##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
 Form 10-Q
 (Mark one)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended October 31, 2007
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period fromto
 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) (Zip Code)
 (602) 266-6700  (Registrants telephone number, including area code)
 þ o
  o þ o
 o þ




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TABLE OF CONTENTS
 PAGEPART I  FINANCIAL INFORMATIONItem 1.
    
    Financial Statements.Condensed Consolidated Balance Sheets as of October 31, 2007 (unaudited) and July 31, 2007
    
    2Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended October 31, 2007 and 2006
    
    3Unaudited Condensed Consolidated Statement of Shareholders' Equity for the Three Months Ended October 31, 2007
    
    4Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended October 31, 2007 and 2006
    
    5Notes to Unaudited Condensed Consolidated Financial Statements
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and  Results of Operations
    
    19Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    27Item 4.
    
    Controls and Procedures
    
    27PART II  OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    27Item 1A.
    
    Risk Factors
    
    27Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    28Item 3.
    
    Defaults Upon Senior Securities
    
    28Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    28Item 5.
    
    Other Information
    
    28Item 6.
    
    Exhibits
    
    28Signatures
    
    
    
    29EX-31.1EX-31.2EX-32.1
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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 ZILA, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 October 31,
    
    
    July 31,2007
    
    
    2007(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    8,660,176
    
    
    $
    14,859,159Trade receivables  net of allowances of $162,000 and $173,000
    
    
    6,219,983
    
    
    
    4,273,580Inventories  net
    
    
    4,027,235
    
    
    
    4,074,733Prepaid expenses and other current assets
    
    
    1,737,560
    
    
    
    1,646,229Total current assets
    
    
    20,644,954
    
    
    
    24,853,701Property and equipment  net
    
    
    6,246,847
    
    
    
    6,219,436Goodwill
    
    
    10,171,351
    
    
    
    10,171,351Purchased technology  net
    
    
    9,628,131
    
    
    
    9,884,017Trademarks and other intangible assets  net
    
    
    11,214,608
    
    
    
    11,555,041Other assets
    
    
    1,098,315
    
    
    
    1,197,684Total assets
    
    $
    59,004,206
    
    
    $
    63,881,230LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    4,282,391
    
    
    $
    3,207,480Accrued liabilities
    
    
    4,639,673
    
    
    
    5,587,825Warrant and common stock repurchase liability
    
    
    
    
    
    
    1,376,393Current portion of deferred gain on sale leaseback
    
    
    152,976
    
    
    
    152,976Short-term borrowings and current portion of long-term debt
    
    
    351,878
    
    
    
    77,472Current liabilities of discontinued operations
    
    
    309,436
    
    
    
    165,368Total current liabilities
    
    
    9,736,354
    
    
    
    10,567,514Deferred gain on sale leaseback
    
    
    37,415
    
    
    
    75,659Long-term debt  net of current portion
    
    
    7,687,673
    
    
    
    7,258,569Total liabilities
    
    
    17,461,442
    
    
    
    17,901,742Shareholders equity:Preferred stock  Series B, $.001 par value - 2,500,000
shares authorized, 100,000 shares issued and outstanding,
liquidation preference of $650,000
    
    
    462,500
    
    
    
    462,500Common stock, $.001 par value - 147,500,000 shares
authorized, 61,575,879 and 62,466,338 shares issued and
outstanding
    
    
    61,576
    
    
    
    62,466Additional paid-in capital
    
    
    122,629,464
    
    
    
    123,436,957Accumulated deficit
    
    
    (80,919,503
    )
    
    
    (76,054,251
    )Accumulated other comprehensive loss
    
    
    (140,202
    )
    
    
    (127,118
    )Treasury stock, at cost (218,411 and 1,151,243 common shares)
    
    
    (551,071
    )
    
    
    (1,801,066
    )Total shareholders equity
    
    
    41,542,764
    
    
    
    45,979,488Total liabilities and shareholders equity
    
    $
    59,004,206
    
    
    $
    63,881,230
  2




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ZILA, INC. AND SUBSIDIARIES
 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 Three Months Ended October 31,2007
    
    
    2006Net revenues
    
    $
    11,440,437
    
    
    $
    339,187Cost of products sold
    
    
    4,581,652
    
    
    
    500,022Gross profit (loss)
    
    
    6,858,785
    
    
    
    (160,835
    )Operating costs and expenses:Marketing and selling
    
    
    5,296,597
    
    
    
