SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
____________
FORM 10-Q

(Mark One)

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended April 30, 2001 or

o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from  to

Commission file number 0-17521

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|------------------------------------------------------
|ZILA, INC                                             
|                                                      
|                                                      
|                                                      
|                                                      
|                                                      
|(Exact Name of Registrant as Specified In Its Charter)

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

Registrants Telephone Number, Including Area Code (602) 266-6700

Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days Yes X    No___

APPLICABLE ONLY TO CORPORATE ISSUERS

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

At April 30, 2001, the number of shares of common stock outstanding was
43,446,150.

Exhibit Index 20
Total pages 20

1



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TABLE OF CONTENTS



|                               |                                                                                               |                                                                                             |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------- |  |  |  |  |  | 
|Part I  Financial Information
|                               | Item 1.  Financial Statements                                                               
|                               |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)                                          
|                               |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS) INCOME
(UNAUDITED)
|                               |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)                                
|                               |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)                           
|                               | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                               | Item 3. Quantitative and Qualitative Disclosures about Market Risk                           
|Part II  Other Information   
|                               | ITEM 1.  Legal Proceedings.                                                                 
|                               | ITEM 2. CHANGES IN 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 AND REPORTS ON FORM 8-K.                                                    
|SIGNATURES                    
|EX-10.O                       
|EX-10.P                       
|EX-10.Q                       
|EX-10.R                       

TABLE OF CONTENTS

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|        |  |                                                                                                                                                    |  | Page no.
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|Part I  |  | FINANCIAL INFORMATION                                                                                                                             
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|Item 1. |  | Financial Statements (Unaudited)

Condensed consolidated balance sheets as of April 30,
2001 and July 31, 2000                                     |  |          | 3     | 
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|        |  | Condensed consolidated statements of operations and
comprehensive (loss) income for the three months and
nine months ended April 30, 2001 and 2000 |  |          | 4     | 
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|        |  | Condensed consolidated statements of cash flows for
the nine months ended April 30, 2001 and 2000                                                  |  |          | 5     | 
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|        |  | Notes to condensed consolidated financial statements                                                                                               |  |          | 6-11  | 
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|Item 2. |  | Managements discussion and analysis of financial condition
and results of operations                                                              |  |          | 11-18 | 
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|Item 3. |  | Quantitative and qualitative disclosures about market risk                                                                                         |  |          | 18    | 
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|Part II |  | OTHER INFORMATION                                                                                                                                 
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|Item 1. |  | Legal proceedings                                                                                                                                  |  |          | 19    | 
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|        |  | SIGNATURES                                                                                                                                         |  |          | 20    | 

2



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ZILA, INC. AND SUBSIDIARIES




CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

|                                            |                                                                                                                                                             |                            |                           |                   |            |            |            |             |            |            |            | 
|------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ------------------------- | ----------------- | ---------- | ---------- | ---------- | ----------- | ---------- | ---------- | ---------- | 
|ASSETS                                      |                                                                                                                                                             | April 30, 2001             |                           | July 31, 2000    
|                                            |                                                                                                                                                             |                            |                           |                  
|CURRENT ASSETS:                            
|                                           
|                                           
|                                           
|                                           
|                                            | Cash and cash equivalents                                                                                                                                   |                            | $                         | 821,254           |            |            | $          | 5,558,487   |           
|                                           
|                                           
|                                           
|                                           
|                                            | Trade receivables net                                                                                                                                      |                            |                           | 8,806,392         |            |            |            | 9,893,587   |           
|                                           
|                                           
|                                           
|                                           
|                                            | Inventories net                                                                                                                                            |                            |                           | 18,504,116        |            |            |            | 13,204,137  |           
|                                           
|                                           
|                                           
|                                           
|                                            | Prepaid expenses and other current assets                                                                                                                   |                            |                           | 2,727,054         |            |            |            | 2,723,860   |           
|                                            |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|                                            |                                                                                                                                                             |                            | Total current assets      |                   |            | 30,858,816 |            |             |            | 31,380,071 |           
|                                            |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|PROPERTY AND EQUIPMENT net                 |                                                                                                                                                             |                            | 11,341,729                |                   |            |            | 9,442,278  |            
|                                           
|                                           
|                                           
|                                           
|PURCHASED TECHNOLOGY RIGHTS net            |                                                                                                                                                             |                            | 5,273,645                 |                   |            |            | 5,600,975  |            
|                                           
|                                           
|                                           
|                                           
|GOODWILL net                               |                                                                                                                                                             |                            | 13,008,182                |                   |            |            | 12,725,978 |            
|                                           
|                                           
|                                           
|                                           
|TRADEMARKS and OTHER INTANGIBLE ASSETS net |                                                                                                                                                             |                            | 12,813,198                |                   |            |            | 12,423,632 |            
|                                           
|                                           
|                                           
|                                           
|CASH HELD BY TRUSTEE                        |                                                                                                                                                             |                            |                           |                   |            |            | 2,928,001  |            
|                                           
|                                           
|                                           
|                                           
|OTHER ASSETS                                |                                                                                                                                                             |                            | 3,886,188                 |                   |            |            | 3,210,524  |            
|                                            |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|TOTAL                                       |                                                                                                                                                             | $                          | 77,181,758                |                   |            | $          | 77,711,459 |            
|                                            |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|LIABILITIES AND SHAREHOLDERS EQUITY       
|                                           
|                                           
|                                           
|                                           
|CURRENT LIABILITIES:                       
|                                           
|                                           
|                                           
|                                           
|                                            | Accounts payable                                                                                                                                            |                            | $                         | 6,625,398         |            |            | $          | 6,599,702   |           
|                                           
|                                           
|                                           
|                                           
|                                            | Accrued liabilities                                                                                                                                         |                            |                           | 3,153,810         |            |            |            | 3,622,330   |           
|                                           
|                                           
|                                           
|                                           
|                                            | Short-term borrowings                                                                                                                                       |                            |                           | 6,289,532         |            |            |            | 51,770      |           
|                                           
|                                           
|                                           
|                                           
|                                            | Current portion of long-term debt                                                                                                                           |                            |                           | 4,859,567         |            |            |            | 776,866     |           
|                                            |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|                                            |                                                                                                                                                             |                            | Total current liabilities |                   |            | 20,928,307 |            |             |            | 11,050,668 |           
|                                           
|                                           
|                                           
|                                           
|LONG-TERM DEBT net of current portion      |                                                                                                                                                             |                            | 144,053                   |                   |            |            | 4,548,953  |            
|                                            |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|                                            |                                                                                                                                                             |                            |                           | Total liabilities |            |            | 21,072,360 |             |            |            | 15,599,621 | 
|                                            |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|COMMITMENTS AND CONTINGENCIES
(Note 11)    
|                                           
|                                           
|                                           
|                                           
|SHAREHOLDERS EQUITY:                      
|                                           
|                                           
|                                           
|                                           
|                                            | Preferred stock, $.001 par value authorized 2,500,000 shares, issued 100,000
shares Series B Preferred Stock (April 30, 2001)
and 0 shares (July 31, 2000) |                            |                           | 462,500           |           
|                                           
|                                           
|                                           
|                                           
|                                            | Common stock, $.001 par value authorized 65,000,000 shares, issued
43,641,150 shares (April 30, 2001) and 43,362,658 shares (July 31, 2000)                |                            |                           | 43,641            |            |            |            | 43,363      |           
|                                           
|                                           
|                                           
|                                           
|                                            | Capital in excess of par value                                                                                                                              |                            |                           | 79,903,066        |            |            |            | 79,424,235  |           
|                                           
|                                           
|                                           
|                                           
|                                            | Accumulated other comprehensive income                                                                                                                      |                            |                           | 134,933           |            |            |            | 71,666      |           
|                                           
|                                           
|                                           
|                                           
|                                            | Deficit                                                                                                                                                     |                            |                           | (23,899,622       | )          |            |            | (17,017,676 | )         
|                                           
|                                           
|                                           
|                                           
|                                            | Less: 195,000 shares (April 30, 2001) and 135,000 shares (July 31, 2000)
of common stock in treasury, at cost                                               |                            |                           | (535,120          | )          |            |            | (409,750    | )         
|                                            |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|                                            |                                                                                                                                                             | Total shareholders equity |                           |                   | 56,109,398 |            |            |             | 62,111,838 |           
|                                            |                                                                                                                                                             |                            |                           |                   |            |            |            |            
|TOTAL                                       |                                                                                                                                                             | $                          | 77,181,758                |                   |            | $          | 77,711,459 |            
|                                            |                                                                                                                                                             |                            |                           |                   |            |            |            |            

