##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
 
 Form 10-Q
 QUARTERLY REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
 For the Fiscal Quarter Ended
April 30, 2006
    
    Commission File Number
0-17521
 ZILA, INC.
 (Exact Name of Registrant as Specified in its Charter)
 Delaware(State or Other Jurisdiction of
Incorporation)
    
    86-0619668(I.R.S. Employer
Identification No.)
 5227 North 7th Street, Phoenix, Arizona 85014-2800  (Address of Principal Executive Offices)
 (602) 266-6700
  þ o
  Large Accelerated Filer o
    
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ZILA, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED APRIL 30, 2006
TABLE OF CONTENTS
 PagePart I. FINANCIAL INFORMATION (UNAUDITED)Item 1. Financial StatementsConsolidated Balance Sheets as of April 30, 2006 and July 31, 2005
    
    
    3Consolidated Statements of Operations and Comprehensive Loss for the three-month and nine-month periods ended April 30, 2006 and 2005
    
    
    4Consolidated Statements of Cash Flows for the nine-month periods ended April 30, 2006 and 2005
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3.Quantitative and Qualitative Disclosures about Market Risk
    
    
    27Item 4. Controls and Procedures
    
    
    27Part II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    27Item 1A. Risk Factors
    
    
    28Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    35Item 3. Defaults upon Senior Securities
    
    
    35Item 4. Submission of Matters to a Vote of Security Holders
    
    
    35Item 5. Other Information
    
    
    35Item 6. Exhibits
    
    
    35SIGNATURES
    
    
    36INDEX TO EXHIBITS
    
    
    37Exhibit 4.1Exhibit 4.2Exhibit 10.1Exhibit 10.2Exhibit 10.3Exhibit 10.4Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION (UNAUDITED)
 
 Item 1. Financial Statements.
 ZILA, INC. AND SUBSIDIARIES
 
 CONSOLIDATED BALANCE SHEETS
 April 30,
    
    
    July 31,2006
    
    
    2005(Unaudited)ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    9,173,927
    
    
    $
    12,937,517Restricted cash collateral
    
    
    3,599,806
    
    
    
    527,783Trade receivables  net of allowances of $95,000 and $150,000
    
    
    7,559,041
    
    
    
    11,422,743Inventories  net
    
    
    7,868,817
    
    
    
    6,024,266Prepaid expenses and other current assets
    
    
    2,161,015
    
    
    
    1,726,778Total current assets
    
    
    30,362,606
    
    
    
    32,639,087Property and equipment  net
    
    
    9,531,679
    
    
    
    9,691,686Purchased technology  net
    
    
    2,672,606
    
    
    
    3,031,613Goodwill  net
    
    
    6,930,192
    
    
    
    6,930,192Trademarks and other intangible assets  net
    
    
    12,812,985
    
    
    
    12,652,564Other assets
    
    
    2,501,555
    
    
    
    473,095Total Assets
    
    $
    64,811,623
    
    
    $
    65,418,237LIABILITIES AND SHAREHOLDERS EQUITYCurrent Liabilities:Accounts payable
    
    $
    3,236,816
    
    
    $
    5,397,213Accrued liabilities
    
    
    5,349,428
    
    
    
    3,717,630Warrant liability
    
    
    2,330,770
    
    
    
    Short-term borrowings
    
    
    91,475
    
    
    
    154,335Deferred revenue and deferred gain on sale leaseback
    
    
    152,976
    
    
    
    221,726Current portion of long-term debt and capital lease obligations
    
    
    315,319
    
    
    
    323,758Total current liabilities
    
    
    11,476,784
    
    
    
    9,814,662Deferred revenue and deferred gain on sale leaseback
    
    
    266,879
    
    
    
    553,486Long-term debt and capital lease obligations  net of discount and current portion
    
    
    21,100,294
    
    
    
    3,328,139Total liabilities
    
    
    32,843,957
    
    
    
    13,696,287Commitments and contingencies (Note 13)Shareholders Equity:Preferred stock  Series B, $.001 par value - 2,500,000 shares authorized,
100,000 shares issued and outstanding
    
    
    462,500
    
    
    
    462,500Common stock, $.001 par value - 65,000,000 shares authorized,
45,965,002 shares and 45,864,050 shares issued and outstanding
    
    
    45,965
    
    
    
    45,864Capital in excess of par value
    
    
    84,980,740
    
    
    
    84,372,257Accumulated other comprehensive loss
    
    
    (74,713
    )
    
    
    (63,924
    )Accumulated deficit
    
    
    (52,895,755
    )
    
    
    (32,543,676
    )Common stock in treasury, at cost (218,411 shares)
    
    
    (551,071
    )
    
    
    (551,071
    )Total shareholders equity
    
    
    31,967,666
    
    
    
    51,721,950Total Liabilities and Shareholders Equity
    
    $
    64,811,623
    
    
    $
    65,418,237
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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
 Three months ended April 30,
    
    
    Nine months ended April 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net revenues
    
    $
    6,750,369
    
    
    $
    12,019,926
    
    
    $
    26,051,715
    
    
    $
    32,826,468Cost of products sold
    
    
    2,968,796
    
    
    
    3,909,493
    
    
    
    11,037,802
    
    
    
    11,059,756Gross profit
    
    
    3,781,573
    
    
    
    8,110,433
    
    
    
    15,013,913
    
    
    
    21,766,712Operating costs and expenses:Marketing and selling
    
    
    4,028,805
    
    
    
    4,578,858
    
    
    