    1,423,047General and administrative
    
    
    3,473,677
    
    
    
    3,067,440Research and development
    
    
    1,201,785
    
    
    
    1,534,692Depreciation and amortization
    
    
    915,013
    
    
    
    389,341Loss from operations
    
    
    (4,028,287
    )
    
    
    (6,575,355
    )Other income (expense):Interest income
    
    
    124,182
    
    
    
    95,629Interest expense
    
    
    (766,708
    )
    
    
    (4,811,130
    )Derivative income (expense)
    
    
    (23,600
    )
    
    
    1,058,873Other income (expense)
    
    
    22,772
    
    
    
    (5,299
    )Other expense  net
    
    
    (643,354
    )
    
    
    (3,661,927
    )Loss from continuing operations before income taxes
    
    
    (4,671,641
    )
    
    
    (10,237,282
    )Income tax benefit (expense)
    
    
    (11,592
    )
    
    
    3,864,900Loss from continuing operations
    
    
    (4,683,233
    )
    
    
    (6,372,382
    )Loss from discontinued operations
    
    
    (172,269
    )
    
    
    (1,119,301
    )Gain on disposal of discontinued operations
    
    
    
    
    
    
    11,110,406Income tax expense
    
    
    
    
    
    
    (3,877,000
    )Total income (loss) from discontinued operations
    
    
    (172,269
    )
    
    
    6,114,105Net loss
    
    
    (4,855,502
    )
    
    
    (258,277
    )Preferred stock dividends
    
    
    9,750
    
    
    
    9,750Net loss attributable to common shareholders
    
    $
    (4,865,252
    )
    
    $
    (268,027
    )Basic and diluted net income (loss) per common share:Loss from continuing operations
    
    $
    (0.08
    )
    
    $
    (0.14
    )Income from discontinued operations
    
    
    
    
    
    
    0.13Net loss attributable to common shareholders
    
    $
    (0.08
    )
    
    $
    (0.01
    )Weighted average common shares outstanding  basic and diluted
    
    
    61,404,226
    
    
    
    45,798,041
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ZILA, INC. AND SUBSIDIARIES
 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
For the Three Months Ended October 31, 2007
 AccumulatedAdditional
    
    
    
    
    
    
    Other
    
    
    
    
    
    
    TotalPreferred Stock
    
    
    Common Stock
    
    
    Paid-in
    
    
    Accumulated
    
    
    Comprehensive
    
    
    Treasury
    
    

ShareholdersShares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Capital
    
    
    Deficit
    
    
    Loss
    
    
    Stock
    
    
    EquityBalance  July 31, 2007
    
    
    100,000
    
    
    $
    462,500
    
    
    
    62,466,338
    
    
    $
    62,466
    
    
    $
    123,436,957
    
    
    $
    (76,054,251
    )
    
    $
    (127,118
    )
    
    $
    (1,801,066
    )
    
    $
    45,979,488Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,750
    )
    
    
    
    
    
    
    
    
    
    
    (9,750
    )Exercise of common
stock options
    
    
    
    
    
    
    
    
    
    
    10,000
    
    
    
    10
    
    
    
    11,190
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,200Stock-based
compensation expense
    
    
    
    
    
    
    
    
    
    
    32,373
    
    
    
    33
    
    
    
    430,379
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    430,412Retirement of
treasury stock
    
    
    
    
    
    
    
    
    
    
    (932,832
    )
    
    
    (933
    )
    
    
    (1,249,062
    )
    
    
    
    
    
    
    
    
    
    
    1,249,995
    
    
    
    Foreign currency
translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (13,084
    )
    
    
    
    
    
    
    (13,084
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,855,502
    )
    
    
    
    
    
    
    
    
    
    
    (4,855,502
    )Balance  October 31, 2007
    
    
    100,000
    
    
    $
    462,500
    
    
    
    61,575,879
    
    
    $
    61,576
    
    
    $
    122,629,464
    
    
    $
    (80,919,503
    )
    
    $
    (140,202
    )
    
    $
    (551,071
    )
    
    $
    41,542,764
  4




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ZILA, INC. AND SUBSIDIARIES
 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 Three Months Ended October 31,2007
    
    
    2006Cash flows from operating activities:Net loss
    
    $
    (4,855,502
    )
    
    $
    (258,277
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    1,023,727
    
    
    
    597,369Non-cash amortization of financing costs
    
    
    99,369
    
    
    
