##### 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 January 31, 2008
 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
    
    86-0619668(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation)
    
    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
  Large accelerated filer o
    
    Accelerated filer þ
    
    Non-accelerated filer   o
(Do not check if a smaller reporting company)
    
    Smaller reporting company o
 o þ




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##### 



TABLE OF CONTENTS
 PAGEPART I  FINANCIAL INFORMATIONItem 1. Financial StatementsCondensed Consolidated Balance Sheets as of January 31, 2008 (unaudited) and July 31, 2007
    
    
    2Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended January 31, 2008 and 2007
    
    
    3Unaudited Condensed Consolidated Statement of Shareholders Equity for the Six Months Ended January 31, 2008
    
    
    4Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended January 31, 2008 and 2007
    
    
    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
    
    
    29Item 4. Controls and Procedures
    
    
    29PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    29Item 1A. Risk Factors
    
    
    29Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    30Item 3. Defaults Upon Senior Securities
    
    
    30Item 4. Submission of Matters to a Vote of Security Holders
    
    
    31Item 5. Other Information
    
    
    31Item 6. Exhibits
    
    
    31Signatures
    
    
    32EX-31.1EX-31.2EX-32.1
  1




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 ZILA, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 January 31,
    
    
    July 31,2008
    
    
    2007(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    5,884,485
    
    
    $
    14,859,159Trade receivables  net of allowances of $172,000 and $173,000
    
    
    5,796,537
    
    
    
    4,273,580Inventories  net
    
    
    4,348,208
    
    
    
    4,074,733Prepaid expenses and other current assets
    
    
    1,848,577
    
    
    
    1,646,229Total current assets
    
    
    17,877,807
    
    
    
    24,853,701Property and equipment  net
    
    
    6,033,752
    
    
    
    6,219,436Goodwill
    
    
    10,171,351
    
    
    
    10,171,351Purchased technology  net
    
    
    9,372,245
    
    
    
    9,884,017Trademarks and other intangible assets  net
    
    
    10,782,935
    
    
    
    11,555,041Other assets
    
    
    1,007,987
    
    
    
    1,197,684Total assets
    
    $
    55,246,077
    
    
    $
    63,881,230LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    4,993,077
    
    
    $
    3,207,480Accrued liabilities
    
    
    4,026,520
    
    
    
    5,587,825Warrant and common stock repurchase liability
    
    
    
    
    
    
    1,376,393Current portion of deferred gain on sale leaseback
    
    
    152,147
    
    
    
    152,976Short-term borrowings and current portion of long-term debt
    
    
    261,478
    
    
    
    77,472Current liabilities of discontinued operations
    
    
    173,531
    
    
    
    165,368Total current liabilities
    
    
    9,606,753
    
    
    
    10,567,514Deferred gain on sale leaseback
    
    
    
    
    
    
    75,659Long-term debt  net of current portion
    
    
    8,119,729
    
    
    
    7,258,569Total liabilities
    
    
    17,726,482
    
    
    
    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,
62,019,921 and 62,466,338 shares issued and outstanding
    
    
    62,020
    
    
    
    62,466Additional paid-in capital
    
    
    123,327,077
    
    
    
    123,436,957Accumulated deficit
    
    
    (85,664,821
    )
    
    
    (76,054,251
    )Accumulated other comprehensive loss
    
    
    (116,110
    )
    
    
    (127,118
    )Treasury stock, at cost (218,411 and 1,151,243 common shares)
    
    
    (551,071
    )
    
    
    (1,801,066
    )Total shareholders equity
    
    
    37,519,595
    
    
    
    45,979,488Total liabilities and shareholders equity
    
    $
    55,246,077
    
    
    $
    63,881,230
  2




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ZILA, INC. AND SUBSIDIARIES
 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 Three Months Ended January 31,
    
    
    Six Months Ended January 31,2008
    
    
    2007
    
    
    2008
    
    
    2007Net revenues
    
    $
    10,490,657
    
    
    $
    7,149,383
    
    
    $
    21,931,094
    
    
    $
    7,488,570Cost of products sold
    
    
    4,244,551
    
    
    
    3,026,432
    
    
    
    8,826,203
    
    
    
    3,526,454Gross profit
    
    
    6,246,106
    
    
    
    4,122,951
    
    
    
    13,104,891
    
    
    
    3,962,116Operating costs and expenses:Marketing and selling
    
    
    5,220,677
    
    
    
    3,590,311
    
    
    
    10,517,274
    
    
    
    5,013,358General and administrative
    
    
    3,128,326
    
    
    
