##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
 
 Form 10-Q
 QUARTERLY REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
 For the Fiscal Quarter Ended
    
    Commission File NumberJanuary 31, 2006
    
    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.)
 5227 North 7th Street, Phoenix, Arizona 85014-2800  (Address of Principal Executive Offices)
 (602) 266-6700
 þ o
 o þ o
 o þ




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##### Table of Contents



ZILA, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JANUARY 31, 2006
TABLE OF CONTENTS
 PagePart I. FINANCIAL INFORMATION (UNAUDITED)Item 1. Financial StatementsConsolidated Balance Sheets as of January 31, 2006 and July 31, 2005
    
    
    3Consolidated Statements of Operations and Comprehensive Loss for the three-month and six-month periods ended
January 31, 2006 and 2005
    
    
    4Consolidated Statements of Cash Flows for the three-month and six-month periods ended January 31, 2006 and
2005
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 3.Quantitative and Qualitative Disclosures about Market Risk
    
    
    24Item 4. Controls and Procedures
    
    
    24Part II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    25Item 1A. Risk Factors
    
    
    25Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    25Item 3. Defaults upon Senior Securities
    
    
    25Item 4. Submission of Matters to a Vote of Security Holders
    
    
    25Item 5. Other Information
    
    
    25Item 6. Exhibits
    
    
    26SIGNATURES
    
    
    26INDEX TO EXHIBITS
    
    
    27Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
 2




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##### Table of Contents



PART I. FINANCIAL INFORMATION (UNAUDITED)
 
 Item 1. Financial Statements.
 ZILA, INC. AND SUBSIDIARIES
 
 CONSOLIDATED BALANCE SHEETS
 January 31,
    
    
    July 31,2006
    
    
    2005(Unaudited)ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    5,172,022
    
    
    $
    12,937,517Restricted cash collateral
    
    
    537,491
    
    
    
    527,783Trade receivables  net of allowances of $200,000 and $150,000
    
    
    9,448,347
    
    
    
    11,422,743Inventories  net
    
    
    7,704,171
    
    
    
    6,024,266Prepaid expenses and other current assets
    
    
    2,107,323
    
    
    
    1,726,778Total current assets
    
    
    24,969,354
    
    
    
    32,639,087Property and equipment  net
    
    
    9,880,349
    
    
    
    9,691,686Purchased technology  net
    
    
    2,792,275
    
    
    
    3,031,613Goodwill  net
    
    
    6,930,192
    
    
    
    6,930,192Trademarks and other intangible assets  net
    
    
    12,408,740
    
    
    
    12,652,564Other assets
    
    
    452,577
    
    
    
    473,095Total Assets
    
    $
    57,433,487
    
    
    $
    65,418,237LIABILITIES AND SHAREHOLDERS EQUITYCurrent Liabilities:Accounts payable
    
    $
    8,749,718
    
    
    $
    5,397,213Accrued liabilities
    
    
    4,405,578
    
    
    
    3,717,630Short-term borrowings
    
    
    180,274
    
    
    
    154,335Deferred revenue and deferred gain on sale leaseback
    
    
    221,726
    
    
    
    221,726Current portion of long-term debt and capital lease obligations
    
    
    314,341
    
    
    
    323,758Total current liabilities
    
    
    13,871,637
    
    
    
    9,814,662Deferred revenue and deferred gain on sale leaseback
    
    
    442,623
    
    
    
    553,486Long-term debt and capital lease obligations  net of current portion
    
    
    3,221,235
    
    
    
    3,328,139Total liabilities
    
    
    17,535,495
    
    
    
    13,696,287Commitments and contingencies (Note 12)Shareholders Equity:Preferred stock  Series B, $.001 par value - 2,500,000 shares authorized,
100,000 shares issued and outstanding
    
    
    462,500
    
    
    
    462,500Common stock, $.001 par value - 65,000,000 shares authorized,
45,937,662 shares and 45,864,050 shares issued and outstanding
    
    
    45,938
    
    
    
    45,864Capital in excess of par value
    
    
    84,814,647
    
    
    
    84,372,257Accumulated other comprehensive loss
    
    
    (62,875
    )
    
    
    (63,924
    )Accumulated deficit
    
    
    (44,811,147
    )
    
    
    (32,543,676
    )Common stock in treasury, at cost (218,411 shares)
    
    
    (551,071
    )
    
    
    (551,071
    )Total shareholders equity
    
    
    39,897,992
    
    
    
    51,721,950Total Liabilities and Shareholders Equity
    
    $
    57,433,487
    
    
    $
    65,418,237
 3
    Table of Contents   ZILA, INC. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
 Three months ended January 31,
    