    15,734,471
    
    
    
    13,741,365General and administrative
    
    
    3,376,455
    
    
    
    3,383,552
    
    
    
    10,115,705
    
    
    
    8,893,458Research and development
    
    
    2,654,219
    
    
    
    1,635,960
    
    
    
    6,211,310
    
    
    
    5,196,683Depreciation and amortization
    
    
    768,688
    
    
    
    701,237
    
    
    
    2,216,775
    
    
    
    2,015,99810,828,167
    
    
    
    10,299,607
    
    
    
    34,278,261
    
    
    
    29,847,504Loss from operations
    
    
    (7,046,594
    )
    
    
    (2,189,174
    )
    
    
    (19,264,348
    )
    
    
    (8,080,792
    )Other income (expense):Interest income
    
    
    82,913
    
    
    
    35,212
    
    
    
    230,517
    
    
    
    128,929Interest expense
    
    
    (787,634
    )
    
    
    (43,675
    )
    
    
    (897,502
    )
    
    
    (143,553
    )Loss on sale of assets
    
    
    (1,625
    )
    
    
    (3,395
    )
    
    
    (26,518
    )
    
    
    (4,647
    )Other expense
    
    
    (244,216
    )
    
    
    (27,737
    )
    
    
    (278,752
    )
    
    
    (73,922
    )(950,562
    )
    
    
    (39,595
    )
    
    
    (972,255
    )
    
    
    (93,193
    )Loss from continuing operations before income taxes
    
    
    (7,997,156
    )
    
    
    (2,228,769
    )
    
    
    (20,236,603
    )
    
    
    (8,173,985
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    (3,600
    )
    
    
    (1,955
    )Loss from continuing operations
    
    
    (7,997,156
    )
    
    
    (2,228,769
    )
    
    
    (20,240,203
    )
    
    
    (8,175,940
    )Income (loss) from discontinued operations
    
    
    (77,702
    )
    
    
    78,011
    
    
    
    (82,626
    )
    
    
    657,216Net loss
    
    
    (8,074,858
    )
    
    
    (2,150,758
    )
    
    
    (20,322,829
    )
    
    
    (7,518,724
    )Preferred stock dividends
    
    
    9,750
    
    
    
    9,750
    
    
    
    29,250
    
    
    
    29,250Net loss attributable to common shareholders
    
    $
    (8,084,608
    )
    
    $
    (2,160,508
    )
    
    $
    (20,352,079
    )
    
    $
    (7,547,974
    )Basic and diluted net income (loss) per common
share:Loss from continuing operations
    
    $
    (0.18
    )
    
    $
    (0.05
    )
    
    $
    (0.45
    )
    
    $
    (0.18
    )Income (loss) from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.01Net loss
    
    $
    (0.18
    )
    
    $
    (0.05
    )
    
    $
    (0.45
    )
    
    $
    (0.17
    )Weighted average shares outstanding
    
    
    45,734,371
    
    
    
    45,600,364
    
    
    
    45,683,925
    
    
    
    45,550,966Net loss
    
    $
    (8,074,858
    )
    
    $
    (2,150,758
    )
    
    $
    (20,322,829
    )
    
    $
    (7,518,724
    )Foreign currency translation adjustments
    
    
    (11,838
    )
    
    
    (1,872
    )
    
    
    (10,789
    )
    
    
    (6,279
    )Comprehensive loss
    
    $
    (8,086,696
    )
    
    $
    (2,152,630
    )
    
    $
    (20,333,618
    )
    
    $
    (7,525,003
    )
  4




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 Nine months ended April 30,2006
    
    
    2005Operating activities:Net loss
    
    $
    (20,322,829
    )
    
    $
    (7,518,724
    )Adjustments to reconcile net loss to net cash
used in operating activities:Depreciation and amortization continuing operations
    
    
    2,216,775
    
    
    
    2,015,998Depreciation and amortization discontinued operations
    
    
    
    
    
    
    49,261Amortization of deferred financing costs
    
    
    203,604
    
    
    
    27,123Amortization of term loan discount
    
    
    114,064
    
    
    
    Non cash interest expense on term loan
    
    
    76,759
    
    
    
    Increase in fair value of warrant liability
    
    
    97,526
    
    
    
    Loss on sale of assets
    
    
    26,518
    
    
    
    4,647Noncash stock based compensation expense
    
    
    329,041
    
    
    
    24,201Options issued for services
    
    
    63,064
    
    
    
    Noncash research and development expense
    
    
    
    
    
    
    49,000Deferred revenue and deferred gain on sale leaseback
    
    
    (362,038
    )
    
    
    (166,860
    )Other
    
    
    53,264
    
    
    
    141,604Change in assets and liabilities:Receivables  net
    
    
    3,863,702
    
    
    
    (2,196,649
    )Inventories
    
    
    (1,844,551
    )
    
    
    (190,128
    )Prepaid expenses and other assets
    
    
    (386,452
    )
    
    
    (210,801
    )Accounts payable and accrued liabilities
    
    
    (521,919
    )
    
    
    3,162,774Net cash used by operating activities
    
    
    (16,393,472
    )
    
    
    (4,808,554
    )Investing activities:Additions to property and equipment, net
    
    
    (942,982
    )
    
    
    (1,134,754
    )Additions to intangible assets, net
    
    
    (956,387
    )
    
    
    (505,799
    )Proceeds from disposition of assets
    
    
    8,463
    
    
    
    500Proceeds from sale of short-term investments
    
    
    