    3,817,195
    
    
    
    6,602,003
    
    
    
    6,884,635Research and development
    
    
    788,883
    
    
    
    1,817,546
    
    
    
    1,990,668
    
    
    
    3,352,238Depreciation and amortization
    
    
    943,711
    
    
    
    699,060
    
    
    
    1,858,724
    
    
    
    1,088,401Loss from operations
    
    
    (3,835,491
    )
    
    
    (5,801,161
    )
    
    
    (7,863,778
    )
    
    
    (12,376,516
    )Other income (expense):Interest income
    
    
    73,319
    
    
    
    180,997
    
    
    
    197,501
    
    
    
    276,626Interest expense
    
    
    (800,819
    )
    
    
    (790,893
    )
    
    
    (1,567,527
    )
    
    
    (5,602,023
    )Derivative income (expense)
    
    
    
    
    
    
    
    
    
    
    (23,600
    )
    
    
    1,058,873Other income (expense)
    
    
    (25,812
    )
    
    
    23,561
    
    
    
    (3,040
    )
    
    
    18,262Other expense  net
    
    
    (753,312
    )
    
    
    (586,335
    )
    
    
    (1,396,666
    )
    
    
    (4,248,262
    )Loss from continuing operations
before income taxes
    
    
    (4,588,803
    )
    
    
    (6,387,496
    )
    
    
    (9,260,444
    )
    
    
    (16,624,778
    )Income tax benefit (expense)
    
    
    
    
    
    
    (54,761
    )
    
    
    (11,592
    )
    
    
    3,810,139Loss from continuing operations
    
    
    (4,588,803
    )
    
    
    (6,442,257
    )
    
    
    (9,272,036
    )
    
    
    (12,814,639
    )Income (loss) from discontinued operations
    
    
    (146,765
    )
    
    
    407,588
    
    
    
    (319,034
    )
    
    
    (710,877
    )Gain (loss) on disposal of discontinued operations
    
    
    
    
    
    
    (116,132
    )
    
    
    
    
    
    
    10,993,438Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,877,000
    )Total income (loss) from discontinued operations
    
    
    (146,765
    )
    
    
    291,456
    
    
    
    (319,034
    )
    
    
    6,405,561Net loss
    
    
    (4,735,568
    )
    
    
    (6,150,801
    )
    
    
    (9,591,070
    )
    
    
    (6,409,078
    )Preferred stock dividends
    
    
    9,750
    
    
    
    9,750
    
    
    
    19,500
    
    
    
    19,500Net loss attributable to common shareholders
    
    $
    (4,745,318
    )
    
    $
    (6,160,551
    )
    
    $
    (9,610,570
    )
    
    $
    (6,428,578
    )Basic and diluted net income (loss) per common share:Loss from continuing operations
    
    $
    (0.08
    )
    
    $
    (0.12
    )
    
    $
    (0.15
    )
    
    $
    (0.25
    )Income (loss) from discontinued operations
    
    
    
    
    
    
    0.01
    
    
    
    (0.01
    )
    
    
    0.12Net loss attributable to common shareholders
    
    $
    (0.08
    )
    
    $
    (0.11
    )
    
    $
    (0.16
    )
    
    $
    (0.13
    )Weighted average common shares
outstanding  basic and diluted
    
    
    61,478,617
    
    
    
    55,544,636
    
    
    
    61,441,422
    
    
    
    50,671,338
  3




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ZILA, INC. AND SUBSIDIARIES
 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
 For the Six Months Ended January 31, 2008
 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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (19,500
    )
    
    
    
    
    
    
    
    
    
    
    (19,500
    )Exercise of common stock
options
    
    
    
    
    
    
    
    
    
    
    10,000
    
    
    
    10
    
    
    
    11,190
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,200Stock-based compensation
expense
    
    
    
    
    
    
    
    
    
    
    199,955
    
    
    
    200
    
    
    
    882,935
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    883,135Shares issued for
payment of interest
    
    
    
    
    
    
    
    
    
    
    276,460
    
    
    
    277
    
    
    
    245,057
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    245,334Retirement of
treasury stock
    
    
    
    
    
    
    
    
    
    
    (932,832
    )
    
    
    (933
    )
    
    
    (1,249,062
    )
    
    
    
    
    
    
    
    
    
    
    1,249,995
    
    
    
    Foreign currency
translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,008
    
    
    
    
    
    
    
    11,008Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,591,070
    )
    
    
    
    
    
    
    
    
    
    
    (9,591,070
    )Balance  January 31, 2008
    
    
    100,000
    
    
    $
    462,500
    
    
    