    2,095,234Non-cash amortization of debt discounts
    
    
    447,362
    
    
    
    2,067,271Non-cash interest on term loan
    
    
    
    
    
    
    137,540Non-cash derivative (income) expense
    
    
    23,600
    
    
    
    (1,058,873
    )Gain on disposal of discontinued operations
    
    
    
    
    
    
    (11,110,406
    )Non-cash stock-based compensation expense
    
    
    430,412
    
    
    
    218,465Other non-cash items  net
    
    
    (51,663
    )
    
    
    (54,041
    )Changes in operating assets and liabilities:Trade receivables
    
    
    (1,946,403
    )
    
    
    955,686Inventories
    
    
    47,498
    
    
    
    (305,989
    )Prepaid expenses and other assets
    
    
    183,075
    
    
    
    7,589Accounts payable and accrued liabilities
    
    
    271,328
    
    
    
    2,604,450Net cash used in operating activities
    
    
    (4,327,197
    )
    
    
    (4,103,982
    )Cash flows from investing activities:Additions to property and equipment
    
    
    (375,212
    )
    
    
    (172,948
    )Additions to intangible assets
    
    
    (80,235
    )
    
    
    (125,380
    )Proceeds from sale of assets
    
    
    462
    
    
    
    Restricted cash returned from collateralized letter of credit
    
    
    
    
    
    
    3,610,950Proceeds from disposition of discontinued operations
    
    
    
    
    
    
    34,705,077Deposits for the acquisition of Pro-Dentec
    
    
    
    
    
    
    (283,470
    )Net cash provided by (used in) investing activities
    
    
    (454,985
    )
    
    
    37,734,229Cash flows from financing activities:Short-term borrowings  net
    
    
    
    
    
    
    268,554Proceeds from issuance of common stock
    
    
    11,200
    
    
    
    27,975Financing costs
    
    
    
    
    
    
    (463,934
    )Principal payments on long-term debt
    
    
    (18,258
    )
    
    
    (22,757,953
    )Payment of obligation to repurchase common stock and warrants
    
    
    (1,399,993
    )
    
    
    Dividends paid to preferred stockholders
    
    
    (9,750
    )
    
    
    (9,750
    )Net cash used in financing activities
    
    
    (1,416,801
    )
    
    
    (22,935,108
    )Net increase (decrease) in cash and cash equivalents
    
    
    (6,198,983
    )
    
    
    10,695,139Cash and cash equivalents  beginning of period
    
    
    14,859,159
    
    
    
    3,958,190Cash and cash equivalents  end of period
    
    $
    8,660,176
    
    
    $
    14,653,329
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ZILA, INC. AND SUBSIDIARIES
 
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. Description of Business and Basis of Presentation
  ® 630TM ® ® ® ® TM ® ® Disclosures about Segments of an Enterprise and Related Information.
    6




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ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  Three Months Ended October 31,2007
    
    
    2006Options and warrants to purchase common shares
    
    
    82
    
    
    
    343Common stock awards
    
    
    19
    
    
    
    Convertible preferred stock
    
    
    100
    
    
    
    100Total potentially dilutive securities
    
    
    201
    
    
    
    443
  2. Recently Issued Accounting Pronouncements and Adopted Accounting
 Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109
 
    
    an allocation or a shift of income between taxing jurisdictions,
    
    the characterization of income or a decision to exclude reporting taxable income in a
tax return, or
    
    a decision to classify a transaction, entity, or other position in a tax return as tax
exempt.
     7




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ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 Fair Value Measures
 The Fair Value Option for Financial Assets
and Financial Liabilities  Including an Amendment of FASB Statement No. 115, Accounting for
Certain Investments in Debt and Equity Securities
 3. Acquisition of Pro-Dentec
   Net revenues
    
    $
    9,159Loss from continuing operations
    
    $
    (5,505
    )Basic and diluted net loss per common share from continuing operations
    
    $
    (0.09
    )Pro forma weighted average common shares outstanding  basic and diluted
    
    
    61,798
  4. Dispositions
 ®
  8




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ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  ®
 ® ® ®
 Accounting for the
Impairment or Disposal of Long-Lived Assets
 Nutraceuticals
    
    
    Pharmaceuticals
    
    
    TotalNet revenues
    
    $
    1,629
    
    
    $
    1,039
    
    
    $
    2,668Loss from discontinued operations
    
    $
    (754
    )
    