    
    
    
    7,000,000Restricted cash deposited to collaterize letter of credit
    
    
    (3,072,023
    )
    
    
    (3,707
    )Net cash provided (used) by investing activities
    
    
    (4,962,929
    )
    
    
    5,356,240Financing activities:Net proceeds (repayments) from short-term borrowing
    
    
    3,417,932
    
    
    
    255,444Repayment of short-term borrowing from term loan proceeds
    
    
    (3,480,792
    )
    
    
    Proceeds from issuance of common stock
    
    
    216,479
    
    
    
    212,134Dividends paid to preferred stockholders
    
    
    (29,250
    )
    
    
    (58,500
    )Proceeds from long-term borrowings
    
    
    20,000,000
    
    
    
    Financing costs paid for term loan
    
    
    (2,273,192
    )
    
    
    Principal payments on long-term debt
    
    
    (258,366
    )
    
    
    (259,635
    )Net cash provided by financing activities
    
    
    17,592,811
    
    
    
    149,443Net change in cash and cash equivalents
    
    
    (3,763,590
    )
    
    
    697,129Cash and cash equivalents at beginning of period
    
    
    12,937,517
    
    
    
    3,679,915Cash and cash equivalents at end of period
    
    $
    9,173,927
    
    
    $
    4,377,044
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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
 1. ORGANIZATION AND BASIS OF PRESENTATION
  Advanced Protection ® ® ® ® ® ®
   Reclassifications
 ®
 Business Concentration
    Three months ended
    
    Nine months endedApril 30,
    
    April 30,2006
    
    2005
    
    2006
    
    2005Customer A
    
    
    *
    %
    
    
    45.7
    %
    
    
    15.6
    %
    
    
    45.7
    %Customer B
    
    
    *
    
    
    
    10.0
    
    
    
    12.1
    
    
    
    10.2
 
 *
    
    Less than 10% 6




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##### Table of Contents



April 30,
    
    July 31,2006
    
    2005Customer A
    
    
    10.0
    %
    
    
    24.5
    %Customer B
    
    
    13.7
    
    
    
    17.7Customer C
    
    
    *
    
    
    
    10.6
 
 *
    
    Less than 10% Recent Accounting Pronouncements
 Hybrid Instruments ( )  Accounting for Derivative Instruments
and Hedging Activities ), Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ) Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.
 Practical
Accommodation to the Application of Grant Date as Defined in FASB Statement No. 123R
 Transition Election
Related to Accounting for the Tax Effects of Share-Based Payment Awards Accounting for Stock-Based Compensation.
 2. STOCK BASED COMPENSATION
 Share-Based Payment Accounting for Stock-Based Compensation Accounting for Stock Issued to Employees
  7




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Three
    
    
    NineMonths
    
    
    MonthsEnded
    
    
    EndedApril 30,
    
    
    April 30,2005
    
    
    2005Net loss attributable to common shareholders:As reported
    
    $
    (2,161
    )
    
    $
    (7,548
    )Add: Employee compensation expense for equity awards recorded at fair value included
in the determination of net loss as reported
    
    
    1
    
    
    
    24Less: Employee compensation expense determined under fair value based method for all
awards, net of related tax effects
    
    
    2,980
    
    
    
    3,780Pro-forma net loss
    
    $
    (5,140
    )
    
    $
    (11,304
    )Net loss attributable to common shareholders per basic and diluted share outstanding:As reported
    
    $
    (0.05
    )
    
    $
    (0.17
    )Pro forma
    
    $
    (0.11
    )
    
    $
    (0.25
    )
 3. STOCK OPTIONS AND WARRANTS
 Stock Options
 8




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##### Table of Contents



WeightedWeighted
    
    AverageAverage
    
    Remaining
    
    AggregateNumber
    
    Exercise
    
    Contractual
    
    Intrinsicof Shares
    
    Price
    
    Term
    
    ValueBalance outstanding at July 31, 2005
    
    
    2,345
    
    
    $
    3.58Granted
    
    
    871
    
    
    
    3.64Exercised
    
    
    (82
    )
    
    
    2.09Terminated/expired
    
    
    (319
    )
    
    
    4.22Balance outstanding at April 30, 2006
    
    
    2,815
    
    
    $
    3.57
    
    
    
    6.75
    
    
    $
    850Ending vested and expected to vest
    
    
    2,638
    
    
    $
    3.57
    
    
    
    6.62
    
    
    $
    845Options exercisable at April 30, 2006
    
    
    2,051
    
    
    $
    3.55
    
    
    
    6.21
    
    
    $
    832
   Nine Months Ended April 30,2006
    
    2005Expected stock price volatility
    
    63% to 68%
    
    
    75
    %Expected life of options
    
    
    3 to 5 Years
    
    
    7 YearsRisk-free interest rate
    
    3.6% to 3.7%
    
    
    3.8
    %Dividend yield
    
    
    0.0%
    
    
    
    0.0
    %
  Common Stock Warrants
   9




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##### Table of Contents



WeightedWeighted
    
    AverageNumber
    
    Average
    
    Remainingof
    
    Exercise
    
    ContractualShares
    
    Price
    
    TermBalance outstanding at July 31, 2005
    
    
    133
    
    
    $
    1.50Granted
    
    
    1,200
    
    
    $
    3.14Balance outstanding at April 30, 2006
    
    
    1,333
    
    
    $
    2.98
    
    
    
    4.68Warrants exercisable at April 30, 2006
    
    
    1,331
    
    
    $
    2.98
    
    
    
