SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   FORM 10-KSB

(Mark One)

   |X| ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
                                     OF 1934

                   For the fiscal year ended December 31, 2004

   |_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                                   ACT OF 1934

           For the transition period from ___________ to _____________

                         Commission file number: 1-6787

                             HEALTH-CHEM CORPORATION
                 (Name of small business issuer in its charter)

           Delaware                                      13-2682801
           --------                                      ----------
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
incorporation or organization)

101 Sinking Springs Lane, Emigsville, PA                   17318
----------------------------------------                   -----
(Address of principal executive offices)                 (Zip code)

Issuer's telephone number, including area code: 717-764-1191

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act:

                          Common Stock, $.01 Par Value
                          ----------------------------

         10.375% Convertible Subordinated Debentures due April 15, 1999
         --------------------------------------------------------------
                                (Title of class)

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. |X|

State the issuer's revenues for its most recent fiscal year: $9,192,000

State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was sold, or the average bid and asked price of such common equity, as of a
specified date within the past 60 days. (See definition of affiliate in Rule
12b-2 of the Exchange Act.): $697,092 as of May 1, 2006.

Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). |_| Yes |X| No

State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 11,443,424 as of May 1, 2006.

                       DOCUMENTS INCORPORATED BY REFERENCE

None.

Transitional Small Business Disclosure Format (Check one): |_| Yes |X| No

<PAGE>

<TABLE>
<S>                                                                                                     <C>
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS .................................................      3
PART I ............................................................................................      5
   ITEM 1.  DESCRIPTION OF BUSINESS ...............................................................      5
   ITEM 2.  DESCRIPTION OF PROPERTIES .............................................................     36
   ITEM 3.  LEGAL PROCEEDINGS .....................................................................     36
   ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ...................................     37
PART II ...........................................................................................     37
   ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ..............................     37
   ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS .     40
   ITEM 7.  FINANCIAL STATEMENTS ..................................................................     53
   ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ..     53
   ITEM 8A. CONTROLS AND PROCEDURES ...............................................................     53
   ITEM 8B. OTHER INFORMATION .....................................................................     53
PART III ..........................................................................................     54
   ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH
            SECTION 16(A) OF THE EXCHANGE ACT .....................................................     54
   ITEM 10. EXECUTIVE COMPENSATION ................................................................     55
   ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ........................................     59
   ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K ......................................................     62
   ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES ................................................     69
SIGNATURES ........................................................................................     70
</TABLE>


                                     - 2 -
<PAGE>

                SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

      This Annual Report on Form 10-KSB for the years ended December 31, 2003
and 2004 ("Annual Report") contains forward-looking statements. We have based
these forward-looking statements on our current expectations and projections
about future events. These statements include, but are not limited to:

o     statements relating to our ability to restructure our outstanding past due
      liabilities;

o     statements as to the development of new products and the commercialization
      of products;

o     statements as to the anticipated timing of clinical tests and other
      business developments;

o     expectations as to the adequacy of our cash balances to support our
      operations for specified periods of time and as to the nature and level of
      cash expenditures; and

o     expectations as to the market opportunities for our products, as well as
      our ability to take advantage of those opportunities.

      These statements may be found in the sections of this Annual Report
entitled "Description of Business", "Risk Factors", and "Management's Discussion
and Analysis of Financial Condition and Results of Operations," as well as in
this Annual Report generally. Actual results could differ materially from those
anticipated in these forward-looking statements as a result of various factors,
including all the risks discussed in "Risk Factors" and elsewhere in this Annual
Report.

      In addition, statements that use the terms "can," "continue," "could,"
"may," "potential," "predicts," "should," "will," "believe," "expect," "plan,"
"intend," "estimate," "anticipate," "scheduled" and similar expressions are
intended to identify forward-looking statements. All forward-looking statements
in this Annual Report reflect our current views about future events and are
based on assumptions and are subject to risks and uncertainties that could cause
our actual results to differ materially from future results expressed or implied
by the forward-looking statements. Many of these factors are beyond our ability
to control or predict. Forward-looking statements do not guarantee future
performance and involve risks and uncertainties. Actual results will differ, and
may differ materially, from projected results as a result of certain risks and
uncertainties. The risks and uncertainties include, without limitation, those
described under "Risk Factors" and those detailed from time to time in our
filings with the Securities and Exchange Commission, and include, among others,
the following:

o     our ability to restructure outstanding liabilities and continue as a going
      concern;

o     our ability to successfully develop and commercialize new products;

o     a lengthy approval process and the uncertainty of the Food and Drug
      Administration and other government regulatory requirements;

o     the degree and nature of our competition;

o     our continued ability to obtain certain raw materials from which we
      manufacture our products;

o     our ability to employ and retain qualified employees; and


                                     - 3 -
<PAGE>

o     the other factors referenced in this Annual Report, including, without
      limitation, under the section entitled "Risk Factors", "Management's
      Discussion and Analysis of Financial Condition and Results of Operations,"
      and "Description of Business."

      These risks are not exhaustive. Other sections of this Annual Report may
include additional factors that could adversely impact our business and
financial performance. Moreover, we operate in a very competitive and rapidly
changing environment. New risk factors emerge from time to time, and it is not
possible for our management to predict all risk factors, nor can we assess the
impact of all factors on our business or to the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those
contained in any forward-looking statements. Given these risks and
uncertainties, investors should not place undue reliance on forward-looking
statements as a prediction of actual results. These forward-looking statements
are made only as of the date of this Annual Report. Except for our ongoing
obligation to disclose material information as required by federal securities
laws, we do not intend to update you concerning any future revisions to any
forward-looking statements to reflect events or circumstances occurring after
the date of this Annual Report.


                                     - 4 -
<PAGE>

                                INTRODUCTORY NOTE

      Health-Chem Corporation has not filed a report under the Securities
Exchange Act of 1934, as amended, which describes its business and financial
condition since 1999, as more fully explained in PART I, Item 1, below. This
Annual Report covers the years ended December 31, 2003 and 2004. In some cases,
such as under the headings "Recent Sales of Unregistered Securities," "Equity
and Related Stockholder Matters" and "Certain Relationships and Related
Transactions" this report includes information from the period January 1, 1999
through December 31, 2004 because we believe this information is of particular
interest and importance to investors.

      Health-Chem Corporation previously had filed annual reports on Form 10-K
but is entitled to file this Annual Report on Form 10-KSB because it met the
definition of "small business issuer" at the end of each of 2003, 2004 and 2005
(revenues and public float of less than $25 million).

                                     PART I

ITEM 1. DESCRIPTION OF BUSINESS

Overview.

      Health-Chem Corporation ("Health-Chem") and its subsidiaries (Health-Chem
and its subsidiaries collectively may be referred to as "we", "us" or the
"Company") manufacture controlled release products to deliver drugs topically or
transdermally (transdermal patches). Currently, our sole product is a
prescription transdermal patch which delivers nitroglycerin for use in the
relief of angina pectoris (chest pain); however, we have the manufacturing
capability to produce transdermal patches which deliver other medications. We
manufacture our nitroglycerin patch both on a contract basis for specific
clients and for sale to distributors and wholesalers for distribution in the
United States. We manufacture our products in accordance with Good Manufacturing
Practices, or GMP, prescribed by the United States Food and Drug Administration,
or FDA, at our facility in Emigsville, Pennsylvania. We conduct the majority of
our business through Transderm Laboratories Corporation ("Transderm"), of which
Health-Chem owns 90% of the outstanding common stock.

Operations from 1999 through 2004.

      Health-Chem has not filed any of the annual or quarterly reports which it
is required to file under the Securities Exchange Act since November 1999, when
it filed a Form 10-K for the year ended December 31, 1998 (the "1998 Annual
Report") and quarterly reports on Form 10-Q for each of the first three quarters
of 1999 (collectively, the "1999 Quarterly Reports"). Set forth below is a brief
chronological account of the Company's operations since the date it filed its
last reports under the Securities Exchange Act and the events which caused it to
discontinue filing reports.

      In 1996, at the peak of operations, the Company employed 242 persons and
generated $47.6 million in revenue. During this time, Health-Chem conducted its
business primarily through its wholly-owned subsidiaries, Herculite Products,
Inc. ("Herculite") and Pacific Combining Corp. ("Pacific"), and through its
majority owned subsidiaries, Transderm and Hercon Environmental Corporation
("Hercon Environmental"), of which it owns 98.5%. The Company developed,
manufactured and distributed products relying on or derived from laminated or
coated films. The products included controlled release dispensers for
prescription pharmaceuticals and over-the-counter pharmaceutical and cosmetic
products (Transderm); reinforced synthetic fabrics for industrial and health
care use (Herculite and Pacific); and controlled release dispensers for
environmental chemicals (Hercon Environmental).


                                     - 5 -
<PAGE>

      In growing its business to the 1996 levels, Health-Chem had incurred debts
and accumulated liabilities aggregating nearly $24 million at December 31, 1998.
The liabilities included (i) approximately $10 million under a bank line of
credit and term loan secured by all of the Company's assets (the "Bank Loan"),
(ii) $8 million of principal under certain convertible subordinated debentures
due on April 15, 1999, which provided for payments to a sinking fund, as more
fully described below ("Debentures") and (iii) $6 million of trade payables and
other miscellaneous liabilities.

      After 1996, the Company's business began to decline, as reported in
Health-Chem's annual report on Form 10-K for the year ended December 31, 1997.
Net sales during 1997 decreased by 21% compared to 1996 due primarily to
decreases in sales of the Company's two principal products, transdermal
nitroglycerin patches and synthetic fabrics. Revenues continued to decline
during 1998. The Company's financial and operating condition was subjected to
additional pressures given the Company's inability to offer its new generation
of transdermal products both because (i) approval of the Company's new
generation transdermal nitroglycerin patch, which was expected during the first
half of 1997, was delayed by the FDA, and (ii) a pending legal action against
the Company alleging patent infringement by its new generation transdermal
patch. These circumstances cast doubt about when, if ever, the Company would be
able to offer its new transdermal patch product on a commercial basis and
rendered management uncertain as to how the Company would generate revenues
sufficient to satisfy its obligations going forward. On October 30, 1998, the
Company received FDA market approval for its improved nitroglycerin patch but
was prevented from selling products incorporating this technology because of the
lawsuit. Sales of the older generation patch were diminishing rapidly.

      The Company's deteriorating financial condition required immediate
attention and, beginning in November 1998, management took steps to restructure
a portion of the Company's operations by discontinuing a portion of its
synthetic fabric manufacturing operations and closing the Pacific plant. The
restructuring reduced annual payroll expenses but did not generate cash for the
Company. The continuing pressure to generate cash to service debt obligations
prompted management to sell the assets of Herculite and Hercon Environmental to
a management-led group that included two members of Health-Chem's Board of
Directors, one of whom was its vice president of finance, and one other
Health-Chem executive. The sale was concluded on August 19, 1999, pursuant to an
agreement dated July 20, 1999 under which Health-Chem sold all of the assets of
these two subsidiaries and the buyer assumed certain liabilities of these
companies (the "Asset Sale"). Proceeds derived from the Asset Sale were used to
repay all amounts outstanding under the Bank Loan ($9.8 million) and to make a
$1.9 million payment on the Debentures, so that the Company's annual redemption
obligations under the sinking fund provisions of the Debentures remained
current. Management believed that these actions would provide the Company with
additional time in which to increase cash flow from operations and secure new
funding sources; however, notwithstanding the application of the proceeds from
the Asset Sale, the Company continued to carry substantial liabilities and debt
which it could not service, let alone satisfy, with the then current revenues.

      Since Health-Chem was unable to meet its payment obligations under the
Debentures and had been unable to develop an effective plan with which to
mitigate such conditions, management concluded that Health-Chem should present
the financial statements included in the financial statements accompanying the
reports it filed with the Securities and Exchange Commission, or SEC, on a
liquidation basis, meaning that all assets and liabilities that were subject to
binding sale agreements would be reflected at realizable values and Health-Chem
would cease taking charges for depreciation on its remaining assets after the
Asset Sale.


                                     - 6 -
<PAGE>

      On August 9, 1999, in advance of the closing of the Asset Sale, a major
shareholder of Health-Chem initiated an action to enjoin the Asset Sale and
compel Health-Chem to hold a shareholders meeting for the purpose of electing
directors. The suit cited the following, among others reasons, in support of the
request for injunctive relief: (i) Health-Chem had not filed any reports with
the SEC since the third quarter of 1998, which prejudiced the shareholders
because they were not fully apprised of the Company's grave financial condition
and could not scrutinize the terms of the Asset Sale and management's other
actions; (ii) management had failed to provide the plaintiff shareholder with
the financial and operating information he had requested on numerous occasions
which information otherwise would have been available to the public in reports
Health-Chem was required to file with the SEC; and (iii) Health-Chem was in
default under the Debentures and management had not developed a plan to satisfy
obligations to its lenders or a business model which would return the Company to
profitability. This lawsuit was settled and, on November 23, 1999, Health-Chem
filed a Definitive Proxy Statement with the SEC, along with its annual report
for the year ended December 31, 1998 and quarterly reports for the first three
quarters of 1999.

      A new slate of directors prevailed in the proxy contest and assumed
control of Health-Chem in February 2000. The new board members did not become
fully apprised of the gravity of the Company's financial, operational and
administrative condition until it was seated. All cash generated from the Asset
Sale had been expended to satisfy the Bank Loan and reduce the sum outstanding
on the Debentures, leaving the Company sufficient cash, as of February 2000, to
operate at existing levels for less than eight weeks. Moreover, the Company was
precluded from selling products incorporating its new generation transdermal
drug delivery technology, which had been approved by the FDA in October 1998,
because of the outstanding patent infringement action against the use of this
technology by the Company. The Company had almost no inventory of its only
remaining product available for sale. In short, the Company did not have any
money and had no immediate prospects to generate revenue. Two members of the new
Board of Directors resigned immediately when they ascertained the Company's
financial condition, and another member resigned shortly thereafter.

      In the spring of 2000, management obtained a $1.6 million loan from a
non-traditional lender at 15% interest secured by a mortgage on the Company's
Pennsylvania facility in order to fund operations until the Company could begin
generating revenues from product sales. During that period, management
negotiated a license with the holder of the patent whose intellectual property
the Company was ruled to have infringed in the patent litigation which permitted
the Company to sell products incorporating the new transdermal drug delivery
technology. In late summer 2000, when the proceeds of the mortgage loan were
nearly exhausted, the FDA advised the Company that because it had obtained a new
manufacturer for the release liner used in its new generation nitroglycerin
patch, the FDA would require additional testing and new approval before the
product could be sold, a process that could extend at least into the late winter
of 2001.

      Faced with the prospect of at least six months and probably longer without
revenue, and with no further borrowing capacity, the new board members were
forced to choose between immediately ceasing the Company's operations and
winding up its business or personally lending the Company funds to continue
business operations. They chose the latter course, lending the Company nearly $1
million over a 2-year period, which loans were secured by second liens on the
Pennsylvania facility and certain other Company assets. The funds were utilized
to satisfy the Company's most important current obligations, including interest
payments on the first mortgage, maintaining its manufacturing facility within
FDA standards and retaining a skeleton staff. In an effort to reduce cash
expenditures, the Company eliminated non-essential management personnel and put
manufacturing personnel on indefinite furlough until the Company could resume
normal manufacturing operations. In addition, management accrued all salaries
during this period. The Company lacked the cash with which to satisfy its other
outstanding obligations, which included $10,197,000 of principal plus interest
accrued due under the Debentures through December 31, 2004, potential state
taxes and trade and other payables.


                                     - 7 -
<PAGE>

      The Company received the additional FDA approval required for the new
release liner in its second generation transdermal nitroglycerin patch in June
2001. The Company commenced marketing this product shortly thereafter but did
not begin to generate material revenues from sales until 2003. Meanwhile, the
Company had made no progress in reducing its liabilities, which, in fact,
continued to grow. Moreover, the Company was on a cash on delivery basis with
its most important suppliers and was forced to factor its accounts receivable,
thereby further squeezing its margins and, hence, its cash availability.