    
    Six months ended January 31,2006
    
    
    2005
    
    
    2006
    
    
    2005Net revenues
    
    $
    9,619,898
    
    
    $
    10,930,730
    
    
    $
    19,301,345
    
    
    $
    20,806,542Cost of products sold
    
    
    4,044,586
    
    
    
    3,680,162
    
    
    
    8,069,005
    
    
    
    7,150,263Gross profit
    
    
    5,575,312
    
    
    
    7,250,568
    
    
    
    11,232,340
    
    
    
    13,656,279Operating costs and expenses:Marketing and selling
    
    
    6,924,809
    
    
    
    4,883,401
    
    
    
    11,705,666
    
    
    
    9,162,507General and administrative
    
    
    3,376,135
    
    
    
    2,792,521
    
    
    
    6,739,250
    
    
    
    5,509,906Research and development
    
    
    1,739,292
    
    
    
    1,630,668
    
    
    
    3,557,091
    
    
    
    3,560,723Depreciation and amortization
    
    
    739,233
    
    
    
    656,719
    
    
    
    1,448,087
    
    
    
    1,314,76112,779,469
    
    
    
    9,963,309
    
    
    
    23,450,094
    
    
    
    19,547,897Loss from operations
    
    
    (7,204,157
    )
    
    
    (2,712,741
    )
    
    
    (12,217,754
    )
    
    
    (5,891,618
    )Other income (expense):Interest income
    
    
    63,621
    
    
    
    41,023
    
    
    
    147,604
    
    
    
    93,717Interest expense
    
    
    (57,804
    )
    
    
    (52,080
    )
    
    
    (109,868
    )
    
    
    (99,878
    )Gain (loss) on sale of assets
    
    
    (25,078
    )
    
    
    192
    
    
    
    (24,893
    )
    
    
    (1,252
    )Other expense
    
    
    (20,598
    )
    
    
    (20,681
    )
    
    
    (34,536
    )
    
    
    (46,185
    )(39,859
    )
    
    
    (31,546
    )
    
    
    (21,693
    )
    
    
    (53,598
    )Loss from continuing operations before income taxes
    
    
    (7,244,016
    )
    
    
    (2,744,287
    )
    
    
    (12,239,447
    )
    
    
    (5,945,216
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    (3,600
    )
    
    
    (1,955
    )Loss from continuing operations
    
    
    (7,244,016
    )
    
    
    (2,744,287
    )
    
    
    (12,243,047
    )
    
    
    (5,947,171
    )Income (loss) from discontinued operations
    
    
    (1,781
    )
    
    
    88,213
    
    
    
    (4,924
    )
    
    
    579,205Net loss
    
    
    (7,245,797
    )
    
    
    (2,656,074
    )
    
    
    (12,247,971
    )
    
    
    (5,367,966
    )Preferred stock dividends
    
    
    9,750
    
    
    
    9,750
    
    
    
    19,500
    
    
    
    19,500Net loss attributable to common shareholders
    
    $
    (7,255,547
    )
    
    $
    (2,665,824
    )
    
    $
    (12,267,471
    )
    
    $
    (5,387,466
    )Basic and diluted net income (loss) per common
share:Loss from continuing operations
    
    $
    (0.16
    )
    
    $
    (0.06
    )
    
    $
    (0.27
    )
    
    $
    (0.13
    )Income (loss) from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.01Net loss
    
    $
    (0.16
    )
    
    $
    (0.06
    )
    
    $
    (0.27
    )
    
    $
    (0.12
    )Weighted average shares outstanding
    
    
    45,683,014
    
    
    
    45,557,785
    
    
    
    45,668,127
    
    
    
    45,529,493Net loss
    
    $
    (7,245,797
    )
    
    $
    (2,656,074
    )
    
    $
    (12,247,971
    )
    
    $
    (5,367,966
    )Foreign currency translation adjustments
    
    
    880
    
    
    
    (2,782
    )
    
    
    1,049
    
    
    
    (4,407
    )Comprehensive loss
    
    $
    (7,244,917
    )
    
    $
    (2,658,856
    )
    
    $
    (12,246,922
    )
    
    $
    (5,372,373
    )
  4




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##### Table of Contents



ZILA, INC. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 Six months ended January 31,2006
    
    
    2005Operating activities:Net loss
    
    $
    (12,247,971
    )
    
    $
    (5,367,966
    )Adjustments to reconcile net loss to net cash
used in operating activities:Depreciation and amortization continuing operations
    
    
    1,448,087
    
    
    
    1,314,761Depreciation and amortization discontinued operations
    
    
    
    
    
    
    37,040Amortization of deferred financing costs
    
    
    15,183
    
    
    
    25,955Loss on sale of assets
    
    
    24,893
    
    
    