    4.68
 4. DISCONTINUED OPERATION
 ® ®
  ® ®
 ®
 Three months ended
    
    Nine months endedApril 30,
    
    April 30,2006
    
    2005
    
    2006
    
    2005Net revenues
    
    $
    
    
    
    $
    1,785
    
    
    $
    
    
    
    $
    5,361Income (loss) from operations
    
    $
    (78
    )
    
    $
    78
    
    
    $
    (83
    )
    
    $
    657
 5. NET LOSS PER COMMON SHARE
  6. INVENTORIES
  April 30,
    
    
    July 31,2006
    
    
    2005Finished goods
    
    $
    4,080
    
    
    $
    732Work in process
    
    
    279
    
    
    
    579Raw materials
    
    
    3,527
    
    
    
    4,853Inventory reserves
    
    
    (17
    )
    
    
    (140
    )$
    7,869
    
    
    $
    6,024
 10




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##### Table of Contents



7. INTANGIBLE ASSETS
  April 30, 2006
    
    
    July 31, 2005Gross
    
    
    
    
    
    
    Net
    
    
    Gross
    
    
    
    
    
    
    NetCarrying
    
    
    Accumulated
    
    
    Carrying
    
    
    Carrying
    
    
    Accumulated
    
    
    CarryingAmount
    
    
    Amortization
    
    
    Amount
    
    
    Amount
    
    
    Amortization
    
    
    AmountAmortizable intangibles:Purchased technology rights
    
    $
    7,419
    
    
    $
    4,746
    
    
    $
    2,673
    
    
    $
    7,419
    
    
    $
    4,387
    
    
    $
    3,032Trademarks and other
intangible assets:Trademarks
    
    
    11,754
    
    
    
    3,950
    
    
    
    7,804
    
    
    
    11,657
    
    
    
    3,602
    
    
    
    8,055Patents
    
    
    4,006
    
    
    
    777
    
    
    
    3,229
    
    
    
    3,168
    
    
    
    624
    
    
    
    2,544Licensing costs
    
    
    3,111
    
    
    
    1,331
    
    
    
    1,780
    
    
    
    3,162
    
    
    
    1,108
    
    
    
    2,054Total trademarks and
other intangible assets
    
    
    18,871
    
    
    
    6,058
    
    
    
    12,813
    
    
    
    17,987
    
    
    
    5,334
    
    
    
    12,653Total amortizable
intangible assets
    
    
    26,290
    
    
    
    10,804
    
    
    
    15,486
    
    
    
    25,406
    
    
    
    9,721
    
    
    
    15,685Unamortizable intangible asset:Goodwill
    
    
    12,401
    
    
    
    5,471
    
    
    
    6,930
    
    
    
    12,401
    
    
    
    5,471
    
    
    
    6,930Total intangible assets
    
    $
    38,691
    
    
    $
    16,275
    
    
    $
    22,416
    
    
    $
    37,807
    
    
    $
    15,192
    
    
    $
    22,615
   8. DEBT AND LEASE OBLIGATIONS
  April 30,
    
    
    July 31,2006
    
    
    2005Short-term borrowings:Installment note payable on insurance policies
    
    $
    91
    
    
    $
    154Current portion of long-term debt:IDA bond payable, Series A, current portion
    
    $
    245
    
    
    $
    245Capital lease obligations, current portion
    
    
    70
    
    
    
    50Note payable for equipment
    
    
    
    
    
    
    29Total current portion of long-term debt
    
    $
    315
    
    
    $
    324Long-term debt:Secured term loan
    
    $
    20,076
    
    
    $
    Less  unamortized discount on term loan
    
    
    (2,119
    )
    
    
    17,957
    
    
    
    
 11




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##### Table of Contents



April 30,
    
    
    July 31,2006
    
    
    2005IDA bond payable, Series A
    
    
    2,783
    
    
    
    2,967PharmaBio
    
    
    500
    
    
    
    500Capital lease obligations
    
    
    175
    
    
    
    156Note payable for equipment
    
    
    
    
    
    
    29Total long-term debt
    
    
    21,415
    
    
    
    3,652Less current portion
    
    
    315
    
    
    
    324Long-term portion
    
    $
    21,100
    
    
    $
    3,328
         12




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##### Table of Contents



®
    Long-term
    
    
    Capital
    
    
    TotalDebt
    
    
    Leases
    
    
    DebtRemaining 2006
    
    $
    61
    
    
    $
    16
    
    
    $
    772007
    
    
    245
    
    
    
    72
    
    
    
    3172008
    
    
    18,203
    
    
    
    66
    
    
    
    18,2692009
    
    
    745
    
    
    
    21
    
    
    
    7662010
    
    
    246
    
    
    
    
    
    
    
    2462011
    
    
    245
    
    
    
    
    
    
    
    2452012 and thereafter
    
    
    1,495
    
    
    
    
    
    
    
    1,495Total
    
    
    21,240
    
    
    
    175
    
    
    
    21,415Less current portion
    
    
    245
    
    
    
    70
    
    
    
    315Long-term portion
    
    $
    20,995
    
    
    $
    105
    
    
    $
    21,100
 9. INCOME TAXES
   10. ACCRUED LIABILITIES
  April 30,
    
    
    July 31,2006
    
    
    2005Accrued professional and consulting fees
    
    $
    2,168
    
    
    $
    1,248Accrued advertising
    
    
    1,606
    
    
    