    62,019,921
    
    
    $
    62,020
    
    
    $
    123,327,077
    
    
    $
    (85,664,821
    )
    
    $
    (116,110
    )
    
    $
    (551,071
    )
    
    $
    37,519,595
  4




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ZILA, INC. AND SUBSIDIARIES
 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 Six Months Ended January 31,2008
    
    
    2007Cash flows from operating activities:Net loss
    
    $
    (9,591,070
    )
    
    $
    (6,409,078
    )Adjustments to reconcile net loss to net cash used
in operating activities:Depreciation and amortization
    
    
    2,084,687
    
    
    
    1,377,583Non-cash amortization of financing costs
    
    
    196,190
    
    
    
    2,255,624Non-cash amortization of debt discounts
    
    
    898,160
    
    
    
    2,486,423Non-cash interest
    
    
    245,334
    
    
    
    201,940Non-cash derivative (income) expense
    
    
    23,600
    
    
    
    (1,058,873
    )Gain on disposal of discontinued operations
    
    
    
    
    
    
    (10,993,438
    )Non-cash stock-based compensation expense
    
    
    883,135
    
    
    
    1,078,057Other non-cash items  net
    
    
    18,026
    
    
    
    (56,023
    )Changes in operating assets and liabilities:Trade receivables
    
    
    (1,522,957
    )
    
    
    (173,650
    )Inventories
    
    
    (273,475
    )
    
    
    (247,804
    )Prepaid expenses and other assets
    
    
    65,565
    
    
    
    934,490Accounts payable and accrued liabilities
    
    
    288,106
    
    
    
    2,786,161Net cash used in operating activities
    
    
    (6,684,699
    )
    
    
    (7,818,588
    )Cash flows from investing activities:Additions to property and equipment
    
    
    (549,234
    )
    
    
    (224,658
    )Additions to intangible assets
    
    
    (205,510
    )
    
    
    (263,831
    )Proceeds from sale of assets
    
    
    462
    
    
    
    Restricted cash returned from collateralized letter of credit
    
    
    
    
    
    
    3,610,950Proceeds from disposition of discontinued operations
    
    
    
    
    
    
    34,705,077Acquisition of Pro-Dentec
    
    
    
    
    
    
    (35,554,421
    )Net cash provided by (used in) investing activities
    
    
    (754,282
    )
    
    
    2,273,117Cash flows from financing activities:Short-term borrowings  net
    
    
    
    
    
    
    151,296Proceeds from convertible notes payable
    
    
    
    
    
    
    24,075,000Proceeds from issuance of common stock
    
    
    11,200
    
    
    
    15,971,481Financing costs
    
    
    
    
    
    
    (2,381,727
    )Principal payments on debt
    
    
    (127,400
    )
    
    
    (22,841,909
    )Payment of obligation to repurchase common stock and warrants
    
    
    (1,399,993
    )
    
    
    Dividends paid to preferred stockholders
    
    
    (19,500
    )
    
    
    (19,500
    )Net cash used in financing activities
    
    
    (1,535,693
    )
    
    
    14,954,641Net increase (decrease) in cash and cash equivalents
    
    
    (8,974,674
    )
    
    
    9,409,170Cash and cash equivalents  beginning of period
    
    
    14,859,159
    
    
    
    3,958,190Cash and cash equivalents  end of period
    
    $
    5,884,485
    
    
    $
    13,367,360
  5




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ZILA, INC. AND SUBSIDIARIES
 
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. Description of Business, Basis of Presentation and Continuance of Operations
  ® 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 January 31,
    
    
    Six Months Ended January 31,2008
    
    
    2007
    
    
    2008
    
    
    2007Options and warrants to purchase common shares
    
    
    44
    
    
    
    436
    
    
    
    62
    
    
    
    440Common stock awards
    
    
    51
    
    
    
    13
    
    
    
    52
    
    
    
    7Convertible preferred stock
    
    
    100
    
    
    
    100
    
    
    
    100
    
    
    
    100Convertible secured notes
    
    
    
    
    
    
    2,846
    
    
    
    
    
    
    
    1,423Total potentially dilutive securities
    
    
    195
    
    
    
    3,395
    
    
    
    214
    
    
    
    1,970
  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
 Business Combinations
 Noncontrolling Interests in Consolidated
Financial Statements  an amendment of ARB No. 51
 8




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ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 3. Acquisition of Pro-Dentec
   Three Months
    