    1,252Noncash stock based compensation expense
    
    
    240,789
    
    
    
    22,801Options issued for services
    
    
    31,226
    
    
    
    Noncash research and development expense
    
    
    
    
    
    
    49,000Deferred revenue and other
    
    
    21,244
    
    
    
    (102,172
    )Change in assets and liabilities:Receivables  net
    
    
    1,974,396
    
    
    
    (1,724,070
    )Inventories
    
    
    (1,679,905
    )
    
    
    513,569Prepaid expenses and other assets
    
    
    (453,765
    )
    
    
    134,488Accounts payable and accrued liabilities
    
    
    4,040,452
    
    
    
    1,366,202Net cash used in operating activities
    
    
    (6,585,371
    )
    
    
    (3,729,140
    )Investing activities:Additions to property and equipment, net
    
    
    (898,757
    )
    
    
    (424,514
    )Additions to intangible assets, net
    
    
    (277,924
    )
    
    
    (403,587
    )Proceeds from disposition of assets
    
    
    8,413
    
    
    
    Proceeds from sale of short-term investments
    
    
    
    
    
    
    4,000,000Restricted cash deposited to collaterize letter of credit
    
    
    (9,708
    )
    
    
    (2,283
    )Net cash (used in) provided by investing activities
    
    
    (1,177,976
    )
    
    
    3,169,616Financing activities:Net proceeds from short-term borrowings
    
    
    25,939
    
    
    
    202,162Proceeds from issuance of common stock
    
    
    170,449
    
    
    
    206,397Dividends paid to preferred stockholders
    
    
    (19,500
    )
    
    
    (39,000
    )Principal payments on long-term debt
    
    
    (179,036
    )
    
    
    (172,262
    )Net cash (used in) provided by financing activities
    
    
    (2,148
    )
    
    
    197,297Net decrease in cash and cash equivalents
    
    
    (7,765,495
    )
    
    
    (362,227
    )Cash and cash equivalents at beginning of period
    
    
    12,937,517
    
    
    
    3,679,915Cash and cash equivalents at end of period
    
    $
    5,172,022
    
    
    $
    3,317,688
 5
    Table of Contents   ZILA, INC. AND SUBSIDIARIES
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
 1. ORGANIZATION AND BASIS OF PRESENTATION
  Advanced Protection
   Reclassifications
  Business Concentration
  Recent Accounting Pronouncements
 Practical
Accommodation to the Application of Grant Date as Defined in FASB Statement No. 123R
 6




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##### Table of Contents



Transition Election
Related to Accounting for the Tax Effects of Share-Based Payment Awards Accounting for Stock-Based Compensation.
 2. STOCK-BASED COMPENSATION
  Accounting for Stock-Based Compensation Accounting
for Stock Issued to Employees
 Share-Based Payment
     7




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##### Table of Contents



WeightedWeighted
    
    AverageAverage
    
    Remaining
    
    AggregateNumber
    
    Exercise
    
    Contractual
    
    Intrinsicof Shares
    
    Price
    
    Term
    
    ValueBalance outstanding at July 31, 2005
    
    
    2,345
    
    
    $
    3.58Granted
    
    
    859
    
    
    
    3.64Exercised
    
    
    (55
    )
    
    
    2.29Terminated/expired
    
    
    (237
    )
    
    
    4.26Balance outstanding at January 31, 2006
    
    
    2,912
    
    
    $
    3.57
    
    
    
    7.0
    
    
    $
    (228
    )Options exercisable at January 31, 2006
    
    
    2,099
    
    
    $
    3.56
    
    
    
    6.5
    
    
    $
    (153
    )
   Six Months Ended January 31,2006
    
    2005Expected stock price volatility
    
    63% to 68%
    
    
    75%Expected life of options
    
    
    3 to 5 Years
    
    
    7 YearsRisk-free interest rate
    
    3.6% to 3.7%
    
    
    3.8%Dividend yield
    
    
    0.0%
    
    
    
    0.0%
   Three
    
    
    SixMonths
    
    
    MonthsEnded
    
    
    EndedJanuary 31,
    
    
    January 31,2005
    
    
    2005Net loss attributable to common shareholders:As reported
    
    $
    (2,666
    )
    
    $
    (5,387
    )Add: Employee compensation expense for equity awards recorded at fair value included
in the determination of net loss as reported
    
    
    17
    
    
    
    23Less: Employee compensation expense determined under fair value based method for all
awards, net of related tax effects
    
    
    432
    
    
    
    796Pro-forma net loss
    
    $
    (3,081
    )
    
    $
    (6,160
    )Net loss attributable to common shareholders per basic and diluted share outstanding:As reported
    
    $
    (0.06
    )
    