    433Accrued employee compensation and related taxes
    
    
    602
    
    
    
    712Accrued royalties
    
    
    263
    
    
    
    815Other
    
    
    710
    
    
    
    510Total accrued liabilities
    
    $
    5,349
    
    
    $
    3,718
 13




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##### Table of Contents



11. SUPPLEMENTAL CASHFLOW DISCLOSURES
  Nine Months Ended April 30,2006
    
    2005Supplemental cashflow information:Interest paid
    
    $
    393
    
    
    $
    127Income taxes paid
    
    $
    102
    
    
    $
    Supplemental schedule of non-cash investing and financing activities:Capital lease obligations for new equipment
    
    $
    65
    
    
    $
    6Value of warrant issued with debt  liability
    
    $
    2,331
    
    
    $
    
 12. SEGMENT INFORMATION
 : Advanced Protection ® ® ® ® ®
  Nutraceuticals
    
    Pharmaceuticals
    
    Biotechnology
    
    Corporate
    
    TotalNet revenues from continuing operations:2006
    
    $
    3,612
    
    
    $
    3,139
    
    
    $
    
    
    
    $
    
    
    
    $
    6,7512005
    
    
    10,432
    
    
    
    1,588
    
    
    
    
    
    
    
    
    
    
    
    12,020Income (loss) from continuing operations
before income taxes:2006
    
    
    (774
    )
    
    
    (1,332
    )
    
    
    (3,074
    )
    
    
    (2,818
    )
    
    
    (7,997
    )2005
    
    
    2,619
    
    
    
    (1,031
    )
    
    
    (2,057
    )
    
    
    (1,760
    )
    
    
    (2,229
    )Depreciation and amortization:2006
    
    
    312
    
    
    
    183
    
    
    
    222
    
    
    
    52
    
    
    
    7692005
    
    
    282
    
    
    
    155
    
    
    
    213
    
    
    
    51
    
    
    
    701
  Nutraceuticals
    
    Pharmaceuticals
    
    Biotechnology
    
    Corporate
    
    TotalNet revenues from continuing operations:2006
    
    $
    18,266
    
    
    $
    7,786
    
    
    $
    
    
    
    $
    
    
    
    $
    26,0522005
    
    
    28,953
    
    
    
    3,873
    
    
    
    
    
    
    
    
    
    
    
    32,826Income (loss) from continuing operations
before income taxes:2006
    
    
    (2,676
    )
    
    
    (3,780
    )
    
    
    (7,298
    )
    
    
    (6,483
    )
    
    
    (20,237
    )2005
    
    
    5,492
    
    
    
    (2,493
    )
    
    
    (6,296
    )
    
    
    (4,877
    )
    
    
    (8,174
    )Depreciation and amortization:2006
    
    
    920
    
    
    
    529
    
    
    
    614
    
    
    
    154
    
    
    
    2,2172005
    
    
    846
    
    
    
    456
    
    
    
    559
    
    
    
    155
    
    
    
    2,016Identifiable assets from continuing
operations:April 30, 2006
    
    
    34,114
    
    
    
    12,254
    
    
    
    13,730
    
    
    
    4,714
    
    
    
    64,812July 31, 2005
    
    
    34,083
    
    
    
    10,950
    
    
    
    18,993
    
    
    
    1,392
    
    
    
    65,418
 14




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##### Table of Contents



13. COMMITMENTS AND CONTINGENCIES
 FDA approval of the OraTest® product
 ®
 ® ®
 ®
 ViziLite®
 ® ®
 Supply Arrangements
 ®
  Litigation
   15




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
 ZILA, INC. AND SUBSIDIARIES
 COMPANY OVERVIEW
  ® ®
 ® 630 ®
 ®
 ® ® ® ® ® ® ® ®
   ®
 16




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##### Table of Contents



®
  RESULTS OF OPERATIONS
  Three months ended April 30, 2006 and 2005Percent of
    
    
    
    
    
    
    Percent ofNet
    
    
    
    
    
    
    Net2006
    
    
    Revenues
    
    
    2005
    
    
    Revenues
    
    
    ChangeNet revenues
    
    $
    6,751
    
    
    
    100
    %
    
    $
    12,020
    
    
    
    100
    %
    
    
    (44
    )%Cost of products sold
    
    
    2,969
    
    
    
    44
    
    
    
    3,910
    
    
    
    33
    
    
    
    (24
    )Gross profit
    
    
    3,782
    
    
    
    56
    
    
    
    8,110
    
    
    
    67
    
    
    
    (53
    )Operating Costs and Expenses:Marketing & selling
    
    
    4,029
    
    
    
    60
    
    
    
    4,579
    
    
    
    38
    
    
    
    (12
    )General & administrative
    
    
    3,376
    
    
    
    50
    
    
    
    3,383
    
    
    
    28
    
    
    
    Research & development
    
    
    2,654
    
    
    
    39
    
    
    
    1,636
    
    
    
    14
    
    
    
    62Depreciation & amortization
    
    
    769
    
    
    
    11
    
    
    
    701
    
    
    
    6
    
    
    
    1010,828
    
    
    
    160
    
    
    
    10,299
    
    
    
    86
    
    
    
    5Loss from operations
    
    
    (7,046
    )
    
    
    (104
    )
    
    
    (2,189
    )
    
    
    (19
    )
    
    
    (222
    )Other income (expense), net
    
    
    (951
    )
    
    
    (14
    )
    
    
    (40
    )
    
    
    
    
    
