    | 3,003,693 |      |  | $ | (1,966,982 | )
|                                                                  |  |   |            |                      |  |      |           |      | 

The changes in the components of other comprehensive income were as
follows:

|                          |  |                                   |         |                  |        |                           |        |                   |        |   |         |   |        | 
|------------------------- |  | --------------------------------- | ------- | ---------------- | ------ | ------------------------- | ------ | ----------------- | ------ | - | ------- | - | ------ | 
|                          |  |                                   |         | Foreign Currency |        | Unrealized Holding (Loss) |        | Accumulated
Other
|                          |  |                                   |         | Translation      |        | Gains on                  |        | Comprehensive    
|                          |  |                                   |         | Adjustments      |        | Securities                |        | Income           
|                          |  |                                   |         |                  |        |                           |        |                  
|Balance at August 1, 1999 |  |                                   |        |                  |        |                           |       |                   |        |   |        |  
|                         
|                         
|                         
|                         
|                          |  | Other comprehensive income
(loss) |         | $                | 75,166 |                           |        | $                 | (3,500 | ) |         | $ | 71,666 | 
|                         
|Balance at July 31, 2000  |  |                                   | 75,166  |                  |        |                           | (3,500 | )                 |        |   | 71,666  |  
|                         
|                         
|                         
|                         
|                          |  | Other comprehensive income        |         |                  | 75,810 |                           |        |                   | 3,500  |   |         |   | 79,310 | 
|                         
|Balance at July 31, 2001  |  | $                                 | 150,976 |                  |        |                           |       |                   |        | $ | 150,976 |  
|                          |  |                                   |         |                  |        |                           |        |                   |        |   |         |  

F-17



---



##### Table of Contents



13. Commitments and Contingencies

In June 1992, the Company entered into an agreement with Daleco Capital
Corporation to form a limited partnership known as Daleco Zila Partners II,
L.P. (the Partnership). The Company and its officers have no partnership
interest in the Partnership. The purpose of the Partnership was to provide the
Company with a means to fund the marketing program for certain products. The
original Partnership agreement provided for a minimum of $150,000 and a maximum
of $1,562,500 to be raised by the sale of partnership units. Under the original
agreement, the Partnership will expend up to 80% of the gross partnership
proceeds for marketing and sales-related expenditures on behalf of the Company.
In 1994, the Partnership agreement was amended to increase the maximum amount
of marketing funds potentially available to the Company to be raised to
$2,250,000. At July 31, 2001, approximately $1,820,000 has been spent.

The Company is committed to pay the Partnership a commission equal to 5%
to 10% of the gross sales of certain of the Companys products, until such time
as three times the amount of funds expended on the Companys marketing program
by the Partnership has been paid to the Partnership. The Company has paid
commissions to the Partnership of approximately $15,000, $16,000 and $31,000
for the years ended July 31, 2001, 2000 and 1999, respectively.

In connection with the acquisition of patent rights in 1980, the Company
agreed to pay to Dr. James E. Tinnell (Tinnell), the inventor of one of the
Companys treatment compositions, a royalty of 5% of gross sales of the
invention disclosed in his then pending patent application. Royalty expense to
Tinnell for the years ended July 31, 2001, 2000 and 1999 was $38,000, $449,916
and $390,170, respectively.

In September 2000, counsel advised Zila that its obligation to pay
royalties to Tinnell, under a 1980 agreement ceased as of August 25, 1998 when
the patent expired. In September 2000, Zila gave notice to Tinnell that it
would not continue paying such royalties and requested reimbursement of
royalties paid since August 1998. After attempts to settle the matter failed,
Zila filed suit in the Federal District Court for the District of Nevada (Zila,
Inc. v. James E. Tinnell, No. CV-S-00-1344), requesting a declaratory judgment
that it had no royalty obligations to Tinnell after August 1998 and judgment
for the overpaid royalties.

Tinnell asserted a counterclaim for royalties since the last payment in
August 2000 and several additional counterclaims based on transactions between
Tinnell and Zila in the 1980s. Counsel have advised Zila that, based on their
investigations and discovery to date, that (1) the counterclaim for royalties
is without merit and (2) the additional counterclaims are meritless and, in any
event, are time-barred by the applicable statutes of limitation.