See notes to condensed consolidated financial statements

3



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ZILA, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS) INCOME (UNAUDITED)

|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |            |            |       |            |           |            |   |            | 
|--------------------------------------------- | --------------------------------- | ----------------------------------- | ---------------------------------------------------- | ---------- | --------- | ---------------------------- | ---------- | --------------------------- | --------- | ---- | ---------- | ---------- | ---------- | ----- | ---------- | --------- | ---------- | - | ---------- | 
|                                              |                                   |                                     |                                                      |            |           | Three months ended April 30, |            | Nine months ended April 30,
|                                              |                                   |                                     |                                                      |            |           |                              |            |                            
|                                              |                                   |                                     |                                                      |            |           | 2001                         |            | 2000                        |           | 2001 |            | 2000      
|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |           
|NET REVENUES                                  |                                   | $                                   | 16,233,762                                           |            |           | $                            | 19,422,777 |                             |           | $    | 53,627,357 |            |            | $     | 58,811,167 |          
|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |            |            |       |            |          
|OPERATING COSTS AND EXPENSES:                
|                                             
|                                             
|                                             
|                                             
|                                              |                                   | Cost of products sold               | 9,939,220                                            |            |           |                              | 10,020,367 |                             |           |      | 30,334,581 |            |            |       | 29,979,275 |          
|                                             
|                                             
|                                             
|                                             
|                                              |                                   | Selling, general and administrative |                                                      |            | 9,071,680 |                              |            |                             | 8,351,277 |      |            |            | 24,623,207 |       |            |           | 25,080,020 |  
|                                             
|                                             
|                                             
|                                             
|                                              |                                   | Research and development            |                                                      |            | 1,148,820 |                              |            |                             | 379,535   |      |            |            | 2,621,364  |       |            |           | 1,482,434  |  
|                                             
|                                             
|                                             
|                                             
|                                              |                                   | Depreciation and amortization       |                                                      |            | 903,949   |                              |            |                             | 841,893   |      |            |            | 2,625,847  |       |            |           | 2,649,290  |  
|                                             
|                                             
|                                             
|                                             
|                                              |                                   | Impairment charge                   |                                                      |            |           |                              |            |                             |           |      |            |            | 310,000    |      
|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |            |            |       |            |          
|                                              |                                   |                                     | 21,063,669                                           |            |           |                              | 19,593,072 |                             |           |      | 60,514,999 |            |            |       | 59,191,019 |          
|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |            |            |       |            |          
|LOSS FROM OPERATIONS                          |                                   |                                     | (4,829,907                                           | )          |           |                              | (170,295   | )                           |           |      | (6,887,642 | )          |            |       | (379,852   | )        
|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |            |            |       |            |          
|OTHER INCOME (EXPENSES):                     
|                                             
|                                             
|                                             
|                                             
|                                              |                                   | Interest income                     |                                                      |            | 37,579    |                              |            |                             | 118,317   |      |            |            | 192,751    |       |            |           | 293,322    |  
|                                             
|                                             
|                                             
|                                             
|                                              |                                   | Interest expense                    |                                                      |            | (191,957  | )                            |            |                             | (20,400   | )    |            |            | (358,474   | )     |            |           | (194,231   | )
|                                             
|                                             
|                                             
|                                             
|                                              |                                   | Other expense                       |                                                      |            | (108,674  | )                            |            |                             | (6,979    | )    |            |            | (163,581   | )     |            |           | (30,917    | )
|                                             
|                                             
|                                             
|                                             
|                                              |                                   | Gain on sale of assets              |                                                      |            |           |                              |            |                             |           |      |            |            |            |       |            |           | 4,659,127  |  
|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |            |            |       |            |          
|                                              |                                   |                                     | (263,052                                             | )          |           |                              | 90,938     |                             |           |      | (329,304   | )          |            |       | 4,727,301  |          
|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |            |            |       |            |          
|                                              | (LOSS) INCOME BEFORE INCOME TAXES |                                     |                                                      | (5,092,959 | )         |                              |            | (79,357                     | )         |      |            | (7,216,946 | )          |       |            | 4,347,449 |           
|                                             
|                                             
|                                             
|                                             
|INCOME TAX (EXPENSE) BENEFIT                  |                                   |                                     |                                                     |            |           |                              | 95,770     |                             |           |      | 335,000    |            |            |       | (2,418,170 | )        
|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |            |            |       |            |          
|NET (LOSS) INCOME                             |                                   | $                                   | (5,092,959                                           | )          |           | $                            | 16,413     |                             |           | $    | (6,881,946 | )          |            | $     | 1,929,279  |          
|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |            |            |       |            |          
|NET (LOSS) INCOME PER SHARE:                 
|                                             
|                                             
|                                             
|                                             
|                                              |                                   |                                     |                                                      | BASIC      |           | $                            | (0.12      | )                           |           | $    | 0.00       |            |            | $     | (0.16      | )         |            | $ | 0.05       | 
|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |            |            |       |            |          
|                                              |                                   |                                     |                                                      | DILUTED    |           | $                            | (0.12      | )                           |           | $    | 0.00       |            |            | $     | (0.16      | )         |            | $ | 0.05       | 
|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |            |            |       |            |          
|WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING
|                                             
|                                             
|                                             
|                                             
|                                              |                                   |                                     |                                                      | BASIC      |           |                              | 43,446,150 |                             |           |      | 43,271,080 |            |            |       | 43,401,455 |           |            |   | 42,175,534 | 
|                                             
|                                             
|                                             
|                                             
|                                              |                                   |                                     |                                                      | DILUTED    |           |                              | 43,446,150 |                             |           |      | 43,819,995 |            |            |       | 43,401,455 |           |            |   | 42,489,219 | 
|                                             
|                                             
|                                             
|                                             
|
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|NET LOSS                                      |                                   | $                                   | (5,092,959                                           | )          |           |                              |            |                             |           | $    | (6,881,946 | )         
|                                             
|                                             
|                                             
|                                             
|Other comprehensive income, net of tax       
|                                             
|                                             
|                                             
|                                             
|                                              |                                   |                                     | Foreign currency translation adjustment              |            | 28,597    |                              |            |                             |           |      |            |            | 59,767     |      
|                                             
|                                             
|                                             
|                                             
|                                              |                                   |                                     | Net unrealized gain on available-for-sale-securities |            |           | 5,370                        |            |                             |           |      |            |            |            | 3,500 |           
|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |           
|Other comprehensive income                    |                                   |                                     | 33,967                                               |            |           |                              |            |                             |           |      | 63,267     |           
|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |           
|COMPREHENSIVE LOSS                            |                                   | $                                   | (5,058,992                                           | )          |           |                              |            |                             |           | $    | (6,818,679 | )         
|                                              |                                   |                                     |                                                      |            |           |                              |            |                             |           |      |            |           

See notes to condensed consolidated financial statements.