    
    (2,278
    )Loss before income taxes
    
    
    (7,997
    )
    
    
    (118
    )
    
    
    (2,229
    )
    
    
    (19
    )
    
    
    (259
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss from continuing operations
    
    $
    (7,997
    )
    
    
    (118
    )
    
    $
    (2,229
    )
    
    
    (19
    )
    
    
    (259
    )
  Nine months ended April 30, 2006 and 2005Percent of
    
    
    
    
    
    
    Percent ofNet
    
    
    
    
    
    
    Net2006
    
    
    Revenues
    
    
    2005
    
    
    Revenues
    
    
    ChangeNet revenues
    
    $
    26,052
    
    
    
    100
    %
    
    $
    32,826
    
    
    
    100
    %
    
    
    (21
    )%Cost of products sold
    
    
    11,038
    
    
    
    42
    
    
    
    11,060
    
    
    
    34
    
    
    
    Gross profit
    
    
    15,014
    
    
    
    58
    
    
    
    21,766
    
    
    
    66
    
    
    
    (31
    )Operating Costs and Expenses:Marketing & selling
    
    
    15,734
    
    
    
    60
    
    
    
    13,741
    
    
    
    42
    
    
    
    15General & administrative
    
    
    10,116
    
    
    
    39
    
    
    
    8,893
    
    
    
    27
    
    
    
    14Research & development
    
    
    6,211
    
    
    
    24
    
    
    
    5,197
    
    
    
    16
    
    
    
    20Depreciation & amortization
    
    
    2,217
    
    
    
    9
    
    
    
    2,016
    
    
    
    6
    
    
    
    1034,278
    
    
    
    132
    
    
    
    29,847
    
    
    
    91
    
    
    
    15Loss from operations
    
    
    (19,264
    )
    
    
    (74
    )
    
    
    (8,081
    )
    
    
    (25
    )
    
    
    (138
    )Other income (expense), net
    
    
    (972
    )
    
    
    (4
    )
    
    
    (93
    )
    
    
    
    
    
    
    (945
    )Loss before income taxes
    
    
    (20,236
    )
    
    
    (78
    )
    
    
    (8,174
    )
    
    
    (25
    )
    
    
    (148
    )Income tax expense
    
    
    (4
    )
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    (100
    )Net loss from continuing operations
    
    $
    (20,240
    )
    
    
    (78
    )
    
    $
    (8,176
    )
    
    
    (25
    )
    
    
    (148
    )
 17




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®
  ®
 ®
 ®
   Nutraceuticals Business Unit
  Three months ended
    
    Nine months endedApril 30,
    
    April 30,2006
    
    2005
    
    Change
    
    2006
    
    2005
    
    ChangeNet revenues
    
    $
    3,612
    
    
    $
    10,432
    
    
    
    (65
    )%
    
    $
    18,266
    
    
    $
    28,953
    
    
    
    (37
    )%Gross profit
    
    
    2,274
    
    
    
    7,332
    
    
    
    (69
    )
    
    
    11,449
    
    
    
    19,976
    
    
    
    (43
    )Gross profit %
    
    
    63
    %
    
    
    70
    %
    
    
    
    
    
    
    63
    %
    
    
    69
    %Income from operations before income taxes
    
    
    (774
    )
    
    
    2,619
    
    
    
    (130
    )
    
    
    (2,676
    )
    
    
    5,492
    
    
    
    (149
    )
  18




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®
   Pharmaceuticals Business Unit
  Three months ended
    
    Nine months endedApril 30,
    
    April 30,2006
    
    2005
    
    Change
    
    2006
    
    2005
    
    ChangeNet revenues
    
    $
    3,139
    
    
    $
    1,588
    
    
    
    98
    %
    
    $
    7,786
    
    
    $
    3,873
    
    
    
    101
    %Gross profit
    
    
    1,511
    
    
    
    778
    
    
    
    94
    
    
    
    3,571
    
    
    
    1,791
    
    
    
    99Gross profit %
    
    
    48
    %
    
    
    49
    %
    
    
    
    
    
    
    46
    %
    
    
    46
    %Income from operations before income taxes
    
    
    (1,332
    )
    
    
    (1,031
    )
    
    
    (29
    )
    
    
    (3,780
    )
    
    
    (2,493
    )
    
    
    (52
    )
 ® ®
  ® ® 630
 Biotechnology Business Unit
  Three months ended
    
    Nine months endedApril 30,
    
    April 30,2006
    
    2005
    
    Change
    
    2006
    
    2005
    
    ChangeResearch and development
    
    $
    2,452
    
    
    $
    1,473
    
    
    
    66
    %
    
    $
    5,739
    
    
    $
    4,893
    
    
    
    17
    %Income from operations before income taxes
    
    
    (3,074
    )
    
    
    (2,057
    )
    
    
    (49
    )
    
    
    (7,298
    )
    
    
    (6,296
    )
    
    
    (16
    )
 19




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##### Table of Contents



® ®
  Inflation and Seasonality
  LIQUIDITY AND CAPITAL RESOURCES
 ® ® ®
  Nine months ended April 30,2006
    
    2005Net cash used in operating activities
    
    $
    (16,394
    )
    
    $
    (4,808
    )Net cash provided by (used in) investing activities
    
    
    (4,963
    )
    
    
    5,356Net cash provided by financing activities
    
    
    17,593
    
    
    
    149
 April 30, 2006
    
    July 31, 2005Cash and cash equivalents
    
    $
    9,174
    
    
    $
    12,938Working capital
    
    
    18,886
    
    
    