      In June 2001, management sought to diversify the Company's business to
reduce its reliance on its single nitroglycerin transdermal patch product and
investigated a variety of strategies which could initiate a new and ongoing
product pipeline. Toward that end, the Company leased and eventually purchased
from a related party the key machinery and equipment of TCPI, Inc., a
Florida-based manufacturer of medical diagnostic products, out of bankruptcy in
December 2001. In February 2002, the Company organized a division which entered
into a series of agreements pursuant to which (i) it licensed thirty diagnostic
products derived from a common platform technology, (ii) it retained the
inventor of these products to continue development work and (iii) arranged to
manufacture the products at a leased facility located in Pompano Beach, Florida.
The new diagnostic division purchased pregnancy test wands manufactured under
the licenses and launched shipment of these products to European customers.
However, the division was unable to manufacture the pregnancy test wands
utilizing the equipment it purchased. Moreover, the Company brought to market
only two additional diagnostic products of the thirty it licensed and generated
minimal revenues from sales of these products. After sales of the pregnancy test
products declined dramatically due to patent issues, and with continuing
operating losses and cash flow drains, the Company divested itself of this
division in 2004. Health-Chem became involved in protracted litigation with
respect to the divestiture of this division and the decision of trial court in
favor of Health-Chem remains on appeal.

      In May 2002, Health-Chem rehired a former financial officer on a part-time
basis, though it was not until July 2002, when he was engaged on a full-time
basis, that he began to establish accounting controls and procedures. It was not
until late 2003 that Health-Chem's financial record keeping practices had been
restored to a level that would prospectively allow it to prepare financial
statements which could be audited, thereby allowing management to begin
considering the preparation and filing of reports with the SEC.

      As indicated above, management points to two primary reasons for failing
to file Exchange Act reports after 1998. First, the Company did not have
sufficient cash to undertake activities other than maintaining a
subsistence-level existence using minimal staff and satisfying only newly
incurred obligations - i.e., then-current trade payables. Second, the absence of
personnel essential to manage the Company's day-to-day operations beginning in
1999 created administrative chaos which was concentrated specifically in the
area of record keeping, including financial record keeping.

The 10.375% Convertible Subordinated Debentures Due April 15, 1999.

      Certain Terms of the Debentures and the Indenture under which the
Debentures were Issued.

      On April 15, 1981, the Company sold and issued 10.375% convertible
subordinated Debentures due April 15, 1999 in the principal amount of $20
million under the terms of an Indenture between the Company and Bankers Trust
Company (now Deutsche Bank Trust Company Americas), as trustee (the "Trustee").
Interest on the Debentures is payable semi-annually on April 15 and October 15
in each year. The Debentures are subject to the other principal terms described
below:


                                     - 8 -
<PAGE>

      Conversion. The Debentures were convertible into shares of the Company's
common stock at an initial conversion price of $20 per share subject, to
adjustment in certain cases, through April 15, 1999. The conversion price of the
Debentures was adjusted after issuance to $19.52 per share.

      Redemption. The Debentures were redeemable in whole or in part at any time
after October 15, 1982 at the option of the Company on thirty days' notice. The
Debentures initially were redeemable at 108.82% of the principal amount thereof
decreasing to 100% of the principal amount if redeemed after April 15, 1991. The
Debentures also were redeemable through the operation of a sinking fund
described below at the principal amount thereof together with interest accrued
thereon.

      Sinking Fund. The indenture governing the Debentures (the "Indenture")
required the Company to provide for the retirement, by redemption, of Debentures
in the aggregate principal amount of $1.5 million on April 15 of each year
commencing in 1991 to and including 1998 through the operation of a sinking
fund. The Company was entitled to reduce the amount of any sinking funds payment
by the principal amount of Debentures (a) acquired by the Company and
surrendered for cancellation (including converted Debentures) and (b) redeemed
or called for redemption other than pursuant to the sinking fund.

      Subordination. The payment of the principal of and premium, if any, and
interest on the Debentures is subordinated in right of payment to the prior
payment of all "senior indebtedness" (as defined below) of the Company whenever
created, incurred, assumed or guaranteed. Upon (i) the maturity of senior
indebtedness by lapse of time, acceleration or otherwise or (ii) any
distribution of the assets of the Company upon any dissolution, winding up,
liquidation or reorganization of the Company, the holders of senior indebtedness
are entitled to receive payment in full before holders of the Debentures are
entitled to receive any payment. The term "senior indebtedness" is defined as
the principal of and premium, if any, and interest on indebtedness whether
outstanding on the date of the Indenture or created thereafter, (i) incurred or
guaranteed by the Company for money borrowed from person, firms or corporations
which engage in lending money (ii) evidenced by notes, bonds, or debentures of
the Company under the provisions of an indenture or similar instrument or (iii)
incurred assumed or guaranteed in connection with the acquisition of by the
Company or a subsidiary of a business, and all renewals, extensions or
refundings of any such indebtedness, unless the terms of the instrument creating
the indebtedness specifically provide that such debt is not superior in right of
payment to the Debentures.

      Dividend Restriction. The Indenture provides that the Company shall not
(i) declare or make any distribution on its capital stock or to its stockholders
(other than dividends payable in its capital stock) or (ii) purchase, redeem or
otherwise acquire or retire for value any of its capital stock or permit any
subsidiary to do so, if at the time of such action, an event of default under
the Debentures (as described below) shall have occurred and be continuing or if
upon giving effect thereto, the aggregate amount expended for all such purposes
subsequent to December 31, 1980 shall exceed the sum of (A) 50% of the aggregate
consolidated net income (or net deficit) accrued subsequent to December 31, 1980
or (b) the aggregate net proceeds received by the Company from the issue or sale
of capital stock of the Company after December 31, 1980 and (c) the aggregate
net proceeds received by the Company from the issue or sale of any indebtedness
of the Company (other than the Debentures) after December 31, 1980 which is
subsequently converted into capital stock of the Company subject to certain
exceptions.

      Events of Default. Events of default under the Debentures include (i)
failure to pay interest for 30 days, failure to pay principal or any sinking
fund installment when due; (ii) the failure to perform any other covenants under
the Indenture for 60 days after notice; (iii) the default by the Company or any
of its subsidiaries under any instrument evidencing or securing any indebtedness
resulting in the acceleration of outstanding indebtedness in excess of $250,000,
which is not rescinded or annulled and (iv) the occurrence of certain events of
bankruptcy, insolvency or reorganization.


                                     - 9 -
<PAGE>

      Upon an event of default, the Trustee or the holders of at least 25% in
aggregate principal amount of all Debentures may declare the outstanding
principal of the Debentures plus all accrued and unpaid interest immediately due
and payable.

      Performance under the Debentures.

      With respect to the Debentures:

o     No Debentures have been converted into common stock.

o     From 1981 through 1998, the Company paid interest on the Debentures as it
      became due from cash flow from operations.

o     The Company satisfied its obligations under the sinking fund provisions of
      the Indenture by redeeming or repurchasing Debentures in the principal
      amount of $1.5 million from 1991 through 1998. From 1991 through 1997, the
      Company redeemed Debentures from cash flow from business operations. In
      1998, the Company satisfied its redemption obligation under the sinking
      fund requirements of the Debentures by application of $.3 million
      Debentures previously repurchased or redeemed and by calling for
      redemption of the remaining $1.2 million, which sum it borrowed under its
      term loan.

o     The Company made a $1.9 million payment on its debt obligations in respect
      of the Debentures out of the proceeds of the sale of assets of Herculite
      and Hercon Environmental in August 1999. The Company has not made any
      principal or interest payments with respect to the Debentures since August
      1999 and as of December 31, 2004, the Company owed $6.1 million principal
      amount on the Debentures and approximately $4.1 million in interest.

      In April 1999, the Company defaulted on its obligations to repay the $8.0
million in principal then outstanding as well as the accrued interest of $.4
million due on the Debentures at maturity. The Company has remained in sporadic
contact with the Trustee for the Debentures since it defaulted but has not had
the funds to make any payments or principal or interest since August 1999. On
several occasions, including by letter dated December 6, 2004 and most recently
by telephone conversations, the Trustee has requested a meeting to discuss the
status of the Company and its plans for repaying the Debenture holders and has
suggested that the Company call a shareholders meeting for such purpose.

Subsequent Agreements Bearing on the Debentures and the Indenture.

      As a result of our inability to pay the Debentures when they became due in
April 1999 and our continuing default thereunder, in August 1999, the Company
and its subsidiaries entered into two agreements with the Trustee. Under a
Security and Pledge Agreement, the Company granted to the Trustee a first
priority security interest in the $550,000 escrow deposit created at the closing
of the sale of assets of its Herculite and Hercon Environmental subsidiaries on
August 19, 1999. Pursuant to a second agreement with the Trustee, the Company
agreed: (i) to exercise its best efforts to effect a repayment plan to pay the
Debentures at the earliest practical date; (ii) that pending a repayment plan,
it will not make any payments to insiders except for salaries and benefits due
and becoming due to them and that insiders can receive pari passu payments on
Debentures they hold; and (iii) to give the Trustee not less than two business
days' notice before engaging in any extraordinary transactions.


                                     - 10 -
<PAGE>

      In June 2004, the Company entered into a Tolling Agreement with the
Trustee which provided, among other things, that (i) all potential actions which
the Trustee or any Debenture holder could have asserted against the Company as
of the date of the agreement would survive until the termination of the
agreement and would not be extinguished by reason of the statute of limitations,
contractual restrictions, equitable doctrine or other basis under federal or
state law which would prevent the Trustee or any Debenture holder from
commencing any action or claim under the Debentures; (ii) all provisions of the
Indenture would remain in full force and effect; and (iii) the agreement would
terminate on the earlier of April 15, 2006 or 120 days after the Trustee shall
have received from the Company or the Company shall have received from the
Trustee or a majority of the holders of Debentures then outstanding, a notice
stating that the agreement shall be terminated 120 days after receipt thereof.
In March 2006, the parties entered into a second Tolling Agreement which expires
on the earlier of April 15, 2007 or 120 days after the Trustee shall have
received from the Company or the Company shall have received from the Trustee or
a majority of the holders of Debentures then outstanding, a notice stating that
the agreement shall be terminated 120 days after receipt thereof.

      We have not commenced negotiating with the Trustee as to restructuring of
the debt represented by such instruments. Any failure to enter into an agreement
with the Trustee to restructure the repayment provisions of the Debenture on
terms favorable to us could have a material negative impact on our Company, as
more fully described under the heading "Risk Factors."

Transdermal Delivery Systems.

      Transdermal systems deliver drugs through the skin into the bloodstream.
These systems utilize a special membrane to control the rate at which the liquid
drug contained in the patch can pass through the skin and into the bloodstream
(plasma). Transdermal drug delivery involves the inherent challenge of
overcoming the skin barrier. Skin protects the body from the environment very
effectively and generally is only permeable to small molecule, lipophilic (oil
soluble) drugs which require only limited dose sizes. Transdermal delivery
systems, therefore, not only have to provide drug to the skin under stable
conditions in controlled dosages and in a format convenient to the patient, but
also serve to locally increase the permeability of skin to larger, charged, or
hydrophilic (easily dissolved in water) drug molecules while minimizing
irritation.

      The first transdermal patch was approved by the FDA in 1979. It contained
the drug scopolamine used to prevent the nausea and vomiting associated with
motion sickness. In 1981, the FDA approved a patch for nitroglycerin and today
patches have been approved to deliver 15 molecules spanning 35 different drugs,
including combination patches utilized for, among other purposes, contraception
and hormone replacement.

      The first transdermal systems consisted of plastic dipped into a drug that
was dissolved in alcohol. The plastic had an adhesive around the edges. These
patches created a significant number of skin reactions and frequently became
dislodged from the skin. Second, third and fourth generation patches have been
developed which have significantly advanced adhesion properties, delivery
control and skin permeability. There are four major types of transdermal drug
delivery systems in use today: single layer drug-in-adhesive systems,
multi-layer drug-in-adhesive systems, reservoir transdermal systems and matrix
systems. The basic components of current transdermal delivery systems include
the drug(s) either incorporated directly into the adhesive or dissolved or
dispersed in a reservoir or inert polymer matrix; an outer backing film of
paper, plastic, or foil; and a pressure-sensitive adhesive that anchors the
patch to the skin. Developments and improvements to transdermal systems are
being made rapidly.


                                     - 11 -
<PAGE>

      Transdermal drug delivery has numerous advantages over conventional drug
delivery methods. In contrast to orally delivered drugs, compounds entering the
body through the skin escape first-pass metabolism in the liver (which may
destroy the drug), often resulting in higher bioavailability of the drug.
Transdermal delivery is effective for use in nauseous patients because there are
few or no gastrointestinal effects from the drug itself and is useful for those
drugs that have poor oral uptake, need frequent administration or that interact
with stomach acid and allows effective use of drugs with short half-lives that
otherwise require large initial doses (bolus dosing) to achieve desired drug
levels (e.g., nitroglycerin). As a result, the side effects, or variability in
therapeutic effect due to peaks and troughs in plasma concentration, that are
seen with bolus administration are minimized. In contrast to intravenous drug
delivery, transdermal administration is noninvasive and poses little risk of
infection. It is also relatively easy for patients to apply and remove a
transdermal system.

      Although transdermal drug delivery patches have a relatively short
regulatory history compared to other, more traditional dosage forms, the
technology has a proven record of FDA approval. Since the first transdermal
patch was approved in 1979, the FDA has approved more than 35 transdermal patch
products spanning 15 molecules. In 2001, the US transdermal market approached
$1.2 billion and was based on 11 drug molecules. By the end of 2003, the market
for transdermal patches was based on 15 drug molecules and growing at an annual
revenue rate of 12 percent with a worldwide market of approximately $3 billion,
with the U.S. constituting about $1.7 billion (56%) of the market.

Our Nitroglycerin Transdermal Patch.

      In 1986, we introduced the first FDA-approved generic transdermal
nitroglycerin patch into the United States market. Currently, we manufacture and
market a transdermal nitroglycerin patch which provides relief from angina
pectoris or angina.

      Angina pectoris, or "heart pain," is the chest discomfort that occurs when
the blood oxygen supply to an area of the heart muscle does not meet the demand.
Blood returning from the body in the veins must be pumped by the heart through
the lungs and into the arteries against the high pressure in the arteries. In
order to accomplish this work, the heart's muscle must produce and use energy.
The production of energy requires oxygen. Angina is due to an inadequate flow of
blood (and oxygen) to the muscle of the heart. In most cases, the lack of blood
supply is due to a narrowing of the coronary arteries as a result of
arteriosclerosis. Angina is usually felt as a squeezing, pressure or tightening
across the chest, particularly behind the breastbone and often radiates to the
neck, jaw, arms, back, or even the teeth. Angina usually occurs during exertion,
severe emotional stress, or after a heavy meal. During these periods, the heart
muscle demands more blood oxygen than the narrowed coronary arteries can
deliver. Angina typically lasts from 1 to 15 minutes and is relieved by rest or
by administering nitroglycerin, also known as glycerin trinitrate. It is
believed that all nitrates, including nitroglycerin, correct the imbalance
between the flow of blood and oxygen to the heart and relieves the work that the
heart must do by dilating the arteries and veins in the body. Dilation of the
veins reduces the amount of blood that returns to the heart that must be pumped.
Dilation of the arteries lowers the pressure in the arteries against which the
heart must pump. As a consequence, the heart works less and requires less blood
and oxygen. Additionally, nitroglycerin preferentially dilates blood vessels
that supply the areas of the heart where there is not enough oxygen, thereby
delivering oxygen to the heart tissue that needs it most.


                                     - 12 -
<PAGE>

      Since no one holds a valid patent covering nitroglycerin, which would
grant to the patent holder the exclusive right to sell the drug while the patent
is in effect and which is intended to protect the holder's development
investment, others can seek to obtain FDA approval to sell nitroglycerin based
products, assuming the proposed product meets certain specific criteria, by
submitting an Abbreviated New Drug Application, or ANDA. The ANDA approval
process can be substantially quicker and significantly less expensive than the
new drug approval process because the applicant can rely on results collected
from clinical trials conducted by the new drug developer.

      Our nitroglycerin transdermal patch comprises a multi-layer
drug-in-adhesive system wherein the medication and all the excipients (the inert
substance used as a diluent or vehicle for a drug) are incorporated into a
membrane between two distinct drug-in-adhesive layers under a single backing
film. Our patch is comprised of three layers; a transparent outer backing layer
composed of a composition plastic film and printed with the name of the drug and
strength; nitroglycerin in a acrylic-based polymer adhesive with a cross-linking
agent; and a protective, translucent peelable liner which covers the second
layer and must be removed prior to use. Our nitroglycerin transdermal patch is
AB2 rated, which means it is considered bioequivalent to Novartis' NitroDerm(TM)
product based on clinical trial data. Our patch is a one-day use patch and is
sold in shelf cartons, with each shelf carton containing thirty patches. Our
patch is produced in three different dosage sizes, with each size delivering
different milligrams per hour (mg/hr) amounts of nitroglycerin to the patient.
The three sizes are: 0.2mg/hr, 0.4mg/hr and 0.6mg/hr.