The Company is pursuing approval of a New Drug Application (NDA) with
the FDA for OraTest®. The initiation of the marketing of OraTest® in the United
States is dependent upon the approval of the NDA by the FDA. During 1994, the
FDA approved the Companys application for an Investigational New Drugfor
OraTest, which allows the Company to manufacture the product in the United
States for clinical studies and export to certain foreign countries. In
November 1998, the FDA notified the Company that the OraTest® NDA was being
given priority review, which targeted agency review within six months from
September 3, 1998, the date when the Company provided additional data to the
FDA. On January 13, 1999, the FDAs Oncologic Drugs Advisory Committee (the
Committee) met to review the OraTest® NDA and recommended, among other
things, that the FDA not approve the NDA as submitted. Subsequent to the
Committee meeting, Company representatives engaged in a dialog with the FDA,
culminating in meetings at the agency in 1999 and 2000.

On March 3, 1999, the Company received an action letter from the FDA
outlining certain deficiencies in the OraTest® NDA that prevented the FDA from
approving the product at that time. The FDAs letter detailed a procedure for
amending the NDA to rectify those matters. In November 1999, the Company
contracted with ILEX Oncology Services, Inc. (ILEX), a wholly-owned subsidiary of ILEX
Oncology, Inc. of San Antonio, Texas, for management of clinical research and
liaison with the FDA related to the Companys pursuit of regulatory approval
for the OraTest® oral cancer detection product. In March 2000, the Company paid
approximately $792,000 to ILEX as a deposit on estimated expenses related to an
FDA-required clinical study associated with the Companys ongoing efforts to
obtain FDA approval of OraTest®. Current commitments under the ILEX agreement
include a monthly installment payment of $76,000 plus reimbursement for out of
pocket expenses as they occur during the course of the study. The contract or
any workplan may be terminated at any time by Zila upon not less than 90 days
prior written notice of termination to ILEX. If the agreement is so
terminated, Zila shall pay ILEX any amount owed, but not yet paid, for work
performed prior to the date of termination.

F-18



---



##### Table of Contents



The Company leases offices, warehouse facilities and certain equipment,
under operating leases that expire through 2006. Future minimum lease payments
under these non-cancelable leases are as follows:

|      |  |   |           | 
|----- |  | - | --------- | 
|2002  |  | $ | 492,464   | 
|     
|     
|     
|     
|2003  |  |   | 489,881   | 
|     
|     
|     
|     
|2004  |  |   | 501,499   | 
|     
|     
|     
|     
|2005  |  |   | 310,632   | 
|     
|     
|     
|     
|2006  |  |   | 111,919   | 
|      |  |   |           | 
|Total |  | $ | 1,906,395 | 
|      |  |   |           | 

Rent expense for the years ended July 31, 2001, 2000 and 1999 totaled
$475,230, $352,502 and $340,170, respectively.

The Company and certain officers of the Company were named as defendants
in a consolidated First Amended Class Action Complaint filed July 6, 1999 in
the United States District Court for the District of Arizona under the caption
In re Zila Securities Litigation, No. CIV 99 0115 PHX EHC. The First Amended
Class Action Complaint sought damages in an unspecified amount on behalf of a
class consisting of purchasers of the Companys securities for alleged
violations of the federal securities laws. During the fourth quarter 2001, the
parties settled this matter without a material impact on the Companys
financial statements.

On September 8, 1999, the Securities and Exchange Commission (the
Commission) entered an order directing an investigation entitled In the Matter
of Zila, Inc.At that time, the Commission stated it was investigating, inter
alia, whether there were false and misleading statements in press releases,
filings with the Commission, or elsewhere concerning the prospects that the
Oncologic Drugs Advisory Committee for the FDA would recommend approval of the
OraTest® NDA and whether the FDA would subsequently approve the NDA. The
Company has cooperated with the Commission in its investigation. The
Company and Mr. Hines, its President, are engaged in settlement
discussions with the staff of the Commission.

The Company is subject to other legal proceedings and claims, which arise
in the ordinary course of business. In the opinion of management, the amount of
ultimate liability with respect to these actions will not materially affect the
financial position or results of operations of the Company.

14. Employee Benefit Plan
During fiscal year 2001, the Company has made available to all eligible
employees, the Zila, Inc. 401(k) Savings and Retirement Plan (the Zila Plan).
Participants may contribute, through payroll deductions, up to 15% of their
basic compensation not to exceed Internal Revenue Code limitations. The
Company may make matching or profit sharing contributions to the Zila Plan.
During 2001, 2000 and 1999, the Company contributed approximately $296,000,
$293,000 and $62,000, respectively, to the Zila Plan. Prior to fiscal year
2000, eligible Oxycal employees participated in a different 401(k) defined
contribution plan (the Oxycal Plan) whereby an employee could contribute up
to a certain maximum amount each year. During the 1999 fiscal year, Oxycal
contributed approximately $60,488 to the Oxycal Plan. Effective July 1, 1999,
the Oxycal Plan was merged into the Zila Plan.

