##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
 Form 10-Q
 (Mark one)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended April 30, 2009
 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
 Zila, Inc.
 (Exact Name of Registrant as Specified in its Charter)
 Delaware
    
    86-0619668(State or Other Jurisdiction of 
Incorporation)
    
    (I.R.S. Employer
Identification No.)
 16430 North Scottsdale Road, Suite 450, Scottsdale, Arizona, 85254-1770  (Address of Principal Executive Offices) (Zip Code)
 (602) 266-6700  (Registrants telephone number, including area code)
 þ o
 þ o
  Large accelerated filer o
Accelerated filer þ
Non-accelerated filer o(Do not check if a smaller reporting company)
Smaller reporting company o o þ




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##### 



TABLE OF CONTENTS
 PAGEPART I  FINANCIAL INFORMATIONItem 1.
    
    Financial Statements.Condensed Consolidated Balance Sheets as of April 30, 2009 (unaudited) and July 31, 2008
    
    2Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended
April 30, 2009 and 2008
    
    3Unaudited Condensed Consolidated Statement of Shareholders Equity for the Nine
Months Ended April 30, 2009
    
    4Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended
April 30, 2009 and 2008
    
    5Notes to Unaudited Condensed Consolidated Financial Statements
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    20Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    34Item 4.
    
    Controls and Procedures
    
    35PART II  OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    35Item 1A.
    
    Risk Factors
    
    35Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    42Item 3.
    
    Defaults Upon Senior Securities
    
    42Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    42Item 5.
    
    Other Information
    
    42Item 6.
    
    Exhibits
    
    42Signatures
    
    43EX-10.1EX-10.2EX-10.3EX-31.1EX-31.2EX-32.1
  1




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 
 ZILA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
 April 30,
    
    
    July 31,2009
    
    
    2008(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    3,064,408
    
    
    $
    4,462,328Trade receivables  net of allowances of $249,000 and $229,000
    
    
    4,114,682
    
    
    
    5,252,215Inventories  net
    
    
    2,551,592
    
    
    
    3,107,152Prepaid expenses and other current assets
    
    
    1,448,181
    
    
    
    1,853,373Total current assets
    
    
    11,178,863
    
    
    
    14,675,068Property and equipment  net
    
    
    4,458,263
    
    
    
    5,317,061Goodwill
    
    
    
    
    
    
    10,171,351Purchased technology  net
    
    
    2,276,067
    
    
    
    8,860,475Trademarks and other intangible assets  net
    
    
    2,220,222
    
    
    
    9,533,024Other assets
    
    
    1,169,469
    
    
    
    1,813,512Total assets
    
    $
    21,302,884
    
    
    $
    50,370,491LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    2,870,607
    
    
    $
    3,843,262Accrued liabilities
    
    
    3,663,846
    
    
    
    4,059,017Current portion of deferred gain on sale leaseback
    
    
    
    
    
    
    75,659Short-term borrowings and current portion of long-term debt
    
    
    9,849,968
    
    
    
    71,252Current liabilities of discontinued operations
    
    
    48,476
    
    
    
    67,532Total current liabilities
    
    
    16,432,897
    
    
    
    8,116,722Long-term debt  net of current portion
    
    
    500,000
    
    
    
    8,974,048Total liabilities
    
    
    16,932,897
    
    
    
    17,090,770Shareholders equity:Preferred stock  Series B, $.001 par value  2,500,000 shares authorized,
100,000 shares issued and outstanding, liquidation preference of $650,000
    
    
    462,500
    
    
    
    462,500Common stock, $.001 par value  30,000,000 shares authorized,
10,438,965 and 9,953,818 shares issued and outstanding
    
    
    10,439
    
    
    
    69,677Additional paid-in capital
    
    
    126,619,725
    
    
    
    125,901,682Accumulated deficit
    
    
    (122,040,636
    )
    
    
    (92,471,235
    )Accumulated other comprehensive loss
    
    
    (130,970
    )
    
    
    (131,832
    )Treasury stock, at cost (31,202 common shares)
    
    
    (551,071
    )
    
    
    (551,071
    )Total shareholders equity
    
    
    4,369,987
    
    
    
    33,279,721Total liabilities and shareholders equity
    
    $
    21,302,884
    
    
    $
    50,370,491
  2




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ZILA, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 Three Months Ended April 30,
    
    
    Nine Months Ended April 30,2009
    
    
    2008
    
    
    2009
    
    
    2008Net revenues
    
    $
    8,466,627
    
    
    $
    11,244,786
    
    
    $
    26,620,312
    
    
    $
    33,175,880Cost of products sold
    
    
    3,458,175
    
    
    
    4,437,621
    
    
    
    11,006,614
    
    
    
    13,263,824Gross profit
    
    
    5,008,452
    
    
    
    6,807,165
    
    
    
    15,613,698
    
    
    
    19,912,056Operating costs and expenses:Marketing and selling
    
    
    3,164,984
    
    
    
    6,046,250
    
    
    
    10,884,287
    
    
    