      Our second generation transdermal patch technology developed during the
mid 1990's, as described above, incorporates certain technology which,
unbeknownst to us at the time of development, was the subject of a patent held
by Key Pharmaceuticals, Inc., or Key, a subsidiary of Schering-Plough
Corporation. In December 1997, Key obtained a court order enjoining us from
making, using, offering for sale, selling or importing any transdermal
nitroglycerin patches that have been found to infringe Key's patent, before the
expiration of Key's patent on February 16, 2010. In March 2000, we acquired a
non-exclusive license from Key to manufacture, use, import, sell and offer for
sale any drug-in-adhesive transdermal nitroglycerin patch product developed by
the Company either before or during the term of the license which provided for
the payment of a royalty per unit sold in amounts ranging from $2 to $3, based
upon the dosage delivered. The license extends to February 16, 2010, the
expiration of Key's patents. We have not made royalty payments under our license
with Key and as of December 31, 2004 we owed aggregate royalties to Key of
approximately $4,522,000. We recently entered into discussions with Key with
respect to payment of past due royalties. Any failure to negotiate a repayment
agreement with Key on terms favorable to us could have a material negative
impact on our Company, as more fully described under the headings "Risk Factors"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations."

Research and Development.

      Our primary research and development strategy is to identify generic drugs
which can be delivered transdermally, which are suitable for delivery utilizing
our patch technology and which we believe have substantial market potential or
for which a product niche may exist. We may also explore developing transdermal
products that use approved drugs that currently are being delivered to patients
through means other than transdermal delivery. In addition, we may seek to
supplement our research and development efforts by entering into research and
development agreements, joint ventures and other collaborative arrangements with
other companies.

      By focusing on bringing new products to market based upon unprotected,
generic drugs that are then being delivered transdermally, we will not have to
bear the same level of research and development and other expenses associated
with bringing a new drug formulation to market. Thus, we believe that we would
be able to charge significantly less for a product, a decided competitive
advantage in our industry, given that managed care organizations typically favor
generic products over brand name drugs, and governments encourage, or under some
circumstances mandate generic drugs.


                                     - 13 -
<PAGE>

      We currently are developing transdermal products for two companies, one of
which has engaged us to assist in the development of two drug formulations to be
delivered transdermally. In all cases, we act as an independent contractor for
the party that engaged us and said party owns all intellectual property which
may emanate from the projects we are retained to complete or the services which
we render.

      In February 2001, we entered into a series of agreements with Ranbaxy
Pharmaceuticals Inc., or Ranbaxy, namely a Product Purchase Agreement,
Development Assistance Agreement and Finished Goods Supply Agreement. Under
these agreements, we:

      o     granted a worldwide, non-exclusive, royalty-free license to Ranbaxy
            to use certain intellectual property we developed relating to the
            transdermal delivery of a certain generic pharmaceutical compound;

      o     acquired a license from Ranbaxy to use certain intellectual property
            it had developed in connection with the pharmaceutical compound and
            were retained by Ranbaxy to assist in the development of commercial
            products to deliver the pharmaceutical compound transdermally; and

      o     agreed to supply the products which may be developed and approved by
            the FDA exclusively to Ranbaxy which agreed to purchase from us all
            of its requirements for such products from us on an exclusive basis.

      We currently are performing under the Product Purchase Agreement,
including producing a supply of the pharmaceutical compound to permit Ranbaxy to
complete pilot bioequivalence study results which will be filed with the ANDA
with the FDA.

      Under our Development Assistance Agreement with Ranbaxy, we have
undertaken to provide certain services, including, completing the development of
the initial formulation of the pharmaceutical compound for transdermal delivery,
demonstrating that our production techniques can be scaled-up to meet
anticipated production runs of the transdermal patch, providing all laboratory
data relating to the utilization of our patch technology for this pharmaceutical
compound, completing documentation necessary for GMP production of the product,
providing dosage forms for the pilot and bioequivalence studies, conducting the
pilot and other studies and providing underlying documentation required for
Ranbaxy to gain regulatory approval for the product and support Ranbaxy's ANDA
filing. We are performing under this agreement as requested by Ranbaxy

      Under our Finished Goods Supply Agreement, Ranbaxy granted us a license to
utilize certain intellectual property we will require for the manufacture of the
products which are the subject of the agreement and we have agreed to supply
Ranbaxy with such product in the strengths and amounts as Ranbaxy may require
for its bioequivalence studies. Thereafter, assuming Ranbaxy's ANDA for this
product is approved by the FDA, of which neither we nor Ranbaxy can be certain,
we will manufacture and supply Ranbaxy with all of its commercial requirements
of the product, subject to its right to acquire the product elsewhere if we are
unable to furnish the supplies it requires, under the circumstances provided in
the agreement. We have agreed to sell the product exclusively to Ranbaxy. We
also have agreed to conform to GMP's in connection with the manufacture of the
product and otherwise supply product in conformity with Ranbaxy's specifications
as enumerated in the agreement which relate to quality control, packaging and
labeling, among other things. Ranbaxy will pay us fixed prices for the products
of various dosages and a royalty in excess of the per product price in the event
it achieves certain net sales milestones. The agreement has a ten-year term from
the date of the first commercial sale of the products. We have agreed to
indemnify Ranbaxy for damages resulting from, among other things, our
formulation or manufacturing of the product and Ranbaxy has agreed to indemnify
us for damages relating to regulatory improprieties.


                                     - 14 -
<PAGE>

      In June 2004, we entered into a Development, Manufacturing and Supply
Agreement with Ranbaxy relating to a generic pharmaceutical compound subject to
transdermal delivery. Under the agreement, we have been engaged to manufacture
and supply products for use both in connection with Ranbaxy's regulatory
approval requirements and ANDA application and thereafter, if FDA approval is
granted, of which neither we nor Ranbaxy can be certain, on an ongoing basis to
meet its requirements. In furtherance of our efforts, Ranbaxy extended a loan to
us in the amount of $166,664 to purchase certain equipment required in
connection with our obligations under the agreement which is repayable by
offsetting amounts payable for product which may eventually be purchased from
us, agreed to pay for the active pharmaceutical ingredient incorporated into the
product during the trial phases and to pay for a contract research organization
to conduct bioequivalence studies of the proposed product. Our obligations under
this agreement are similar to those in our agreement with Ranbaxy described
above. For example, we have agreed to conform to GMP's in connection with the
manufacture of the product and otherwise supply product in conformity with
Ranbaxy's specifications as enumerated in the agreement which relate to quality
control, packaging and labeling, among other things, and in accordance with all
applicable laws. The successful completion of the development portion of the
agreement could yield us an aggregate of $678,800 of gross revenues, payable in
tranches upon achieving certain milestones. Ranbaxy will purchase products from
us calculated in relation to the price we pay for the underlying pharmaceutical
ingredient and in the event that the price for said ingredient exceeds the
maximum amount set forth in the agreement, Ranbaxy may terminate the agreement
as to that specific product. We have agreed to indemnify Ranbaxy for damages
resulting from, among other things, our development and related obligations
under the agreement and Ranbaxy has agreed to indemnify us for damages relating
to regulatory improprieties.

      In April 2006, we entered into a Development, Manufacturing and Supply
Agreement with Cure Therapeutics, Inc., or CTI, relating to the development of a
transdermal patch which delivers two generic pharmaceutical compounds which will
be utilized for new indications (i.e., the treatment of conditions not covered
by the original FDA approval) for such drugs. Under the agreement, CTI engaged
us to undertake all processing of the pharmaceutical compound for the purpose of
filing a new drug application, or NDA, with the FDA and to manufacture and
supply sufficient quantities of the compound required for obtaining approval of
the NDA. Our engagement is divided into three stages: technology transfer,
formulation optimization, and scale-up; FDA phase 2 clinical trial batch
manufacturing; and FDA phase 3 clinical trial batch manufacturing. Our
obligations under the agreement include all manner of analyzing, testing,
optimizing the formulation of or process by which clinical trial products are
made, creation of dedicated tooling, scaling-up our manufacturing facility to
produce commercial quantities of product, finishing, packaging, inspecting,
labeling and preparing product for shipment, all as required under applicable
law. In addition, we are required to maintain data and records with respect to
all aspects of the foregoing for the specific purpose of filing same with the
FDA with respect to the NDA and to report to CTI with respect to each phase of
the process. CTI pays us fees upon our successful completion of milestones
enumerated in the agreement. We are currently working on the first stage under
the agreement. CTI has agreed, at its own cost and expense, to engage a contract
research organization to conduct safety and efficacy studies of the clinical
trial products we manufacture and, in the event that such studies fail to
demonstrate the safety or efficacy of such products, CTI may terminate the
agreement. We have agreed to conform to GMP's in connection with the manufacture
of the product and otherwise supply product in conformity with CTI's
specifications as enumerated in the agreement which relate to quality control,
packaging and labeling, among other things, and in accordance with all
applicable laws. We have agreed to indemnify CTI for damages resulting from,
among other things, our performance of or failure to perform our obligations
under the agreement and CTI has agreed to indemnify us for damages relating to
regulatory improprieties. Each party has agreed to maintain the confidentiality
of the other's confidential information. The agreement has a term of two years
but is subject to prior termination by either party in the event of a material
breach by the other party and by CTI for any reason at any time upon written
notice. The parties recognize the possibility that no commercial product may
arise from their efforts.


                                     - 15 -
<PAGE>

      We are also conducting a number of feasibility studies on transdermal
products which we may develop independently or on behalf of client companies and
are pursuing additional contract manufacturing opportunities. We do not
undertake clinical studies. As a contract manufacturer for developing products,
it would be the responsibility of our client to undertake and absorb the cost of
these clinical studies, including preparing and filing all documents required by
the FDA. We would, however, perform routine chemical analysis of these products
to determine if they meet proposed product specifications.

      For the years ended December 31, 2004 and 2003, we spent $414,000 and
$418,000, respectively, for research and development activities. Our research
and development expense may vary significantly from quarter to quarter and year
to year depending on product development cycles, the timing of clinical studies
and whether we or a third party are funding development. These variations in
research and development spending may not be accurately anticipated and may have
a material effect on our results of operations. Currently, research and
development personnel engage in assisting with technical transfers of existing
formulation and test methodology to our production facility. In addition, our
personnel perform small scale development work on behalf of clients, including
producing hand cut transdermal patches on a research laminator for analytical
testing or performing permeation studies to show how drug formulations penetrate
a skin layer. Our personnel also work on improving test methods that may impact
day to day testing requirements for commercial products. We periodically
outsource analytical testing due to either lack of equipment on-site or cost
justification due to the test not being of a routine nature.

      The time necessary to complete clinical trials and the regulatory process
to obtain marketing approval varies significantly. We cannot assure that we will
have the financial resources necessary to complete products which we propose to
develop, that those projects to which we dedicate resources will be successfully
completed, that we will be able to obtain regulatory approval for any such
product, or that any approved product may be produced in commercial quantities,
at reasonable costs, and be successfully marketed. Similarly, we cannot assure
that our competitors, most of which have greater resources than we do, will not
develop and introduce products that will adversely affect our business and
results of operations.

Manufacturing.

      We conduct our manufacturing operations in a single facility comprised of
an approximately 61,000 square foot building located on approximately 3.5 acres
in Emigsville, Pennsylvania. The Company's products are manufactured in
accordance with GMPs prescribed by the FDA. The FDA visited the Company in
November 2003 and issued an establishment inspection report. The report
indicated that there were no objectionable conditions or practices noted during
their review. The FDA also inspected the Company in June 2006 and has not yet
issued an establishment inspection report. However, the FDA did inform us that
they would not be issuing a Form FDA 483 (Inspectional Observations) report. The
FDA uses the Form FDA 483 report to communicate all observations of
objectionable conditions noted during their inspection process. This facility
has also been licensed by the United States Drug Enforcement Administration
("DEA") to research and manufacture products containing Schedule II controlled
substances. To bring new products to market as quickly as possible, we will seek
to have the manufacturing capacity to produce the new product prior to obtaining
FDA approval.


                                     - 16 -
<PAGE>

      Our products are manufactured according to current GMPs as specified by
federal regulations which require us to maintain and update procedures and
specifications as provided under federal law. We must maintain records that
demonstrate the application of raw materials from receipt to use in a finished
product. In addition, any complaints received must be documented and
investigated. We are obligated to submit to the FDA reports covering our
marketed products that include both chemistry information and adverse event
information on an annual basis. If current GMPs are not adhered to, the FDA and
courts can seek an injunction barring commercial distribution of our products.

      The manufacture of advanced transdermal drug delivery systems requires
specialized skills in several areas, as well as specialized manufacturing
equipment. The Company's process development and design engineers work closely
with the research and development department starting early in the product
design stage, resulting in efficiencies in the manufacturing development
process. All scale up work (spanning the gamut of initial research on a
potential product to large-scale manufacturing for clinical and stability work),
commencing with initial product development trials, is conducted on full-size,
completely functional manufacturing equipment, reducing delays in the
development and approval process and smoothing the transition to commercial
production. Some of this equipment is manufactured in-house; the balance is
fabricated by outside manufacturers to the Company's specifications. The Company
believes that this equipment provides a decided advantage in the manufacture of
the complex multi-layer systems necessary for successful transdermal drug
delivery. The Company currently has assembly packaging equipment in place having
a single shift capacity of over 24 million patches annually. The Company
believes that its current manufacturing facility is adequate for its intended
purpose and will be sufficient for product expansion for the foreseeable future.

      As part of the manufacturing process, the Company has developed and
performs appropriate quality control procedures including testing of all raw
materials and finished product. Quality Control procedures are specific checks
and balances performed on raw materials and finished product to ensure materials
adhere to the predetermined specifications.

      Several raw materials used in the manufacture of the Company's products
are only available from single sources, all of which are domestic companies.
These materials have generally been available to the Company and the
pharmaceutical industry on commercially reasonable terms. To date, the Company
has not experienced difficulty acquiring necessary materials. The Company will
seek to negotiate supply agreements, as appropriate, for certain components.

      Any curtailment in the availability of such raw materials could result in
production or other delays, and, in the case of products for which only one raw
material supplier exists, could result in a material loss of sales, with
consequent adverse effects on our business and results of operations. In
addition, because most raw material sources for transdermal patches must
generally be approved by regulatory authorities, changes in raw material
suppliers may result in production delays, higher raw material costs and loss of
sales, customers and market share.

      We do not believe that compliance with federal, state or local laws and
regulations which have been enacted or adopted regulating the discharge of
materials into the environment or otherwise relating to the protection of the
environment has or will have any material effect upon our capital expenditures,
earnings or competitive position. There can be no assurance, however, (i) that
changes in federal, state or local laws or regulations, changes in regulatory
policy or the discovery of unknown problems or conditions will not in the future
require substantial expenditures, or (ii) as to the extent of the Company's
liabilities, if any, for past failures, if any, to comply with laws, regulations
and permits applicable to its operations. Any interruption of supply could have
a material adverse effect on the Company's ability to manufacture its products.


                                     - 17 -
<PAGE>

Marketing and Sales.

      We have contracted with a full-service sales and marketing outsourcing
company that focuses on generic and branded pharmaceutical companies to handle
the majority of the sales and marketing efforts for our transdermal
nitroglycerin product. This company monitors client sales, as well as examines
our competition in order to anticipate and recommend changes to our sales,
marketing and promotional strategy. This company also assists in providing the
industry contacts to reach all distribution channels.

      We have engaged Cardinal Health, Inc. as a non-exclusive distributor of
our transdermal patches pursuant to an agreement dated October 1, 2001. We sell
product to Cardinal at our list price and Cardinal is entitled to receive
certain discounts and rebates as stipulated in the agreement. During the years
ended December 31, 2003 and 2004, Cardinal purchased products representing in
excess of 10% of our total sales.

      We market our products directly to wholesalers, distributors, retail
pharmacy chains, mail order pharmacies and group purchasing organizations. We
also market our products indirectly to independent pharmacies, managed care
organizations, hospitals, nursing homes and pharmacy benefit management
companies, collectively referred to as "indirect customers." We may enter into
agreements with our indirect customers to establish contract pricing for certain
products. The indirect customers then independently select a wholesaler whom
they actually purchase the products at these contracted prices. Alternatively,
certain wholesalers may enter into agreements with indirect customers which
establish contract pricing for certain products which the wholesalers provide.