F-19



---



##### Table of Contents



15. Segment Information

The Company is organized into four major groups, all of which have
distinct product lines, brand names and are managed as autonomous business
units. The Company has identified the following reporting segments for
purposes of applying SFAS No. 131: Consumerwhich includes Zila
Pharmaceuticals, Inc. and the Zilactin® line of products; Professionalwhich
includes Peridex®, Pro-Ties, OraTest®,and the IST line of products; Dental
Supply,which includes Bio-Dental Technologies Corporation and Ryker Dental of
Kentucky, Inc. (a subsidiary of Bio-Dental Technologies Corporation) which does
business under the name Zila Dental Supply; and Nutraceuticals,which includes
Oxycal Laboratories, Inc. and its wholly-owned subsidiary, Inter-Cal, Inc. The
Company evaluates performance and allocates resources to segments based on
operating results. Expenses related to the manufacturing facility for Zila
Tolonium Chloride and ongoing OraTest® capital expenditures and clinical study
have been combined with the Corporate segment. The Dental Imaging and Dental
Software businesses, sold in fiscal year 2000, are combined into the Other
segment. Prior to August 1, 2000, the Consumer and Professional segment were
combined and shown as the Pharmaceutical segment. The Professional segment was
removed from the Pharmaceutical segment as a result of the change in management
reporting structure. Previous segment disclosures have been restated to reflect
this presentation.

The table below presents information about reported segments for the three
years ended July 31 (in thousands):