    $
    (365
    )
    
    $
    (1,119
    )Gain (loss) on disposal of discontinued operations
    
    
    11,135
    
    
    
    (25
    )
    
    
    11,110Income tax expense
    
    
    (3,877
    )
    
    
    
    
    
    
    (3,877
    )Total income (loss) from discontinued operations
    
    $
    6,504
    
    
    $
    (390
    )
    
    $
    6,114
  5. Inventories
  October 31,
    
    
    July 31,2007
    
    
    2007(Unaudited)Finished goods
    
    $
    1,426
    
    
    $
    1,413Work-in-process
    
    
    415
    
    
    
    323Raw materials
    
    
    2,558
    
    
    
    2,659Inventory reserves
    
    
    (372
    )
    
    
    (320
    )Total inventories
    
    $
    4,027
    
    
    $
    4,075
 9




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ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 6. Property and Equipment
  October 31,
    
    
    July 31,2007
    
    
    2007(Unaudited)Land
    
    $
    529
    
    
    $
    529Building and improvements
    
    
    2,162
    
    
    
    2,181Furniture and equipment
    
    
    3,123
    
    
    
    2,360Leasehold improvements and other assets
    
    
    821
    
    
    
    1,360Production, laboratory and warehouse equipment
    
    
    4,591
    
    
    
    4,423Total property and equipment
    
    
    11,226
    
    
    
    10,853Less: Accumulated depreciation and amortization
    
    
    (4,979
    )
    
    
    (4,634
    )Property and equipment  net
    
    $
    6,247
    
    
    $
    6,219
 7. Goodwill and Other Intangible Assets
  October 31, 2007 (Unaudited)
    
    
    July 31, 2007Gross
    
    
    
    
    
    
    Net
    
    
    Gross
    
    
    
    
    
    
    NetCarrying
    
    
    Accumulated
    
    
    Carrying
    
    
    Carrying
    
    
    Accumulated
    
    
    CarryingAmount
    
    
    Amortization
    
    
    Amount
    
    
    Amount
    
    
    Amortization
    
    
    AmountAmortizable intangible assets:Purchased technology
    
    $
    15,592
    
    
    $
    (5,964
    )
    
    $
    9,628
    
    
    $
    15,592
    
    
    $
    (5,708
    )
    
    $
    9,884Trademarks
    
    
    137
    
    
    
    (11
    )
    
    
    126
    
    
    
    132
    
    
    
    (11
    )
    
    
    121Patents
    
    
    2,570
    
    
    
    (383
    )
    
    
    2,187
    
    
    
    2,495
    
    
    
    (350
    )
    
    
    2,145Licensing costs
    
    
    2,674
    
    
    
    (1,580
    )
    
    
    1,094
    
    
    
    2,674
    
    
    
    (1,514
    )
    
    
    1,160Covenants not to compete and other
    
    
    3,557
    
    
    
    (1,198
    )
    
    
    2,359
    
    
    
    3,556
    
    
    
    (876
    )
    
    
    2,680Total amortizable intangible assets
    
    
    24,530
    
    
    
    (9,136
    )
    
    
    15,394
    
    
    
    24,449
    
    
    
    (8,459
    )
    
    
    15,990Unamortizable trademarks
    
    
    5,449
    
    
    
    
    
    
    
    5,449
    
    
    
    5,449
    
    
    
    
    
    
    
    5,449Total other intangible assets
    
    
    29,979
    
    
    
    (9,136
    )
    
    
    20,843
    
    
    
    29,898
    
    
    
    (8,459
    )
    
    
    21,439Goodwill
    
    
    10,171
    
    
    
    
    
    
    
    10,171
    
    
    
    10,171
    
    
    
    
    
    
    
    10,171Total intangible assets
    
    $
    40,150
    
    
    $
    (9,136
    )
    
    $
    31,014
    
    
    $
    40,069
    
    
    $
    (8,459
    )
    
    $
    31,610
  Weighted AverageRange of
    
    Remaining Useful LivesUseful Lives
    
    October 31, 2007
    
    July 31, 2007(Unaudited)Purchased technology
    
    
    15
    
    
    
    14.2
    
    
    
    14.5Trademarks
    
    
    7-10
    
    
    
    7.4
    
    
    
    7.6Patents
    
    
    4-17
    
    
    
    6.1
    
    
    
    6.2Licensing costs
    
    
    7-10
    
    
    
    4.2
    
    
    