Competition.

      The market for our nitroglycerin transdermal patches is highly
competitive. Because nitroglycerin is generic drug, companies willing and able
to comply with FDA and other applicable regulations can produce nitroglycerin
based products. Moreover, nitroglycerin can be administered utilizing a wide
array of conventional and alternate forms of drug delivery. Accordingly, our
product faces intense competition from a diverse group of domestic and
multinational companies most of which possess significantly greater financial
and personnel resources than we do and that includes:

o     large conglomerates of which pharmaceutical nitroglycerin formulations,
      including nitroglycerin based products, represent only a portion of the
      products they offer;

o     pharmaceutical companies of all sizes which focus on the development of
      advanced transdermal systems which deliver nitroglycerin;

o     pharmaceutical companies which offer nitroglycerin based products other
      than transdermal patches or other formulations which relieve angina; and

o     companies that offer alternate non-drug therapies.


                                     - 18 -
<PAGE>

      In addition, medical science is constantly evolving and the entities
against which compete may change in the future. As developments in medicine are
made, drugs and delivery methods may become obsolete or fall out of favor with
physicians.

      Most of our competitors have substantially greater financial resources and
larger research and development staffs than we do and may have substantially
greater experience in developing products, in obtaining regulatory approvals and
in manufacturing and marketing pharmaceutical products. Many other
pharmaceutical companies have the financial resources to acquire the skills
necessary to develop transdermal systems.

      Advances in transdermal patch technology have intensified over the last
several years. As new materials have been developed which allow for more
efficient delivery of drugs through the patch membrane and adhesive,
manufacturers have been able to develop smaller patches which are more
comfortable for the user. New adhesive technologies have recently been
incorporated into patches which have selective adhesive properties once in
contact with the skin, exhibit substantial strength of initial adhesion and
duration of adhesion and are compatible with skin and various drug molecules.
Other advances in patch technology include the development of chemical
penetration enhancers, substances that make the skin more permeable and allow
drug molecules to cross the skin at a faster rate, and the development of
micro-needles to enlarge the skin pores through which drugs flow. In addition,
active transdermal patches which use energy, such as electricity and ultrasound,
to enhance the extent and rate at which pharmaceutical compounds cross the skin
and which will allow for larger drug molecules to be delivered transdermally,
are being developed at a rapid rate. All of these new transdermal technologies
could supplant our technology and render our product obsolete.

      Since we manufacture a generic drug product and are not subject to the
myriad of factors which impact drug developers, such as high development costs
and establishing name and brand recognition, we believe that the principal
factors that bear upon our competitive position are price, consistency and
quality of product, our ability to deliver product on a timely basis,
reliability and patient convenience. We have been manufacturing nitroglycerin
patches for nearly twenty years and believe that we have gained significant
experience that contributes to our ability to compete effectively in the market.
The Company's competitive position will also depend on its ability to attract
and retain qualified scientific and other personnel, develop effective
proprietary products, implement production and marketing plans, effect
distribution of its products, obtain patent protection and secure adequate
capital resources.

Patents and Proprietary Rights.

      We seek to obtain patent protection on our delivery systems and
manufacturing processes whenever possible. We have obtained eleven United States
and foreign patents and trademarks relating to our transdermal delivery systems
and manufacturing processes. While we view our patents and trademarks as a
valuable asset, we do not consider any single patent or trademark to be of
material importance to our business as a whole.

      As a result of changes in United States patent law under the General
Agreement on Tariffs and Trade and the accompanying agreement on Trade-Related
Aspects of Intellectual Property Law, which took effect in their entirety on
January 1, 1996, the terms of some of our existing patents have been extended
beyond the original term of seventeen years from the date of grant. Our patents
filed after June 7, 1995 will have a term of twenty years computed from the
effective filing date.


                                     - 19 -
<PAGE>

      We are unaware of any challenge to the validity of our patents or of any
third party claim of patent infringement with respect to any of our products, in
either case that could have a material adverse effect on our business or
prospects.

      Although there is a statutory presumption as to a patent's validity, the
issuance of a patent is not conclusive as to such validity, or as to the
enforceable scope of the claims of the patent. We cannot assure that our patents
or any future patents will prevent other companies from developing similar or
functionally equivalent products. We cannot assure that we would have the
resources to prosecute an action to enforce our patent rights against an alleged
infringer or that we would be successful in any infringement action that we
elect to bring. Likewise, we cannot assure that we would have the resources to
defend an infringement action or that we would be successful in any such
defense. Furthermore, we cannot assure that any of our future processes or
products will be patentable, that any pending or additional patents will be
issued in any or all appropriate jurisdictions or that our processes or products
will not infringe upon the patents of third parties. In addition, since our
patents typically cover our product formulation rather than the compound being
delivered, competitors may seek to create functionally equivalent products
(i.e., patches delivering the same compound over the same time period to treat
the same indication) that avoid our patents. In those cases, we may face
competition from functionally equivalent products even before our patents
expire.

      We also attempt to protect our proprietary information under trade secret
and confidentiality agreements. Generally, our agreements with each employee,
client, consultant and agent contain provisions designed to protect the
confidentiality of our proprietary information. There can be no assurance that
these agreements will not be breached, that we will have adequate legal remedies
as a result thereof, or that our trade secrets will not otherwise become known
or be independently developed by others.

Government Regulation.

      Our operations are subject to extensive regulation by governmental
authorities in the United States and in other countries in which we or our
distributors may sell products which we manufacture in the future with respect
to the testing, approval, manufacture, labeling, marketing and sale of
pharmaceutical products and the possession and use of controlled substances. We
devote significant time, effort and expense to address the extensive government
regulations applicable to our business.

      The marketing of pharmaceutical products requires the approval of the FDA
in the United States. The process for obtaining such approval varies depending
upon the nature of the product we are seeking to manufacture and sell. The FDA
has established regulations, guidelines and safety standards, which apply to the
pre-clinical evaluation, clinical testing, manufacturing and marketing of
pharmaceutical products. New drugs or drugs to be delivered by a new route of
administration are subject to a more lengthy approval process. Typically, drugs
that, among other factors, have been previously approved by the FDA are subject
to a less stringent, less time consuming and less expensive approval process.

      The process of obtaining FDA approval for a new product may take several
years or more and is likely to involve the expenditure of substantial resources.
The steps required before a product can be produced and marketed for human use
typically include: (i) pre-clinical studies; (ii) submission to the FDA of an
Investigational New Drug Exemption ("IND"), which must become effective before
human clinical trials may commence in the United States; (iii) adequate and well
controlled human clinical trials; (iv) submission to the FDA of a New Drug
Application ("NDA"); and (v) review and approval of the NDA by the FDA. Approval
of a product by the FDA does not serve as a guaranty of the product's safety or
efficacy.


                                     - 20 -
<PAGE>

      Generally, products with new active ingredients, new indications, new
routes of administration, new dosage forms or new strengths require an NDA to be
filed with the FDA. An NDA requires that complete clinical studies of a
product's safety and efficacy be submitted to the FDA, the cost of which is
substantial. These costs can be reduced, however, for delivery systems that
utilize approved drugs. In these cases, the company seeking approval may refer
to safety and toxicity data reviewed by the FDA in its approval process for the
innovator product. In addition, a supplemental NDA may be filed to add an
indication to an already approved product.

      Since we expect that any new products we may bring to market will contain
drugs previously approved by the FDA for transdermal delivery, an abbreviated
approval process may be available. Such products must have, among other
requirements, the same active ingredient(s), indication, route of
administration, dosage form and dosage strength as an existing FDA-approved
product covered by an NDA, if clinical studies have demonstrated bio-equivalence
of the new product to the FDA-approved product covered by an NDA. For this
abbreviated process, we would submit an ANDA to the FDA instead of an NDA. Under
FDA ANDA regulations, companies that seek to introduce an ANDA product must also
certify that the product does not infringe on any approved product's patent
listed with the FDA or that such patent has expired. If the applicant certifies
that its product does not infringe on the approved product's patent or that such
patent is invalid, the patent holder may institute legal action to determine the
relative rights of the parties and the application of the patent. Under the Drug
Price Competition and Patent Term Restoration Act of 1984 (the "Hatch-Waxman
Act"), the FDA may not finally approve the ANDA until the later of thirty months
from the date of the legal action or a final determination by a court that the
applicable patent is invalid or would not be infringed by the applicant's
product.

      With respect to any new products we may seek to develop, the results of
our product development and pre-clinical and clinical studies (if necessary)
will be submitted to the FDA as an NDA or ANDA for approval. If an application
is submitted, there can be no assurance that the FDA will review and approve the
NDA or ANDA in a timely manner. The FDA may deny an NDA or ANDA if applicable
regulatory criteria are not satisfied or it may require additional clinical
testing. Even if such data is submitted, the FDA may ultimately deny approval of
the product. Further, if there are modifications to the drug, including changes
in indication, manufacturing process, labeling, or a change in manufacturing
facility, an NDA or ANDA notification may be required to be submitted to the FDA
and FDA approval required prior to implementation of the change. Product
approvals may be withdrawn after the product reaches the market if compliance
with regulatory standards is not maintained or if problems occur regarding the
safety or efficacy of the product. The FDA may require testing and surveillance
programs to monitor the effect of products that have been commercialized, and
has the power to prevent or limit further marketing of these products based on
the results of these post-marketing programs.

      Manufacturing facilities are subject to periodic inspections for
compliance with the FDA's good manufacturing practices regulations and each
domestic drug manufacturing facility must be registered with the FDA. In
addition, our manufacturing operations must be registered with the Pennsylvania
Department of Health. In complying with standards set forth in these
regulations, we must expend significant time, money and effort in the area of
quality assurance to ensure full technical compliance. Facilities handling
controlled substances, such as ours, also must be licensed by the DEA, and are
subject to more extensive regulatory requirements than those facilities not
licensed to handle controlled substances. We also require approval of the DEA to
obtain and possess controlled substances. We produce transdermal drug delivery
products in accordance with United States regulations for manufacturing process
validation studies and commercial sale. FDA approval to manufacture a drug
product is site specific. In the event our approved manufacturing facility
becomes inoperable, obtaining the required FDA approval to manufacture such drug
at a different manufacturing site could result in production delays, which could
adversely affect our business and results of operations.


                                     - 21 -
<PAGE>

      Failure to comply with governmental regulations may result in fines,
warning letters, unanticipated compliance expenditures, interruptions or
suspension of production and resulting loss of sales, product seizures or
recalls, injunctions prohibiting further sales, withdrawal of previously
approved marketing applications and criminal prosecution.

      Our activities are subject to various federal, state and local laws and
regulations regarding occupational safety, sales practices, laboratory
practices, environmental protection and hazardous substance control, and may be
subject to other present and possible future local, state, federal and foreign
regulations. Under certain of these laws, we could be liable for substantial
costs and penalties in the event that waste is disposed of improperly. While it
is impossible to accurately predict the future costs associated with
environmental compliance and potential remediation activities, compliance with
environmental laws is not expected to require significant capital expenditures
and has not had, and is not presently expected to have, a material adverse
effect on our earnings or competitive position.

Employees.

      We employ approximately sixty three employees, of whom twenty-six are
covered by a collective bargaining agreement with a local unit of the Retail
Wholesale and Department Store Union, AFL-CIO ("R.W.D.S.U."). The R.W.D.S.U.
agreement is for a three year period ending December 10, 2007. The contract is
subject to annual renewal thereafter and acknowledges that the R.W.D.S.U. is the
exclusive bargaining agent for the Company's regular production employees,
excluding all other employees including but not limited to supervisors, foremen,
clerical employees, time-keepers, watchmen, guards, maintenance personnel and
part-time employees. We believe our employee relations are good.


                                     - 22 -
<PAGE>

Risk Factors.

      The following is a summary of certain risk factors that may cause our
results to differ from the "forward-looking statements" made in this report. The
risks and uncertainties described below are not listed in order of priority and
are not the only ones we face. Additional risks not presently known to us or
other factors not perceived by us to present significant risks to our business
at this time also may impair our business operations. If any of these risks
actually occur, our business, financial condition, and/or results of operations
would likely suffer significantly. We do not undertake to update any of these
forward-looking statements or to announce the results of any revisions to these
forward-looking statements except as required by law.

Risks Relating to Our Financial Condition.

As of December 31, 2004, we had aggregate debts and liabilities of approximately
$19,898,000, including $10,197,000 under the outstanding Debentures under which
we currently are in default, $4,522,000 due under a license agreement which
represents royalty payments owed over the last five years and $5,167,000 of
miscellaneous debts and liabilities. If we are unable to satisfy these sums or
otherwise negotiate satisfactory payment terms, we may be required to liquidate
all of our assets and wind-up or dissolve our Company or seek protection from
our creditors under the bankruptcy laws, in which case holders of our stock
could lose the entire amount of their investment.

      As of December 31, 2004, we had aggregate debts and liabilities of
approximately $19,898,000. These debts and liabilities include $10,197,000 due
under outstanding Debentures which became due in 1999 and under which we
currently are in default, approximately $4,522,000 of royalties due under a
license agreement with Key Pharmaceuticals, Inc., or Key, which allows us to
utilize certain technology incorporated into our current transdermal patch which
has been accumulating since 2000 and approximately $5,167,000 of other debts and
liabilities. As of December 31, 2005, we estimate that our liabilities and debts
are approximately $22,864,000 (unaudited), including $10,830,000 under the
Debentures and $6,108,000 for royalties due under the license.

      We have been paying our debts and liabilities not related to the
Debentures or the Key license on a current basis from cash flow generated from
operations. We do not have cash on hand to repay the amount due under the
Debentures or the royalty payment owed under the license agreement. Our
financial condition has prevented us from securing financing or obtaining loans
from third parties from which we could repay all or a portion of the amounts
due.

      We are in default under several provisions of the Debentures as a result
of our failure to have paid interest and principal when they became due in April
1999. Upon an event of default, the Trustee of the Debentures or the holders of
at least 25% in aggregate principal amount of all Debentures may declare the
outstanding principal of the Debentures plus all accrued and unpaid interest
immediately due and payable. We have entered into two agreements with the
Trustee whereby we agreed to extend the statute of limitations for actions to be
brought under the Debentures.

      We also are in breach of the Key license agreement for failing to pay
royalties as they became due. Our default under and breach of this license
agreement entitles the licensor to terminate the agreement.

      We have entered into preliminary negotiations with Key with respect to
devising a plan to pay the royalties due and will approach the Trustee of the
Debentures to negotiate a payment plan which will allow for the normal operation
of the Company. We cannot assure you that we will be successful in negotiating
payment plans with respect to these debts and liabilities which are favorable to
the Company and which do not unduly burden the Company or otherwise prohibit
normal operations, if at all. If we are unable to negotiate payment terms with
the Trustee of the outstanding Debentures or with Key for the amounts due, these
entities could initiate legal action against the Company for the entire amount
due to them. In such case we might have to liquidate all of our assets and
dissolve or wind-up the Company or seek protection from our creditors under the
federal bankruptcy laws which likely would result in the loss of all value which
our stock now or at such time may have and result in investors losing the entire
amount of their investment.


                                     - 23 -
<PAGE>

Our financial condition creates substantial doubt whether we will continue to
operate as a going concern. If we do not continue as a going concern, we may
have to cease all operations and investors will lose their entire investment in
our company.

      Our audited consolidated financial statements for the years ended December
31, 2003 and 2004 have been prepared assuming that we will continue as a going
concern. However, Note 3 of the Notes to Consolidated Financial Statements
details certain conditions and other factors that raise substantial doubt about
our ability to continue to operate as a going concern, including:

o     the aggregate amount of our outstanding debts and liabilities at December
      31, 2004 and specifically the amounts due to the Debenture holders and
      Key, as described in the foregoing risk factor;

o     the fact that we currently are in default under our obligations to the
      Debenture holders and Key, having not made any payments to holders of the
      Debentures since 1999 or to Key since the inception of the license and
      that we have been able to continue as a going concern because we have not
      paid the Debenture holders or Key;

o     we do not have cash on hand to repay the amounts due under the Debentures
      or the royalty payment owed to Key;

o     our financial condition has prevented us from securing financing or
      obtaining loans from third parties from which we could repay all or a
      portion of the amounts due; and

o     if our creditors initiated legal action against us, we would not be able
      to continue to operate as a going concern unless there was an increase in
      profitability and/or an infusion of additional funds in order to meet
      these obligations for both the past amounts due and ongoing amounts as
      they became due.