    $
    (0.12
    )Pro forma
    
    $
    (0.07
    )
    
    $
    (0.14
    )
 8




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##### Table of Contents



3. DISCONTINUED OPERATION
    Three months ended
    
    
    Six months endedJanuary 31,
    
    
    January 31,2006
    
    
    2005
    
    
    2006
    
    
    2005Net revenues
    
    $
    
    
    
    $
    1,884
    
    
    $
    
    
    
    $
    3,576Income (loss) from operations
    
    $
    (2
    )
    
    $
    88
    
    
    $
    (5
    )
    
    $
    579
 4. NET LOSS PER COMMON SHARE
  5. INVENTORIES
  January 31,
    
    
    July 31,2006
    
    
    2005Finished goods
    
    $
    2,483
    
    
    $
    732Work in process
    
    
    476
    
    
    
    579Raw materials
    
    
    4,827
    
    
    
    4,853Inventory reserves
    
    
    (82
    )
    
    
    (140
    )$
    7,704
    
    
    $
    6,024
 6. INTANGIBLE ASSETS
  January 31, 2006
    
    
    July 31, 2005Gross
    
    
    
    
    
    
    Net
    
    
    Gross
    
    
    
    
    
    
    NetCarrying
    
    
    Accumulated
    
    
    Carrying
    
    
    Carrying
    
    
    Accumulated
    
    
    CarryingAmount
    
    
    Amortization
    
    
    Amount
    
    
    Amount
    
    
    Amortization
    
    
    AmountAmortizable intangibles:Purchased technology rights
    
    $
    7,419
    
    
    $
    4,627
    
    
    $
    2,792
    
    
    $
    7,419
    
    
    $
    4,387
    
    
    $
    3,032Trademarks and other intangible
assets:Trademarks
    
    
    11,701
    
    
    
    3,832
    
    
    
    7,869
    
    
    
    11,657
    
    
    
    3,602
    
    
    
    8,055Patents
    
    
    3,404
    
    
    
    734
    
    
    
    2,670
    
    
    
    3,168
    
    
    
    624
    
    
    
    2,544Licensing costs
    
    
    3,109
    
    
    
    1,239
    
    
    
    1,870
    
    
    
    3,162
    
    
    
    1,108
    
    
    
    2,054
 9




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##### Table of Contents



January 31, 2006
    
    
    July 31, 2005Gross
    
    
    
    
    
    
    Net
    
    
    Gross
    
    
    
    
    
    
    NetCarrying
    
    
    Accumulated
    
    
    Carrying
    
    
    Carrying
    
    
    Accumulated
    
    
    CarryingAmount
    
    
    Amortization
    
    
    Amount
    
    
    Amount
    
    
    Amortization
    
    
    AmountTotal trademarks and other
intangible assets
    
    
    18,214
    
    
    
    5,805
    
    
    
    12,409
    
    
    
    17,987
    
    
    
    5,334
    
    
    
    12,653Total amortizable intangible assets
    
    
    25,633
    
    
    
    10,432
    
    
    
    15,201
    
    
    
    25,406
    
    
    
    9,721
    
    
    
    15,685Unamortizable intangible asset:Goodwill
    
    
    12,401
    
    
    
    5,471
    
    
    
    6,930
    
    
    
    12,401
    
    
    
    5,471
    
    
    
    6,930Total intangible assets
    
    $
    38,034
    
    
    $
    15,903
    
    
    $
    22,131
    
    
    $
    37,807
    
    
    $
    15,192
    
    
    $
    22,615
   7. DEBT AND LEASE OBLIGATIONS
  January 31,
    
    
    July 31,2006
    
    
    2005Short-term borrowings:Installment note payable on insurance policies
    
    $
    180
    
    
    $
    154Current portion of long-term debt:IDA bond payable, Series A, current portion
    
    $
    245
    
    
    $
    245Capital lease obligations, current portion
    
    
    69
    
    
    
    50Note payable for equipment
    
    
    
    
    
    
    29Total current portion of long-term debt
    
    $
    314
    
    
    $
    324Long-term debt:IDA bond payable, Series A
    
    $
    2,844
    
    
    $
    2,967PharmaBio
    
    
    500
    
    
    
    500Capital lease obligations
    
    
    191
    
    
    
    156Note payable for equipment
    
    
    
    
    
    
    29Total long-term debt
    
    
    3,535
    
    
    
    3,652Less current portion
    
    
    314
    
    
    
    324Long-term portion
    
    $
    3,221
    
    
    $
    3,328
    10




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##### Table of Contents



Long-term
    
    
    Capital
    
    
    TotalDebt
    
    
    Leases
    
    
    DebtRemaining 2006
    
    $
    123
    
    
    $
    46
    
    
    $
    1692007
    
    
    245
    
    
    