4



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ZILA, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |      |            |            |            |  
|-------------------------------------------------- | --------------------------------------------------------- | ------------------------------------------------------------------------------------ | --------------------------------- | --------------------------------------------------- | ---------- | --------------------------- | ---------- | ---- | ---------- | ---------- | ---------- | -
|                                                   |                                                           |                                                                                      |                                   |                                                     |            | Nine months ended April 30,
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                            
|                                                   |                                                           |                                                                                      |                                   |                                                     |            | 2001                        |            | 2000
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|OPERATING ACTIVITIES:                             
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           | Net (loss) income                                                                    |                                   | $                                                   | (6,881,946 | )                           |            | $    | 1,929,279  |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           | Adjustments to reconcile net (loss) income to net cash used in operating activities:
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           |                                                                                      | Depreciation and amortization     |                                                     |            | 2,625,847                   |            |      |            | 2,649,290  |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           |                                                                                      | Gain on sale of assets            |                                                     |            |                            |            |      |            | (4,659,127 | )         
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           |                                                                                      | Impairment of asset               |                                                     |            | 310,000                     |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           |                                                                                      | Deferred income taxes and other   |                                                     |            | (331,178                    | )          |      |            | 2,355,538  |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           |                                                                                      | Change in assets and liabilities:
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           |                                                                                      |                                   | Receivables net                                    |            |                             | 1,087,195  |      |            |            | (2,994,671 | )
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           |                                                                                      |                                   | Inventories                                         |            |                             | (5,092,835 | )    |            |            | (1,476,507 | )
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           |                                                                                      |                                   | Prepaid expenses and other assets                   |            |                             | (254,522   | )    |            |            | (1,240,197 | )
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           |                                                                                      |                                   | Accounts payable and other liabilities              |            |                             | (442,825   | )    |            |            | 1,527,763  |  
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|                                                   |                                                           |                                                                                      |                                   | Net cash used in operating activities               |            |                             | (8,980,264 | )    |            |            | (1,908,632 | )
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|INVESTING ACTIVITIES:                             
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           | Purchases of property and equipment                                                  |                                   |                                                     | (2,524,501 | )                           |            |      | (2,030,067 | )         
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           | Net proceeds from sale of assets                                                     |                                   |                                                     |           |                             |            |      | 7,749,927  |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           | Net cash paid for acquisition                                                        |                                   |                                                     | (1,849,418 | )                           |            |      |           |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           | Purchases of intangible assets                                                       |                                   |                                                     | (550,353   | )                           |            |      | (45,938    | )         
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|                                                   |                                                           |                                                                                      |                                   | Net cash (used in) provided by investing activities |            |                             | (4,924,272 | )    |            |            | 5,673,922  |  
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|FINANCING ACTIVITIES:                             
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           | Net proceeds from short-term borrowings                                              |                                   |                                                     | 6,237,762  |                             |            |      | (63,885    | )         
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           | Net proceeds from issuance of common stock                                           |                                   |                                                     | 449,109    |                             |            |      | 196,028    |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           | Acquisition of treasury stock                                                        |                                   |                                                     | (125,370   | )                           |            |      | 346,573    |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           | Cash released by trustee                                                             |                                   |                                                     | 2,928,001  |                             |            |      | (372,413   | )         
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           | Principal payments on long-term debt                                                 |                                   |                                                     | (322,199   | )                           |            |      | (5,307,856 | )         
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|                                                   |                                                           |                                                                                      |                                   | Net cash provided by (used in) financing activities |            |                             | 9,167,303  |      |            |            | (5,201,553 | )
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|NET DECREASE IN CASH AND CASH EQUIVALENTS          |                                                           |                                                                                      | (4,737,233                        | )                                                   |            |                             | (1,436,263 | )   
|                                                  
|                                                  
|                                                  
|                                                  
|CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD     |                                                           |                                                                                      | 5,558,487                         |                                                     |            |                             | 5,770,970  |     
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|CASH AND CASH EQUIVALENTS, END OF PERIOD           |                                                           | $                                                                                    | 821,254                           |                                                     |            | $                           | 4,334,707  |     
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|CASH PAID FOR INTEREST                             |                                                           | $                                                                                    | 300,797                           |                                                     |            | $                           | 167,685    |     
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|CASH PAID FOR INCOME TAXES                         |                                                           | $                                                                                    | 75,114                            |                                                     |            | $                           | 86,650     |     
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           | FINANCING ACTIVITIES:                                                               
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                           | Issuance of Series B Convertible Preferred Stock for acquisition                     |                                   | $                                                   | 462,500    |                            
|                                                   |                                                           |                                                                                      |                                   |                                                    
|                                                   |                                                           | Income tax benefit attributable to exercise of common stock options                  |                                   |                                                     |            |                             |            | $    | 250,000    |           
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|                                                   |                                                           | Conversion of Series A Convertible Redeemable Preferred stock                        |                                   |                                                     |            |                             |            | $    | 8,787,191  |           
|                                                   |                                                           |                                                                                      |                                   |                                                     |            |                             |            |     
|                                                   | See notes to condensed
consolidated financial statements.

5



---



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



|1. |  | BASIS OF PRESENTATION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | The condensed consolidated financial statements include the accounts of
Zila, Inc. and its wholly-owned subsidiaries, Zila Pharmaceuticals, Inc.,
Zila International Inc., Zila Ltd., Bio-Dental Technologies Corporation
(Bio-Dental), Zila Technologies, Inc., formerly Cygnus Imaging, Inc.
(Cygnus), Zila Swab Technologies, Inc. dba Innovative Swab Technologies
(IST) and Oxycal Laboratories, Inc. (Oxycal). All significant
intercompany balances and transactions are eliminated in consolidation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  
|   |  | In the opinion of management of Zila, Inc. and its subsidiaries
(collectively referred to herein as Zila or the Company), all
adjustments, consisting of normal recurring accruals, considered necessary
for a fair presentation have been included in the condensed consolidated
financial statements. The results of operations for the interim period
are not necessarily indicative of the results that may be expected for the
entire year. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Certain
reclassifications have been made to the prior year financial statements to
conform to the current year presentation.
|  
|   |  | On February 5, 2001, the Company announced it had acquired the patent
rights and the Antioch, Illinois manufacturing operations for swab
products from National Healthcare Manufacturing Corporation, headquartered
in Winnipeg, Canada. Intellectual property, inventory, plus molding,
labeling, filling and sealing equipment were included in the acquisition.
The business unit is known as Innovative Swab Technologies. Zila paid
approximately $2.4 million in a combination of cash and preferred stock
for the unit (See Note 8).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  
|2. |  | NET (LOSS) INCOME PER SHARE                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  
|   |  | The following is a reconciliation of the numerator and denominator of
basic and diluted (loss) earnings per share:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

|                                                 |  |   |                            |   |                           |   |            |  |      |   |            |   |  |   |            |  | 
|------------------------------------------------ |  | - | -------------------------- | - | ------------------------- | - | ---------- |  | ---- | - | ---------- | - |  | - | ---------- |  | 
|                                                 |  |   | For the three months ended |   | For the nine months ended
|                                                 |  |   | April 30,                  |   | April 30,                
|                                                 |  |   |                            |   |                          
|                                                 |  |   | 2001                       |   | 2000                      |   | 2001       |  | 2000
|                                                 |  |   |                            |   |                           |   |            |  |     
|Net (loss) income                                |  | $ | (5,092,959                 | ) |                           | $ | 16,413     |  |      | $ | (6,881,946 | ) |  | $ | 1,929,279  | 
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|Average outstanding common shares                |  |   | 43,446,150                 |   |                           |   | 43,271,080 |  |      |   | 43,401,455 |   |  |   | 42,175,534 | 
|                                                
|                                                
|                                                
|                                                
|Basic net income (loss) per share                |  | $ | (0.12                      | ) |                           | $ | 0.00       |  |      | $ | (0.16      | ) |  | $ | 0.05       | 
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                
|Diluted net (loss) income per share:            
|                                                
|                                                
|                                                
|                                                
|Net (loss) income available for diluted earnings |  | $ | (5,092,959                 | ) |                           | $ | 16,413     |  |      | $ | (6,881,946 | ) |  | $ | 1,929,279  | 
|                                                
|                                                
|                                                
|                                                
|Average outstanding common shares from above     |  |   | 43,446,150                 |   |                           |   | 43,271,080 |  |      |   | 43,401,455 |   |  |   | 42,175,534 | 

6



---



|                                                                 |  |   |                            |   |                           |   |            |  |      |   |       |   |  |   |            |  | 
|---------------------------------------------------------------- |  | - | -------------------------- | - | ------------------------- | - | ---------- |  | ---- | - | ----- | - |  | - | ---------- |  | 
|                                                                 |  |   | For the three months ended |   | For the nine months ended
|                                                                 |  |   | April 30,                  |   | April 30,                
|                                                                 |  |   |                            |   |                          
|                                                                 |  |   | 2001                       |   | 2000                      |   | 2001       |  | 2000
|                                                                 |  |   |                            |   |                           |   |            |  |     
|                                                                
|                                                                
|                                                                
|                                                                
|Additional dilutive shares related to
stock options and warrants |  |   |                            |   |                           |   | 548,915    |  |      |   |       |   |  |   | 313,685    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Average outstanding and potentially dilutive common shares       |  |   |                            |   |                           |   | 43,819,995 |  |      |   |       |   |  |   | 42,489,219 | 
|                                                                
|                                                                
|                                                                
|                                                                
|Dilutive net (loss) income per share                             |  | $ | (0.12                      | ) |                           | $ | 0.00       |  |      | $ | (0.16 | ) |  | $ | 0.05       | 



|   |  | Since a loss was incurred for the quarter and nine months ended April 30,
2001, convertible preferred stock, options and warrants to purchase shares
of common stock that would otherwise qualify as common stock equivalents
were not included in the computation of diluted net income per share
because their effect would be antidilutive.
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|3. |  | INVENTORIES                                                                                                                                                                                                                                                                                                                                   
|  
|   |  | Inventories consist of the following:                                                                                                                                                                                                                                                                                                         

|                   |  |           |            |          |  |   |            |  
|------------------ |  | --------- | ---------- | -------- |  | - | ---------- | -
|                   |  | April 30, |            | July 31,
|                   |  | 2001      |            | 2000    
|                   |  |           |            |         
|Finished goods     |  | $         | 11,076,398 |          |  | $ | 9,219,343  |  
|                  
|                  
|                  
|                  
|Raw materials      |  |           | 7,642,094  |          |  |   | 4,168,834  |  
|                  
|                  
|                  
|                  
|Inventory reserves |  |           | (214,376   | )        |  |   | (184,040   | )
|                   |  |           |            |          |  |   |            |  
|                   |  | $         | 18,504,116 |          |  | $ | 13,204,137 |  
|                   |  |           |            |          |  |   |            |  