    4.4Covenants not to compete and other
    
    
    2-15
    
    
    
    1.6
    
    
    
    1.8
 10




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ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 8. Accrued Liabilities
  October 31,
    
    
    July 31,2007
    
    
    2007(Unaudited)Accrued research and development
    
    $
    1,596
    
    
    $
    1,864Accrued employee compensation and related taxes
    
    
    1,435
    
    
    
    1,876Accrued professional and consulting fees
    
    
    642
    
    
    
    569Accrued fee due Investors for Restructuring (see Note 9)
    
    
    
    
    
    
    600Other accrued expenses
    
    
    967
    
    
    
    679Total accrued expenses
    
    $
    4,640
    
    
    $
    5,588
 9. Debt
  October 31,
    
    
    July 31,2007
    
    
    2007(Unaudited)Short-term borrowings and current portion of long-term debt:Short-term borrowings
    
    $
    275
    
    
    $
    Capital lease obligations
    
    
    77
    
    
    
    77Total short-term borrowings and current portion of long-term debt
    
    $
    352
    
    
    $
    77Long-term debt:Senior secured convertible notes  net of unamortized discount of $4,898 and $5,345
    
    $
    7,102
    
    
    $
    6,655PharmaBio
    
    
    500
    
    
    
    500Capital lease obligations
    
    
    163
    
    
    
    181Total long-term debt
    
    
    7,765
    
    
    
    7,336Less: Current portion of long-term debt
    
    
    (77
    )
    
    
    (77
    )Long-term debt  net of current portion
    
    $
    7,688
    
    
    $
    7,259
 Short-term Borrowings
  Private Placements
   (i)
    
    9,100,000 shares of Zilas common stock for $1.75 per share (the Shares);(ii)
    
    Approximately $12.1 million in aggregate principal amount of 12.0% Unsecured
Convertible Notes (the Unsecured Notes), which converted into 6,900,000 shares (the
Unsecured Note Shares) of Zilas common stock at a conversion price of $1.75 per share on
December 14, 2006, the date on which our stockholders approved, among other things, the
Private Placements;
 11




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 (iii)
    
    Warrants to purchase approximately 5,403,000 shares of Zilas common stock, which
became exercisable in May 2007 for five years at an exercise price of $2.21 per share (the
Initial Warrants);(iv)
    
    Warrants to purchase approximately 3,105,000 shares of Zilas common stock, which
became exercisable for five years at an exercise price of $2.21 per share following
approval by our stockholders on December 14, 2006 (the Additional Warrants);
  (i)
    
    Approximately $12.0 million in aggregate principal amount of 6.0% Senior Secured
Convertible Notes (the Secured Notes), which are due in November 2009 and became
convertible into 5,454,546 shares of Zilas common stock at a conversion price of $2.20
following approval by our stockholders on December 14, 2006; and(ii)
    
    Warrants to purchase 1,909,091 shares of Zilas common stock, which became exercisable
for five years at an exercise price of $2.21 per share following approval by our
stockholders on December 14, 2006 (the Secured Note Warrants).
  (i)
    
    Maintain, at the end of each fiscal quarter commencing with the fiscal quarter ending
July 31, 2007, free cash in an amount not less than $2.0 million; and(ii)
    
    Maintain, at the end of each of the fiscal quarters ending July 31, 2008 and
October 31, 2008, defined EBITDA of at least $1.00.
   (i)
    
    Repurchase 932,832 Unsecured Note Shares from the Investors for approximately $1.25
million in cash, at a price based on the average closing bid price of our common stock for
the ten trading days prior to August 13, 2007, or $1.34 per Unsecured Note Share;(ii)
    
    Repurchase 227,270 Secured Note Warrants from the Investors for approximately $0.15
million in cash, at a price based on a Black-Scholes valuation, or $0.66 per Secured Note
Warrant; and(iii)
    
    Pay the Investors a $0.6 million fee.
 12




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
   PharmaBio Development, Inc.
 ®
 10. Share-Based Payments
   Three Months Ended October 31,2007
    
    2006Risk-free interest rate
    
    
    3
    %
    
    
    5
    %Expected volatility
    
    
    60
    %
    
    
    44
    %Expected term (in years)
    
    
    5.1
    
    
    
    3.3Dividend yield
    
    
    0
    %
    
    
    0
    %
  Share-Based Payment
 13




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
   WeightedWeighted
    
    AverageAverage
    
    Remaining
    
    AggregateNumber
    
    Exercise
    
    Contractual
    
    Intrinsicof Options
    
    Price
    
    Term (Years)
    