    67
    
    
    
    3122008
    
    
    245
    
    
    
    61
    
    
    
    3062009
    
    
    745
    
    
    
    17
    
    
    
    7622010
    
    
    246
    
    
    
    
    
    
    
    2462011 and thereafter
    
    
    1,740
    
    
    
    
    
    
    
    1,740Total
    
    
    3,344
    
    
    
    191
    
    
    
    3,535Less current portion
    
    
    245
    
    
    
    69
    
    
    
    314Long-term portion
    
    $
    3,099
    
    
    $
    122
    
    
    $
    3,221
 8. INCOME TAXES
   11




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##### Table of Contents



9. ACCRUED LIABILITIES
  January 31,
    
    
    July 31,2006
    
    
    2005Accrued professional and consulting fees
    
    $
    1,533
    
    
    $
    1,248Accrued advertising
    
    
    1,542
    
    
    
    433Accrued employee compensation and related taxes
    
    
    599
    
    
    
    712Accrued royalties
    
    
    171
    
    
    
    815Other
    
    
    561
    
    
    
    510Total accrued liabilities
    
    $
    4,406
    
    
    $
    3,718
 10. SUPPLEMENTAL CASH FLOW INFORMATION
  Six Months Ended January 31,2006
    
    2005Interest paid
    
    $
    86
    
    
    $
    84Income taxes paid
    
    $
    102
    
    
    $
    Capital lease obligations for new equipment
    
    
    63
    
    
    
    6
 11. SEGMENT INFORMATION
 : Advanced Protection
  Nutraceuticals
    
    Pharmaceuticals
    
    Biotechnology
    
    Corporate
    
    TotalNet revenues from continuing operations:2006
    
    $
    7,240
    
    
    $
    2,380
    
    
    $
    
    
    
    $
    
    
    
    $
    9,6202005
    
    
    9,801
    
    
    
    1,130
    
    
    
    
    
    
    
    
    
    
    
    10,931Income (loss) from continuing operations
before income taxes:2006
    
    
    (1,998
    )
    
    
    (1,430
    )
    
    
    (2,127
    )
    
    
    (1,689
    )
    
    
    (7,244
    )2005
    
    
    1,526
    
    
    
    (730
    )
    
    
    (1,955
    )
    
    
    (1,585
    )
    
    
    (2,744
    )Depreciation and amortization:2006
    
    
    305
    
    
    
    176
    
    
    
    207
    
    
    
    51
    
    
    
    7392005
    
    
    284
    
    
    
    151
    
    
    
    173
    
    
    
    49
    
    
    
    657
  Nutraceuticals
    
    Pharmaceuticals
    
    Biotechnology
    
    Corporate
    
    TotalNet revenues from continuing operations:2006
    
    $
    14,654
    
    
    $
    4,647
    
    
    $
    
    
    
    $
    
    
    
    $
    19,3012005
    
    
    18,522
    
    
    
    2,285
    
    
    
    
    
    
    
    
    
    
    
    20,807
 12




---



##### Table of Contents



Nutraceuticals
    
    Pharmaceuticals
    
    Biotechnology
    
    Corporate
    
    TotalIncome (loss) from continuing operations
before income taxes:2006
    
    
    (1,902
    )
    
    
    (2,448
    )
    
    
    (4,224
    )
    
    
    (3,665
    )
    
    
    (12,239
    )2005
    
    
    2,872
    
    
    
    (1,462
    )
    
    
    (4,239
    )
    
    
    (3,116
    )
    
    
    (5,945
    )Depreciation and amortization:2006
    
    
    608
    
    
    
    345
    
    
    
    392
    
    
    
    103
    
    
    
    1,4482005
    
    
    564
    
    
    
    301
    
    
    
    346
    
    
    
    104
    
    
    
    1,315Identifiable assets from continuing
operations:January 31, 2006
    
    
    33,904
    
    
    
    10,407
    
    
    
    9,354
    
    
    
    3,768
    
    
    
    57,433July 31, 2005
    
    
    34,083
    
    
    
    10,950
    
    
    
    18,993
    
    
    
    1,392
    
    
    
    65,418
 12. COMMITMENTS AND CONTINGENCIES
 FDA approval of the OraTest® product
    ViziLite®
  Supply Arrangements
   Litigation
  13




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##### Table of Contents



13.
SUBSEQUENT EVENT
  
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
 ZILA, INC. AND SUBSIDIARIES
 COMPANY OVERVIEW
   630
     14




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##### Table of Contents



630
   RESULTS OF OPERATIONS
  Three months ended January 31, 2006 and 2005Percent of
    
    
    
    
    
    
    Percent ofNet
    
    
    