|4. |  | INCOME TAXES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | Deferred income taxes reflect the tax effect of temporary differences
between the amounts of assets and liabilities recognized for financial
reporting and tax purposes. At the end of each fiscal quarter, the
Company makes its best estimate of the effective tax rate expected to be
applicable for the full fiscal year. The rate so determined is used in
providing for income taxes on a current year-to-date basis. The rate is
revised, if necessary, as of the end of each quarter during the fiscal
year to the Companys best estimate of its annual effective tax rate. In
the nine months ended April 30, 2001, the Company recorded a tax benefit
of $335,000.
|  
|   |  | In the prior year quarter ended October 31, 1999, the Company recorded an
income tax benefit of $820,000 ($250,000 of which was attributable to the
exercise of common stock options in prior years and therefore was credited
to capital in excess of par value). In the nine months ended April 30,
2000, the Company recorded income tax expense of $2,418,170, which is net
of the income tax benefit of $820,000 recorded in the first quarter of
fiscal year 2000.                                                                                                                                                                                                     
|  
|5. |  | DEBT                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|  
|   |  | On December 1, 2000, the Company renewed its $9 million line of credit
with Bank One for an additional 12 months under similar terms and
conditions, including a variable interest rate equal to the prime rate
(the Index), which was 7.5% at April 30, 2001. Under the line of credit
loan agreement, the Company is required to comply with financial covenants
based on certain financial ratios. At April 30, 2001, the Company had
borrowings of $6.1 million against the line of credit. As of April 30,
2001, the Company was in default of the debt service coverage ratio.                                                                                       

7



---





|   |  | On May 7, 2001, the Company and Bank One entered into the First Loan
Modification Agreement whereby the line of credit was reduced to $7.25
million, the interest rate was raised to 3.0% over the Index, the Company
agreed to cross-defaulting and cross-collateralizing of all Bank One loans
and obligations and Bank One agreed to forebear in exercising any remedy
with respect to the default through May 31, 2001. On
June 14, 2001, the forbearance period contained in the First Loan Modification Agreement ended
May 31, 2001, and the Agreement was amended and the forbearance
period was extended to June 29, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | The Company is currently negotiating with Bank One to enter into a Second
Loan Modification Agreement (the Agreement) that will include a
provision to waive the debt service covenant so that the Company will no
longer be in default and will add certain new obligations that must be met
by the Company. The Company believes an agreement will be reached with
respect to the terms of the Agreement as both parties are negotiating in
good faith. However, there is no assurance that an agreement between
the parties can be reached or that the Agreement
will be executed. In the event that the Agreement is not executed, the
Company will be in default under the line of credit and as a result of the
cross default provision in the First Loan Modification Agreement, will be
in default of the building loan on the 7th Street location and Bank One
may demand payment of all amounts due to them. Moreover, due to the cross
default provision in the Reimbursement Agreement between Oxycal
Laboratories, Inc. and Bank One, Arizona, dated March 1, 1999 related to
the issuance of certain Industrial Development Revenue Bonds (the
Bonds), of which the Company is a guarantor, Bank One
will have the right to provide notice of default which would then
cause the Company to be in
default on the Bonds. The Company has reclassified the Bonds outstanding of $4.1
million from long-term debt to a current liability.
|  
|6. |  | ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  
|   |  | The Company accounts for impairment of long-lived assets in accordance
with Statement of Financial Accounting Standards (SFAS) No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of which was issued in March 1995. SFAS No. 121
requires that long-lived assets be reviewed for impairment whenever events
or changes in circumstances indicate that the book value of the asset may
not be recoverable. In the quarter ended October 31, 2000, the Company
recorded a non-cash charge of $310,000, in the Nutraceuticals segment, to
write down the carrying amount of the land and buildings located at 533
Madison Avenue, Prescott, Arizona to an estimated fair value related to
its anticipated sale.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|  
|   |  | The building was sold in February 2001 for $1.35 million, of which
$200,000 was paid at closing with the remaining $1.15 million receivable
as a short-term note bearing interest at 5% per annum. The initial
$200,000 investment received from the buyers was insufficient to qualify
the transaction as a sale under the requirements of SFAS 66, Accounting
for Sales of Real Estate. As a result, the transaction was recorded
using the deposit method of accounting with the amount received from the
buyers reflected as a customer deposit within accrued liabilities. On May
15, 2001, the sale was consummated upon receipt of the additional
cash, and the then remaining balance of the short-term note of $310,000
was restructured and is due and payable on May 31, 2002 with interest at a
rate of 10% to be paid monthly.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|  
|7. |  | NEW ACCOUNTING PRONOUNCEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|  
|   |  | In May 2000, the Financial Accounting Standards Boards Emerging Issues
Task Force (EITF) issued Issue No. 00-14, Accounting for Certain Sales
Incentives. The Issue addresses the recognition, measurement, and income
statement classification for certain sales incentives including coupons,
rebates and free products. The implementation of this consensus will
require the Company to change the way it classifies certain sales
incentives, which are currently                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

8



---





|   |  | recorded as selling, general and administrative expenses. The cost of
coupons and rebates will be recorded as a reduction of net sales. The
cost of free products will be recorded as a reduction of products sold.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | In April 2001, the EITF issued Issue No. 00-25 Vendor Income Statement
Characterization of Consideration from a Vendor to a Retailer. The issue
discusses accounting and income statement classification of costs, other
than those directly addressed in Issue 00-14, that are incurred by a
vendor (typically a manufacturer or distributor) to or on behalf of a
customer (typically a retailer) in connection with the customers purchase
or promotion of the vendors products. Such costs include consideration
given to retailers for space in their stores (slotting fees),
consideration given to obtain favorable display positions in the
retailers stores and other promotional activity (cooperative
advertising). The issue addresses the recognition and measurement of such
costs and whether a vendor should classify such costs in its income
statement when incurred as a reduction of revenues or as an expense item.
|  
|   |  | The consensus on EITF 00-14 and 00-25 will be effective for the Company in
the third quarter of fiscal year 2002. The Company is in the process of
analyzing the requirements of these pronouncements and the expected impact
on the financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  
|8. |  | CONVERTIBLE PREFERRED STOCK                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|  
|   |  | On February 1, 2001, the Company issued 100,000 shares of Series B
convertible preferred stock to National Healthcare Manufacturing
Corporation, U.S. as part of the acquisition of the patent rights and the
Antioch, Illinois manufacturing operations for swab products. The
preferred stock is convertible into shares of the Companys common stock
at any time at a conversion ratio of one to one. The holders of the
preferred stock are entitled to receive cumulative quarterly dividends at
a rate of $0.0975 per share per fiscal quarter, payable in arrears.
Holders of the preferred shares have no voting rights except as required
by applicable law.                                                                                                                                                                                                                                                                     
|  
|9. |  | SALE OF ASSETS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  
|   |  | On October 28, 1999, Cygnus completed the sale of substantially all of its
assets and certain liabilities to Procare Laboratories, Inc. (Procare),
of Scottsdale, Arizona for approximately $4.0 million. Procare is
controlled by the former owner and President of Cygnus. The purchase
price was paid through the issuance of a $4.0 million note receivable that
was collateralized by the assets of Procare and matured and was paid in
full on November 10, 1999. The net book value of the assets sold and
liabilities assumed was $3.9 million. The sale resulted in a $139,000
gain.                                                                                                                                                                                                                                                                                                                                            
|  
|   |  | On December 20, 1999, the Company, through its wholly-owned subsidiary
Integrated Dental Technologies, Inc. (IDT), completed the sale of
substantially all of its assets and liabilities related to its
PracticeWorks division located in Gold River, California to InfoCure
Corporation (InfoCure), of Atlanta, Georgia for approximately $4.65
million. InfoCure is a national provider of healthcare practice management
software products and services to targeted healthcare practice
specialties.                                                                                                                                                                                                                                                                                                                                                                                                                                
|  
|   |  | The following unaudited pro forma information presents the condensed
consolidated results of operations as if the sales had occurred as of the
beginning of the nine month period ended April 30, 2000 and does not
purport to be indicative of what would have occurred had the sale been
made as of that date.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