|                                   |      |  |          |        |              |  |        |        |                |  |           |        |       |  |       |        |  |  |  |        |   |  |  |        |   |  |   |        |  
|---------------------------------- | ---- |  | -------- | ------ | ------------ |  | ------ | ------ | -------------- |  | --------- | ------ | ----- |  | ----- | ------ |  |  |  | ------ | - |  |  | ------ | - |  | - | ------ | -
|                                   |      |  |          |        |              |  |        |        |                |  | Dental    |        |       |  |       |        |  |  |  |        |   |  |  |        |   |  |  
|                                   |      |  | Consumer |        | Professional |  | Supply |        | Nutraceuticals |  | Corporate |        | Other |  | Total
|Net revenues:                      |      |  |          |        |              |  |        |        |                |  |           |        |       |  |       |        |  |  |  |        |   |  |  |        |   |  |   |       
|                                  
|                                  
|                                  
|                                  
|                                   | 2001 |  | $        | 11,816 |              |  | $      | 4,847  |                |  | $         | 41,630 |       |  | $     | 15,432 |  |  |  |        |   |  |  |        |   |  | $ | 73,725 |  
|                                  
|                                  
|                                  
|                                  
|                                   | 2000 |  |          | 11,724 |              |  |        | 5,194  |                |  |           | 39,817 |       |  |       | 19,138 |  |  |  |        |   |  |  | 1,708  |   |  |   | 77,581 |  
|                                  
|                                  
|                                  
|                                  
|                                   | 1999 |  |          | 9,131  |              |  |        | 9,328  |                |  |           | 31,534 |       |  |       | 15,005 |  |  |  |        |   |  |  | 6,297  |   |  |   | 71,295 |  
|                                  
|                                  
|                                  
|                                  
|Income (loss) before income taxes: |      |  |          |        |              |  |        |        |                |  |           |        |       |  |       |        |  |  |  |        |   |  |  |        |   |  |   |       
|                                  
|                                  
|                                  
|                                  
|                                   | 2001 |  |          | 3,950  |              |  |        | (2,778 | )              |  |           | (129   | )     |  |       | 1,173  |  |  |  | (8,865 | ) |  |  |        |   |  |   | (6,649 | )
|                                  
|                                  
|                                  
|                                  
|                                   | 2000 |  |          | 4,047  |              |  |        | (2,940 | )              |  |           | 290    |       |  |       | 5,848  |  |  |  | (6,674 | ) |  |  | 4,121  |   |  |   | 4,692  |  
|                                  
|                                  
|                                  
|                                  
|                                   | 1999 |  |          | 2,365  |              |  |        | 513    |                |  |           | 658    |       |  |       | 3,003  |  |  |  | (5,949 | ) |  |  | (3,153 | ) |  |   | (2,563 | )
|                                  
|                                  
|                                  
|                                  
|Identifiable assets:               |      |  |          |        |              |  |        |        |                |  |           |        |       |  |       |        |  |  |  |        |   |  |  |        |   |  |   |       
|                                  
|                                  
|                                  
|                                  
|                                   | 2001 |  |          | 3,197  |              |  |        | 14,576 |                |  |           | 12,033 |       |  |       | 33,769 |  |  |  | 12,982 |   |  |  |        |   |  |   | 76,557 |  
|                                  
|                                  
|                                  
|                                  
|                                   | 2000 |  |          | 3,265  |              |  |        | 10,545 |                |  |           | 12,292 |       |  |       | 32,644 |  |  |  | 18,487 |   |  |  | 478    |   |  |   | 77,711 |  
|                                  
|                                  
|                                  
|                                  
|                                   | 1999 |  |          | 2,289  |              |  |        | 10,869 |                |  |           | 10,413 |       |  |       | 29,797 |  |  |  | 18,583 |   |  |  | 4,605  |   |  |   | 76,556 |  
|                                  
|                                  
|                                  
|                                  
|Capital expenditures:              |      |  |          |        |              |  |        |        |                |  |           |        |       |  |       |        |  |  |  |        |   |  |  |        |   |  |   |       
|                                  
|                                  
|                                  
|                                  
|                                   | 2001 |  |          | 42     |              |  |        | 101    |                |  |           | 274    |       |  |       | 2,108  |  |  |  | 73     |   |  |  |        |   |  |   | 2,598  |  
|                                  
|                                  
|                                  
|                                  
|                                   | 2000 |  |          | 195    |              |  |        | 441    |                |  |           | 237    |       |  |       | 4,200  |  |  |  |        |   |  |  | 125    |   |  |   | 5,198  |  
|                                  
|                                  
|                                  
|                                  
|                                   | 1999 |  |          | 13     |              |  |        | 681    |                |  |           | 115    |       |  |       | 790    |  |  |  |        |   |  |  | 164    |   |  |   | 1,763  |  
|Depreciation and amortization:     |      |  |          |        |              |  |        |        |                |  |           |        |       |  |       |        |  |  |  |        |   |  |  |        |   |  |   |       
|                                  
|                                  
|                                  
|                                  
|                                   | 2001 |  |          | 78     |              |  |        | 1,167  |                |  |           | 268    |       |  |       | 1,159  |  |  |  | 853    |   |  |  |        |   |  |   | 3,525  |  
|                                  
|                                  
|                                  
|                                  
|                                   | 2000 |  |          | 46     |              |  |        | 998    |                |  |           | 300    |       |  |       | 1,021  |  |  |  | 968    |   |  |  | 145    |   |  |   | 3,478  |  
|                                  
|                                  
|                                  
|                                  
|                                   | 1999 |  |          | 46     |              |  |        | 987    |                |  |           | 293    |       |  |       | 833    |  |  |  | 897    |   |  |  | 526    |   |  |   | 3,582  |  

Revenues from customers attributed to all foreign countries from which the
Company derives revenue were $5,646,000, $5,681,000, and $2,934,000 for the
years ended July 31, 2001, 2000 and 1999, respectively.

F-20



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##### Table of Contents



16. Quarterly Financial Data (Unaudited)

Quarterly financial information is presented in the following summary:

|                                      |  |                |            |            |  |          |            |         |  |   |            |   |  |   |            | 
|------------------------------------- |  | -------------- | ---------- | ---------- |  | -------- | ---------- | ------- |  | - | ---------- | - |  | - | ---------- | 
|                                      |  | 2001          
|                                      |  |               
|                                      |  | Quarters Ended
|                                      |  |               
|                                      |  | October 31     |            | January 31 |  | April 30 |            | July 31
|                                      |  |                |            |            |  |          |            |        
|Net revenues                          |  | $              | 18,836,235 |            |  | $        | 18,557,361 |         |  | $ | 16,233,762 |   |  | $ | 20,097,565 | 
|                                     
|                                     
|                                     
|                                     
|Gross profit                          |  |                | 8,720,572  |            |  |          | 8,277,662  |         |  |   | 6,294,542  |   |  |   | 9,007,064  | 
|                                     
|                                     
|                                     
|                                     
|Net (loss) income                     |  |                | (162,555   | )          |  |          | (1,626,431 | )       |  |   | (5,092,959 | ) |  |   | 568,122    | 
|                                     
|                                     
|                                     
|                                     
|Net (loss) income per share  basic   |  |                | (0.00      | )          |  |          | (0.04      | )       |  |   | (0.12      | ) |  |   | 0.01       | 
|                                     
|                                     
|                                     
|                                     
|Net (loss) income per share  diluted |  |                | (0.00      | )          |  |          | (0.04      | )       |  |   | (0.12      | ) |  |   | 0.01       | 