    
    
    
    Net2006
    
    
    Revenues
    
    
    2005
    
    
    Revenues
    
    
    ChangeNet revenues
    
    $
    9,620
    
    
    
    100
    %
    
    $
    10,931
    
    
    
    100
    %
    
    
    (12
    )%Cost of products sold
    
    
    4,045
    
    
    
    42
    
    
    
    3,680
    
    
    
    34
    
    
    
    10Gross profit
    
    
    5,575
    
    
    
    58
    
    
    
    7,251
    
    
    
    66
    
    
    
    (23
    )Operating Costs and Expenses:Marketing & selling
    
    
    6,925
    
    
    
    72
    
    
    
    4,883
    
    
    
    45
    
    
    
    42General & administrative
    
    
    3,376
    
    
    
    35
    
    
    
    2,793
    
    
    
    25
    
    
    
    21Research & development
    
    
    1,739
    
    
    
    18
    
    
    
    1,631
    
    
    
    15
    
    
    
    7Depreciation & amortization
    
    
    739
    
    
    
    8
    
    
    
    657
    
    
    
    6
    
    
    
    1212,779
    
    
    
    133
    
    
    
    9,964
    
    
    
    91
    
    
    
    28Loss from operations
    
    
    (7,204
    )
    
    
    (75
    )
    
    
    (2,713
    )
    
    
    (25
    )
    
    
    (166
    )Other income (expense), net
    
    
    (40
    )
    
    
    
    
    
    
    (31
    )
    
    
    
    
    
    
    29Loss before income taxes
    
    
    (7,244
    )
    
    
    (75
    )
    
    
    (2,744
    )
    
    
    (25
    )
    
    
    (164
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss from continuing operations
    
    $
    (7,244
    )
    
    
    (75
    )
    
    $
    (2,744
    )
    
    
    (25
    )
    
    
    (164
    )
  Six months ended January 31, 2006 and 2005Percent of
    
    
    
    
    
    
    Percent ofNet
    
    
    
    
    
    
    Net2006
    
    
    Revenues
    
    
    2005
    
    
    Revenues
    
    
    ChangeNet revenues
    
    $
    19,301
    
    
    
    100
    %
    
    $
    20,807
    
    
    
    100
    %
    
    
    (7
    )%Cost of products sold
    
    
    8,069
    
    
    
    42
    
    
    
    7,150
    
    
    
    34
    
    
    
    13Gross profit
    
    
    11,232
    
    
    
    58
    
    
    
    13,657
    
    
    
    66
    
    
    
    (18
    )Operating Costs and Expenses:Marketing & selling
    
    
    11,706
    
    
    
    60
    
    
    
    9,163
    
    
    
    45
    
    
    
    28
 15




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##### Table of Contents



Six months ended January 31, 2006 and 2005Percent of
    
    
    
    
    
    
    Percent ofNet
    
    
    
    
    
    
    Net2006
    
    
    Revenues
    
    
    2005
    
    
    Revenues
    
    
    ChangeGeneral & administrative
    
    
    6,739
    
    
    
    35
    
    
    
    5,510
    
    
    
    26
    
    
    
    22Research & development
    
    
    3,557
    
    
    
    18
    
    
    
    3,561
    
    
    
    17
    
    
    
    Depreciation & amortization
    
    
    1,448
    
    
    
    8
    
    
    
    1,315
    
    
    
    6
    
    
    
    1023,450
    
    
    
    121
    
    
    
    19,549
    
    
    
    94
    
    
    
    20Loss from operations
    
    
    (12,218
    )
    
    
    (63
    )
    
    
    (5,892
    )
    
    
    (28
    )
    
    
    (107
    )Other income (expense), net
    
    
    (21
    )
    
    
    
    
    
    
    (53
    )
    
    
    
    
    
    
    (60
    )Loss before income taxes
    
    
    (12,239
    )
    
    
    (63
    )
    
    
    (5,945
    )
    
    
    (28
    )
    
    
    (106
    )Income tax expense
    
    
    (4
    )
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    100Net loss from continuing operations
    
    $
    (12,243
    )
    
    
    (63
    )
    
    $
    (5,947
    )
    
    
    (28
    )
    
    
    (106
    )
       Nutraceuticals Business Unit
  16




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##### Table of Contents



Three months ended
    
    
    
    
    
    
    
    
    
    Six months endedJanuary 31,
    
    January 31,2006
    
    2005
    
    Change
    
    2006
    
    2005
    
    ChangeNet revenues
    
    $
    7,240
    
    
    $
    9,801
    
    
    
    (26
    )%
    
    $
    14,654
    
    
    $
    18,522
    
    
    
    (21
    )%Gross profit
    
    
    4,577
    
    
    