9



---



|                           |  |                   |        | 
|-------------------------- |  | ----------------- | ------ | 
|                           |  | Nine months ended
|                           |  | April 30, 2000   
|                           |  |                  
|                           |  | (in thousands)   
|Net revenues               |  | $                 | 57,103 | 
|                          
|                          
|                          
|                          
|                          
|                          
|                          
|                          
|                          
|Operating income           |  |                   | 188    | 
|                          
|                          
|                          
|                          
|                          
|                          
|                          
|                          
|                          
|Income before income taxes |  |                   | 944    | 

10.   SEGMENT INFORMATION



| |  | The Company is organized into five major groups, all of which have
distinct product lines, brand names and are managed as autonomous business
units. The Company has identified the following segments for purposes of
applying SFAS No. 131:Consumerwhich includes Zila Pharmaceuticals, Inc.
and the Zilactin® line of products; Professionalwhich
includes Peridex®, Pro-Ties,
OraTest®,and the IST line of products; Dental Supply,which
includes Bio-Dental Technologies Corporation and Ryker Dental of Kentucky,
Inc. (a subsidiary of Bio-Dental Technologies Corporation) which does
business under the name Zila Dental Supply; and Nutraceuticals,which
includes Oxycal Laboratories, Inc. and its wholly-owned subsidiary,
Inter-Cal, Inc. The Company evaluates performance and allocates resources
to segments based on operating results. Expenses related to the
manufacturing facility for Zila Tolonium Chloride and the ongoing
OraTest® clinical study have been combined with the Corporate
segment. The Dental Imaging and Dental Software businesses, sold in
fiscal year 2000, are combined into the Othersegment. Prior to August 1,
2000, the Consumer and Professional segment were combined and shown as the
Pharmaceutical segment. The Professional segment was removed from the
Pharmaceutical segment as a result of the change in management reporting
structure. Previous segment disclosures have been restated to reflect this
presentation.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The table below presents information about reported segments as of and for
the nine months ended April 30 (in thousands):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

|                                   |      |  |          |       |              |  |        |        |           |  |                |        |       |  |       |        |   |  |   |        |   |  |   |       |  |  |   |        |  
|---------------------------------- | ---- |  | -------- | ----- | ------------ |  | ------ | ------ | --------- |  | -------------- | ------ | ----- |  | ----- | ------ | - |  | - | ------ | - |  | - | ----- |  |  | - | ------ | -
|                                   |      |  |          |       |              |  |        |        |           |  | Dental        
|                                   |      |  | Consumer |       | Professional |  | Supply |        | Corporate |  | Nutraceuticals |        | Other |  | Total
|Net revenues:                     
|                                  
|                                  
|                                  
|                                  
|                                   | 2001 |  | $        | 8,998 |              |  | $      | 3,633  |           |  | $              | 30,814 |       |  | $     | 0      |   |  | $ | 10,182 |   |  | $ | 0     |  |  | $ | 53,627 |  
|                                  
|                                  
|                                  
|                                  
|                                   | 2000 |  |          | 8,489 |              |  |        | 3,941  |           |  |                | 29,817 |       |  |       | 0      |   |  |   | 14,856 |   |  |   | 1,708 |  |  |   | 58,811 |  
|                                  
|                                  
|                                  
|                                  
|(Loss) income before
income taxes:
|                                  
|                                  
|                                  
|                                  
|                                   | 2001 |  |          | 3,505 |              |  |        | (2,136 | )         |  |                | (178   | )     |  |       | (7,200 | ) |  |   | (1,208 | ) |  | $ | 0     |  |  |   | (7,217 | )
|                                  
|                                  
|                                  
|                                  
|                                   | 2000 |  |          | 2,989 |              |  |        | (2,146 | )         |  |                | 319    |       |  |       | (5,096 | ) |  |   | 4,185  |   |  |   | 4,096 |  |  |   | 4,347  |  
|                                  
|                                  
|                                  
|                                  
|Depreciation and
amortization:    
|                                  
|                                  
|                                  
|                                  
|                                   | 2001 |  |          | 60    |              |  |        | 850    |           |  |                | 213    |       |  |       | 648    |   |  |   | 855    |   |  | $ | 0     |  |  |   | 2,626  |  
|                                  
|                                  
|                                  
|                                  
|                                   | 2000 |  |          | 32    |              |  |        | 1,155  |           |  |                | 226    |       |  |       | 332    |   |  |   | 759    |   |  |   | 145   |  |  |   | 2,649  |  
|                                  
|                                  
|                                  
|                                  
|Total assets:                     
|                                  
|                                  
|                                  
|                                  
|                                   | 2001 |  |          | 2,764 |              |  |        | 14,888 |           |  |                | 12,394 |       |  |       | 12,879 |   |  |   | 34,257 |   |  | $ | 0     |  |  |   | 77,182 |  
|                                  
|                                  
|                                  
|                                  
|                                   | 2000 |  |          | 3,319 |              |  |        | 10,492 |           |  |                | 11,987 |       |  |       | 16,561 |   |  |   | 30,979 |   |  |   | 470   |  |  |   | 73,808 |  



|11. |  | COMMITMENTS AND CONTINGENCIES                                                             
|--- |  | ------------------------------------------------------------------------------------------
|   
|    |  | The Company and certain officers of the Company were named as defendants
in a consolidated

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| |  | First Amended Class Action Complaint filed July 6, 1999 in the United
States District Court for the District of Arizona under the caption In re
Zila Securities Litigation, No. CIV 99 0115 PHX EHC. The First Amended
Class Action Complaint sought damages in an unspecified amount on behalf
of a class consisting of purchasers of the Companys securities for
alleged violations of the federal securities laws. The parties settled
this matter without a material impact on the Companys financial
statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | On September 8, 1999, the Securities and Exchange Commission (the
Commission) entered an order directing an investigation entitled In the
Matter of Zila, Inc.The Commission is investigating whether (i) there
were purchases or sales of securities of the Company by persons while in
possession of material non-public information concerning the prospects
that the Oncologic Drugs Advisory Committee for the FDA would recommend
approval of the OraTest® NDA and whether the FDA would
subsequently approve the NDA; (ii) such persons conveyed information
regarding these matters to other persons who effected transactions in
securities of the Company without disclosing the information; and (iii)
there were false and misleading statements in press releases, filings with
the Commission, or elsewhere concerning these matters. The Company does
not believe it has violated any of the federal securities laws and is
cooperating fully with the Commission in its investigation.
|
| |  | The Company is subject to other legal proceedings and claims, which arise
in the ordinary course of business. In the opinion of management, the
amount of ultimate liability with respect to these other actions will not
materially affect the financial position or results of operations of the
Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

ZILA, INC. AND SUBSIDIARIES

Forward Looking Information

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

Factors that could cause or contribute to the Companys actual results
differing materially from those discussed herein or for the Companys stock
price to be affected adversely include, but are not limited to:
(i) the Companys failure to enter into a second modification
agreement with respect to its line of credit with Bank One,
(ii) the Companys failure to maintain compliance with the
covenants of its outstanding debt instruments, (iii) industry
trends, including a downturn or slowing of the growth of the dietary supplement
industry, the dental supplies and equipment industry and the consumer oral
care, OTC and prescription industries,

11



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(iv) increased competition from current competitors and new market entrants,
(v) adverse publicity regarding the industries where the Company markets
their products, (vi) the Companys dependence upon its ability to develop new
products, (vii) the Companys ability to gain or expand distribution within new
or existing channels of trade, (viii) an increase in the cost of obtaining and
maintaining shelf space with major national retailers who demand various forms
of incentives from their suppliers such as slotting fees, coop advertising or
rebates, (ix) adverse changes in government regulations, (x) exposure to
product liability claims, (xi) dependence on significant
customers, (xii) the
Companys ability to keep and attract key management employees,
(xiii) the
Companys inability to manage growth and execute its business
plan, (xiv) sales
and earnings volatility, (xv) volatility of the stock market,
(xvi) the
Companys reliance on independent brokers to sell many of its
products, (xvii)
the inability of the Company to protect its intellectual property,
and (xviii)
a general downturn in the national economy as a whole.

Included among the factors affecting OraTest® are (i) the FDAs
ultimate decision regarding OraTest®; (ii) the length and expense
of the new clinical study and the FDA review process; (iii) the limitations on
indicated uses for which OraTest® may be marketed; and, (iv) if
approved, the market reception to OraTest® and any post-marketing
reports or surveillance programs to monitor usage or side effects of
OraTest®. There can be no assurance that the forward-looking
statements contained in this document will, in fact, transpire or prove to be
accurate. For a more detailed description of these and other cautionary
factors that may affect the Companys future results, please refer to the
Companys Annual Report on Form 10-K for its fiscal year ended July 31, 2000
filed with the Securities and Exchange Commission.