    ValueOptions outstanding  beginning of period
    
    
    2,917
    
    
    $
    3.11
    
    
    
    5.8
    
    
    $
    130Granted
    
    
    1,097
    
    
    
    1.15Exercised
    
    
    (10
    )
    
    
    1.12Expired
    
    
    (144
    )
    
    
    3.28Forfeited
    
    
    (33
    )
    
    
    2.55Options outstanding  end of period
    
    
    3,827
    
    
    
    2.55
    
    
    
    6.7
    
    
    
    42Options vested or expected to vest  end of period
    
    
    3,359
    
    
    
    2.61
    
    
    
    6.4
    
    
    
    42Options exercisable  end of period
    
    
    1,965
    
    
    
    3.11
    
    
    
    4.8
    
    
    
    42
   WeightedWeighted
    
    AverageAverage
    
    RemainingNumber
    
    Grant
    
    Recognitionof Shares
    
    Value
    
    Period (Years)Unvested balance  beginning of period
    
    
    133
    
    
    $
    2.42
    
    
    
    1.4Granted
    
    
    373
    
    
    
    1.17Vested
    
    
    (140
    )
    
    
    1.50Forfeited
    
    
    Unvested balance  end of period
    
    
    366
    
    
    
    1.49
    
    
    
    1.4
  Three Months Ended October 31,2007
    
    
    2006Marketing and selling expense
    
    $
    55
    
    
    $
    7General and administrative expense
    
    
    373
    
    
    
    223Research and development expense
    
    
    1
    
    
    
    (8
    )Inventory
    
    
    1
    
    
    
    2Discontinued operations
    
    
    
    
    
    
    (6
    )Total stock-based compensation
    
    $
    430
    
    
    $
    218
  14




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
   11. Warrants
  12. Convertible Preferred Stock
  13. Treasury Stock
   14. Income Taxes
  15




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 15. Supplemental Cash Flow Information
  Three Months Ended October 31,2007
    
    2006Interest paid
    
    $
    227
    
    
    $
    620Income taxes paid
    
    
    35
    
    
    
    23Insurance policy financed with short-term borrowings
    
    
    275
    
    
    
    
 16. Comprehensive Loss
  Three Months Ended October 31,2007
    
    
    2006Net loss
    
    $
    (4,856
    )
    
    $
    (258
    )Foreign currency translation adjustment
    
    
    (13
    )
    
    
    (9
    )Comprehensive loss
    
    $
    (4,869
    )
    
    $
    (267
    )
 17. Commitments and Contingencies
 Legal Proceedings
    16




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  Indemnifications
  Registration Payment Arrangements
     17




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
     18




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
  Forward-Looking Statements
  Company Overview and Recent Developments
  ® 630TM ® ® ® ® ® TM ® ®
  19




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##### Table of Contents



® ® ® ® 630TM 630TM ® ®
 TM TM ®
 ®
 Results of Operations
  For the Three Months Ended October 31,% of
    
    
    
    
    
    
    % of
    
    
    %2007
    
    
    Revenue
    
    
    2006
    
    
    Revenue
    
    
    ChangeNet revenues
    
    $
    11,440
    
    
    
    100.0
    %
    
    $
    339
    
    
    
    100.0
    %
    
    
    3,274.6
    %Cost of products sold
    
    
    4,581
    
    
    
    40.0
    
    
    
    500
    
    
    
    147.5
    
    
    
    816.2Gross profit (loss)
    
    
    6,859
    
    
    
    60.0
    
    
    
    (161
    )
    
    
    (47.5
    )
    
    
    (4,360.2
    )Operating costs and expenses:Marketing and selling
    
    
    5,297
    
    
    
    46.3
    
    
    
    1,423
    
    
    
    419.8
    
    
    
    272.2General and administrative
    
    
    3,473
    
    
    
    30.4
    
    
    
    3,067
    
    
    
    904.7
    
    
    
    13.2Research and development
    
    
    1,202
    
    
    
    10.5
    
    
    
    1,535
    
    
    
    452.8
    
    
    
    (21.7
    )Depreciation and amortization
    
    
    915
    
    
    
    8.0
    
    
    
    389
    
    
    
    114.7
    
    
    
    135.2Loss from operations
    
    
    (4,028
    )
    