    
    Six MonthsEnded
    
    
    EndedJanuary 31, 2007
    
    
    January 31, 2007Net revenues
    
    $
    9,806
    
    
    $
    19,107Loss from continuing operations
    
    $
    (6,376
    )
    
    $
    (11,881
    )Basic and diluted net loss per common share from continuing operations
    
    $
    (0.10
    )
    
    $
    (0.19
    )Pro forma weighted average common shares outstanding  basic and diluted
    
    
    61,812
    
    
    
    61,805
  4. Dispositions
 ®
  ®
 ® ® ®
 Accounting for the
Impairment or Disposal of Long-Lived Assets.
 9




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ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  Three Months Ended January 31, 2007Nutraceuticals
    
    
    Pharmaceuticals
    
    
    TotalNet revenues
    
    $
    
    
    
    $
    1,387
    
    
    $
    1,387Income (loss) from discontinued operations
    
    $
    (282
    )
    
    $
    689
    
    
    $
    407Gain (loss) on disposal of discontinued operations
    
    
    (114
    )
    
    
    (2
    )
    
    
    (116
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    Total income (loss) from discontinued operations
    
    $
    (396
    )
    
    $
    687
    
    
    $
    291
 Six Months Ended January 31, 2007Nutraceuticals
    
    
    Pharmaceuticals
    
    
    TotalNet revenues
    
    $
    1,629
    
    
    $
    2,426
    
    
    $
    4,055Loss from discontinued operations
    
    $
    (1,036
    )
    
    $
    325
    
    
    $
    (711
    )Gain (loss) on disposal of discontinued operations
    
    
    11,021
    
    
    
    (27
    )
    
    
    10,994Income tax expense
    
    
    (3,877
    )
    
    
    
    
    
    
    (3,877
    )Total income from discontinued operations
    
    $
    6,108
    
    
    $
    298
    
    
    $
    6,406
  5. Inventories
  January 31,
    
    
    July 31,2008
    
    
    2007(Unaudited)Finished goods
    
    $
    1,457
    
    
    $
    1,413Work-in-process
    
    
    317
    
    
    
    323Raw materials
    
    
    2,811
    
    
    
    2,659Inventory reserves
    
    
    (237
    )
    
    
    (320
    )Total inventories
    
    $
    4,348
    
    
    $
    4,075
 10




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ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 6. Property and Equipment
  January 31,
    
    
    July 31,2008
    
    
    2007(Unaudited)Land
    
    $
    529
    
    
    $
    529Building and improvements
    
    
    2,077
    
    
    
    2,181Furniture and equipment
    
    
    3,377
    
    
    
    2,360Leasehold improvements and other assets
    
    
    828
    
    
    
    1,360Production, laboratory and warehouse equipment
    
    
    4,584
    
    
    
    4,423Total property and equipment
    
    
    11,395
    
    
    
    10,853Less: Accumulated depreciation and amortization
    
    
    (5,361
    )
    
    
    (4,634
    )Property and equipment  net
    
    $
    6,034
    
    
    $
    6,219
 7. Goodwill and Other Intangible Assets
  January 31, 2008 (Unaudited)
    
    
    July 31, 2007Gross
    
    
    
    
    
    
    Net
    
    
    Gross
    
    
    
    
    
    
    NetCarrying
    
    
    Accumulated
    
    
    Carrying
    
    
    Carrying
    
    
    Accumulated
    
    
    CarryingAmount
    
    
    Amortization
    
    
    Amount
    
    
    Amount
    
    
    Amortization
    
    
    AmountAmortizable intangible assets:Purchased technology
    
    $
    15,592
    
    
    $
    (6,220
    )
    
    $
    9,372
    
    
    $
    15,592
    
    
    $
    (5,708
    )
    
    $
    9,884Trademarks
    
    
    151
    
    
    
    (12
    )
    
    
    139
    
    
    
    132
    
    
    
    (11
    )
    
    
    121Patents
    
    
    2,544
    
    
    
    (416
    )
    
    
    2,128
    
    
    
    2,495
    
    
    
    (350
    )
    
    
    2,145Licensing costs
    
    
    2,674
    
    
    
    (1,645
    )
    
    
    1,029
    
    
    
    2,674
    
    
    
    (1,514
    )
    
    
    1,160Covenants not to
compete and other
    
    
    3,555
    
    
    
    (1,516
    )
    
    
    2,039
    
    
    
    3,556
    
    
    
    (876
    )
    
    
    2,680Total amortizable
intangible assets
    
    
    24,516
    
    
    
    (9,809
    )
    
    
    14,707
    
    
    
    24,449
    
    
    
    (8,459
    )
    