COMPANY OVERVIEW

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

On October 28, 1999, Cygnus completed the sale of substantially all of its
assets and certain liabilities to Procare Laboratories, Inc. (Procare), of
Scottsdale, Arizona for approximately $4.0 million. Procare is controlled by
the former owner and President of Cygnus. The purchase price was paid through
the issuance of a note receivable, which was collateralized by the assets of
Procare and was paid in full on November 10, 1999. The sale resulted in a
$139,000 gain.

On December 20, 1999, the Company, through its wholly-owned subsidiary,
Integrated Dental Technologies, Inc. (IDT), completed the sale of
substantially all of IDTs assets and liabilities related to its PracticeWorks
division located in Gold River, California to InfoCure Corporation
(InfoCure), of Atlanta, Georgia for approximately $4.65 million. InfoCure is
a national provider of healthcare practice management software products and
services to targeted healthcare practice specialties and is listed on the
NASDAQ under the symbol INCX. Under the terms of the agreement, ten percent
(10%) of the

12



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sales price was held in escrow for one year in order to secure the
representations, warranties, and covenants made by the Company to InfoCure. The
trustee released approximately $422,000 in January 2001.

On February 5, 2001, the Company acquired the patent rights and the
Antioch, Illinois manufacturing operations for swab products from National
Healthcare Manufacturing Corporation, headquartered in Winnipeg, Canada.
Intellectual property, inventory, plus molding, labeling, filling and sealing
equipment were included in the acquisition. The business unit is known as
Innovative Swab Technologies, Inc. Zila paid approximately $2.4 million in a
combination of cash and preferred stock for the unit.

RESULTS OF OPERATIONS

THREE MONTHS ENDED APRIL 30, 2001 AND 2000

Total net revenues declined 16.4% to $16.2 million for the quarter ended
April 30, 2001, compared to revenues of $19.4 million during the third quarter
of the prior fiscal year.

Net revenues for Zila Dental Supply increased slightly to $10.5 million
for the quarter ended April 30, 2001, compared to $10.1 million for the
corresponding fiscal quarter in 2000. This increase was primarily due to an
increase in sales of full service supplies and internet sales. Consumer
Pharmaceuticals had net revenues of $2.4 million for the quarter ended April
30, 2001, a 15.2% decline over the $2.8 million recorded during the
corresponding quarter last year. The decrease was due, among other things, to a
delay in receiving an adequate supply of the Zilactin® L products
thereby causing an inability to fill certain customer orders during the period.
This situation has now been rectified.

Net revenues for Professional Pharmaceuticals (including sales of
OraTest®) were $917,000, a decrease of 24.8% from $1.2 million
during the prior year quarter. The decrease was due primarily to lower sales
of Peridex® due to increased pricing pressures and substitutions
of generic equivalents. In order to stimulate sales of its Professional
Pharmaceutical products, in April 2001, the Company signed a contract with the
Lanmark Group for telemarketing and fulfillment services for its new Pro-Series
of products that are being marketed directly to dental professionals. Included
in the revenues for Professional Pharmaceuticals for the current quarter are
sales for the new IST division of $273,000 (excluding $227,000 of intercompany
sales). OraTest® products had net revenue of $59,000 for the
quarter ended April 30, 2001 as compared to $29,000 in the corresponding
quarter last year. Sales of OraTest® during the current quarter
were in the United Kingdom, Taiwan and China.

Net revenues for Inter-Cal for the quarter ended April 30, 2001, were $2.5
million, a 52.8% decrease when compared to $5.2 million for the corresponding
2000 fiscal quarter. Inter-Cals international sales during the quarter
decreased approximately 67% when compared to the previous years third quarter.
The decrease is largely attributable to an overall slowdown in the domestic
and foreign vitamin and food supplement markets and the affects of promotional
discounting programs in prior periods.

For the quarter ended April 30, 2001, cost of products sold was $9.9
million; a slight decrease from the $10.0 million recorded in the quarter ended
April 30, 2000. Cost of products sold as a percentage of net revenues increased
to 61.2% in the quarter ended April 30, 2001 from 51.6% in the quarter ended
April 30, 2000. The increase for the quarter reflects primarily the growth of
Zila Dental Supply as a percentage of total revenues, 64.5% for the quarter
ended April 30, 2001, compared to 52.2% for the previous year quarter. Margins
for Zila Dental Supply are lower as compared to the other

13



---

operating groups resulting in a higher cost of products sold as a percentage of
revenues.

Cost of products sold as a percentage of net revenues for Zila Dental
Supply increased slightly to 75.8% for the quarter ended April 30, 2001 when
compared to the 74.3% recorded in the prior year quarter, primarily due to a
change in product mix and that Zila Dental Supply had no increase in prices to
customers even though the cost of products have increased from the
manufacturers. Zila Dental Supply will be releasing its new catalog in June
2001 that will include some price increases.

Cost of products sold as a percentage of net revenues for Consumer
Pharmaceuticals increased to 25.9% in the quarter ended April 30, 2001, from
23.6% in the quarter ended April 30, 2000. The increase for the quarter is a
result of a change in the mix of products sold. Cost of products sold as a
percentage of net product sales for Professional Pharmaceuticals increased to
48.9% for the quarter ended April 30, 2001 from 25.6% in the quarter ended
April 30, 2000. The increase is due primarily to the addition of IST to the
group during the quarter.

Cost of products sold as a percentage of net revenues for Inter-Cal
increased to 31.6% in the quarter ended April 30, 2001 from 26.1% in the
previous year quarter. The increase was caused by a change in the mix of
products sold including the new Palmettx botanical line of products.

The Company incurred selling, general and administrative expenses of $9.1
million, or 55.9% of net revenues during the third quarter of fiscal year 2001
compared to $8.4 million, or 43.0% of net revenue in the same period in fiscal
2000. The increase is due primarily to increased legal and marketing expenses.

Research and development expenses increased $769,000, or approximately
202.7%, from $380,000 in the third quarter of fiscal year 2000 to $1.1 million
for the same period in fiscal year 2001. The increase is primarily due to
increased costs paid to ILEX Oncology related to the FDA-required clinical
study associated with the Companys ongoing efforts to obtain FDA approval of
OraTest®.

Depreciation and amortization expenses increased slightly to $904,000 in
the third quarter of fiscal year 2001 from $842,000 for the same period in
fiscal year 2000. The increase is due primarily to the increased depreciation
of assets associated with Inter-Cals new manufacturing facility.

The Company recorded interest expense of $192,000 for the quarter ended
April 30, 2001 compared to $20,000 in the same period of the previous year. The
increase was attributable to increased bank borrowings and debt obligations
incurred during the third quarter of fiscal year 2001 as compared to the
previous year period.

At the end of each fiscal quarter, the Company makes its best estimate of
the effective tax rate expected to be applicable for the full fiscal year. The
rate so determined is used in providing for income taxes on a current
year-to-date basis. The rate is revised, if necessary, as of the end of each
quarter during the fiscal year to the Companys best current estimate of its
effective rate. The effective tax rate could change significantly in future
interim periods if there is a change in the Companys estimates
because of (i) the proportion of non-deductible amortization of intangible assets in relation
to pre-tax income (loss) for financial reporting purposes and (ii) the
non-deductibility of foreign operating losses. In the three months ended April
30, 2001, the Company recorded no income tax benefit as compared to an income
tax expense of $96,000 recorded in the same period of the prior year. The
Company continually analyzes the reasonableness of its reserves against
deferred tax assets. Should the Company continue to experience losses,
additional allowances may be required.

For the quarter ended April 30, 2001, the Company had a net loss of $5.1
million compared to

14



---



net income of $16,000 for the prior year quarter. The decrease in profitability
is primarily attributable to the decrease in sales and profitability at
Inter-Cal and increased research and development expenses during the current
quarter.

NINE MONTHS ENDED APRIL 30, 2001 AND 2000

Total net revenues declined 8.8% to $53.6 million for the nine months
ended April 30, 2001, compared to revenues of $58.8 million for the nine months
ended April 30, 2000. Excluding the year-to-date revenues in the prior fiscal
year for the PracticeWorks and Cygnus divisions of $1.7 million, which were
sold in the prior fiscal year, net revenues decreased 6.1%.

Net revenues for Zila Dental Supply increased 3.3% to $30.8 million for
the nine months ended April 30, 2001, compared to $29.8 million for the
corresponding nine months in 2000. This increase was primarily attributable to
an increase in full-service operations and increases in internet sales.
Consumer Pharmaceuticals had net revenues of $9.0 million for the nine months
ended April 30, 2001, a 6.0% increase over the $8.5 million recorded during the
corresponding period last year. The increase was due primarily to increased
sales of all of the Zilactin products related primarily to the use of discount
programs.