|                                      |  |                |            |            |  |          |            |         |  |   |            |  |  |   |            | 
|------------------------------------- |  | -------------- | ---------- | ---------- |  | -------- | ---------- | ------- |  | - | ---------- |  |  | - | ---------- | 
|                                      |  | 2000          
|                                      |  |               
|                                      |  | Quarters Ended
|                                      |  |               
|                                      |  | October 31     |            | January 31 |  | April 30 |            | July 31
|                                      |  |                |            |            |  |          |            |        
|Net revenues                          |  | $              | 19,171,593 |            |  | $        | 20,216,797 |         |  | $ | 19,422,777 |  |  | $ | 18,769,741 | 
|                                     
|                                     
|                                     
|                                     
|Gross profit                          |  |                | 9,669,362  |            |  |          | 9,850,710  |         |  |   | 9,311,819  |  |  |   | 8,744,626  | 
|                                     
|                                     
|                                     
|                                     
|Net (loss) income                     |  |                | (51,382    | )          |  |          | 1,964,252  |         |  |   | 16,413     |  |  |   | 1,002,744  | 
|                                     
|                                     
|                                     
|                                     
|Net (loss) income per share  basic   |  |                | 0.00       |            |  |          | 0.05       |         |  |   | 0.00       |  |  |   | 0.02       | 
|                                     
|                                     
|                                     
|                                     
|Net (loss) income per share  diluted |  |                | 0.00       |            |  |          | 0.05       |         |  |   | 0.00       |  |  |   | 0.02       | 