    
    15,990Unamortizable trademarks
    
    
    5,449
    
    
    
    
    
    
    
    5,449
    
    
    
    5,449
    
    
    
    
    
    
    
    5,449Total other intangible assets
    
    
    29,965
    
    
    
    (9,809
    )
    
    
    20,156
    
    
    
    29,898
    
    
    
    (8,459
    )
    
    
    21,439Goodwill
    
    
    10,171
    
    
    
    
    
    
    
    10,171
    
    
    
    10,171
    
    
    
    
    
    
    
    10,171Total intangible assets
    
    $
    40,136
    
    
    $
    (9,809
    )
    
    $
    30,327
    
    
    $
    40,069
    
    
    $
    (8,459
    )
    
    $
    31,610
  Weighted AverageRange of
    
    Remaining Useful LivesUseful Lives
    
    January 31, 2008
    
    July 31, 2007(Unaudited)Purchased technology
    
    
    15
    
    
    
    14.0
    
    
    
    14.5Trademarks
    
    
    7-10
    
    
    
    7.8
    
    
    
    7.6Patents
    
    
    4-17
    
    
    
    6.1
    
    
    
    6.2Licensing costs
    
    
    7-10
    
    
    
    3.9
    
    
    
    4.4Covenants not to compete and other
    
    
    2-15
    
    
    
    1.3
    
    
    
    1.8
 11




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 8. Accrued Liabilities
  January 31,
    
    
    July 31,2008
    
    
    2007(Unaudited)Accrued research and development
    
    $
    1,193
    
    
    $
    1,864Accrued employee compensation and related taxes
    
    
    1,278
    
    
    
    1,876Accrued professional and consulting fees
    
    
    315
    
    
    
    569Accrued fee due Investors for Restructuring (see Note 9)
    
    
    
    
    
    
    600Other accrued expenses
    
    
    1,241
    
    
    
    679Total accrued liabilities
    
    $
    4,027
    
    
    $
    5,588
 9. Debt
  January 31,
    
    
    July 31,2008
    
    
    2007(Unaudited)Short-term borrowings and current portion of long-term debt:Short-term borrowings
    
    $
    184
    
    
    $
    Capital lease obligations
    
    
    77
    
    
    
    77Total short-term borrowings and current portion of long-term debt
    
    $
    261
    
    
    $
    77Long-term debt:Senior secured convertible notes  net of unamortized discount of $4,447 and $5,345
    
    $
    7,553
    
    
    $
    6,655PharmaBio
    
    
    500
    
    
    
    500Capital lease obligations
    
    
    144
    
    
    
    181Total long-term debt
    
    
    8,197
    
    
    
    7,336Less: Current portion of long-term debt
    
    
    (77
    )
    
    
    (77
    )Long-term debt  net of current portion
    
    $
    8,120
    
    
    $
    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;(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);
 12




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 (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.
  13




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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 January 31,
    
    Six Months Ended January 31,2008
    
    2007
    
    2008
    
    2007Risk-free interest rate
    
    
    3.5
    %
    
    
    5.1
    %
    
    
    3.5
    %
    
    
    5.1
    %Expected volatility
    
    
    59.3
    %
    
    
    60.9
    %
    
    
    59.6
    %
    
    
    60.5
    %Expected term (in years)
    
    
    5.2
    
    
    
    5.9
    
    
    
    5.2
    
    
    
    5.1Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
  Share-Based Payment
 14




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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
    
    
    3,128
    
    
    
    1.11Exercised
    
    
    (10
    )
    
    
    1.12Expired
    
    
    (220
    )
    
    
    2.68Forfeited
    
    
    (65
    )
    
    
    1.84Options outstanding  end of period
    
    
    5,750
    
    
    
    2.06
    
    
    
    7.6
    
    
    
    46Options vested or expected to vest  end of period
    
    
    4,863
    
    
    
    2.15
    
    
    
    7.3
    
    
    
    46Options exercisable  end of period
    
    
    2,268
    
    
    
    3.00
    
    
    
    5.3
    
    
    
    46
   WeightedWeighted
    
    AverageAverage
    
    RemainingNumber
    
    Grant
    
    Recognitionof Shares
    
    Value
    
    Period (Years)Unvested balance  beginning of period
    
    
    133
    
    
    $
    2.42
    
    
    
    1.4Granted
    
    
    598
    
    
    
    1.13Vested
    
    
    (284
    )
    
    
    1.52Forfeited
    
    
    Unvested balance  end of period
    
    
    447
    
    
    
    1.27
    
    
    