    16,563,524General and administrative
    
    
    1,773,543
    
    
    
    3,281,067
    
    
    
    5,809,796
    
    
    
    9,883,070Impairment of goodwill
and other intangible assets
    
    
    
    
    
    
    
    
    
    
    23,192,967
    
    
    
    Research and development
    
    
    90,121
    
    
    
    246,597
    
    
    
    334,527
    
    
    
    2,237,265Depreciation and amortization
    
    
    308,194
    
    
    
    952,241
    
    
    
    1,842,991
    
    
    
    2,810,965Total operating costs and expenses
    
    
    5,336,842
    
    
    
    10,526,155
    
    
    
    42,064,568
    
    
    
    31,494,824Loss from operations
    
    
    (328,390
    )
    
    
    (3,718,990
    )
    
    
    (26,450,870
    )
    
    
    (11,582,768
    )Other income (expense):Interest income
    
    
    
    
    
    
    26,116
    
    
    
    15,816
    
    
    
    223,617Interest expense
    
    
    (1,100,479
    )
    
    
    (786,289
    )
    
    
    (2,916,796
    )
    
    
    (2,353,816
    )Derivative expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (23,600
    )Other income (expense)
    
    
    (20,621
    )
    
    
    2,049
    
    
    
    (110,731
    )
    
    
    (991
    )Other expense  net
    
    
    (1,121,100
    )
    
    
    (758,124
    )
    
    
    (3,011,711
    )
    
    
    (2,154,790
    )Loss from continuing operations before income taxes
    
    
    (1,449,490
    )
    
    
    (4,477,114
    )
    
    
    (29,462,581
    )
    
    
    (13,737,558
    )Income tax benefit (expense)
    
    
    (31,978
    )
    
    
    33,979
    
    
    
    (45,175
    )
    
    
    22,387Loss from continuing operations
    
    
    (1,481,468
    )
    
    
    (4,443,135
    )
    
    
    (29,507,756
    )
    
    
    (13,715,171
    )Loss from discontinued operations,
net of income tax expense of nil
    
    
    (3,656
    )
    
    
    (1,858
    )
    
    
    (32,395
    )
    
    
    (320,892
    )Net loss
    
    
    (1,485,124
    )
    
    
    (4,444,993
    )
    
    
    (29,540,151
    )
    
    
    (14,036,063
    )Preferred stock dividends
    
    
    9,750
    
    
    
    9,750
    
    
    
    29,250
    
    
    
    29,250Net loss attributable to common shareholders
    
    $
    (1,494,874
    )
    
    $
    (4,454,743
    )
    
    $
    (29,569,401
    )
    
    $
    (14,065,313
    )Basic and diluted net loss per common share:Loss from continuing operations
    
    $
    (0.14
    )
    
    $
    (0.50
    )
    
    $
    (2.89
    )
    
    $
    (1.56
    )Loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.04
    )Net loss attributable to common shareholders
    
    $
    (0.14
    )
    
    $
    (0.50
    )
    
    $
    (2.89
    )
    
    $
    (1.60
    )Weighted average common shares
outstanding  basic and diluted
    
    
    10,407,090
    
    
    
    8,838,961
    
    
    
    10,248,628
    
    
    
    8,794,807
  3




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ZILA, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
For the Nine Months Ended April 30, 2009
 AccumulatedAdditional
    
    
    
    
    
    
    Other
    
    
    
    
    
    
    TotalPreferred Stock
    
    
    Common Stock
    
    
    Paid-in
    
    
    Accumulated
    
    
    Comprehensive
    
    
    Treasury
    
    
    ShareholdersShares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Capital
    
    
    Deficit
    
    
    Loss
    
    
    Stock
    
    
    EquityBalance  July 31, 2008
    
    
    100,000
    
    
    $
    462,500
    
    
    
    9,953,818
    
    
    $
    69,677
    
    
    $
    125,901,682
    
    
    $
    (92,471,235
    )
    
    $
    (131,832
    )
    
    $
    (551,071
    )
    
    $
    33,279,721Stock-based compensation
expense
    
    
    
    
    
    
    
    
    
    
    54,047
    
    
    
    215
    
    
    
    442,883
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    443,098Common shares withheld
for income taxes
    
    
    
    
    
    
    
    
    
    
    (15,040
    )
    
    
    (53
    )
    
    
    (32,904
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (32,957
    )Issuance of common stock
under employee stock
purchase plan
    
    
    
    
    
    
    
    
    
    
    11,057
    
    
    
    47
    
    
    
    3,284
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,331Effect of reverse stock
split approved on
September 12, 2008
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (59,882
    )
    
    
    59,882
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Shares issued for payment
of interest
    
    
    
    
    
    
    
    
    
    
    435,083
    
    
    
    435
    
    
    
    244,898
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    245,333Foreign currency
translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    862
    
    
    
    
    
    
    
    862Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (29,250
    )
    
    
    
    
    
    
    
    
    
    
    (29,250
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (29,540,151
    )
    
    
    
    
    
    
    
    
    