      In addition to the foregoing, except for the 2004 fiscal year, in which we
reported net income of $9,000 in our financial statements but did not make any
payments of the amounts due under the Debentures or to Key, we have experienced
net losses from operations in every year since 1995 and have an accumulated
deficit of approximately $23,922,000 at December 31, 2004. In addition, we had a
working capital deficit of approximately $12,412,000 for the year ended December
31, 2004.

      Our independent auditors have cited certain of these conditions in an
explanatory paragraph to their audit report issued on our financial statements
for the years ended December 31, 2003 and 2004, and indicated that these
factors, among others, raise substantial doubt about our ability to continue as
a going concern.


                                     - 24 -
<PAGE>

      Management has formulated a plan to address these conditions, as described
under the heading "Management's Discussion and Analysis of Financial Condition
and Results of Operation" and in Note 3 of the Notes to Consolidated Financial
Statements which it hopes will position us to generate sufficient revenues to
provide positive cash flows from operations and meet our obligations as they
become due. This plan includes negotiating payment arrangements with the
Debenture holders and Key which take into consideration our current financial
condition, expanding our current business operations, forming business alliances
with other pharmaceutical companies with respect to the development and/or
manufacture of new products, raising additional working capital through third
party borrowing or through issuing equity, and evaluating new directions for the
Company. Our current financial condition and the status of our obligations under
the Debentures and the Key license have prevented us from borrowing money from
third parties or raising capital from the sale of equity. We cannot be certain
that we will be successful in executing this plan or that if we are successful
that we will achieve profitability. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.

      If we are unable to address the conditions that raise doubt about our
ability to continue to operate as a going concern, particularly our efforts to
negotiate favorable payment terms of the amounts due to Debenture holders and
Key, we may have to discontinue our operations and possibly seek protection
under bankruptcy laws, in which case investors would lose the entire amount of
their investment in the Company.

Even if we are able to negotiate payment terms for those debts and liabilities
upon which we are in default, our cash flow and ability to operate our business
will be adversely affected.

      As of December 31, 2004, our total liabilities and indebtedness was
approximately $19.9 million. If we are able to successfully negotiate payment
plans with respect to the sums due to holders of the Debentures and the licensor
of important technology, it is likely that a significant portion of our revenues
will be used to satisfy the terms of any such agreements and that we will have
little capital to fund other operations, including new product development and
marketing. In addition, our substantial indebtedness could have other important
consequences, including:

o     negatively impacting our ability to remain current in the payment of our
      other liabilities and current accounts payable;

o     limiting our ability to obtain additional financing for working capital,
      capital expenditures, acquisitions and general corporate or other
      purposes;

o     increasing our vulnerability to general economic and industry conditions;
      and

o     placing us at a disadvantage compared to our competitors who have less
      debt.

If we are able to restructure our debts and liabilities in a way that allow us
to continue normal operations, we may not be able to generate sufficient cash
from operations to abide by the terms of the restructuring agreements and we may
be forced to take other actions to satisfy our obligations under our
indebtedness and to pay our other principal liabilities, which may not be
successful.

      If we successfully restructure the payment obligations owed to our largest
creditors, the holders of the Debentures and Key, our ability to make scheduled
payments on these obligations and remain current with respect to our other
financial obligations will depend on our financial condition and operating
performance, which is subject to prevailing economic and competitive conditions
and to certain financial, business and other factors beyond our control. We
cannot assure you that we will maintain a level of cash flows from operating
activities sufficient to permit us to pay the principal, premium, if any, and
interest on our indebtedness, to repay the amount due to Key or remain current
with respect to our other outstanding liabilities


                                     - 25 -
<PAGE>

      If our cash flows and capital resources are insufficient to fund the
payment of our obligations, we could face substantial liquidity problems and may
be forced to reduce or delay investments and capital expenditures and we might
be required to dispose of material assets or operations to meet our obligations.
These alternative measures may not be successful and may not permit us to
satisfy our obligations. We may not be able to consummate those dispositions or
to obtain the proceeds that we could realize from them and these proceeds may
not be adequate to meet any debt service obligations then due. Our inability to
generate cash from operations could have a material negative impact on the
Company and the value of your investment in our common stock.

We rely on the terms of our license agreement with Key to utilize certain
technology incorporated into our transdermal patch under which we are five years
in arrears in royalty payments and, consequently, are in breach. If we are
unable to negotiate a plan with Key that allows us to pay the past due royalties
and Key revokes the license or if we otherwise lose our right to utilize the
technology subject to such license we will have to discontinue manufacturing our
sole product.

      Our second generation transdermal patch technology developed during the
mid 1990's incorporates certain technology which, unbeknownst to us at the time
of development, was the subject of a patent held by Key. In December 1997, Key
obtained a court order enjoining us from making, using, offering for sale,
selling or importing any transdermal nitroglycerin patches that have been found
to infringe Key's patent, before the expiration of Key's patent on February 16,
2010. In March 2000, we acquired a license from Key to use the patent covering
that technology in our transdermal patch which provided for the payment of a
royalty per unit sold in amounts ranging from $2 to $3, based upon the dosage
delivered. We have not made any royalty payments under our license with Key and
as of December 31, 2004 we owed aggregate royalties to Key of approximately
$4,522,000. We recently entered into discussions with Key with respect to
payment of past due royalties.

      As referenced above, we are seeking to negotiate a payment plan with Key
for past due royalties which does not impede our ability to operate and does not
materially impact our cash flow but we cannot be certain that we will enter into
an agreement favorable to us, if at all. If we are not able to negotiate
favorable payment terms and lose the license for the technology for this or any
other reason, we will not be able to sell our nitroglycerin transdermal patch,
our sole product, and will have no source of revenue from product sales. Given
our current liabilities and debt, it is unlikely we would be able to continue
operating under such circumstances and investors would lose the entire amount of
their investment in the Company.

Risks Relating to Our Failure to File Reports under Federal Securities Laws.

We have not filed the reports we are required to file with the SEC since 1999
and we could become the subject of enforcement proceedings by the SEC, including
the de-registration of our securities, which could materially adversely affect
our business and your ability to obtain information about our Company.


                                     - 26 -
<PAGE>

      For the reasons explained elsewhere in this report, since 1999 we have not
filed a report under the Securities Exchange Act, which describes our business
and financial condition as we are required to do under the Securities Exchange
Act. Our failure to file such reports could give rise to action by the SEC or
private litigation by our current and former shareholders. Among other possible
penalties to which we may be subject, the SEC could seek to revoke registration
of our common stock and the Debentures under the Securities Exchange Act which
could result in less public information available to our security holders and
make it more difficult for us to raise capital in the future. The inclusion in
this report of audited financial and other information for the years 2003 and
2004 will not cure our failure to file reports for 1999, 2000, 2001 and 2002 and
the SEC could compel us to prepare and file such reports, which may not be
possible given the inadequate financial and other records available to us for
those years. We cannot predict what, if any, penalties, fines, sanctions,
enforcement or other actions or proceedings the SEC may impose upon or take
against our Company; however, any such actions could cause us to incur
significant additional compliance expenditures and divert management's attention
from our core business activities. Moreover, we may be subject to private suit
by our current and former security holders for failing to make available current
information about our Company which could subject the Company as well as our
officers and directors to civil liabilities.

We have expended and will continue to apply considerable time, effort and
expense in connection with preparing and filing delinquent reports under the
federal securities laws which may divert our attention from our core business
and negatively impact the Company's operations.

      As described elsewhere in this Annual Report, we have not filed any
reports under the federal securities laws since 1999. We have expended
considerable administrative time and effort to prepare and file delinquent
reports under the federal securities laws and return to reporting compliance
under such laws and will continue to do so until we are able to satisfy our
reporting obligations. We also have allocated considerable financial resources
to pay for auditing and legal fees in connection with the preparation of such
reports. We will continue to expend these administrative and financial resources
until such time as we are able to file all reports which the staff of the SEC
requires. This effort also will divert management's attention from our core
business. These factors may adversely impact our current and future operations
and financial condition.

Risks Relating to Our Business.

We rely on the Key license agreement to utilize certain key technology
incorporated into our transdermal patch under which we are five years in arrears
in royalty payments and, consequently are in default. If we are unable to
negotiate a plan with Key that allows us to pay the past due royalties and Key
revokes the license or if we otherwise lose our right to utilize the technology
subject to such license, we will have to discontinue manufacturing our sole
product.

      As described elsewhere throughout this Annual Report we rely on, and are
in default under the terms of, a license agreement with Key. To date, we have
not made any royalty payments under our license with Key and as of December 31,
2004 we owed aggregate royalties to Key of approximately $4,522,000. We recently
entered into discussions with Key with respect to payment of past due royalties.

      We are seeking to negotiate a payment plan with Key for past due royalties
which does not impede our ability to operate and does not materially impact our
cash flow but we cannot be certain that we will enter into an agreement
favorable to us, if at all. If we are not able to negotiate favorable payment
terms and lose the license for the technology for this or any other reason, we
will not be able to sell our nitroglycerin transdermal patch, our sole product,
and will have no source of revenue from product sales. Given our current
liabilities and debt, it is unlikely we would be able to continue operating
under such circumstances and investors would lose the entire amount of their
investment in the Company.


                                     - 27 -
<PAGE>

We are subject to all of the risks associated with being a single product
company, including special risks relating to the fact that we manufacture and
sell such product pursuant to a license. If we are unable to develop and bring
to market other products, our current and future operations and financial
condition may be adversely affected.

      We manufacture and sell only one product, our nitroglycerin transdermal
patch. We are subject to all of the risks associated with being a single product
company, including

      o     the inordinate effect of competition on our business which could
            cause us to reduce the price we charge for the product or erode
            total sales, and the corresponding reduction in earnings we generate
            from such product as result of competition;

      o     the loss of the license pursuant to which we manufacture and sell
            the product described in the foregoing risk factor; and

      o     our inability to obtain critical raw materials from which we
            manufacture the product.

      If we experience any of the foregoing or other difficulties or impediments
with respect to sales of such product, our business, financial condition and
results of operations would be materially adversely effected.

      We are seeking to develop and bring to market other products to broaden
our revenue base and reduce reliance on revenues generated from sales of our
nitroglycerin patch. We cannot be certain that our efforts to develop and market
other products will be successful. To the extent that we are unable to expand
our product offerings, our business and results of operation could be negatively
impacted and shareholders in our company may lose all or part of their
investment.

The development and manufacturing agreements to which we currently are a party
allow our clients to terminate these agreements at will. The termination of
these agreements for any reason would have a material negative impact on our
operations.

      We are party to contracts with two clients under which we have agreed to
develop and manufacture three potential pharmaceutical compounds. We currently
generate revenues from these agreements in connection with our product
development efforts and may generate revenues under these agreements in the
future from the manufacture of products which ultimately are approved by the FDA
for sale in the United States, of which we can offer no assurance. In some
cases, our clients are permitted to terminate these agreements at will for any
reason. If our clients elect to terminate these agreements our current and
future operations would be adversely impacted.

We are subject to extensive regulation by the FDA and other federal and state
agencies. If we fail to maintain satisfactory compliance with FDA regulations
and other governmental agencies, we may be forced to suspend or terminate our
operations and we could be subject to civil or criminal penalties.

      Our operations are subject to extensive regulation by governmental
authorities in the United States with respect to the testing, approval,
manufacture, labeling, marketing and sale of pharmaceutical products. These
regulations are wide-ranging and govern, among other things: adverse drug
experience reporting, product promotion, product pricing and discounting, drug
sample accountability, drug product stability, product manufacturing, including
good manufacturing practices, and product changes or modifications. Our
facilities handle controlled substances, resulting in additional extensive
regulatory requirements and oversight. Compliance with the extensive government
regulations applicable to our business requires the allocation of significant
time, effort and expense. Even if a product is approved by a regulatory
authority, product approvals may be withdrawn after the product reaches the
market if compliance with regulatory standards is not maintained or if problems
occur regarding the safety or efficacy of the product. If we fail to comply with
the regulatory requirements of the FDA and other applicable U.S. regulatory
authorities or previously unknown problems with our products or manufacturing
processes are discovered, we could be subject to administrative or judicially
imposed sanctions, including: restrictions on the products, manufacturers or
manufacturing processes; warning letters; civil or criminal penalties; fines;
injunctions; product seizures or detentions; voluntary or mandatory product
recalls and publicity requirements; unanticipated compliance expenditures;
suspension or withdrawal of previously approved marketing applications; total or
partial suspension of production; and criminal prosecution.


                                     - 28 -
<PAGE>

Our product sales are concentrated among a few clients and a substantial
decrease in revenues generated from sales to these customers would have an
adverse effect on our business unless we were able to identify other customers.

      During each of fiscal years ended December 31, 2004 and 2003, a
significant portion of our revenues were derived from a small number of
customers. In 2004, two customers accounted for approximately 53% of our
revenues and these customers accounted for approximately 49% of our revenues
during fiscal 2003. A significant decrease in business from these customers and
the revenues lost, if we are unable to replace them, would have a material
adverse effect on our business, financial condition and results of operations.

      Because our sales tend to be concentrated among a small number of
customers during any period, our operating results may be subject to substantial
fluctuations. Moreover, we tend to receive relatively large orders for products
from a relatively small number of customers. Consequently, a single order from
one customer may represent a substantial portion of our sales in any one period
and significant orders by any customer during one period may not be followed by
further orders from the same customer in subsequent periods. These and other
factors cause our sales and operating results to be subject to very substantial
periodic variations. Since quarterly performance is likely to vary
significantly, our results of operations for any quarter are not necessarily
indicative of the results that we might achieve for any subsequent period.
Accordingly, quarter-to-quarter comparisons of our operating results may not be
meaningful.

We rely on a single supplier or a limited number of suppliers for certain raw
materials used in our products.

      Certain raw materials and components used in the manufacture of our
products are available from limited sources, and, in some cases, a single
source. Generally, regulatory authorities must approve raw material sources for
transdermal products, and in the case of controlled substances, the DEA sets
quotas for controlled substances and we must receive authorization from the DEA
to purchase and handle these substances. We cannot be certain that we will be
granted sufficient DEA quota to meet production requirements for controlled
substances. Without adequate approved supplies of raw materials or packaging
supplies, our manufacturing operations could be interrupted until another
supplier is identified, our products approved and trading terms with it
negotiated. We may not be able to identify an alternative supplier and any
supplier that we do identify may not be able to obtain the requisite regulatory
approvals in a timely manner, or at all. Furthermore, we may not be able to
negotiate favorable terms with an alternative supplier. Any disruptions in our
manufacturing operations from the loss of an approved supplier may cause us to
incur increased costs and lose revenues and may have an adverse effect on our
relationships with our partners and customers, any of which could have adverse
effects on our business and results of operations. Our business also faces the
risk that third party suppliers may supply us with raw materials that do not
meet required specifications, which, if undetected by us, could cause our
products to test out of specification and require us to recall the affected
product.


                                     - 29 -
<PAGE>

We rely on the services of a single agent to market our product and if we were
to lose the services of such entity or it was not as successful in its sales
efforts, our business and results of operations would be adversely affected.

      We market all of our products through one entity. If we were to lose the
services of such marketing agent for any reason or said entity does not maintain
a steady demand for our product, and we are unable to identify an adequate
replacement, our business, results of operations and financial condition would
be materially adversely affected.

We may expend significant cash and personnel resources in the development of any
new products and if we do not generate the anticipated level of revenues from
sales of such products, our business will be negatively and adversely affected.

      Our efforts to commercialize new products will require significant
expenditures of resources, including cash and time, in the research,
development, testing, preparation and execution of applications with
governmental authorities to manufacture and sell such product, preparation of
manufacturing operations and marketing of such product. If we do not generate
revenues from sales of any such product at levels anticipated prior to embarking
on such development, our business, financial position and results of operations
would be materially adversely affected.

We may lose out to larger and better-established competitors.

      The drug delivery industry is intensely competitive. We face competition
from a number of companies that develop, market and sell transdermal patches
that deliver generic drugs, and competition is expected to intensify as more
companies enter the field. Most of our competitors have significantly greater
financial, technical, manufacturing, marketing and distribution resources as
well as greater experience in the drug delivery industry than we have. The
particular medical conditions our product addresses can also be addressed by
other drugs and other delivery modalities. Many of these alternatives are widely
accepted by physicians and have a long history of use. Physicians may use our
competitors' products and/or our products may not be competitive with other
technologies. If these things happen, our sales and revenues will decline.
Competition may result in price reductions, reduced gross margins and loss of
market share.