    1.5
  Three Months Ended January 31,
    
    
    Six Months Ended January 31,2008
    
    
    2007
    
    
    2008
    
    
    2007Marketing and selling expense
    
    $
    47
    
    
    $
    85
    
    
    $
    102
    
    
    $
    92General and administrative expense
    
    
    398
    
    
    
    757
    
    
    
    771
    
    
    
    980Research and development expense
    
    
    1
    
    
    
    10
    
    
    
    2
    
    
    
    2Inventory
    
    
    7
    
    
    
    7
    
    
    
    8
    
    
    
    9Discontinued operations
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    (5
    )Total stock-based compensation
    
    $
    453
    
    
    $
    860
    
    
    $
    883
    
    
    $
    1,078
  15




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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
  16




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 15. Supplemental Cash Flow Information
  Six Months Ended January 31,2008
    
    2007Interest paid
    
    $
    235
    
    
    $
    759Income taxes paid
    
    
    8
    
    
    
    139Insurance policy financed with short-term borrowings
    
    
    275
    
    
    
    Conversion of Unsecured Notes
    
    
    
    
    
    
    4,497Capital lease obligations for new equipment
    
    
    
    
    
    
    181
 16. Comprehensive Loss
  Three Months Ended January 31,
    
    
    Six Months Ended January 31,2008
    
    
    2007
    
    
    2008
    
    
    2007Net loss
    
    $
    (4,736
    )
    
    $
    (6,151
    )
    
    $
    (9,591
    )
    
    $
    (6,409
    )Foreign currency translation adjustment
    
    
    24
    
    
    
    (17
    )
    
    
    11
    
    
    
    (26
    )Comprehensive loss
    
    $
    (4,712
    )
    
    $
    (6,168
    )
    
    $
    (9,580
    )
    
    $
    (6,435
    )
 17. Commitments and Contingencies
 Legal Proceedings
   Indemnifications
  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 Continuance of Operations
  ® 630TM ® ® ® ® ® ® TM ® ®
  19




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##### Table of Contents



Recent Developments
  ® ® ® ® 630TM 630TM ® ® TM TM ® ®
 ®
 20




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##### Table of Contents



Results of Operations
  For the Three Months Ended January 31,% of
    
    
    
    
    
    
    % of
    
    
    %2008
    
    
    Revenue
    
    
    2007
    
    
    Revenue
    
    
    ChangeNet revenues
    
    $
    10,491
    
    
    
    100.0
    %
    
    $
    7,149
    
    
    
    100.0
    %
    
    
    46.7
    %Cost of products sold
    
    
    4,245
    
    
    
    40.5
    
    
    
    3,026
    
    
    
    42.3
    
    
    
    40.3Gross profit
    
    
    6,246
    
    
    
    59.5
    
    
    
    4,123
    
    
    
    57.7
    
    
    
    51.5Operating costs and expenses:Marketing and selling
    
    
    5,221
    
    
    
    49.8
    
    
    
    3,590
    
    
    
    50.2
    
    
    
    45.4General and administrative
    
    
    3,127
    
    
    
    29.9
    
    
    
    3,817
    
    
    
    53.4
    
    
    
    (18.1
    )Research and development
    
    
    789
    
    
    
    7.5
    
    
    
    1,818
    
    
    
    25.4
    
    
    
    (56.6
    )Depreciation and amortization
    
    
    944
    
    
    
    8.9
    
    
    
    699
    
    
    
    9.8
    
    
    
    35.1Loss from operations
    
    
    (3,835
    )
    
    
    (36.6
    )
    
    
    (5,801
    )
    
    
    (81.1
    )
    
    
    (33.9
    )Other expense  net
    
    
    (754
    )
    
    
    (7.1
    )
    
    
    (586
    )
    
    
    (8.2
    )
    
    
    28.7Loss from continuing operations
before income taxes
    
    
    (4,589
    )
    
    
    (43.7
    )
    
    
    (6,387
    )
    
    
    (89.3
    )
    
    
    (28.2
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    (55
    )
    
    
    (0.8
    )
    
    
    (100.0
    )Loss from continuing operations
    
    $
    (4,589
    )
    
    
    (43.7
    )%
    
    $
    (6,442
    )
    
    
    (90.1
    )%
    
    
    (28.8
    )
 For the Six Months Ended January 31,% of
    
    
    
    
    
    
    % of
    
    
    %2008
    
    
    Revenue
    
    
    2007
    
    
    Revenue
    
    
    ChangeNet revenues
    
    $
    21,931
    
    
    
    100.0
    %
    
    $
    7,489
    
    
    