    
    (29,540,151
    )Balance  April 30, 2009
    
    
    100,000
    
    
    $
    462,500
    
    
    
    10,438,965
    
    
    $
    10,439
    
    
    $
    126,619,725
    
    
    $
    (122,040,636
    )
    
    $
    (130,970
    )
    
    $
    (551,071
    )
    
    $
    4,369,987
  4




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ZILA, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 Nine Months Ended April 30,2009
    
    
    2008Cash flows from operating activities:Net loss
    
    $
    (29,540,151
    )
    
    $
    (14,036,063
    )Adjustments to reconcile net loss to net cash used
in operating activities:Depreciation and amortization
    
    
    2,167,150
    
    
    
    3,154,531Non-cash amortization of financing costs
    
    
    670,176
    
    
    
    293,576Non-cash amortization of debt discounts
    
    
    1,331,381
    
    
    
    1,336,259Non-cash interest
    
    
    245,333
    
    
    
    485,334Non-cash derivative expense
    
    
    
    
    
    
    23,600Non-cash stock-based compensation expense
    
    
    443,705
    
    
    
    1,381,420Impairment of goodwill and other intangible assets
    
    
    23,192,967
    
    
    
    Other non-cash items  net
    
    
    (1,017
    )
    
    
    40,386Changes in operating assets and liabilities:Trade receivables
    
    
    1,137,533
    
    
    
    (1,209,934
    )Inventories
    
    
    555,560
    
    
    
    (39,707
    )Prepaid expenses and other assets
    
    
    572,596
    
    
    
    (277,146
    )Accounts payable and accrued liabilities
    
    
    (1,415,650
    )
    
    
    85,891Net cash used in operating activities
    
    
    (640,417
    )
    
    
    (8,761,853
    )Cash flows from investing activities:Additions to property and equipment
    
    
    (198,131
    )
    
    
    (630,753
    )Additions to intangible assets
    
    
    (323,792
    )
    
    
    (310,855
    )Proceeds from sale of assets
    
    
    11,196
    
    
    
    11,495Net cash used in investing activities
    
    
    (510,727
    )
    
    
    (930,113
    )Cash flows from financing activities:Principal payments on debt
    
    
    (220,250
    )
    
    
    (269,268
    )Payment of obligation to repurchase common stock and warrants
    
    
    
    
    
    
    (1,399,993
    )Dividends paid to preferred stockholders
    
    
    (29,250
    )
    
    
    (29,250
    )Proceeds from issuance of common stock
    
    
    2,724
    
    
    
    71,909Net cash used in financing activities
    
    
    (246,776
    )
    
    
    (1,626,602
    )Net decrease in cash and cash equivalents
    
    
    (1,397,920
    )
    
    
    (11,318,568
    )Cash and cash equivalents  beginning of period
    
    
    4,462,328
    
    
    
    14,859,159Cash and cash equivalents  end of period
    
    $
    3,064,408
    
    
    $
    3,540,591
  5




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ZILA, INC. AND SUBSIDIARIES
 
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. Description of Business and Basis of Presentation
 Nature of Business Activities and Basis of Presentation
 ® ® ® ® ® ®
     6




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ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  Three Months Ended April 30,
    
    Nine Months Ended April 30,2009
    
    2008
    
    2009
    
    2008Options and warrants to purchase common shares
    
    
    
    
    
    
    
    
    
    
    9
    
    
    
    5Common stock awards
    
    
    
    
    
    
    1
    
    
    
    7
    
    
    
    8Convertible preferred stock
    
    
    100
    
    
    
    100
    
    
    
    100
    
    
    
    100Total potentially dilutive securities
    
    
    100
    
    
    
    101
    
    
    
    116
    
    
    
    113
  Liquidity
 ® ®
   7




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ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
      2. Recently Issued Accounting Pronouncements and Adopted Accounting
 Fair Value Measurements
 8




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ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  Level one 
    
    Quoted market prices in active markets for identical assets or liabilities;Level two 
    
    Inputs other than Level one inputs that are either directly or indirectly
observable; andLevel three 
    
    Unobservable inputs developed using estimates and assumptions, which are
developed by the reporting entity and reflect those assumptions that a market participant
would use.
    Noncontrolling Interests in Consolidated
Financial Statements  an amendment of ARB No. 51
 Business Combinations
 Disclosures about Derivative Instruments and
Hedging Activities, an amendment of FASB Statement No. 133
 Determination of
the Useful Life of Intangible Assets
 9




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ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 Accounting for
Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement)
 Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entitys Own Stock Accounting for Derivative Instruments and Hedging
Activities
  3. Inventories
  April 30,
    
    
    July 31,2009
    
    
    2008(Unaudited)Finished goods
    
    $
    613
    
    
    $
    675Work-in-process
    
    
    135
    
    
    
    396Raw materials
    
    
    2,247
    
    
    
    2,470Inventory reserves
    
    
    (443
    )
    
    
    (434
    )Total inventories
    
    $
    2,552
    
    
    $
    3,107
 10




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ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 4. Property and Equipment
  April 30,
    