F-21



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##### Table of Contents



INDEX TO EXHIBITS

|        |  |                                                                                                                                                                                                           |  |                 
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------
|Exhibit |  |                                                                                                                                                                                                           |  |                 
|Number  |  | Description                                                                                                                                                                                               |  | Method of Filing
|        |  |                                                                                                                                                                                                           |  |                 
|3-A     |  | Certificate of Incorporation, as amended                                                                                                                                                                  |  | A               
|       
|       
|       
|       
|3-B     |  | Bylaws                                                                                                                                                                                                    |  | A               
|       
|       
|       
|       
|3-C     |  | Certificate of Designations, Preferences and Rights of Series A
Convertible Preferred Stock                                                                                                               |  | C               
|       
|       
|       
|       
|3-D     |  | Certificate of Designations, Preferences and Rights of Series B
Convertible Preferred Stock                                                                                                               |  | *               
|       
|       
|       
|       
|4-A     |  | Specimen Stock Certificate                                                                                                                                                                                |  | A               
|       
|       
|       
|       
|10-A    |  | Revolving Line of Credit Loan Agreement dated February 1, 1999 between
Zila, Inc. and Bank One, Arizona                                                                                                   |  | A               
|       
|       
|       
|       
|10-B    |  | Stock Option Award Plan (as amended through April 10, 1991)                                                                                                                                               |  | B               
|       
|       
|       
|       
|10-C    |  | Non-Employee Directors Stock Option Plan (as amended through April 10, 1991)                                                                                                                              |  | B               
|       
|       
|       
|       
|10-L    |  | Asset Purchase Agreement dated October 28, 1999 between Zila, Inc., Cygnus
Imaging, Inc. and Procare Laboratories, Inc.                                                                                   |  | A               
|       
|       
|       
|       
|10-M    |  | Secured Note dated October 28, 1999 between Zila, Inc. and Procare Laboratories, Inc.                                                                                                                     |  | A               
|       
|       
|       
|       
|10-N    |  | Asset Purchase agreement dated as of November 30, 1999 by and among Zila, Inc.,
Integrated Dental Technologies, Inc., InfoCure Systems, Inc., and InfoCure Corporation                                    |  | E               
|       
|       
|       
|       
|10-O    |  | Revolving Line of Credit Loan Agreement dated December 1, 2000 between Zila, Inc.
and Bank One, Arizona, NA.                                                                                              |  | H               
|       
|       
|       
|       
|10-P    |  | First Loan Modification Agreement dated May 7, 2001 between Zila, Inc.
and Bank One Arizona, NA.                                                                                                          |  | H               
|       
|       
|       
|       
|10-Q    |  | Engagement Letter dated March 15, 2001 between Zila, Inc. and
Douglas, Curtis and Allyn, LLC                                                                                                              |  | H               
|       
|       
|       
|       
|10-R    |  | Extension to First Loan Modification Agreement dated effective May 31, 2001
between Zila, Inc. and Bank One Arizona, NA.                                                                                  |  | H               
|       
|       
|       
|       
|10-S    |  | Second Extension to First Loan Modification Agreement dated effective June 29, 2001
between Zila, Inc. and Bank One Arizona, NA.                                                                          |  | I               
|       
|       
|       
|       
|10-T    |  | Third Extension to First Loan Modification Agreement dated effective July 31, 2001
between Zila, Inc. and Bank One Arizona, NA.                                                                           |  | J               
|       
|       
|       
|       
|10-U    |  | 1997 Stock Option Award Plan (as amended through September 13, 2001)                                                                                                                                      |  | G               
|       
|       
|       
|       
|10-V    |  | Employee Stock Purchase Plan                                                                                                                                                                              |  | F               
|       
|       
|       
|       
|10-W    |  | Loan and Security Agreement dated August 17, 2001 by and between Congress Financial
Corporation and Zila, Inc., Zila Pharmaceuticals, Inc. Ryker Dental of Kentucky, Inc. and
Inter-Cal Corporation, Inc. |  | K               
|       
|       
|       
|       
|21      |  | Subsidiaries of Registrant                                                                                                                                                                                |  | D               
|       
|       
|       
|       
|23      |  | Consent of Deloitte & Touche LLP (regarding Form S-8 Registration Statements)                                                                                                                             |  | *               
|       
|       
|       
|       
|24-A    |  | Power of Attorney of Joseph Hines                                                                                                                                                                         |  | L               
|       
|       
|       
|       
|24-B    |  | Power of Attorney of Bradley C. Anderson                                                                                                                                                                  |  | L               
|       
|       
|       
|       
|24-C    |  | Power of Attorney of Carl A. Schroeder                                                                                                                                                                    |  | L               
|       
|       
|       
|       
|24-D    |  | Power of Attorney of Michael S. Lesser                                                                                                                                                                    |  | L               
|       
|       
|       
|       
|24-E    |  | Power of Attorney of Curtis M. Rocca                                                                                                                                                                      |  | L               
|       
|       
|       
|       
|24-F    |  | Power of Attorney of Christopher D. Johnson                                                                                                                                                               |  | L               
|       
|       
|       
|       
|24-G    |  | Power of Attorney of Kevin J. Tourek                                                                                                                                                                      |  | L               



|* |  | Filed 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 Quarterly Report on Form 10-Q for the
quarterly period ended January 31, 1996, as amended
| 
| 
| 
| 
|C |  | Incorporated by reference to the Companys Annual Report on Form 10-K for fiscal
year ended July 31, 1997                           





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##### Table of Contents



|  |  |                                                                                                                                     
|- |  | ------------------------------------------------------------------------------------------------------------------------------------
| 
| 
| 
| 
|D |  | Incorporated by reference to the Companys Annual Report on Form 10-K for fiscal
year ended July 31, 1998                           
| 
| 
| 
| 
|E |  | Incorporated by reference to the Companys Current Report on Form 8-K dated January 3, 2000                                         
| 
| 
| 
| 
|F |  | Incorporated by reference to the Companys Form S-8 Registration Statement No. 333-54958
dated February 5, 2001                     
| 
| 
| 
| 
|G |  | Incorporated by reference to the Companys Form S-8 Registration Statement No. 333-54960
dated February 5, 2001                     
| 
| 
| 
| 
|H |  | Incorporated by reference to the Companys Quarterly Report on Form 10-Q for the
quarterly period ended April 30, 2001              
| 
| 
| 
| 
|I |  | Incorporated by reference to the Companys Current Report on Form 8-K dated June 29, 2001                                           
| 
| 
| 
| 
|J |  | Incorporated by reference to the Companys Current Report on Form 8-K dated July 31, 2001                                           
| 
| 
| 
| 
|K |  | Incorporated by reference to the Companys Current Report on Form 8-K dated August 17, 2001                                         
| 
| 
| 
| 
|L |  | Incorporated by reference to the Companys Annual Report on Form 10-K for fiscal year ended July 31, 2001 located on signature page.