Net revenues for Professional Pharmaceuticals (including sales of
OraTest®) decreased 7.6% to $3.6 million for the nine months ended
April 30, 2001 as compared to $3.9 million in the prior year period. The
current year period includes (i) a one-time licensing fee of $499,000 generated
from an agreement executed during the second fiscal quarter, whereby the
Company granted a customer the right to use its technology related to
Chlorhexidine Gluconate, the active ingredient in Peridex®, to
produce a generic form of the product for distribution; and (ii) revenues for
IST of $273,000 recorded in the current third quarter. Revenues for
OraTest® products were $131,000.

Net revenues for Inter-Cal for the nine months ended April 30, 2001, were
$10.2 million, a 31.5% decrease when compared to the $14.9 million for the
corresponding period in fiscal year 2000. The decrease is attributable to an
overall slowdown in the domestic vitamin market and promotional discounting in
prior year periods. Inter-Cals international sales decreased 22.8% to $3.1
million during the first nine months of the current fiscal year as compared to
the previous year amount as international customers have experienced a similar
slowdown.

For the nine months ended April 30, 2001, cost of products sold was $30.3
million, a slight increase from $30.0 million for the nine months ended April
30, 2000. Cost of products sold as a percentage of net revenues increased to
56.6% in the nine months ended April 30, 2001 from 51.0% in the corresponding
2000 period. The increase for the period reflects primarily the growth of Zila
Dental Supply as a percentage of total revenues, 57.4% for the nine months
ended April 30, 2001 compared to 50.7% for same period of the previous fiscal
year. Gross profit margins for Zila Dental Supply are lower as compared to the
other operating groups resulting in a higher cost of products sold as a
percentage of revenues.

Cost of products sold as a percentage of net revenues for Zila Dental
Supply increased slightly to 74.4% for the nine months ended April 30, 2001
from 74.3% for the nine months ended April 30, 2000 primarily due to a change
in the product mix as well as an increase in prices paid for merchandise in the
current fiscal quarter. Cost of products sold as a percentage of net revenues
for Consumer Pharmaceuticals decreased slightly to 21.4% in the nine months
ended April 30, 2001, compared to 22.3% for the corresponding period in fiscal
2000. The increase for the quarter is a result of a change in the mix of
products sold. Cost of products sold as a percentage of net product sales for
Professional

15



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Pharmaceuticals increased to 32.4% in the nine months ended April 30, 2001,
compared to 24.8% for the corresponding period in fiscal 2000. The increase is
due primarily to the addition of IST to the group during the current quarter,
which has a cost of products sold of 75.8%.

Cost of products sold as a percentage of net revenues for Inter-Cal
increased to 35.4% in the nine months ended April 30, 2001 from 27.2% in the
nine months ended April 30, 2000. The increase was caused by costs associated
with the manufacturing of the new Palmettx botanical line of
products as well as the duplicate overhead, moving and equipment validation
costs related to the relocation of the manufacturing equipment to the new
facility during the period.

The Company incurred selling, general and administrative expenses of $24.6
million, or 45.9% of net revenues during the first nine months of fiscal year
2001 compared to $25.1 million, or 42.6% of net revenue in the same period in
fiscal 2000. The decrease in selling, general and administrative expenses is
attributable to a reduction in costs related to the Cygnus and PracticeWorks
businesses partially offset by increased costs related to the expansion of the
sales force and service department at Zila Dental Supplys full service
branches, increased selling and administrative costs related to the
OraTest® international product launches, increased marketing and
selling expenses at Inter-Cal and increased corporate legal expenses.

Research and development expenses increased $1.1 million or 76.8%, from
the $1.5 million incurred in the first nine months of fiscal year 2000 to $2.6
million for the same period in fiscal year 2001. The increase was primarily
due to an increase in expenses related to research and clinical activities
associated with OraTest®, partially offset by a reduction of costs
incurred in the Cygnus and PracticeWorks businesses.

Depreciation and amortization expenses decreased $23,000 from $2.6 million
in the nine months of fiscal year 2000 to $2.6 million for the same period in
fiscal year 2001. The decrease is due primarily to the reduction in costs
related to the Cygnus and PracticeWorks businesses partially offset by the
increase in the depreciation of assets associated with Inter-Cals new
manufacturing facility that were placed in service during the current nine
month period.

In October 2000, the Company recorded a non-cash impairment charge of
$310,000 to write down the carrying value of the land and buildings located at
533 Madison Avenue, Prescott, Arizona to an estimated fair value related to its
anticipated sale (See Note 6).

The Company recorded interest expense of $358,000 for the nine months
ended April 30, 2001 compared to $194,000 in the same period of the previous
year. The increase is attributable to increases in debt obligations incurred
during the current year period as compared to the previous year period.

In the nine months ended April 30, 2001, the Company recorded an income
tax benefit of $335,000. In the nine months ended April 30, 2000, the Company
recorded income tax expense of $2.4 million which is net of the income tax
benefit of $820,000 recorded in the first quarter of fiscal year 2000 ($250,000
of which was attributable to the exercise of common stock options in prior
years and therefore was credited to capital in excess of par value). The
Company continually analyzes the reasonableness of its reserves against
deferred tax assets. Should the Company continue to experience losses,
additional allowances may be required.

16



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LIQUIDITY AND CAPITAL RESOURCES

At April 30, 2001, the Companys primary sources of liquidity included
cash and cash equivalents of $821,000 and the bank line of credit discussed
below. Working capital decreased to $9.9 million at April 30, 2001 from $20.3
million at July 31, 2000, and the current ratio decreased to 1.5 at April 30,
2001 from 2.8 at July 31, 2000. The primary reason for the decrease is the
reclassification of certain portions of long-term debt to a current liability
as described below.

On December 1, 2000, the Company renewed its $9 million line of credit
with Bank One for an additional 12 months under similar terms and conditions,
including a variable interest rate equal to the prime rate (the Index), which
was 7.5% at April 30, 2001. Under the line of credit, the Company is required
to comply with financial covenants based on certain financial ratios. At April
30, 2001, the Company had borrowings of $6.1 million against the line of
credit. As of April 30, 2001, the Company was in default of the debt service
coverage ratio. On May 7, 2001, the Company and Bank One entered into the
First Loan Modification Agreement whereby the line of credit was reduced to
$7.25 million, the interest rate was raised to 3.0% over the Index, the Company
agreed to cross-defaulting and cross-collateralizing all Bank One loans and
obligations and Bank One agreed to forebear in exercising any remedy with
respect to the default through May 31, 2001. On June 14, 2001, the forebearance period
contained in the First Loan Modification Agreement ended May 31,
2001, and the Agreement was amended and the forebearance period was extended to June 29, 2001.

The Company is currently negotiating with Bank One to enter into a Second
Loan Modification Agreement (the Agreement) that will include a provision to
waive the debt service covenant so that the Company will no longer be in
default and will add certain new obligations that must be met by the Company.
The Company believes an agreement will be reached with respect to the terms of
the Agreement as both parties are negotiating in good faith. However, there is
no assurance that an agreement between the parties can be reached or that the
Agreement will be executed. In the
event that the Agreement is not executed, the Company will be in default under
the line of credit and as a result of the cross default provision in the First
Loan Modification Agreement, will be in default of the building loan on the 7th
Street location and Bank One may demand payment of all amounts due to them.
Moreover, due to the cross default provision in the Reimbursement Agreement
between Oxycal Laboratories, Inc. and Bank One, Arizona, dated March 1, 1999
related to the issuance of certain Industrial Development Revenue Bonds (the
Bonds), of which the Company is a guarantor, Bank One will have the right
to provide notice of default which would then cause the Company to be in
default on the Bonds. The Company has reclassified the Bonds outstanding of $4.1 million
from long-term debt to a current liability.

Net cash used in operating activities was $9.0 million during the nine
months ended April 30, 2001, attributable to the net loss of $6.9 million plus
changes in operating assets and liabilities totaling $4.7 million partially
offset by non-cash items of $2.6 million. Significant changes in operating
assets and liabilities were primarily comprised of (i) a decrease in accounts
receivable of $1.1 million related to lower sales volume and increased
collection efforts (ii) an increase in inventory of $5.1 million related
primarily to the new Palmettx botanical line of products and other
raw materials at Inter-Cal, and (iii) a decrease in accounts payable and
accrued expenses of $633,000 primarily due to vendor payments made during the
period for inventory purchases.

Net cash used in investing activities was $4.9 million related primarily
to manufacturing additions for the new Inter-Cal facility and other capital
purchases of $2.5 million, the purchases of the assets related to IST of $1.8
million and the purchase of the patent and other rights related to the
Pro-Ties bundling system and patent filings for Inter-Cal of
$550,000.