    
    July 31,2009
    
    
    2008(Unaudited)Land
    
    $
    529
    
    
    $
    529Building and improvements
    
    
    2,185
    
    
    
    2,132Furniture and equipment
    
    
    2,709
    
    
    
    3,408Leasehold improvements and other assets
    
    
    803
    
    
    
    823Production, laboratory and warehouse equipment
    
    
    4,514
    
    
    
    4,582Total property and equipment
    
    
    10,740
    
    
    
    11,474Less: Accumulated depreciation and amortization
    
    
    (6,282
    )
    
    
    (6,157
    )Property and equipment  net
    
    $
    4,458
    
    
    $
    5,317
  5. Goodwill and Other Intangible Assets
  April 30, 2009 (Unaudited)
    
    
    July 31, 2008Gross
    
    
    
    
    
    
    Net
    
    
    Gross
    
    
    
    
    
    
    NetCarrying
    
    
    Accumulated
    
    
    Carrying
    
    
    Carrying
    
    
    Accumulated
    
    
    CarryingAmount
    
    
    Amortization
    
    
    Amount
    
    
    Amount
    
    
    Amortization
    
    
    AmountAmortizable intangible assets:Purchased technology
    
    $
    9,518
    
    
    $
    (7,242
    )
    
    $
    2,276
    
    
    $
    15,592
    
    
    $
    (6,732
    )
    
    $
    8,860Trademarks
    
    
    174
    
    
    
    (29
    )
    
    
    145
    
    
    
    168
    
    
    
    (18
    )
    
    
    150Patents
    
    
    805
    
    
    
    (381
    )
    
    
    424
    
    
    
    2,019
    
    
    
    (385
    )
    
    
    1,634Licensing costs
    
    
    2,028
    
    
    
    (1,902
    )
    
    
    126
    
    
    
    2,674
    
    
    
    (1,777
    )
    
    
    897Customer relationships,
covenants not to
compete and other
    
    
    2,591
    
    
    
    (2,585
    )
    
    
    6
    
    
    
    3,556
    
    
    
    (2,153
    )
    
    
    1,403Total amortizable
intangible assets
    
    
    15,116
    
    
    
    (12,139
    )
    
    
    2,977
    
    
    
    24,009
    
    
    
    (11,065
    )
    
    
    12,944Unamortizable trademarks
    
    
    1,519
    
    
    
    
    
    
    
    1,519
    
    
    
    5,449
    
    
    
    
    
    
    
    5,449Total other intangible assets
    
    
    16,635
    
    
    
    (12,139
    )
    
    
    4,496
    
    
    
    29,458
    
    
    
    (11,065
    )
    
    
    18,393Goodwill
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,171
    
    
    
    
    
    
    
    10,171Total intangible assets
    
    $
    16,635
    
    
    $
    (12,139
    )
    
    $
    4,496
    
    
    $
    39,629
    
    
    $
    (11,065
    )
    
    $
    28,564
 11




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  Weighted AverageRange of
    
    Remaining Useful LivesUseful Lives
    
    April 30, 2009
    
    July 31, 2008(Unaudited)Purchased technology
    
    
    15
    
    
    
    11.6
    
    
    
    11.5Trademarks
    
    
    7-10
    
    
    
    5.9
    
    
    
    6.6Patents
    
    
    4-17
    
    
    
    8.2
    
    
    
    7.4Licensing costs
    
    
    7-10
    
    
    
    2.7
    
    
    
    3.4Customer relationships, covenants
not to compete and other
    
    
    2-15
    
    
    
    2.7
    
    
    
    6.0
   Balance  beginning of period
    
    $
    10,171Impairment of goodwill
    
    
    (10,171
    )Balance  end of period
    
    $
    
 12




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##### Table of Contents



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




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 6. Accrued Liabilities
  April 30,
    
    
    July 31,2009
    
    
    2008(Unaudited)Accrued research and development
    
    $
    1,152
    
    
    $
    1,154Accrued employee compensation and related taxes
    
    
    593
    
    
    
    1,000Accrued professional and consulting fees
    
    
    248
    
    
    
    795Accrued interest payable
    
    
    660
    
    
    
    Other accrued expenses
    
    
    1,011
    
    
    
    1,110Total accrued expenses
    
    $
    3,664
    
    
    $
    4,059
 7. Debt
  April 30,
    
    
    July 31,2009
    
    
    2008(Unaudited)Short-term borrowings and current portion of long-term debt:Senior Secured Convertible Notes
    
    $
    12,000
    
    
    $
    Unamortized discount  Senior Secured Convertible Notes
    
    
    (2,229
    )
    
    
    Senior Secured Convertible Notes  net
    
    
    9,771
    
    
    
    Short-term borrowings
    
    
    28
    
    
    
    Current portion of capital lease obligations
    
    
    51
    
    
    
    71Total short-term borrowings and current portion of long-term
debt
    
    $
    9,850
    
    
    $
    71Long-term debt:Senior Secured Convertible Notes
    
    $
    
    
    