    
    (35.2
    )
    
    
    (6,575
    )
    
    
    (1,939.5
    )
    
    
    (38.7
    )Other expense  net
    
    
    (644
    )
    
    
    (5.6
    )
    
    
    (3,662
    )
    
    
    (1,080.3
    )
    
    
    (82.4
    )Loss from
continuing operations before income taxes
    
    
    (4,672
    )
    
    
    (40.8
    )
    
    
    (10,237
    )
    
    
    (3,019.8
    )
    
    
    (54.4
    )Income tax benefit (expense)
    
    
    (11
    )
    
    
    (0.1
    )
    
    
    3,865
    
    
    
    1,140.2
    
    
    
    (100.3
    )Loss from continuing operations
    
    $
    (4,683
    )
    
    
    (40.9
    )%
    
    $
    (6,372
    )
    
    
    (1,879.6
    )%
    
    
    (26.5
    )
 Net Revenues
 ® ® ®
 Gross Profit
  20




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##### Table of Contents



® ® ® ® ®
 Marketing and Selling Expense
 ® ®
 General and Administrative Expense
  Research and Development Expense
 ® ® TM
 Depreciation and Amortization Expense
  Other Expense  Net
  Three Months Ended October 31,2007
    
    
    2006Senior secured convertible notes
    
    $
    216
    
    
    $
    BDCF secured term loan
    
    
    
    
    
    
    520Amortization of financing costs
    
    
    99
    
    
    
    2,223Amortization of debt discounts
    
    
    447
    
    
    
    2,067Capital leases
    
    
    5
    
    
    
    1Total interest expense
    
    $
    767
    
    
    $
    4,811
 21




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##### Table of Contents



Accounting for Registration Payment Arrangements
 Income Tax Benefit (Expense)
  Inflation and Seasonality
  Liquidity and Capital Resources
  ® ® ® ® ® TM
 ®
 22




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##### Table of Contents



Three Months Ended October 31,2007
    
    2006Net cash used in operating activities
    
    $
    (4,327
    )
    
    $
    (4,104
    )Net cash provided by (used in) investing activities
    
    
    (455
    )
    
    
    37,734Net cash used in financing activities
    
    
    (1,417
    )
    
    
    (22,935
    )October 31,
    
    July 31,2007
    
    2007Cash and cash equivalents
    
    $
    8,660
    
    
    $
    14,859Working capital
    
    
    10,909
    
    
    
    14,286Current ratio
    
    
    2.1
    
    
    
    2.4
  Cash Flows from Operating Activities
 ® ® ®
 Cash Flows from Investing Activities
  Cash Flows from Financing Activities
  23




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##### Table of Contents



Private Placements
   (i)
    
    9,100,000 shares of Zilas common stock for $1.75 per share (the Shares);(ii)
    
    Approximately $12.1 million in aggregate principal amount of 12.0% Unsecured
Convertible Notes (the Unsecured Notes), which converted into 6,900,000 shares (the
Unsecured Note Shares) of Zilas common stock at a conversion price of $1.75 per share on
December 14, 2006, the date on which our stockholders approved, among other things, the
Private Placements;(iii)
    
    Warrants to purchase approximately 5,403,000 shares of Zilas common stock, which
became exercisable in May 2007 for five years at an exercise price of $2.21 per share (the
Initial Warrants);(iv)
    
    Warrants to purchase approximately 3,105,000 shares of Zilas common stock, which
became exercisable for five years at an exercise price of $2.21 per share following
approval by our stockholders on December 14, 2006 (the Additional Warrants);
  (i)
    
    Approximately $12.0 million in aggregate principal amount of 6.0% Senior Secured
Convertible Notes (the Secured Notes), which are due in November 2009 and became
convertible into approximately 5,454,546 shares of Zilas common stock at a conversion
price of $2.20 following approval by our stockholders on December 14, 2006; and(ii)
    
    Warrants to purchase 1,909,091 shares of Zilas common stock, which became exercisable
for five years at an exercise price of $2.21 per share following approval by our
stockholders on December 14, 2006 (the Secured Note Warrants).
  (i)
    
    Zila repurchased 932,832 Unsecured Note Shares from the Investors for approximately
$1.25 million in cash, at a price based on the average closing bid price of our common
stock for the ten trading days prior to August 13, 2007, or $1.34 per Unsecured Note Share;(ii)
    