    100.0
    %
    
    
    192.8
    %Cost of products sold
    
    
    8,826
    
    
    
    40.2
    
    
    
    3,527
    
    
    
    47.1
    
    
    
    150.2Gross profit
    
    
    13,105
    
    
    
    59.8
    
    
    
    3,962
    
    
    
    52.9
    
    
    
    230.8Operating costs and expenses:Marketing and selling
    
    
    10,517
    
    
    
    48.0
    
    
    
    5,013
    
    
    
    66.9
    
    
    
    109.8General and administrative
    
    
    6,602
    
    
    
    30.1
    
    
    
    6,885
    
    
    
    92.0
    
    
    
    (4.1
    )Research and development
    
    
    1,991
    
    
    
    9.1
    
    
    
    3,352
    
    
    
    44.8
    
    
    
    (40.6
    )Depreciation and amortization
    
    
    1,859
    
    
    
    8.5
    
    
    
    1,089
    
    
    
    14.5
    
    
    
    70.7Loss from operations
    
    
    (7,864
    )
    
    
    (35.9
    )
    
    
    (12,377
    )
    
    
    (165.3
    )
    
    
    (36.5
    )Other expense  net
    
    
    (1,396
    )
    
    
    (6.3
    )
    
    
    (4,248
    )
    
    
    (56.7
    )
    
    
    (67.1
    )Loss from continuing operations
before income taxes
    
    
    (9,260
    )
    
    
    (42.2
    )
    
    
    (16,625
    )
    
    
    (222.0
    )
    
    
    (44.3
    )Income tax benefit (expense)
    
    
    (12
    )
    
    
    (0.1
    )
    
    
    3,810
    
    
    
    50.9
    
    
    
    (100.3
    )Loss from continuing operations
    
    $
    (9,272
    )
    
    
    (42.3
    )%
    
    $
    (12,815
    )
    
    
    (171.1
    )%
    
    
    (27.6
    )
 Net Revenues
 ® ®
 21




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##### Table of Contents



®
 Gross Profit
 ® ® ® ® ®
 Marketing and Selling Expense
 ® ®
 General and Administrative Expense
   Research and Development Expense
 ® ® TM
 22




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##### Table of Contents



Depreciation and Amortization Expense
  Other Expense  Net
  Three Months Ended January 31,
    
    
    Six Months Ended January 31,2008
    
    
    2007
    
    
    2008
    
    
    2007Senior secured convertible notes
    
    $
    245
    
    
    $
    128
    
    
    $
    461
    
    
    $
    128BDCF secured term loan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    520Amortization of financing costs
    
    
    97
    
    
    
    161
    
    
    
    196
    
    
    
    2,384Amortization of debt discounts
    
    
    451
    
    
    
    419
    
    
    
    898
    
    
    
    2,486Capital leases
    
    
    4
    
    
    
    1
    
    
    
    9
    
    
    
    2Other
    
    
    4
    
    
    
    82
    
    
    
    4
    
    
    
    82Total interest expense
    
    $
    801
    
    
    $
    791
    
    
    $
    1,568
    
    
    $
    5,602
   Accounting for Registration Payment Arrangements
 Income Tax Benefit (Expense)
  Inflation and Seasonality
  23




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##### Table of Contents



Liquidity and Capital Resources
  ® ® ® ® ® TM
  ® ® ®
  24




---



##### Table of Contents



Six Months Ended January 31,2008
    
    2007Net cash used in operating activities
    
    $
    (6,685
    )
    
    $
    (7,819
    )Net cash provided by (used in) investing
activities
    
    
    (754
    )
    
    
    2,273Net cash used in financing activities
    
    
    (1,536
    )
    
    
    14,955January 31,
    
    July 31,2008
    
    2007Cash and cash
equivalents
    
    $
    5,884
    
    
    $
    14,859Working capital
    
    
    8,271
    
    
    
    14,286Current ratio
    
    
    1.9
    
    
    
    2.4
 ®
 Cash Flows from Operating Activities
 ® ® ®
 Cash Flows from Investing Activities
  Cash Flows from Financing Activities
  25




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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% 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.
  26




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##### Table of Contents



PharmaBio Investment
 ®
 Convertible Preferred Stock
  EBITDA
  27




---



##### Table of Contents



Three Months Ended January 31,
    
    
    Six Months Ended January 31,2008
    
    
    2007
    
    
    2008
    
    
    2007EBITDA
    
    $
    (2,947
    )
    
    $
    (4,706
    )
    
    $
    (6,125
    )
    