    $
    12,000Unamortized discount  Senior Secured Convertible Notes
    
    
    
    
    
    
    (3,560
    )Senior Secured Convertible Notes  net
    
    
    
    
    
    
    8,440PharmaBio
    
    
    500
    
    
    
    500Capital lease obligations
    
    
    51
    
    
    
    105Total long-term debt
    
    
    551
    
    
    
    9,045Less: Current portion
    
    
    (51
    )
    
    
    (71
    )Long-term debt  net of current portion
    
    $
    500
    
    
    $
    8,974
 Short-term Borrowings
  14




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ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 Senior Secured Convertible Notes
    PharmaBio Development, Inc.
  8. Share-Based Payments
  15




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  Nine Months Ended April 30,2009
    
    2008Risk-free interest rate
    
    
    1.1
    %
    
    
    3.5
    %Expected volatility
    
    
    98.0
    %
    
    
    59.6
    %Expected term (in years)
    
    
    3.3
    
    
    
    5.2Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
  Share-Based Payment
  WeightedWeighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateNumber
    
    
    Exercise
    
    
    Contractual
    
    
    Intrinsicof Options
    
    
    Price
    
    
    Term (Years)
    
    
    ValueOptions outstanding  beginning of period
    
    
    515
    
    
    $
    11.55
    
    
    
    6.7
    
    
    $
    Granted
    
    
    50Exercised
    
    
    Expired
    
    
    (54
    )Forfeited
    
    
    (78
    )Options outstanding  end of period
    
    
    433
    
    
    
    10.23
    
    
    
    5.3
    
    
    
    Options vested or expected to vest  end of
period
    
    
    417
    
    
    
    10.37
    
    
    
    5.2
    
    
    
    Options exercisable  end of period
    
    
    292
    
    
    
    12.07
    
    
    
    4.2
    
    
    
    
 16




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  WeightedWeighted
    
    AverageAverage
    
    RemainingNumber
    
    Grant
    
    Recognitionof Shares
    
    Value
    
    Period (Years)Unvested balance  beginning of period
    
    
    56
    
    
    $
    7.00
    
    
    
    1.1Granted
    
    
    21
    
    
    
    2.10Vested
    
    
    (54
    )
    
    
    5.12Forfeited
    
    
    (7
    )
    
    
    7.98Unvested balance  end of period
    
    
    16
    
    
    
    5.61
    
    
    
    0.5
  Three Months Ended April 30,
    
    
    Nine Months Ended April 30,2009
    
    
    2008
    
    
    2009
    
    
    2008Marketing and selling expense
    
    $
    29
    
    
    $
    48
    
    
    $
    124
    
    
    $
    158General and administrative expense
    
    
    65
    
    
    
    344
    
    
    
    246
    
    
    
    1,200Research and development expense
    
    
    
    
    
    
    1
    
    
    
    1
    
    
    
    3Inventory
    
    
    29
    
    
    
    12
    
    
    
    73
    
    
    
    20Total stock-based compensation
    
    $
    123
    
    
    $
    405
    
    
    $
    444
    
    
    $
    1,381
  9. Warrants
  10. Convertible Preferred Stock
  17




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 11. Treasury Stock
  12. Supplemental Cash Flow Information
  Nine Months Ended April 30,2009
    
    2008Interest paid
    
    $
    11
    
    
    $
    246Income taxes paid
    
    
    9
    
    
    
    45Insurance policy financed with
short-term borrowings
    
    
    193
    
    
    
    275
 13. Comprehensive Loss
  Three Months Ended April 30,
    
    
    Nine Months Ended April 30,2009
    
    
    2008
    
    
    2009
    
    
    2008Net loss
    
    $
    (1,485
    )
    
    $
    (4,445
    )
    
    $
    (29,540
    )
    
    $
    (14,036
    )Foreign currency
translation
adjustment
    
    
    
    
    
    
    1
    
    
    
    1
    
    
    
    12Comprehensive loss
    
    $
    (1,485
    )
    
    $
    (4,444
    )
    
    $
    (29,539
    )
    
    $
    (14,024
    )
 14. Commitments and Contingencies
 Legal Proceedings
   18




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 ® ®
 Indemnifications
  Registration Payment Arrangements
  FDA Observation Letter
  Corporate Office Lease
  19




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
  Forward-Looking Statements
  Overview
 Business
 ® ® ® ® ® ®
 Recent Developments and Continuance of Operations
  20




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21




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##### Table of Contents



Other Key Operating Initiatives
 ® ® ® ® ® ®
 ® ® ® ® ® ®
 ® ® ® ®
 ® ® ® ® ®
 22




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##### Table of Contents



Results of Operations
  For the Three Months Ended April 30,% of
    
    
    
    
    
    
    % of
    
    
    %2009
    
    
    Revenue
    
    
    2008
    
    
    Revenue
    
    
    ChangeNet revenues
    
    $
    8,467
    
    
    
    100.0
    %
    
    $
    11,245
    
    
    
    100.0
    %
    
    
    (24.7)
    %Cost of products sold
    
    
    3,459
    
    
    