      We cannot assure that our products will compete successfully against
competitive products or that developments by others will not render our products
obsolete or uncompetitive. If we cannot maintain competitive products and
technologies, our current and potential strategic partners may choose to adopt
the drug delivery technologies of our competitors or their own internally
developed technologies.

Our product may be displaced by more effective medications or newer
technologies.

      The drug delivery industry is undergoing rapid and significant
technological change. Others may succeed in developing or marketing technologies
and products that are more effective than those developed or marketed by us, or
that would make our technology and product obsolete or non-competitive.
Additionally, researchers could develop new delivery devices and medications
that replace or reduce the importance of our products. Accordingly, our success
will depend, in part, on our ability to respond quickly to medical and
technological changes through the development and introduction of new products.
We may not have the resources to do this. If our products become obsolete and
our efforts to develop new products do not result in any commercially successful
products, our sales and revenues will decline.


                                     - 30 -
<PAGE>

Competitors may use legal, regulatory and legislative strategies to prevent or
delay our launch of generic products.

      The Hatch-Waxman Act provides for a period of 180 days of generic
marketing exclusivity for each ANDA applicant that is first to file an ANDA
containing a certification of invalidity, non-infringement or unenforceability
related to a patent listed with respect to a reference drug product, commonly
referred to as a Paragraph IV certification. During this exclusivity period, the
FDA cannot grant final approval to any other Paragraph IV filer. If an ANDA
containing a Paragraph IV certification is successful, it generally results in
higher market share, net revenues and gross margin for that applicant for a
period of time. Even if we obtain FDA approval for generic drug products, we may
lose significant advantages to a competitor who was first to file an ANDA
containing a Paragraph IV certification.

      Competitors may also pursue legislative and other regulatory or litigation
strategies to prevent or delay our launch of a generic product. These strategies
include, but are not limited to: seeking to obtain new patents on drugs for
which patent protection is about to expire, changing the labeling for the
branded product, filing a citizen petition with the FDA, pursuing state
legislative efforts to limit the substitution of generic versions of brand
pharmaceuticals, filing patent infringement lawsuits that automatically delay
FDA approval of many generic products, introducing a second generation product
prior to the expiration of market exclusivity for the first generation product
which may reduce demand for a generic first generation product, and obtaining
market exclusivity extensions by conducting pediatric trials of brand drugs.

Unfavorable pricing regulations, third-party reimbursement practices or
healthcare reform initiatives applicable to our product and product candidates
could limit our potential product revenue.

      The healthcare industry is undergoing fundamental changes resulting from
political, economic and regulatory influences. In the United States,
comprehensive programs have been proposed that seek to increase access to
healthcare for the uninsured, control the escalation of healthcare expenditures
within the economy and use healthcare reimbursement policies to balance the
federal budget.

      We expect that Congress and state legislatures will continue to review and
assess healthcare proposals, and public debate of these issues will likely
continue. We cannot predict which, if any, of such reform proposals will be
adopted and when they might be adopted. Significant changes in the healthcare
system could have a substantial impact on the manner in which we conduct our
business and could require us to revise our strategies and negatively affect our
business, prospects and results of operations.

We may experience reductions in the levels of reimbursement for pharmaceutical
products by governmental authorities, HMOs or other third-party payers.

      Various governmental authorities and private health insurers and other
organizations, such as HMOs, provide reimbursement to consumers for the cost of
certain pharmaceutical products. Demand for our product depends in part on the
extent to which such reimbursement is available. Third-party payers increasingly
challenge the pricing of pharmaceutical products. This trend and other trends
toward the growth of HMOs, managed health care and legislative health care
reform create significant uncertainties regarding the future levels of
reimbursement for pharmaceutical products. Further, any reimbursement may be
reduced in the future, perhaps to the point that market demand for our product
declines. Such a decline could have a material adverse effect on our business,
financial position and results of operations.


                                     - 31 -
<PAGE>

Legislative or regulatory programs that may influence prices of prescription
drugs could have a material adverse effect on our business, financial position
and results of operations.

      Current or future federal or state laws and regulations may influence the
prices of drugs and, therefore, could adversely affect the price that we receive
for our product. Programs in existence in certain states seek to set prices of
all drugs sold within those states through the regulation and administration of
the sale of prescription drugs. Expansion of these programs, in particular,
state Medicaid programs, or changes required in the way in which Medicaid
rebates are calculated under such programs, could adversely affect the price we
receive for our product and could have a material adverse effect on our
business, financial position and results of operations.

We cannot be certain of the protection or confidentiality of our patents and
proprietary rights.

      Our success will depend, in part, on our ability to obtain or license
patents for our products, processes and technologies. If we do not do so, our
competitors may exploit our innovations and deprive us of the ability to realize
revenues from those innovations. There is no assurance that we will be issued
patents for any of our patent applications, that any existing or future patents
that we receive or license will provide competitive advantages for our products,
or that we will be able to enforce successfully our patent rights. Additionally,
there can be no assurance that our patents or any future patents will prevent
other companies from developing similar or functionally equivalent products, or
challenging, invalidating or avoiding our patent applications or any existing or
future patents that we receive or license.

      We also rely on trade secrets, unpatented proprietary know-how and
continuing technological innovation. We use confidentiality agreements with
purchasers, suppliers, employees and consultants to protect our trade secrets,
unpatented proprietary know-how and continuing technological innovation, but
there can be no assurance that these parties will not breach their agreements
with us or that we will be able to effectively enforce our rights under those
agreements. We also cannot be certain that we will have adequate remedies for
any breach. Disputes may arise concerning the ownership of intellectual property
or the applicability of confidentiality agreements. Furthermore, we cannot be
sure that our trade secrets and proprietary technology will not otherwise become
known or that our competitors will not independently develop our trade secrets
and proprietary technology.

Third parties may claim that we infringe their proprietary rights, forcing us to
expend substantial resources in resulting litigation, the outcome of which is
uncertain. Any unfavorable outcome could negatively affect our financial
position and results of operations.

      Our success will depend, in part, on our ability to operate without
infringing the proprietary rights of others, and there can be no assurance that
our products and processes will not infringe upon the patents of others. Third
parties may also institute patent litigation against us for competitive reasons
unrelated to any infringement by us. If a third party asserts a claim of
infringement, we may have to seek licenses, defend infringement actions or
challenge the validity of those third-party patents in court. If we cannot
obtain the required licenses, or are found liable for infringement or are not
able to have these patents declared invalid, we may be liable for significant
monetary damages, encounter significant delays in bringing products to market or
be precluded from participating in the manufacture, use or sale of products or
methods of drug delivery covered by the patents of others. There can be no
assurance that we have identified, or that in the future we will be able to
identify, all U.S. and foreign patents that may pose a risk of potential
infringement claims.


                                     - 32 -
<PAGE>

We may not be able to manufacture new products in commercial quantities
efficiently.

      We may seek to bring to market new products that we have never
manufactured on a commercial scale. Accordingly, inefficiencies and other
scale-up problems may occur in the process of manufacturing new products in
commercial quantities. If we experience manufacturing difficulties, our overall
manufacturing costs may be higher than we had anticipated.

We may be subject to product liability claims and we cannot be certain that we
will have adequate insurance coverage.

      The testing, manufacturing and marketing of our products may expose us to
potential product liability and other claims resulting from their use. If any
such claims against us are successful, we may be required to make significant
compensation payments and suffer adverse publicity. Even unsuccessful claims
could result in the expenditure of funds in litigation and the diversion of
management time and resources. We maintain product liability insurance, but
there can be no assurance that our insurance will cover all future claims or
that we will be able to maintain existing coverage or obtain additional coverage
at reasonable rates. If a claim is not covered or if our coverage is
insufficient, we may incur significant liability payments that would negatively
affect our business, financial position or results of operations.

All of our products are manufactured at one location and any interruption of
production at this facility could negatively affect our business, financial
position and results of operations.

      All of our products are manufactured at a single facility in Emigsville,
Pennsylvania. An interruption of manufacturing resulting from regulatory issues,
technical problems, casualty loss or other factors could result in our inability
to meet production requirements, which may cause us to lose revenues and which
could have an adverse effect on our relationships with our partners and
customers, any of which could have a material adverse effect on our business,
financial position or results of operations. We maintain business interruption
insurance, but there can be no assurance that our insurance will cover all
future claims or that we will be able to maintain existing coverage or obtain
additional coverage at reasonable rates. Without our existing production
facility, we would have no other means of manufacturing our products until we
were able to restore the manufacturing capability at our facility or develop an
alternative manufacturing facility.

Our insurance coverage may not be adequate and rising insurance premiums could
negatively affect our profitability.

      We rely on insurance to protect us from many business risks, including
product liability, business interruption, property and casualty loss and
employment practices liability. The cost of insurance has risen significantly in
recent years. In response, we may increase deductibles and/or decrease certain
coverages to mitigate these costs. There can be no assurance that the insurance
that we maintain and intend to maintain will be adequate, or that the cost of
insurance and limitations in coverage will not adversely affect our business,
financial position or results of operations. Furthermore, if is possible that,
in some cases, coverage may not be available at any price.


                                     - 33 -
<PAGE>

We enter into agreements that include provisions that require us to indemnify
the other party under certain circumstances. If we are required to perform under
these indemnification provisions, our financial condition and results of
operations could be negatively affected.

      Many of the license, development, supply, employment and other agreements
we enter into include indemnification provisions. The various indemnification
provisions in these agreements are not uniform and may be subject to differing
legal interpretations. Accordingly, it may be difficult for us to determine or
accurately predict in advance what indemnification obligations we may owe under
these provisions or, alternatively, what obligations may be owed to us by these
parties, including as it relates to potential damages, settlement amounts and
defense costs associated with the product liability lawsuits that claim the use
of products manufactured by us and distributed by third parties. Our insurance
coverage may mitigate the costs of some of our obligations under these
indemnification provisions but our business, financial position and results of
operations could be harmed if we are required to perform under these
indemnification provisions and there is no or insufficient insurance coverage.

We may have difficulty raising capital, which could deprive us of necessary
resources.

      We expect to continue to devote significant capital resources to fund
research and development and to maintain existing manufacturing capacity. In
order to support the initiatives envisioned in our business plan, we may need to
raise additional funds through the sale of assets, public or private debt or
equity financing, collaborative relationships or other arrangements. Our ability
to raise financing depends on many factors beyond our control, including the
state of capital markets and the development or prospects for development of
competitive technology by others. Because our common stock is not listed on a
major stock market, many investors may not be willing or allowed to purchase it
or may demand steep discounts. Our current financial condition and the status of
our obligations under the Debentures and the Key license have prevented us from
borrowing money from third parties or raising capital from the sale of equity.
Sufficient additional financing may not be available to us or may be available
only on terms that would result in further dilution to the current owners of our
common stock. If we are unable to raise additional funds when we need them, we
may have to severely curtail our operations.

Our success depends on attracting and retaining our key employees.

      Our success depends on our ability to attract and retain qualified,
experienced personnel. We face significant competition in recruiting talented
personnel. The loss of key personnel, or the inability to attract and retain
additional, competent employees, could adversely affect our business, financial
position or results of operations.

Limitations on liability and indemnification matters.

      As permitted by the corporate laws of the State of Delaware, we have
included in our Certificate of Incorporation a provision to eliminate the
personal liability of our directors for monetary damages for breach or alleged
breach of their fiduciary duties as directors, subject to certain exceptions. In
addition, our By-Laws provide that we are required to indemnify our officers and
directors under certain circumstances, including those circumstances in which
indemnification would otherwise be discretionary, and we will be required to
advance expenses to our officers and directors as incurred in connection with
proceedings against them for which they may be indemnified.


                                     - 34 -
<PAGE>

We have no intention of paying dividends on our common stock in the near future
and holders of our common stock will have to rely on the appreciation thereof to
realize any monies from holding these securities.

      We have not paid any dividends on our common stock and do not anticipate
paying cash dividends in the foreseeable future. Management intends to retain
any earnings to finance the growth of the Company's business. Management cannot
assure you that the Company will ever pay cash dividends. Accordingly, holders
of our common stock will have to rely on the appreciation thereof to realize any
monies from holding these securities.

Our common stock is not traded or admitted to quotation on any market, so you
may not be able to sell your shares of common stock and thus you may never
realize any monies from holding these securities.

      Our common stock is not listed on any stock market or admitted to
quotation on the over-the-counter bulletin board, accordingly, there is no
public trading market for our common stock. From time to time, quotations for
our stock are published by market makers in the Pink Sheets, which provides an
extremely limited market for our stock. Therefore, you may only be able to
dispose of our common stock in a private transaction. If no active trading
market develops for our common stock, holders of our common stock will have to
rely on the appreciation thereof to realize any monies from holding these
securities.

We must maintain adequate internal controls and in the future be able, on an
annual basis, to provide an assertion as to the effectiveness of such controls.

      Effective internal controls are necessary for the Company to provide
reasonable assurance with respect to its financial reports. We will be spending
a substantial amount of management time and resources to comply with changing
laws, regulations and standards relating to corporate governance and public
disclosure, including the Sarbanes-Oxley Act of 2002 and new SEC regulations. In
particular, Section 404 of the Sarbanes-Oxley Act of 2002 requires management's
annual review and evaluation of our internal control systems, and attestations
as to the effectiveness of these systems by our independent public accounting
firm. If we fail to maintain the adequacy of our internal controls, we may not
be able to ensure that we can conclude on an ongoing basis that we have
effective internal control over financial reporting. Additionally, internal
control over financial reporting may not prevent or detect misstatements because
of its inherent limitations, including the possibility of human error, the
circumvention or overriding of controls, or fraud. Therefore, even effective
internal controls can provide only reasonable assurance with respect to the
preparation and fair presentation of financial statements. In addition,
projections of any evaluation of effectiveness of internal control over
financial reporting to future periods are subject to the risk that the control
may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate. If the Company fails
to maintain the adequacy of its internal controls, including any failure to
implement required new or improved controls, this could have a material adverse
effect on our business, financial position and results of operations.

There are inherent uncertainties involved in estimates, judgments and
assumptions used in the preparation of financial statements in accordance with
GAAP.

      The consolidated and condensed consolidated financial statements included
in the periodic reports we are required to file with the SEC are prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP"). The preparation of financial statements in accordance with
GAAP involves making estimates, judgments and assumptions that affect reported
amounts of assets (including intangible assets), liabilities, revenues, expenses
and income. Estimates, judgments and assumptions are inherently subject to
change in the future and any necessary revisions to prior estimates, judgments
or assumptions could lead to a restatement. Any such changes could result in
corresponding changes to the amounts of assets (including goodwill and other
intangible assets), liabilities, revenues, expenses and income. Any such changes
could have a material adverse effect on our business, financial position and
results of operations.


                                     - 35 -
<PAGE>

ITEM 2. DESCRIPTION OF PROPERTIES

      We lease an approximately 61,000 square foot building located on
approximately 3.5 acres in Emigsville, Pennsylvania which is used for
manufacturing, laboratory, engineering, quality control, research and
development, warehousing, administrative and office purposes. Our manufacturing
facility complies with GMP standards and is operating under registration from
both the FDA and DEA and pursuant to registration with the Pennsylvania
Department of Health. The lease, which expires December 6, 2019, has an annual
rental of $212,400, payable in equal monthly installments of $17,700. We
currently lease approximately 600 square feet of office space in Suffern, New
York under a lease that expires December 31, 2006. The annual rental is $7,416,
payable in equal monthly installments of $618, inclusive of utilities.

      We believe that our present facilities are in good condition and are
adequate for our current and immediate future requirements.