    $
    585Non-cash derivative (income) expense
    
    
    
    
    
    
    
    
    
    
    24
    
    
    
    (1,059
    )Gain from disposition of discontinued operations
    
    
    
    
    
    
    117
    
    
    
    
    
    
    
    (10,993
    )Non-cash stock-based compensation expense
    
    
    453
    
    
    
    860
    
    
    
    883
    
    
    
    1,078Other non-cash items  net
    
    
    69
    
    
    
    (1
    )
    
    
    19
    
    
    
    (56
    )Defined EBITDA (a)
    
    
    (2,425
    )
    
    
    (3,730
    )
    
    
    (5,199
    )
    
    
    (10,445
    )Interest income
    
    
    74
    
    
    
    181
    
    
    
    198
    
    
    
    306Interest expense
    
    
    (801
    )
    
    
    (791
    )
    
    
    (1,568
    )
    
    
    (5,855
    )Income tax expense
    
    
    
    
    
    
    (55
    )
    
    
    (11
    )
    
    
    (67
    )Amortization of financing costs
    
    
    97
    
    
    
    161
    
    
    
    196
    
    
    
    2,256Amortization of debt discounts
    
    
    451
    
    
    
    419
    
    
    
    898
    
    
    
    2,486Non-cash interest
    
    
    245
    
    
    
    64
    
    
    
    245
    
    
    
    202Changes in operating assets and liabilities:Trade receivables
    
    
    423
    
    
    
    (1,130
    )
    
    
    (1,523
    )
    
    
    (174
    )Inventories
    
    
    (321
    )
    
    
    58
    
    
    
    (274
    )
    
    
    (248
    )Prepaid expenses and other assets
    
    
    (118
    )
    
    
    926
    
    
    
    65
    
    
    
    934Accounts payable and accrued liabilities
    
    
    17
    
    
    
    182
    
    
    
    288
    
    
    
    2,786Net cash used in operating
activities
    
    $
    (2,358
    )
    
    $
    (3,715
    )
    
    $
    (6,685
    )
    
    $
    (7,819
    )
 
 (a)
    
    Defined EBITDA is EBITDA as defined in the Amended and Restated Secured Note
Agreement, which is: Consolidated Net Income plus, without duplication and to the
extent reflected as a charge in the statement of Consolidated Net Income for such
period, the sum of (a) income tax expense, (b) interest expense, amortization or
write-off of debt discount and debt issuance costs and commissions, discounts and other
fees and charges associated with Indebtedness, (c) depreciation and amortization
expense, (d) amortization of intangibles (including, but not limited to, goodwill) and
organization costs and (e) other non-cash items reducing Consolidated Net Income and
minus, to the extent included in the statement of such Consolidated Net Income for such
period, (x) interest income and (y) all other non-cash items increasing Consolidated
Net Income, all as determined on a consolidated basis. Off-Balance Sheet Financing Arrangements
  Summary of Critical Accounting Policies and Estimates
   28




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##### Table of Contents



Recently Issued Accounting Pronouncements and Adopted Accounting
  
 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.
  29




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##### Table of Contents



We may not be able to maintain compliance with our debt covenants in the future, which is the
principal reason we have identified a going concern consideration related to our financial
condition.
  (i)
    
    Maintain, at the end of each fiscal quarter, 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.
   Our stock price may result in our failure to maintain NASDAQ Marketplace Rules related to
minimum stock price requirements which could result in NASDAQ delisting our common stock.
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
  
 Item 3. Defaults Upon Senior Securities.
  30




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##### Table of Contents



Item 4. Submission of Matters to a Vote of Security Holders
   Number of SharesName
    
    For
    
    WithheldDavid R. Bethune
    
    
    44,620,527
    
    
    
    1,730,517J. Steven Garrett
    
    
    42,583,185
    
    
    
    3,767,859David Goldman
    
    
    44,644,925
    
    
    
    1,706,119Leslie H. Green
    
    
    44,199,276
    
    
    
    2,151,768O.B. Parrish
    
    
    36,793,745
    
    
    
    9,557,299George J. Vuturo
    
    
    44,616,590
    
    
    
    1,734,454
   For
    
    Against
    
    Abstain
    
    Non Votes23,491,942
    
    3,436,882
    
    388,788
    
    19,033,432
  For
    
    Against
    
    Abstain45,394,591
    
    402,809
    
    553,644
 
 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
 
 *
    
    Furnished herewith 31




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##### Table of Contents



SIGNATURES
  Date: March 11, 2008
    
    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
 
 *
    
    Furnished herewith 32