    40.9
    
    
    
    4,438
    
    
    
    39.5
    
    
    
    (22.1
    )Gross profit
    
    
    5,008
    
    
    
    59.1
    
    
    
    6,807
    
    
    
    60.5
    
    
    
    (26.4
    )Operating costs and expenses:Marketing and selling
    
    
    3,165
    
    
    
    37.4
    
    
    
    6,046
    
    
    
    53.8
    
    
    
    (47.7
    )General and administrative
    
    
    1,773
    
    
    
    20.9
    
    
    
    3,281
    
    
    
    29.1
    
    
    
    (46.0
    )Research and development
    
    
    90
    
    
    
    1.1
    
    
    
    247
    
    
    
    2.2
    
    
    
    (63.6
    )Depreciation and amortization
    
    
    308
    
    
    
    3.6
    
    
    
    952
    
    
    
    8.5
    
    
    
    (67.6
    )Total operating costs and expenses
    
    
    5,336
    
    
    
    63.0
    
    
    
    10,526
    
    
    
    93.6
    
    
    
    (49.3
    )Loss from operations
    
    
    (328
    )
    
    
    (3.9
    )
    
    
    (3,719
    )
    
    
    (33.1
    )
    
    
    (91.2
    )Other expense  net
    
    
    (1,121
    )
    
    
    (13.2
    )
    
    
    (758
    )
    
    
    (6.7
    )
    
    
    47.9Loss from continuing operations
before income taxes
    
    
    (1,449
    )
    
    
    (17.1
    )
    
    
    (4,477
    )
    
    
    (39.8
    )
    
    
    (67.6
    )Income tax benefit (expense)
    
    
    (32
    )
    
    
    (0.4
    )
    
    
    34
    
    
    
    0.3
    
    
    
    (194.1
    )Loss from continuing operations
    
    $
    (1,481
    )
    
    
    (17.5)
    %
    
    $
    (4,443
    )
    
    
    (39.5)
    %
    
    
    (66.7
    )
 For the Nine Months Ended April 30,% of
    
    
    
    
    
    
    % of
    
    
    %2009
    
    
    Revenue
    
    
    2008
    
    
    Revenue
    
    
    ChangeNet revenues
    
    $
    26,620
    
    
    
    100.0
    %
    
    $
    33,176
    
    
    
    100.0
    %
    
    
    (19.8)
    %Cost of products sold
    
    
    11,006
    
    
    
    41.3
    
    
    
    13,264
    
    
    
    40.0
    
    
    
    (17.0
    )Gross profit
    
    
    15,614
    
    
    
    58.7
    
    
    
    19,912
    
    
    
    60.0
    
    
    
    (21.6
    )Operating costs and expenses:Marketing and selling
    
    
    10,884
    
    
    
    40.9
    
    
    
    16,564
    
    
    
    49.9
    
    
    
    (34.3
    )General and administrative
    
    
    5,810
    
    
    
    21.9
    
    
    
    9,883
    
    
    
    29.8
    
    
    
    (41.2
    )Impairment of goodwill
and other intangible assets
    
    
    23,193
    
    
    
    87.1
    
    
    
    
    
    
    
    Research and development
    
    
    335
    
    
    
    1.3
    
    
    
    2,237
    
    
    
    6.7
    
    
    
    (85.0
    )Depreciation and amortization
    
    
    1,843
    
    
    
    6.9
    
    
    
    2,811
    
    
    
    8.5
    
    
    
    (34.4
    )Total operating costs and expenses
    
    
    42,065
    
    
    
    158.0
    
    
    
    31,495
    
    
    
    94.9
    
    
    
    33.6Loss from operations
    
    
    (26,451
    )
    
    
    (99.4
    )
    
    
    (11,583
    )
    
    
    (34.9
    )
    
    
    128.4Other expense  net
    
    
    (3,012
    )
    
    
    (11.3
    )
    
    
    (2,155
    )
    
    
    (6.5
    )
    
    
    39.8Loss from continuing operations
before income taxes
    
    
    (29,463
    )
    
    
    (110.7
    )
    
    
    (13,738
    )
    
    
    (41.4
    )
    
    
    114.5Income tax benefit (expense)
    
    
    (45
    )
    
    
    (0.1
    )
    
    
    23
    
    
    
    0.1
    
    
    
    (295.7
    )Loss from continuing operations
    
    $
    (29,508
    )
    
    
    (110.8)
    %
    
    $
    (13,715
    )
    
    
    (41.3)
    %
    
    
    115.2
 23




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##### Table of Contents



Net Revenues
 ® ® ® ® ®
 Gross Profit
  Marketing and Selling Expense
  General and Administrative Expense
  24




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##### Table of Contents



Three Months Ended April 30,
    
    
    Nine Months Ended April 30,2009
    
    
    2008
    
    
    2009
    
    
    2008Cash basis salaries and benefits
    
    $
    696
    
    
    $
    1,300
    
    
    $
    2,176
    
    
    $
    3,572Audit, accounting and other professional fees
    
    
    425
    
    
    