ITEM 3. LEGAL PROCEEDINGS

      In June 2004, Plaintiffs Jack Aronowitz and his companies, Health-Chem
Diagnostics, LLC ("Diagnostics") and Leon Services, LLC ("Leon"), filed a
Complaint and subsequently, an Amended Complaint in the United States District
Court Southern District of Florida (the "Court") for breach of contract and
foreclosure of a security interest against the Company. The contracts at issue
were a Master Agreement along with an associated License Agreement and Security
Agreement, executed jointly and dated February 15, 2002 (the "2002 Agreements"),
and a November 6, 2003 Outline Agreement (the "2003 Agreement") terminating the
Company's obligations under the 2002 Agreements and effectuating a purchase of
certain assets by the Company in exchange for monies and a 25% equity stake in
Diagnostics. The Company filed a counterclaim for breach of the 2003 Agreement,
based on Plaintiffs' failure to render payment for the assets which were
transferred to Plaintiffs, as well as a claim for trademark infringement. The
Company also asserted a claim for a declaratory judgment determining that the
2003 Agreement superseded the 2002 Agreements, consistent with the conclusions
in the Order. The jury rendered its verdict on November 21, 2005, finding in
favor of Plaintiffs on the counts for breach of the 2002 and 2003 Agreements.
The jury found that Plaintiffs were guilty of copyright infringement, but did
not find a breach of the 2003 Agreement on the part of Plaintiffs. On December
2, 2005, the Court entered a Final Judgment and Order Closing Case, and ordered
judgment on the jury verdict in the amount of $2,931,000.00 in favor of
Plaintiffs and against the Company. The Court also entered judgment for the
Company in the amount of $25,000.00 for trademark infringement. The Company
filed a Motion for Judgment As A Matter Of Law, and alternatively, Motion for
New Trial. On February 14, 2006, the Court issued an Amended Final Judgment,
vacating the Court's December 2, 2005 Final Judgment and Order Closing Case. The
February 14, 2006 judgment reduced the award to the Plaintiffs Jack Aronowitz,
Health-Chem Diagnostics, LLC and Leon Services, LLC and against the Company to
the amount of $1.00. The February 14, 2006 judgment also awarded $25,000.00 to
the Company and against the Plaintiffs Jack Aronowitz, Health-Chem Diagnostics,
LLC and Leon Services, LLC for trademark infringement. The February 14, 2006
judgment also included a permanent injunction in favor of the Company and
against the Plaintiffs Jack Aronowitz, Health-Chem Diagnostics, LLC and Leon
Services, LLC to cease and desist any present or future use of the "Health-Chem"
trademark or any other marks similar to the Company's trademark. On February 27,
2006, the Plaintiffs filed an appeal from the Court's February 14, 2006 Amended
Final Judgment. The ultimate outcome of this litigation can not be ascertained
at this time.


                                     - 36 -
<PAGE>

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

      None

                                     PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

      Our common stock is not listed or admitted to quotation on any established
trading market. From time to time, quotes for our stock are reported on the Pink
Sheets which is a centralized quotation service that collects and publishes
market maker quotes for over-the-counter securities in real time. Unlike
companies the stock of which trades on a stock exchange, companies quoted on the
Pink Sheets system do not need to meet quantitative and qualitative listing and
maintenance standards or be registered or file reports with the SEC. Investors
may obtain quotes for our common stock by entering our symbol, HCLC, in the
input box of the Web site pinksheets.com. Such quotations reflect inter-dealer
prices, without retail markup, markdown or commission, and may not represent
actual transactions.

      The high and low sales prices for our common stock, as reported by the
Pink Sheets, have been as follows during the two years ended December 31, 2004:

--------------------------------------------------------------------------------
QUARTER                                    2004                     2003
                                           ----                     ----
--------------------------------------------------------------------------------
                                    High          Low         High          Low
                                   ------       ------       ------       ------
--------------------------------------------------------------------------------
1st                                $0.090       $0.060       $0.080       $0.060
--------------------------------------------------------------------------------
2nd                                 0.080        0.060        0.080        0.060
--------------------------------------------------------------------------------
3rd                                 0.070        0.070        0.080        0.070
--------------------------------------------------------------------------------
4th                                 0.100        0.070        0.080        0.060
--------------------------------------------------------------------------------

      There were approximately 1,200 holders of record of our common stock as of
December 31, 2005. This number of holders of record does not include beneficial
owners of our common stock whose shares are held in the names of various
security holders, dealers and clearing agencies.

      We have not paid any cash dividends on our common stock during the five
years ended December 31, 2004 and we do not anticipate paying cash dividends in
the foreseeable future. Under the terms of the Debentures, we are restricted
from paying cash dividends by a formula based upon the consolidated net income
of the Company and other factors. Under the formula, at December 31, 2004, no
amount was available for the payment of dividends.


                                     - 37 -
<PAGE>

Recent Sales of Unregistered Securities.

      Set forth below is information relating to securities issued by
Health-Chem from January 1, 1999, the first year in which Health-Chem did not
file reports with the SEC, through December 31, 2004, the last year covered by
this report, which were not registered under the Securities Act of 1933, as
amended.

2004

      Health-Chem did not issue any securities during fiscal 2004.

2003

      On April 25, 2003, Health-Chem granted to Murray Lieber, a former officer,
options to purchase up to 100,000 shares of common stock in reliance on the
exemption from registration afforded by Section 4(2) of the Securities Act of
1933. The options are exercisable for a period of five years from the date of
the grant at a price of $.12 per share. The options were granted in connection
with the termination of Mr. Lieber's employment with Health-Chem. The options
were not granted under an option plan approved by the stockholders of
Health-Chem.

2002

      On April 19, 2002, Health-Chem granted options to purchase an aggregate of
1,845,500 shares of common stock to the individuals identified in the following
table on the terms specified therein in reliance on the exemption from
registration afforded by Section 4(2) of the Securities Act of 1933. The options
were granted as additional consideration for loans made to Health-Chem by the
named individuals on the basis of five options granted for each dollar loaned.
The options were not granted under an option plan approved by the stockholders
of Health-Chem.

                          Relationship to                               Exercise
      Name                Health-Chem             No. Granted  Term     Price
      ----                -----------             -----------  ----     -----

      Andy Yurowitz       Employee and Director   837,500      5 yrs    $0.10
      Manfred Mayerfeld   Director                958,000      5 yrs    $0.10
      Ken Brody           Former Employee          50,000      5 yrs    $0.10

      On June 6, 2002, Health-Chem issued 50,000 shares of common stock to
Albert David in reliance on the exemption from registration afforded by Section
4(2) of the Securities Act of 1933. The Company issued the stock as additional
consideration for loans made by such individual to Health-Chem on the basis of
three shares for each dollar loaned.

      On June 19, 2002, Health-Chem granted to Charles Lazar & Co., a
consultant, options to purchase up to 1,000,000 shares of common stock in
reliance on the exemption from registration afforded by Section 4(2) of the
Securities Act of 1933. The options are exercisable for a period of five years
from the date of the grant at a price of $.125 per share. The options were not
granted under an option plan approved by the stockholders of Health-Chem.

      On December 31, 2002, Health-Chem issued an aggregate of 471,000 shares of
common stock as a stock bonus to the individuals identified in the table set
forth below in reliance on the exemption from registration afforded by Section
4(2) of the Securities Act of 1933.


                                     - 38 -
<PAGE>

                                Relationship
      Recipient                 to Health-Chem                  No. of Shares
      ---------                 --------------                  -------------

      Ken Brody                 Former Employee                     50,000
      Don Kauffman              Former Employee                     50,000
      Ron Burghauser            Employee                            75,000
      David Zakai               Former Consultant                  250,000
      Other Employees           Employees                           46,000

2001

      On May 30, 2001, Health-Chem granted to Jack Zwick, a consultant, options
to purchase up to 100,000 shares of common stock in reliance on the exemption
from registration afforded by Section 4(2) of the Securities Act of 1933. The
options are exercisable for a period of five years from the date of the grant at
a price of $.125 per share. The options were not granted under an option plan
approved by the stockholders of Health-Chem. The options have expired
unexercised.

      During the period June through August 2001, Health-Chem issued an
aggregate of 2,940,000 shares of common stock to the individuals identified in
the table below in reliance on the exemption from registration afforded by
Section 4(2) of the Securities Act of 1933. The Company issued the stock as
additional consideration for a loan made by such persons to Health-Chem on the
basis of eight shares for each dollar loaned. In connection with this loan, the
Company received an opinion dated August 15, 2001 from its financial advisor,
KSH Investment Group Inc. ("KSH"), that the transaction was fair to the Company
from a financial point of view. KSH also opined that at that time the Company's
common stock had little or no value.

                                   Relationship
      Name                         to Health-Chem                   No. Issued
      ----                         --------------                   ----------

      Manfred Mayerfeld            Director                          400,000
      Andy Yurowitz                Employee and Director             620,000
      Andrew Levinson              Director                          200,000
      Zachary Prensky              Former Director                   600,000
      Dr. Wolf Prensky             Former Director                   400,000
      Spider Financial, Inc.       Mortgageholder                    200,000
      Ken Brody                    Former Employee                   320,000
      David Hammer                 Mortgageholder                    200,000

      During the 2001 fiscal year, Health-Chem granted options to purchase an
aggregate of 350,000 shares of common stock to the individuals listed in the
following table on the terms specified therein in reliance on the exemption from
registration afforded by Section 4(2) of the Securities Act of 1933. The options
were not granted under an option plan approved by the stockholders of
Health-Chem. The options have expired unexercised.


                                     - 39 -
<PAGE>

                                                     No.
      Recipient             Relationship             Granted      Exercise Price
      ---------             ------------             -------      --------------

      Andrew Levinson       Director                  50,000      $0.125
      Andy Yurowitz         Employee and Director     50,000      $0.125
      Manfred Mayerfeld     Director                  50,000      $0.125
      Zachary Prensky       Former Director           50,000      $0.125
      Dr. Wolf Prensky      Former Director           50,000      $0.125
      Ken Brody             Former Employee          100,000      $0.125

2000

      During the 2000 fiscal year, Health-Chem granted to Mercury Capital, a
holder of a mortgage on the Company's facilities in Emigsville, Pennsylvania,
options to purchase up to 691,087 shares of common stock in reliance on the
exemption from registration afforded by Section 4(2) of the Securities Act of
1933. The options were exercisable for a period of five years from the date of
the grant at a price of $.50 per share. The options were not granted under
option plan approved by the stockholders of Health-Chem. The options have
expired unexercised.

1999

      Health-Chem did not issue any securities during fiscal 1999.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

      The following discussion and analysis, as well as other sections in this
Form 10-KSB, should be read in conjunction with the Consolidated Financial
Statements and related Notes to Consolidated Financial Statements included
elsewhere in this report.

      This discussion and analysis may contain "forward-looking statements".
These statements are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements may
include, without limitation, statements about the Company's market
opportunities, strategies, competition and expected activities and expenditures,
and at times may be identified by the use of words such as "may", "will",
"could", "should", "would", "project", "believe", "anticipate", "expect",
"plan", "estimate", "forecast", "potential", "intend", "continue" and variations
of these words or comparable words. Forward-looking statements inherently
involve risks and uncertainties. Accordingly, actual results may differ
materially from those expressed or implied by these forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to, the risks described under "Risk Factors" in Item 1. The Company
undertakes no obligation to update any forward-looking statements for revisions
or changes after the date of this Form 10-KSB.

Company Overview.

      We manufacture controlled release products to deliver drugs topically or
transdermally (transdermal patches). Currently, our sole product is a
prescription transdermal patch which delivers nitroglycerin for use in the
relief of angina pectoris (chest pain); however, we have the manufacturing
capability to produce transdermal patches which deliver other medications. We
manufacture our nitroglycerin patch both on a contract basis for specific
clients and for sale to distributors and wholesalers for distribution in the
United States. We manufacture our products in accordance with GMPs prescribed by
the FDA at our facility in Emigsville, Pennsylvania. We utilize the services of
an independent sales organization to identify customers and market and sell our
transdermal patches. We also derive limited revenues from development work. We
currently conduct the majority of our business through our 90%-owned subsidiary,
Transderm.


                                     - 40 -
<PAGE>

Historical Perspective.

      We were organized in 1970 and developed a diverse and profitable business
which thrived through the mid-1990's. At the peak of our operations in 1996, we
developed, manufactured and distributed products relying on or derived from
laminated or coated films, including controlled release dispensers for
prescription pharmaceuticals and over-the-counter pharmaceutical and cosmetic
products, reinforced synthetic fabrics for industrial and health care use, and
controlled release dispensers for environmental chemicals. In 1986, we had the
distinction of introducing the first FDA approved generic transdermal
nitroglycerin patch into the United States market. By the end of 1996, we
employed 242 persons and generated $47.6 million in revenue. During this time,
Health-Chem conducted its business primarily through its wholly-owned
subsidiaries, Herculite Products, Inc. ("Herculite") and Pacific Combining Corp.
("Pacific"), and through its majority owned subsidiaries Transderm and Hercon
Environmental Corporation ("Hercon Environmental"), of which it owns 98.5%.

      By the end of 1996, we were burdened with excessive debts and liabilities,
including $10,401,000 of principal under the Debentures which became due in 1999
("Debentures") and $6,082,000 under a bank term loan and line of credit, and
were suffering declining sales throughout our product lines as a result of
losing a domestic distributor of our nitroglycerin patch and by lower synthetic
fabrics business (lower sales of industrial fabrics, eliminating unprofitable
business including certain government contracts and lower demand from certain
customers). Sales continued to decline in 1997 and 1998 and management
determined to restructure a portion of the Company's operations by closing one
of our synthetic fabric manufacturing operations plants in July 1999. Continuing
pressure to generate cash to service debt obligations prompted management to
sell the assets of our Herculite and Hercon Environmental subsidiaries in August
1999, the proceeds from which were used to satisfy the entire amount due under
the term loan which aggregated $9.8 million, and to make a $1.9 million payment
on the Debentures.

      During this time frame, key employees left the Company, several of whom
participated in the management-led buyout of our subsidiaries in 1999, including
management responsible for accounting and financial functions. Moreover, after
the divestiture of several of our operating subsidiaries, we were not generating
any revenues from products sales because we had discontinued manufacturing our
first generation patch, in anticipation of the impending introduction of our
second generation patch, and had only minimal stock of that product to sell. We
were prevented from selling this product for nearly two years both because a
third party obtained an injunction against the Company from selling the product
alleging that it infringed upon its registered patent and the FDA had not
approved new manufacturing processes and raw materials to be used in the
product, and were generating only minimal income. Consequently, we could not
afford to retain our senior financial staff and did not have the revenues to
prepare quarterly and annual reports and discontinued filing reports with the
SEC in 1999.

      In March 2000, we negotiated a license with Key Pharmaceuticals, Inc., or
Key, to utilize the technology covered by the patent which was the subject of
litigation (the "Key License") and had received approval from the FDA to proceed
with the manufacture and sale of our second generation patch and began to sell
the product later in that year. Management recognized the need to diversify the
Company's operations so as not to be totally reliant on a single product. Toward
that end, in separate transactions, we acquired certain manufacturing assets and
product schematics with the intention of developing a diagnostic product
division and engaged the inventor of the products we proposed to manufacture and
market. We were unable to manufacture the products efficiently, generated only
minimal revenues from their sale and divested ourselves of this division in
2004.


                                     - 41 -
<PAGE>

      During the period 1999 through 2002, the Company relied upon a loan from a
non-traditional lender secured by a mortgage on the Company's Pennsylvania
facility and loans from management to fund its operations. In 2004, the Company
sold its real property and plant in Pennsylvania to a company owned, in part, by
an affiliate. We have leased the real property, buildings and equipment through
2019, which we can extend for an additional five years. We also have the option
to repurchase the property.

      Currently, we utilize the services of an independent sales organization to
identify customers and market our second generation nitroglycerin transdermal
patches. Revenues generated from sales of this product have increased during
2003 and 2004 as we have ramped-up our manufacturing capacity and demonstrated
an ability to produce quality products on a timely basis at a reasonable price.

      As of December 31, 2004, we had aggregate debts and liabilities of
approximately $19,898,000, including $10,197,000 of principal and accrued
interest due under the Debentures which became due in 1999 and under which we
currently are in default, and approximately $4,522,000 of royalties due under
the Key License. As of December 31, 2005, we estimate that our liabilities and
debts are approximately $22,864,000 (unaudited), including $10,830,000 under the
Debentures and $6,108,000 for royalties due under the license. Our substantial
unpaid debt and failure to resolve our obligations under the Key License, along
with our lack of profitable operations from 2003 through 2004 have caused our
independent auditors to add an explanatory paragraph to their audit opinion
issued on our financial statements for the year ended December 31, 2004
indicating that these factors, among others, raise substantial doubt about our
ability to continue as a going concern.

Factors which We Believe May Affect or Impact Our Current and Future Operations.

      Certain existing issues and potentially material future factors could
impact our business in the short- and long- term. Investors should analyze our
business in light of the issues included in the discussion set forth below which
is intended to highlight and amplify numerical and other information contained
in the remainder of this section.