    22,824Current ratio
    
    
    2.65
    
    
    
    3.33
  ® ® ®
   20




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##### Table of Contents



Operating Activities
  Investing Activities
 ® 630 ®
 Financing Activities
  Black Diamond Commercial Finance Credit Facility
   21




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##### Table of Contents



PharmaBio Investment
 ®
 Industrial Development Revenue Bonds
  DISCLOSURES ABOUT CONTRACTUAL OBLIGATION AND COMMERCIAL COMMITMENTS
  Remaining
    
    
    2007, 2008
    
    
    2010 &Total
    
    
    2006
    
    
    & 2009
    
    
    2011
    
    
    ThereafterLong-term debt
    
    $
    21,240
    
    
    $
    61
    
    
    $
    19,193
    
    
    $
    491
    
    
    $
    1,495Capital lease obligations
    
    
    175
    
    
    
    16
    
    
    
    159
    
    
    
    
    
    
    
    Operating lease obligations
    
    
    1,685
    
    
    
    120
    
    
    
    1,168
    
    
    
    397
    
    
    
    Purchase obligations
    
    
    15,559
    
    
    
    2,205
    
    
    
    13,354
    
    
    
    
    
    
    
    Total
    
    $
    38,659
    
    
    $
    2,402
    
    
    $
    33,874
    
    
    $
    888
    
    
    $
    1,495
  22




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SUMMARY OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
  Revenue Recognition
   Use of Estimates
    ® ® ®
 ® ®
 23




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##### Table of Contents



®
 Goodwill, Intangibles and Other Long-Lived Assets
   Zila Pharmaceuticals Goodwill ® ® ®
 Zila Nutraceuticals Goodwill ®
 OraTest® ® ® ® ®
 Income Taxes 
 FORWARD-LOOKING INFORMATION
  24




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##### Table of Contents




    
    Obtaining regulatory approvals for our products is costly and full of uncertainty.
    
    We may be unable to obtain FDA approval, or to establish a market, for OraTest® in the United States.
    
    We are dependent on a few key products and our growth is dependent on the development of new products.
    
    We are dependent on a few key customers.
    
    We are dependent on our senior management and other key personnel.
    
    We and our products are subject to regulatory oversight that could substantially interfere with our ability to do business.
    
    We are at risk with respect to product liability claims.
    
    We face significant competition that could adversely affect our results of operation and financial condition.
    
    If we fail to secure and then enforce patents and other intellectual property rights underlying our technologies, or if
the use of our technology is determined to infringe on the intellectual property rights of others, our business could be
harmed.
    
    We require certain raw materials for our manufacturing processes that may only be acquired through limited sources.
    
    If we are unable to obtain adequate funds, we may not be able to develop and market our present and potential products.
    
    Acquisitions and strategic alliances may harm our operating results or cause us to incur debt or assume contingent
liabilities or dilute our stockholders.
    
    In the past, we have experienced volatility in the market price of our common stock and we may experience such volatility
in the future.
    
    Our Board of Directors may unilaterally issue Preferred Stock which could dilute our ownership and prevent or delay a
change in our control.
    
    We have, in the past, received minor deficiencies from regulatory agencies related to our manufacturing facilities.
  RECONCILIATION OF GAAP MEASURES TO NON-GAAP MEASURES
  25




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Reconciliation of GAAP Measures to Non-GAAP Measures
Unaudited
(in thousands)
 Three months ended
    
    
    Nine months endedApril 30,
    
    
    April 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Adjusted EBITDA
    
    $
    (6,481
    )
    
    $
    (1,428
    )
    
    $
    (17,043
    )
    
    $
    (5,413
    )Noncash stock related expenses for compensation and services
    
    
    (120
    )
    
    
    (1
    )
    
    
    (392
    )
    
    
    (24
    )EBITDA
    
    
    (6,601
    )
    
    
    (1,429
    )
    
    
    (17,435
    )
    
    
    (5,437
    )Interest income
    
    
    83
    
    
    
    35
    
    
    
    231
    
    
    
    129Interest expense
    
    
    (788
    )
    
    
    (44
    )
    
    
    (898
    )
    
    
    (144
    )Depreciation and amortization
    
    
    (769
    )
    
    
    (713
    )
    
    
    (2,217
    )
    
    
    (2,065
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    (4
    )
    
    
    (2
    )Net loss
    
    $
    (8,075
    )
    
    $
    (2,151
    )
    
    $
    (20,323
    )
    
    $
    (7,519
    )
 RECENT ACCOUNTING PRONOUNCEMENTS
 Hybrid Instruments ( )  Accounting for Derivative Instruments and Hedging
Activities ), Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ) Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.
 Practical
Accommodation to the Application of Grant Date as Defined in FASB Statement No. 123R,
 Transition Election
Related to Accounting for the Tax Effects of Share-Based Payment Awards,
 26




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##### Table of Contents



Accounting for Stock-Based Compensation.
 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk.
    