    6,690
    
    
    
    (32
    )
    
    
    9,175
    
    
    
    12,645
    
    
    
    (27
    )Gross profit %
    
    
    63
    %
    
    
    68
    %
    
    
    
    
    
    
    63
    %
    
    
    68
    %Income from operations before income taxes
    
    
    (1,998
    )
    
    
    1,526
    
    
    
    (231
    )
    
    
    (1,902
    )
    
    
    2,872
    
    
    
    (166
    )
     Pharmaceuticals Business Unit
  Three months ended
    
    
    
    
    
    
    
    
    
    Six months endedJanuary 31,
    
    January 31,2006
    
    2005
    
    Change
    
    2006
    
    2005
    
    ChangeNet revenues
    
    $
    2,380
    
    
    $
    1,130
    
    
    
    111
    %
    
    $
    4,647
    
    
    $
    2,285
    
    
    
    103
    %Gross profit
    
    
    1,002
    
    
    
    561
    
    
    
    79
    
    
    
    2,061
    
    
    
    1,012
    
    
    
    104Gross profit %
    
    
    42
    %
    
    
    50
    %
    
    
    
    
    
    
    44
    %
    
    
    44
    %Income from operations before income taxes
    
    
    (1,430
    )
    
    
    (730
    )
    
    
    (96
    )
    
    
    (2,448
    )
    
    
    (1,462
    )
    
    
    (67
    )
   17




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##### Table of Contents



630
 Biotechnology Business Unit
  Three months ended
    
    
    
    
    
    
    
    
    
    Six months endedJanuary 31,
    
    January 31,2006
    
    2005
    
    Change
    
    2006
    
    2005
    
    ChangeResearch and development
    
    $
    1,607
    
    
    $
    1,566
    
    
    
    3
    %
    
    $
    3,287
    
    
    $
    3,420
    
    
    
    (4
    %)Income from operations before income taxes
    
    
    (2,127
    )
    
    
    (1,955
    )
    
    
    (9
    )
    
    
    (4,224
    )
    
    
    (4,239
    )
    
    
    
   Inflation and Seasonality
  LIQUIDITY AND CAPITAL RESOURCES
   Six months ended January 31,2006
    
    2005Net cash used in operating activities
    
    $
    (6,585
    )
    
    $
    (3,729
    )Net provided by (used in) investing activities
    
    
    (1,178
    )
    
    
    3,170Net cash provided by financing activities
    
    
    (2
    )
    
    
    197
 January 31, 2006
    
    July 31, 2005Cash and cash equivalents
    
    $
    5,172
    
    
    $
    12,938Working capital
    
    
    11,098
    
    
    
    22,824Current ratio
    
    
    1.80
    
    
    
    3.33
  18




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##### Table of Contents



Operating Activities
  Investing Activities
  Financing Activities
  Bank Financing
   19




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##### Table of Contents



PharmaBio Investment
  Long-Term Debt Financing
   DISCLOSURES ABOUT CONTRACTUAL OBLIGATION AND COMMERCIAL COMMITMENTS
  SUMMARY OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
  Revenue Recognition
   20




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##### Table of Contents



Use of Estimates
      Goodwill, Intangibles and Other Long-Lived Assets
   Zila Pharmaceuticals Goodwill
 21




---



##### Table of Contents



Zila Nutraceuticals Goodwill
 OraTest®
 Income Taxes 
 FORWARD-LOOKING INFORMATION
  
    
    Obtaining regulatory approvals for our products is costly and full of uncertainty.
    
    We may be unable to obtain FDA approval, or to establish a market, for OraTest® in the United States.
    
    We are dependent on a few key products and our growth is dependent on the development of new products.
    
    We are dependent on a few key customers.
    
    We are dependent on our senior management and other key personnel.
    
    We and our products are subject to regulatory oversight that could substantially interfere with our ability to do business.
 22




---



##### Table of Contents




    
    We are at risk with respect to product liability claims.
    
    We face significant competition that could adversely affect our results of operation and financial condition.
    
    If we fail to secure and then enforce patents and other intellectual property rights underlying our technologies, or if
the use of our technology is determined to infringe on the intellectual property rights of others, our business could be
harmed.
    
    We require certain raw materials for our manufacturing processes that may only be acquired through limited sources.
    
    If we are unable to obtain adequate funds, we may not be able to develop and market our present and potential products.
    
    In the past, we have experienced volatility in the market price of our common stock and we may experience such volatility
in the future.
    
    Our Board of Directors may unilaterally issue Preferred Stock which could dilute our ownership and prevent or delay a
change in our control.
    
    If we use environmentally hazardous materials in a manner that causes injury, we may be liable for damages.
    