    718
    
    
    
    1,302
    
    
    
    1,994Investment banking fees and
shareholder related expense
    
    
    86
    
    
    
    55
    
    
    
    433
    
    
    
    373Legal and intellectual property related fees
    
    
    147
    
    
    
    253
    
    
    
    477
    
    
    
    905Insurance
    
    
    113
    
    
    
    135
    
    
    
    338
    
    
    
    384Non-cash stock-based compensation expense
    
    
    65
    
    
    
    344
    
    
    
    246
    
    
    
    1,200Other general and administrative expense
    
    
    241
    
    
    
    476
    
    
    
    838
    
    
    
    1,455Total general and administrative expense
    
    $
    1,773
    
    
    $
    3,281
    
    
    $
    5,810
    
    
    $
    9,883
 Impairment of Goodwill and Other Intangible Assets
    Research and Development Expense
  25




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##### Table of Contents



Depreciation and Amortization Expense
  Other Expense  Net
  Three Months Ended April 30,
    
    
    Nine Months Ended April 30,2009
    
    
    2008
    
    
    2009
    
    
    2008Senior secured convertible notes
    
    $
    445
    
    
    $
    240
    
    
    $
    905
    
    
    $
    701Amortization of financing costs
    
    
    218
    
    
    
    97
    
    
    
    670
    
    
    
    293Amortization of debt discounts
    
    
    434
    
    
    
    438
    
    
    
    1,331
    
    
    
    1,336Capital leases and other
    
    
    3
    
    
    
    11
    
    
    
    11
    
    
    
    24Total interest expense
    
    $
    1,100
    
    
    $
    786
    
    
    $
    2,917
    
    
    $
    2,354
  Income Taxes
  Inflation and Seasonality
  Liquidity and Capital Resources
 Overview
 ® ®
 26




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® ®
    27




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##### Table of Contents



Selected Cash Flow and Working Capital Information
  Nine Months Ended April 30,2009
    
    2008Net cash used in operating activities
    
    $
    (640
    )
    
    $
    (8,762
    )Net cash used in investing activities
    
    
    (511
    )
    
    
    (930
    )Net cash used in financing activities
    
    
    (247
    )
    
    
    (1,627
    )
 April 30,
    
    July 31,2009
    
    2008Cash and cash equivalents
    
    $
    3,064
    
    
    $
    4,462Working capital
    
    
    (5,254
    )
    
    
    6,558Current ratio
    
    
    0.7
    
    
    
    1.8
 28




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##### Table of Contents



Cash Flows from Operating Activities
  Cash Flows from Investing Activities
  Cash Flows from Financing Activities
  Senior Secured Convertible Notes
   29




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##### Table of Contents



PharmaBio Development, Inc.
  Convertible Preferred Stock
  Off-Balance Sheet Financing Arrangements
  30




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##### Table of Contents



Summary of Critical Accounting Policies and Estimates
   Goodwill, Intangibles and Other Long-Lived Assets
 Goodwill and Other Intangible Assets
 31




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32




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##### Table of Contents



Recently Issued Accounting Pronouncements and Adopted Accounting
 Fair Value Measurements
 Level one
    
    Quoted market prices in active markets for identical assets or liabilities;Level two
    
    Inputs other than Level one inputs that are either directly or indirectly
observable; andLevel three
    
    Unobservable inputs developed using estimates and assumptions, which are
developed by the reporting entity and reflect those assumptions that a market participant
would use.
    Noncontrolling Interests in Consolidated
Financial Statements  an amendment of ARB No. 51
 Business Combinations
 Disclosures about Derivative Instruments and
Hedging Activities, an amendment of FASB Statement No. 133
 33




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##### Table of Contents



Determination of
the Useful Life of Intangible Assets
 Accounting for
Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement)
 Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entitys Own Stock Accounting for Derivative Instruments and Hedging
Activities
  
 Item 3. Quantitative and Qualitative Disclosures about Market Risk.
   34




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##### Table of Contents



Item 4. Controls and Procedures.
 Evaluation of Disclosure Controls and Procedures.
  Changes in Internal Control over Financial Reporting
  
 PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings.
  
 Item 1A. Risk Factors.
 You should consider carefully the risk factors described below, and all other information
contained in this filing and our other filings made with the SEC, before deciding to invest in our
common stock. If any of the following risks actually occur, they may materially harm our business,
financial condition, operating results or cash flow. As a result, the market price of our common
stock could decline, and you could lose all or part of your investment. Additional risks and
uncertainties that are not yet identified or that we think are immaterial may also materially harm
our business, operating results or financial condition and could result in a complete loss of your
investment.
 Trends, Risks and Uncertainties Related to Our Business
 We are in default with respect to our Senior Secured Convertible Notes.
  35




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##### Table of Contents



Adverse economic conditions could negatively affect our business and operating results.
 ®
 Our lack of earnings history could adversely affect our financial health and prevent us from
fulfilling our payment obligations, and if we are unable to generate funds or obtain funds on
acceptable terms, we may not be able to develop and market our present and potential products.
 ® ®
    36