    Zila repurchased 227,270 Secured Note Warrants from the Investors for approximately
$0.15 million in cash, at a price based on a BlackScholes valuation, or $0.66 per Secured
Note Warrant;(iii)
    
    Zila and the Investors agreed to amend and restate the Secured Notes (the Amended and
Restated Secured Notes) on the terms set forth below and elsewhere herein; and(iv)
    
    Zila paid the Investors a $0.6 million fee.
  24




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##### Table of Contents



PharmaBio Investment
 ®
 Convertible Preferred Stock
  EBITDA
  25




---



##### Table of Contents



Three Months Ended October 31,2007
    
    
    2006EBITDA
    
    $
    (3,178
    )
    
    $
    5,290Non-cash derivative (income) expense
    
    
    24
    
    
    
    (1,059
    )Gain from disposition of discontinued operations
    
    
    
    
    
    
    (11,110
    )Non-cash stock-based compensation expense
    
    
    430
    
    
    
    218Other non-cash items  net
    
    
    (50
    )
    
    
    (54
    )Defined EBITDA (a)
    
    
    (2,774
    )
    
    
    (6,715
    )Interest income
    
    
    124
    
    
    
    125Interest expense
    
    
    (767
    )
    
    
    (5,064
    )Income tax expense
    
    
    (11
    )
    
    
    (12
    )Amortization of financing costs
    
    
    99
    
    
    
    2,095Amortization of debt discounts
    
    
    447
    
    
    
    2,067Non-cash interest on term loan
    
    
    
    
    
    
    138Changes in operating assets and liabilities:Trade receivables
    
    
    (1,946
    )
    
    
    956Inventories
    
    
    47
    
    
    
    (306
    )Prepaid expenses and other assets
    
    
    183
    
    
    
    8Accounts payable and accrued liabilities
    
    
    271
    
    
    
    2,604Net cash used in operating activities
    
    $
    (4,327
    )
    
    $
    (4,104
    )
 
 (a)
    
    Defined EBITDA, is EBITDA as defined in the Amended and Restated Secured Note
Agreement. Off-Balance Sheet Financing Arrangements
  Summary of Critical Accounting Policies and Estimates
   Recently Issued Accounting Pronouncements and Adopted Accounting
  26




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##### Table of Contents



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.
  
 Item 1A. Risk Factors.
  27




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##### Table of Contents



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
 Issuer Purchases of Equity Securities
 (c) TotalNumber of
    
    (d) MaximumShares
    
    Number ofPurchased
    
    Shares thatas Part of
    
    May Yet Be(a) Total
    
    (b) Average
    
    Publicly
    
    PurchasedNumber of
    
    Price
    
    Announced
    
    Under theShares
    
    Paid per
    
    Plans or
    
    Plans orPeriod
                
    
    Purchased
    
    Share
    
    Programs
    
    ProgramsAugust 1, 2007 toAugust 31, 2007
    
    
    
    
    
    
    932,832
    
    
    $
    1.34
    
    
    
    (a
    )
    
    
    (a
    )September 1, 2007 toSeptember 30, 2007
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (a
    )
    
    
    (a
    )October 1, 2007 toOctober 31, 2007
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (a
    )
    
    
    (a
    )
 
 (a)
    
    The above purchases were made as part of an Amendment Agreement with certain
Investors, which is more fully described in the notes to the unaudited condensed
consolidated financial statements included elsewhere in this
Quarterly Report on Form 10-Q.  
 Item 3. Defaults Upon Senior Securities.
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information.
  
 Item 6. Exhibits.
 ExhibitNumber
    
    Description31.1
    
    Section 302 Certification of the Principal Executive Officer31.2
    
    Section 302 Certification of the Principal Financial Officer32.1
    
    Section 1350 Certification of the Principal Executive Officer and Principal Financial Officer
 28




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##### Table of Contents



SIGNATURES
  Date: December 10, 2007
    
    Zila, Inc.By:
    
    /s/ FRANK J. BELLIZZIFrank J. BellizziExecutive Vice President(Principal Executive Officer)By:
    
    /s/ DIANE E. KLEINDiane E. KleinVice President  Finance and Treasurer(Principal Financial Officer)
 ExhibitNumber
    
    Description31.1
    
    Section 302 Certification of the Principal Executive Officer31.2
    
    Section 302 Certification of the Principal Financial Officer32.1
    
    Section 1350 Certification of the Principal Executive Officer and Principal Financial Officer
 29