Net cash provided by financing
activities of $9.2 million was comprised of
bank and other borrowings of $6.2 million, proceeds received from the exercise
of warrants and stock options of $449,000 and $2.9 million of bond proceeds
received from the trustee related to the construction of the

17



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new Inter-Cal facility (as discussed further below). In addition, $125,000
was used to repurchase 60,000 shares of Zila common stock on the open market.

At April 30, 2001, the Company had income tax net operating loss
carryforwards of approximately $17.1 million, which expire in years 2007
through 2019.

During October 2000, Inter-Cal moved into its new manufacturing and
laboratory facility in Prescott, AZ. The facility was financed through a
transaction with The Industrial Development Authority of the County of Yavapai
(the Authority) in which the Authority issued $5.0 million in Bonds, the
proceeds of which were loaned to Oxycal for the construction of the facility.
The Bond proceeds were held by the trustee, Bank One, Arizona until such time
as invoices for building construction and new equipment were submitted for
payment. As of April 30, 2001, the trustee had released all the Bond proceeds.
The Bonds consisted of $3.9 million Series A and $1.1 million Taxable Series B
(of which $675,000 remains outstanding at April 30, 2001). As of April 30,
2001, the Bonds carried interest rates of 4.6% and 4.55%, respectively and have
a maturity of 20 years. In connection with the issuance of the Bonds, the
Authority required that Oxycal obtain, for the benefit of the Bondholders, an
irrevocable direct-pay letter of credit to secure payment of principal and
interest. Zila guarantees the letter of credit.

The Company believes that cash generated from its operations, its
investing activities and the availability of cash under its line of credit are
sufficient to finance its current level of operations and anticipated capital
expenditures. However, if the Company were not able to improve its
financial performance, enter
into an acceptable second modification agreement with Bank One or maintain compliance with the covenants of its outstanding
debt instruments, the Company could be forced to, among other things, sell
assets or raise capital in the equity markets on potentially unfavorable terms.
The Company will require additional financing to support the production and
future OraTest® clinical, regulatory, manufacturing and marketing
costs or to make any significant acquisitions. There can be no assurance that
such funds will be available on terms acceptable to the Company.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk refers to the potential effects of unfavorable changes in
certain prices and rates on the Companys financial results and conditions,
primarily foreign currency exchange rates and interest rates on debt
obligations. The Company transacts business in various foreign countries.
Foreign currency exposures are primarily, but not limited to, vendor and
customer payments and inter-company balances in currencies other than the
functional currency. Fluctuations in foreign currencies could have a material
adverse effect on the Companys results of operations.

The Company is exposed to interest rate fluctuations on its Industrial
Development Revenue Bonds and the line of credit with Bank One as the interest
charged is based on variable rates. The Bonds bear interest based on a
floating rate and adjusted weekly by Banc One Capital Markets. Interest on the
outstanding balance of the line of credit is charged at the Index plus 3%. The
Company does not trade in derivative financial instruments. The Company does
not believe that near-term changes in foreign currency exchange rates or
interest rates will have a material effect on its future earnings, fair values
or cash flows.

18



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Part II  Other Information

ITEM 1.- Legal Proceedings.

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

On September 8, 1999, the Securities and Exchange Commission (the
Commission) entered an order directing an investigation entitled In the
Matter of Zila, Inc.The Commission is investigating whether (i) there were
purchases or sales of securities of the Company by persons while in possession
of material non-public information concerning the prospects that the Oncologic
Drugs Advisory Committee for the FDA would recommend approval of the
OraTest® NDA and whether the FDA would subsequently approve the
NDA; (ii) such persons conveyed information regarding these matters to other
persons who effected transactions in securities of the Company without
disclosing the information; and (iii) there were false and misleading
statements in press releases, filings with the Commission, or elsewhere
concerning these matters. The Company does not believe it has violated any of
the federal securities laws and is cooperating fully with the Commission in its
investigation.

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

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.

Not Applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

On December 1, 2000, the Company renewed its $9 million line of credit
with Bank One for an additional 12 months under similar terms and
conditions, including a variable interest rate equal to the prime rate
(the Index), which was 7.5% at April 30, 2001. Under the line of credit
loan agreement, the Company is required to comply with financial covenants
based on certain financial ratios. At April 30, 2001, the Company had
borrowings of $6.1 million against the line of credit. As of April 30,
2001, the Company was in default of the debt service coverage ratio.
On May 7, 2001, the Company and Bank One entered into the First Loan
Modification Agreement whereby the line of credit was reduced to $7.25
million, the interest rate was raised to 3.0% over the Index, the Company
agreed to cross-defaulting and cross-collateralizing of all Bank One loans
and obligations and Bank One agreed to forebear in exercising any remedy
with respect to the default through May 31, 2001. On
June 14, 2001, the forbearance period contained in the First Loan Modification Agreement ended
May 31, 2001, and the Agreement was amended and the forbearance
period was extended to June 29, 2001.

The Company is currently negotiating with Bank One to enter into a Second
Loan Modification Agreement (the Agreement) that will include a
provision to waive the debt service covenant so that the Company will no
longer be in default and will add certain new obligations that must be met
by the Company. The Company believes an agreement will be reached with
respect to the terms of the Agreement as both parties are negotiating in
good faith. However, there is no assurance that an agreement between
the parties can be reached or that the Agreement
will be executed. In the event that the Agreement is not executed, the
Company will be in default under the line of credit and as a result of the
cross default provision in the First Loan Modification Agreement, will be
in default of the building loan on the 7th Street location and Bank One
may demand payment of all amounts due to them. Moreover, due to the cross
default provision in the Reimbursement Agreement between Oxycal
Laboratories, Inc. and Bank One, Arizona, dated March 1, 1999 related to
the issuance of certain Industrial Development Revenue Bonds (the
Bonds), of which the Company is a guarantor, Bank One
will have the right to provide notice of default which would then
cause the Company to be in
default on the Bonds. The Company has reclassified the Bonds outstanding of $4.1
million from long-term debt to a current liability.

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

Not Applicable.

ITEM 5. OTHER INFORMATION.

Not Applicable.

19



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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a)      Exhibits

|               |  |                                                                                                                        
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                            
|               |  |                                                                                                                        
|10-O           |  | Revolving Line of Credit Loan Agreement dated December 1, 2000
between Zila, Inc. and Bank One, Arizona, NA.           
|              
|              
|              
|              
|10-P           |  | First Loan Modification Agreement dated May 7, 2001 between
Zila, Inc. and Bank One Arizona, NA.                       
|              
|              
|              
|              
|10-Q           |  | Engagement Letter dated March 15, 2001 between Zila, Inc. and
Douglas, Curtis and Allyn, LLC                           
|              
|              
|              
|              
|10-R           |  | Extension to First Loan Modification Agreement dated effective
May 31, 2001 between Zila Inc. and Bank One Arizona, NA.

(b)      Reports on Form 8-K



| |     
| | ----
| | None

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

|                    |  |                                 
|------------------- |  | --------------------------------
|Date: June 14, 2001 |  | By:/s/Joseph Hines              
|                   
|                   
|                   
|                   
|                    |  | Joseph Hines                    
|                   
|                   
|                   
|                   
|                    |  | President, Chairman of the Board
|                   
|                   
|                   
|                   
|                    |  | (Principal Executive Officer)   
|                   
|                   
|                   
|                   
|                    |  |                                 
|                   
|                   
|                   
|                   
|                    |  | By:/s/Bradley C. Anderson       
|                   
|                   
|                   
|                   
|                    |  | Bradley C. Anderson             
|                   
|                   
|                   
|                   
|                    |  | Vice President and Chief        
|                   
|                   
|                   
|                   
|                    |  | Financial Officer (Principal    
|                   
|                   
|                   
|                   
|                    |  | Financial & Accounting Officer) 

20



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EXHIBIT INDEX

|               |  |                                                                                                                         
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                             
|               |  |                                                                                                                         
|10-O           |  | Revolving Line of Credit Loan Agreement dated December 1, 2000
between Zila, Inc. and Bank One, Arizona, NA.            
|              
|              
|              
|              
|10-P           |  | First Loan Modification Agreement dated May 7, 2001 between
Zila, Inc. and Bank One Arizona, NA.                        
|              
|              
|              
|              
|10-Q           |  | Engagement Letter dated March 15, 2001 between Zila, Inc. and
Douglas, Curtis and Allyn, LLC                            
|              
|              
|              
|              
|10-R           |  | Extension to First Loan Modification Agreement dated effective
May 31, 2001 between Zila, Inc. and Bank One Arizona, NA.