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##### Table of Contents




    
    making it more difficult for us to satisfy our obligations with respect to our Senior
Secured Convertible Notes;
    
    increasing our vulnerability to general adverse economic and industry conditions;
    
    limiting our flexibility in planning for, or reacting to, changes in our business and
our industry;
    
    restricting us from making strategic acquisitions, introducing new products or
exploiting business opportunities;
    
    requiring us to dedicate a substantial portion of our cash flow from operations to
payments on our indebtedness, which will reduce the amount of our cash flow available for
other purposes, including capital expenditures and other general corporate purposes;
    
    requiring us to sell debt securities or to sell some of our core assets, possibly on
unfavorable terms;
    
    limiting our ability to obtain additional financing; and
    
    placing us at a possible competitive disadvantage compared to our competitors that may
have greater financial resources.
 We may not be able to maintain compliance with our debt covenants in the future.
  37




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##### Table of Contents



The restrictive covenants contained in our senior debt could adversely affect our business by
limiting our flexibility.
   Historically we have been dependent on a few key products and our future growth is dependent on the
growth of ViziLite ® Plus and on the development and/or acquisition of new products.
 ® ® ® ® ® ®
 ®
 ®
 38




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##### Table of Contents




    
    difficulties in the production process, controlling the costs to produce, market and
distribute the product on a commercial scale, and our ability to do so with favorable gross
margins and otherwise on a profitable basis;
    
    the inherent difficulty of gaining market acceptance for a new product;
    
    competition from larger, more established companies with greater resources;
    
    changes in raw material supplies that could result in production delays and higher raw
material costs;
    
    difficulties in promoting consumer awareness for the new product;
    
    adverse publicity regarding the industries in which we market our products; and
    
    the cost, timing and ultimate results of regulatory program studies that we undertake.
 Our proprietary rights may prove difficult to enforce.
  We are dependent on our senior management and other key personnel.
   We and our products are subject to regulatory oversight that could substantially interfere with our
ability to do business.
  We are at risk with respect to product liability claims.
  39




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##### Table of Contents



We face significant competition that could adversely affect our results of operation and financial
condition.
  If the use of our technology is determined to infringe on the intellectual property rights of
others, our business could be harmed.
    We require certain raw materials for our manufacturing processes that may only be acquired through
limited sources.
  We have, in the past, received minor deficiencies from regulatory agencies related to our
manufacturing facilities.
  40




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##### Table of Contents



Trends, Risks and Uncertainties Related to Our Capital Stock
 The Private Placements and other financing arrangements or corporate events could significantly
dilute existing ownership.
   In the past, we have experienced volatility in the market price of our common stock and we may
experience such volatility in the future.
   We may take actions which could dilute current equity ownership or prevent or delay a change in our
control.
  Failure to maintain NASDAQ Marketplace Rules could materially and adversely affect our business.
  41




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Item 2. Unregistered Sales of Equity 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.
  Base Salary
    
    Base SalaryName
    
    Position
    
    (Current)
    
    (Reinstated)David R. Bethune
    
    Chairman and Chief Executive Officer
    
    $
    315,000
    
    
    $
    350,000Gary V. Klinefelter
    
    Vice President, General Counsel and Secretary
    
    
    216,000
    
    
    
    240,000Diane E. Klein
    
    Vice President of Finance and Treasurer
    
    
    166,500
    
    
    
    185,000
   Name
    
    Date of Employment LetterDavid R. Bethune
    
    May 9, 2008Gary V. Klinefelter
    
    March 30, 2007Diane E. Klein
    
    March 30, 2007
    
 Item 6. Exhibits.
 ExhibitNumber
    
    Description10.1
    
    Amendment Agreement with David R. Bethune dated June 8, 200910.2
    
    Amendment Agreement with Gary V. Klinefelter dated June 8, 200910.3
    
    Amendment Agreement with Diane E. Klein dated June 8, 200931.1
    
    Section 302 Certification of the Principal Executive Officer31.2
    
    Section 302 Certification of the Principal Financial Officer32.1
    
    Section 1350 Certification of the Principal Executive Officer and Principal Financial Officer
 42




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##### Table of Contents



SIGNATURES
  Date:  June 9, 2009
    Zila, Inc.By:
    /s/ DAVID R. BETHUNEDavid R. BethuneChairman and Chief Executive Officer(Principal Executive Officer) By:
    /s/ DIANE E. KLEINDiane E. KleinVice President  Finance and Treasurer
(Principal Financial Officer) ExhibitNumber
    
    Description10.1
    
    Amendment Agreement with David R. Bethune dated June 9, 200910.2
    
    Amendment Agreement with Gary V. Klinefelter dated June 9, 200910.3
    
    Amendment Agreement with Diane E. Klein dated June 9, 200931.1
    
    Section 302 Certification of the Principal Executive Officer31.2
    
    Section 302 Certification of the Principal Financial Officer32.1
    
    Section 1350 Certification of the Principal Executive Officer and Principal Financial Officer
 43