 Item 4. Controls and Procedures.
 Evaluation of Disclosure Controls and Procedures.
   Changes in Internal Control over Financial Reporting
  
 Part II  Other Information
 
 Item 1. Legal Proceedings.
   27




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##### Table of Contents



Item 1A. Risk Factors.
  28




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##### Table of Contents



Trends, Risks and Uncertainties Related to Our Business
 Obtaining regulatory approvals for our products is costly and full of uncertainty.
   We may be unable to obtain FDA approval, or to establish a market, for OraTest® in the United States.
 ® ® ® ® ® ® ®
 ® ®
 ®
 29




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##### Table of Contents



®
 ® tm ®
 We are dependent on a few key products and our growth is dependent on the development of new products.
 ® ® ® ® ® ® ®
    We are dependent on a few key customers.
  We are dependent on our senior management and other key personnel.
 30




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##### Table of Contents



We and our products are subject to regulatory oversight that could
substantially interfere with our ability to do business.
  We are at risk with respect to product liability claims.
  We face significant competition that could adversely affect our results of operation and financial condition.
 ®
 If we fail to secure and then enforce patents and other intellectual property
rights underlying our technologies, or if the use of our technology is
determined to infringe on the intellectual property rights of others, our
business could be harmed.
  31




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##### Table of Contents



We require certain raw materials for our manufacturing processes that may only
be acquired through limited sources.
 ®
 If we are unable to obtain adequate funds on acceptable terms, we may not be
able to develop and market our present and potential products.
 ® ® ®
 32




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##### Table of Contents



Acquisitions and strategic alliances may harm our operating results or cause us
to incur debt or assume contingent liabilities or dilute our stockholders.
  We have, in the past, received minor deficiencies from regulatory agencies related to our manufacturing facilities.
  Trends, Risks and Uncertainties Related to Our Capital Stock
 In the past, we have experienced volatility in the market price of our common
stock and we may experience such volatility in the future.
  33




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##### Table of Contents



Our Board of Directors may unilaterally issue Preferred Stock which could
dilute our ownership and prevent or delay a change in our control.
  34




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##### Table of Contents



Item 2. Unregistered Sales of Securities and Use of Proceeds.
  
 Item 3. Defaults upon Senior Securities.
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information.
   
 Item 6. Exhibits.
 Exhibit Number
    
    Description4.1*
    
    Warrant to Purchase of Shares of Common Stock, dated March 24, 2006,
issued to Black Diamond Commercial Finance, L.L.C. by Zila, Inc.4.2*
    
    Amended and Restated Warrant to Purchase Shares of Common Stock, dated
June 6, 2006, issued to BDC Finance, L.L.C. by Zila, Inc.10.1*
    
    Credit Agreement dated March 24, 2006 by and among Zila, Inc., Zila
Technical, Inc., Zila Biotechnology, Inc., Zila Nutraceuticals, Inc.,
Zila Pharmaceuticals, Inc., and Zila Swab Technologies, Inc. and Black
Diamond Commercial Finance, L.L.C.10.2*
    
    Registration Rights Agreement, dated as of March 24, 2006, by and
between Black Diamond Commercial Finance, L.L.C. and Zila, Inc.10.3*
    
    Fist Amendment to Credit Agreement dated June 6, 2006 by and among
Zila, Inc., Zila Technical, Inc., Zila Biotechnology, Inc., Zila
Nutraceuticals, Inc., Zila Pharmaceuticals, Inc., and Zila Swab
Technologies, Inc. and Black Diamond Commercial Finance, L.L.C.10.4*
    
    Offer Letter between Zila, Inc. and Frank J. Bellizzi dated May 22, 200631.1*
    
    Certification of the Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 (filed herewith)
 35




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Exhibit Number
    
    Description31.2*
    
    Certification of the Chief Financial Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 (filed herewith)32.1**
    
    Certification of the Chief Executive Officer and the Chief Financial
Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith)32.2**
    
    Certification of the Chief Executive Officer and Chief Financial
Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith)
 
 *
    
    Filed herewith**
    
    Furnished herewith 
 SIGNATURES
  ZILA, INC.(Registrant)Date: June 8, 2006
    
    By:
    
    /s/Andrew A. StevensAndrew A. StevensVice President and Chief Financial Officer(Principal Financial Officer)
 36




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##### Table of Contents



INDEX TO EXHIBITS
 Exhibit Number
    
    Description4.1*
    
    Warrant for the purchase of shares of common stock, dated March 24, 2006, issued to Black Diamond
Commercial Finance, L.L.C. by Zila, Inc.4.2*
    
    Amended and Restated Warrant to Purchase Shares of Common Stock, dated June 6, 2006, issued to BDC
Finance, L.L.C. by Zila, Inc.10.1*
    
    Credit Agreement dated March 24, 2006 by and among Zila, Inc., Zila Technical, Inc., Zila
Biotechnology, Inc., Zila Nutraceuticals, Inc., Zila Pharmaceuticals, Inc., and Zila Swab
Technologies, Inc. and Black Diamond Commercial Finance, L.L.C.10.2*
    
    Registration Rights Agreement, dated as of March 24, 2006, by and between Black Diamond Commercial
Finance, L.L.C. and Zila, Inc.10.3*
    
    First Amendment to Credit Agreement
dated June 6, 2006 by and among Zila, Inc., Zila Technical, Inc.,
Zila Biotechnology, Inc., Zila Nutraceuticals, Inc., Zila
Pharmaceuticals, Inc., and Zila Swab Technologies, Inc. and Black
Diamond Commercial Finance, L.L.C.10.4*
    
    Offer Letter between Zila, Inc. and Frank J. Bellizzi dated May 22, 200631.1*
    
    Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 200231.2*
    
    Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 200232.1**
    
    Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section, as adopted pursuant to
Section 906 of the Sarbanes Oxley Act of 200232.2**
    
    Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes Oxley Act of 2002
 
 *
    
    Filed herewith**
    
    Furnished herewith 37