    We have, in the past, received minor deficiencies from regulatory agencies related to our manufacturing facilities.
  EBITDA
   Reconciliation of GAAP Measures to Non-GAAP Measures
Unaudited
(in thousands)
 Three months ended
    
    
    Six months endedJanuary 31,
    
    
    January 31,2006
    
    
    2005
    
    
    2006
    
    
    2005EBITDA
    
    $
    (6,513
    )
    
    $
    (1,969
    )
    
    $
    (10,834
    )
    
    $
    (4,008
    )Interest Income
    
    
    64
    
    
    
    41
    
    
    
    148
    
    
    
    94Interest Expense
    
    
    (58
    )
    
    
    (52
    )
    
    
    (110
    )
    
    
    (100
    )Depreciation and Amortization
    
    
    (739
    )
    
    
    (676
    )
    
    
    (1,448
    )
    
    
    (1,352
    )Income Tax Expense
    
    
    
    
    
    
    
    
    
    
    (4
    )
    
    
    (2
    )Net loss
    
    $
    (7,246
    )
    
    $
    (2,656
    )
    
    $
    (12,248
    )
    
    $
    (5,368
    )
 RECENT ACCOUNTING PRONOUNCEMENTS
 Practical
Accommodation to the Application of Grant Date as Defined in FASB Statement No. 123R
 23




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##### Table of Contents



Transition Election
Related to Accounting for the Tax Effects of Share-Based Payment Awards, Accounting for Stock-Based Compensation.
 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk.
    
 Item 4. Controls and Procedures.
 Evaluation of Disclosure Controls and Procedures.
   Changes in Internal Control over Financial Reporting
  24




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##### Table of Contents



Part II  Other Information
 
 Item 1. Legal Proceedings.
 Legal Proceedings,
 
 Item 1A. Risk Factors.
  
 Item 2. Unregistered Sales of Securities and Use of Proceeds.
  
 Item 3. Defaults upon Senior Securities.
  
 Item 4. Submission of Matters to a Vote of Security Holders
   Number of SharesName
    
    For
    
    WithheldDavid R. Bethune
    
    
    42,731,852
    
    
    
    536,132Douglas D. Burkett, Ph.D.
    
    
    41,285,149
    
    
    
    1,982,835Leslie H. Green
    
    
    38,444,032
    
    
    
    4,823,952Christopher D. Johnson
    
    
    41,279,615
    
    
    
    1,988,369Kurt R. Krauss
    
    
    42,726,647
    
    
    
    541,337Michael S. Lesser
    
    
    41,340,495
    
    
    
    1,927,489S. Timothy Rose, D.D.S.
    
    
    41,278,057
    
    
    
    1,989,927
   For
    
    Against
    
    Abstain
    
    Not Voted42,990,923
    
    
    167,807
    
    
    
    109,254
    
    
    
    2,626,066
  
 Item 5. Other Information.
  25




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##### Table of Contents



Item 6. Exhibits.
 Exhibit Number
    
    Description10.1(A)
    
    Fourth Amendment to Credit and Security Agreement and Amendment to Reimbursement Agreement
dated January 27, 2006 between Zila Nutraceuticals, Inc., Zila Biotechnology, Inc., Zila
Pharmaceuticals, Inc., Zila Swab Technologies, Inc., and Wells Fargo Bank, National
Association31.1*
    
    Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 (filed herewith)31.2*
    
    Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 (filed herewith)32.1**
    
    Certification of the Chief Executive Officer and the Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(furnished herewith)32.2**
    
    Certification of the Chief Executive Officer and Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(furnished herewith)*
    
    Filed herewith**
    
    Furnished herewith(A)
    
    Incorporated by reference to the Companys Current Report on Form 8-K filed February 2, 2006
 
 SIGNATURES
  ZILA, INC.(Registrant)Date:
    
    March 13, 2006
    
    
    
    By:
    
    /s/ Andrew A. StevensAndrew A. StevensVice President and Chief Financial
Officer(Principal Financial Officer)
 26




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##### Table of Contents



INDEX TO EXHIBITS
 Exhibit Number
    
    Description10.1(A)
    
    Fourth Amendment to Credit and Security Agreement and Amendment to Reimbursement Agreement dated
January 27, 2006 between Zila Nutraceuticals, Inc., Zila Biotechnology, Inc., Zila Pharmaceuticals,
Inc., Zila Swab Technologies, Inc., and Wells Fargo Bank, National Association31.1*
    
    Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 200231.2*
    
    Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 200232.1**
    

Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 200232.2**
    

Certification
of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002*
    
    Filed herewith**
    
    Furnished herewith(A)
    
    Incorporated by reference to the Companys Current Report on Form 8-K filed February 2, 2006
 27