      Our company faces several challenges as we continue our efforts to emerge
from the financial and operating crises of the late 1990's. Management has
identified the following factors as those most likely to materially impact our
operations:

o     the resolution of our obligations under the terms of the Debentures and
      the Key License;

o     short and long term liquidity issues;

o     issues relating to reliance on a single product for the majority of our
      revenues;

o     the need to identify and retain senior management who have experience in
      the pharmaceutical industry or in any business in which we may become
      involved in the future;

o     the impact of competition on our business; and

o     issues relating to concentration of our customer base.


                                     - 42 -
<PAGE>

      We defaulted on our obligations under the Debentures by not repaying the
principal and accrued interest on their due date in April 1999 and are in breach
of our agreement under the terms of the Key License for failing to make any
payments thereunder since we entered into the agreement in March 2000. As
described elsewhere in this Annual Report, as of December 31, 2005, our
obligations under both the Debentures and the Key License were considerable and
we currently do not have the financial resources to make significant payments to
reduce our debt under the Debentures or to pay past due royalties under the Key
License. Moreover, we are not generating sufficient cash from operations to make
material payments in the near future. Given these circumstances, we are not
certain whether we will be able to negotiate agreements with the Trustee for the
holders of the Debentures or with Key which will allow us to continue
operations.

      As we have rebuilt sales over the last few years, we have been able to
forestall taking action with respect to resolving our obligations under the
Debentures and the Key License. Over the last several years, we have been in
sporadic contact with the Trustee of the Debentures which has proposed opening
negotiations with respect to our satisfying our obligations under these
instruments, but have not set a meeting date to discuss the matter. We have
executed tolling agreements with the Trustee in each of the last two years
extending the time in which the Trustee is permitted to seek legal redress for
our default under the Debentures. We recently commenced negotiating with
representatives of Key to develop a plan to pay the royalties due under the Key
License but no substantive repayment terms have been discussed as of the date
hereof. The nature of the agreements with these creditors, if we are able to
negotiate them, and the manner in which we will be required to repay our
obligations under the Debentures and the Key License represent a material
uncertainty and will bear significantly on how, or if we are able to, do
business in the future.

      Given that we are in default under the Debentures and the Key License,
either party could initiate legal action against us seeking the entire amount
due. If we were to lose one or both such actions, as of the date hereof, we
would be unable to satisfy the amount due under either such obligation, in which
case, we might be required to liquidate all of our assets and wind-up or
dissolve our company or seek protection from our creditors under the bankruptcy
laws to satisfy these obligations. Management hopes to enter, but can offer no
assurance that it will be successful, into agreements with both the Trustee and
Key which will allow us to continue operating and repay an agreed upon sum over
time. Ideally, we would negotiate agreements with these parties which would
allow us, if and when we achieve profitable operations, of which we cannot be
certain, to retain some cash from operations to permit us to develop new
products. Accordingly, there is substantial uncertainty as to our future which
will become clearer only when we ascertain how the Trustee and Key seek to
resolve our obligations under the respective agreements with them. The terms of
our agreements with these entities, if we are successful in our efforts to
negotiate such agreements, will bear materially on our business and financial
condition and likely will significantly impact our liquidity and cash resources.

      Short - and long - term liquidity issues represent a significant challenge
as we seek to balance rebuilding and restructuring our business with repayment
of amounts due under the Debentures and royalties due under the Key License. Our
lack of liquidity impacts our business in many ways, some of which are
inextricably intertwined and affect all aspects of our operations, as more fully
described below.

      Sales and revenues have increased during 2003 and 2004 as we have
successfully: ramped-up our manufacturing capability which had been dormant for
nearly two years; proven to purchasers that we are a reliable manufacturer of
quality products which we deliver on a timely basis in conformity with contract
requirements; and intensified our marketing efforts. Despite our increased
sales, we remained unprofitable during the years 2003 and 2004 and operate under
the constant pressure of limited available cash. We cannot be certain that we
ever will achieve profitability.


                                     - 43 -
<PAGE>

      Our lack of liquidity and our obligations to the Debenture holders and Key
currently and in the future will affect our ability to:

      o     diversify our operations by developing new products and reduce our
            reliance on revenues generated from sales of a single product;

      o     obtain financing for operations;

      o     endure business cycles resulting from general economic conditions or
            the effects of competition, among other things, as they occur; and

      o     take advantage of business opportunities as they may arise.

      Assuming we are successful in our efforts to reach favorable agreements
with both the Trustee and Key, we are severely constrained by financial and
personnel resources from taking the steps to diversify our operations to reduce
our reliance on revenues generated solely from the sale of our transdermal
nitroglycerin patches. Management believes it is critical to the Company's
future to develop other products to offset potential adverse business
developments which may impact our sales of our transdermal nitroglycerin patch,
including:

      o     the potential negative impact of competition, which could require us
            to reduce the price we charge for our product or which would result
            in diminished sales, either of which would reduce our revenues;

      o     the introduction by others of new products, such as new drugs or
            delivery methods which render our nitroglycerin transdermal patches
            obsolete; or

      o     other events or general economic conditions which result in
            diminished demand for our patch.

      Our efforts to diversify our operations may entail developing a new
product that is compatible with our manufacturing and personnel capabilities or
merging with or acquiring (perhaps in exchange for capital stock) an entity that
already is selling or proposes to market a product within the same general
industry as our transdermal patch. Developing or otherwise acquiring a new
product or entering into a new business, particularly in a highly regulated
industry such as the pharmaceutical business, can be expensive, time consuming
and will divert the attention of management from a company's core operations,
all risks that we would be subject to if we were to pursue such an endeavor.
Moreover, at this time, we do not employ the personnel we likely will need, such
as a chief operating officer who has experience in the pharmaceutical industry,
to attempt to add new products or otherwise diversify our operations in this
area. Further, we can not be certain that we would derive any material revenues
from any diversification and may suffer significant losses from any such
venture. At this time, we do not have capital on-hand nor do we have access to
capital to fund product development or complete an acquisition. We expect that
any available cash from operations we may have in the foreseeable future will be
utilized to satisfy our existing obligations.

      Given our current financial and business condition, it is unlikely that we
will be able to obtain outside financing from any source for any purpose,
including introducing new products. We have no material assets to use as
collateral given that we sold our real property and equipment in 2004 (though we
are able to carry these items on our financial statements because York Realty
Leasing LLC, the entity that purchased the real property and equipment, is
considered a "variable interest entity" and according to GAAP our consolidated
balance sheet must include the assets and liabilities of York Realty Leasing
LLC) and the risks and uncertainties attached to our operations would present
significant impediments to locating a source of financing. Our inability to
obtain outside financing, among other things:


                                     - 44 -
<PAGE>

      o     will restrict our ability to develop or add new products;

      o     restrict our ability to take advantage of other business
            opportunities as they arise; and

      o     puts us at risk to period-to-period operating fluctuations resulting
            from general economic conditions or the effects of competition.

      Accordingly, we expect that available cash is and will be limited to net
income generated from continuing operations, which amounted to $269,000 for
2004, without giving effect to the terms of any agreements with the Trustee or
Key. We are uncertain as to whether we will post net profits in any future years
and the extent to which any such profits would be subject to remittance to the
Debenture holders or Key under our obligations to these entities.

      We have contracted with a full-service sales and marketing outsourcing
company that focuses on generic and branded pharmaceutical companies to handle
the majority of the sales and marketing efforts for our transdermal
nitroglycerin product. This company monitors client sales, as well as
scrutinizes the competition in order to anticipate and recommend changes to our
sales, marketing and promotional strategy. This company also assists in
providing the industry contacts to reach all distribution channels. Two
customers accounted for approximately 53% of the sales volume of our patch
during 2004. Management recognizes the need to expand distribution channels to
reduce our reliance on sales to a few customers and will seek to take the steps
necessary to address this situation and alleviate this risk.

Results of Operations.

      Overview.

      The consolidated financial statements of the Company have been
reclassified to reflect the results of operations and net assets of the
diagnostic product division of the Company as discontinued operations in
accordance with generally accepted accounting principles.

      The increase in net sales for the years 2004 to 2003 and 2003 to 2002 were
due primarily to increased sales volumes of nitroglycerin patches from existing
customers. We were able to increase sales of this product because we
successfully ramped-up our manufacturing capability which had been dormant for
nearly two years, proved to purchasers that we are a reliable manufacturer of
quality products which we deliver on a timely basis in conformity with contract
requirements and intensified marketing efforts. The higher margins from year to
year reflect the benefits of economies of scale attributable to increased sales
volumes of transdermal nitroglycerin patch products.

      Year ended December 31, 2004 versus December 31, 2003

      For the year ended December 31, 2004, our net sales with respect to
continuing operations were $9.2 million consisting solely of transdermal
nitroglycerin patches. For the 2003 year, our net sales with respect to
continuing operations were $7.9 million, comprised solely of net sales of
transdermal nitroglycerin patches. Net sales of transdermal nitroglycerin
patches increased 16% during the 2004 period. This increase is due primarily to
a single customer who purchased approximately 84% more transdermal nitroglycerin
patches in 2004 as compared to the quantity purchased in 2003.


                                     - 45 -
<PAGE>

      Gross profit with respect to continuing operations increased $1.0 million,
or 54%, to $2.9 million for the twelve months ended December 31, 2004 as
compared to $1.9 million for the same period in 2003. Gross profit as a percent
of sales increased from 24% during 2003 to 32% during 2004. The increase in
gross profit was due primarily to increased sales volumes of higher margin
products.

      Selling, general and administrative expenses decreased $.2 million for the
twelve months ended December 31, 2004 as compared to the corresponding period in
2003. The decrease is due primarily to lower factor expenses.

      Research and development expenses were essentially the same for the twelve
months ended December 31, 2004 as compared to the same period in 2003.

      Net interest expense decreased $.1 million for the twelve months ended
December 31, 2004 as compared to the same period in 2003 because interest rates
on the debt outstanding were marginally lower in 2004, due to the Company
refinancing existing debt with new parties at lower interest rates.

      Product development income increased $.2 million for the twelve months
ended December 31, 2004 as compared to the same period in 2003, due primarily to
additional development work income associated with a contract signed in June
2004.

      Loss from discontinued operations decreased $.4 million for the twelve
months ended December 31, 2004 as compared to the corresponding period in 2003.
The loss from discontinued operations in 2004 of $260,000 represents a write-off
of the recorded values of the assets related to the elimination of the
diagnostic division. The loss from discontinued operations in 2003 of $658,000
consists of $659,000 in losses generated by the diagnostic division, partially
offset by $1,000 in collections on the accounts receivable of the Pacific
Combining Corporation subsidiary that was closed on November 20, 1998.

      Year ended December 31, 2003 versus December 31, 2002

      The financial information for the 2002 year in the discussion below is
drawn from unaudited, internally prepared financial statements.

      Net sales with respect to continuing operations increased $1.7 million, or
27%, to $7.9 million for the twelve months ended December 31, 2003 as compared
to $6.2 million for the same period for 2002. Net sales during both years
consisted solely of transdermal nitroglycerin patches. The transdermal
nitroglycerin patch sales increase is due primarily to higher sales volumes to
existing customers.

      Gross profit with respect to continuing operations increased $.1 million,
or 6%, to $1.9 million for the twelve months ended December 31, 2003 as compared
to $1.8 million for the same period in 2002. Gross profit as a percent of sales
was 24% for the year ended December 31, 2003 and 29% for the 2002 period. The
transdermal nitroglycerin patch gross profit increased due primarily to higher
sales volumes to existing customers. Lower margins reflect increased sales
volumes of lower margin transdermal nitroglycerin patch products.


                                     - 46 -
<PAGE>

      Selling, general and administrative expenses increased $.1 million for the
twelve months ended December 31, 2003 as compared to the corresponding period in
2002. The increase is due primarily to higher consulting, commission and factor
expenses of $162,000, $128,000 and $41,000, respectively, partially offset by
lower stock-based compensation expense of $128,000.and lower general legal
matter expenses of $74,000.

      Research and development expenses decreased $32,000, or 7%, for the twelve
months ended December 31, 2003 as compared to the same period in 2002. The
decrease is due primarily to lower depreciation expense of $70,000, partially
offset by higher building operation and testing supplies expenses of $17,000 and
$12,000, respectively.

      Net interest expense was essentially the same for the twelve months ended
December 31, 2003 as compared to the same period in 2002. Outstanding debt
during these periods was relatively constant.

      Product development income was essentially the same for the twelve months
ended December 31, 2003 as compared to the same period in 2002.

      Loss from discontinued operations increased $.3 million for the twelve
months ended December 31, 2003 as compared to the corresponding period in 2002.
The loss from discontinued operations in 2003 of $658,000 consists of $659,000
in losses generated by the diagnostic division, partially offset by $1,000 in
collections on the accounts receivable of the Pacific Combining Corporation
subsidiary that was closed on November 20, 1998. The loss from discontinued
operations in 2002 of $355,000 consists of $376,000 in losses generated by the
diagnostic division, partially offset by $21,000 in collections on the accounts
receivable of Pacific Combining Corporation.

Liquidity and Capital Resources.

      In addition to the discussion on our liquidity and capital resources
below, we refer readers to the section titled "Factors which Affect or May
Impact our Current and Future Operations" appearing above, for more analysis.

      We incurred a net loss during 2003 of $1,973,000 and realized net income
of $9,000 for the 2004 fiscal year. Our total capital deficiency at December 31,
2004 of $12.5 million was essentially the same at December 31, 2003. As of
December 31, 2004, we had an accumulated deficit of approximately $23,922,000.
Our principal sources of liquidity have been cash provided by loans from
management and cash generated by operations. Our principal uses of cash have
been for working capital and research and development.

      Our working capital deficit decreased $2.3 million to $12.4 million from
December 31, 2003 to December 31, 2004 due to an increase of $2.8 million in
current assets, consisting primarily of increases in cash, accounts receivable
and inventory of $.3 million, $2.1 million and $.5 million, respectively, which
was partially offset by an increase of $.5 million in current liabilities,
consisting primarily of increases in royalties payable, accrued interest on the
Debentures and other liabilities of $1.6 million, $.6 million and $.2 million,
respectively, partially offset by a decrease in the current portion of long-term
debt of $2.0 million. The increase in accounts receivable resulted from an
increase in sales in the month of December 2004 as compared to the month of
December 2003 and also reflects the timing of customer payments. The increase in
inventory reflects additional transdermal nitroglycerin product sales and the
timing of raw material purchases. The royalties payable and accrued interest on
the Debentures increases are due to the Company not making payments to the
Debenture holders or Key. The other liabilities increase is due primarily to
increases in accrued chargebacks and rebates. The current portion of long-term
debt decrease is due primarily to replacing the majority of the current portion
with long-term debt (See Note 6 of the Notes to Consolidated Financial
Statements.)


                                     - 47 -
<PAGE>

      Cash provided by operating activities of continuing operations for the
twelve months ended December 31, 2004 was $.5 million as compared to cash
provided by operating activities of continuing operations of $1.4 million for
the same period in 2003. The decrease is due primarily to increasing accounts
receivable, inventory, royalties payable, accrued interest on the Debentures and
other liabilities of $2.1 million, $.5 million, $1.6 million, $.6 million and
$.2 million, respectively, in 2004 as compared to increasing accounts
receivable, inventory, accounts payable, royalties payable, accrued interest on
the Debentures and other liabilities of $.6 million, $.2 million, $.4 million,
$1.5 million, $.6 million and $.6 million, respectively, in 2003, partially
offset by the $2.0 million net loss in 2003. Investing activities of continuing
operations for the twelve months ended December 31, 2004 used cash of $26,000 as
compared to the same period in 2003 which used cash of $188,000. This decrease
in use of cash is due to lower additions to property, plant and equipment for
2004. Financing activities of continuing operations for the twelve months ended
December 31, 2004 provided $60,000 of cash as compared to the same period in
2003 which used $522,000 of cash.

      As of December 31, 2004, we owed an aggregate of $10.2 million under the
Debentures, comprising $6.1 of principal and $4.1 of accrued interest.
Management expects to enter into discussions in the near future with respect to
structuring a plan to satisfy the amount due under the Debentures but cannot
predict the nature of the agreement, if one is reached at all, the parties will
enter or the terms upon which the Company will satisfy its obligations
thereunder. Any failure to enter into an agreement to satisfy its obligations
under the Debentures would have a material adverse effect on the financial
condition and operations of the Company.

      Management has initiated discussions with Key with respect to repaying
past royalties due under the Key License. To date, no agreement has been
reached.

      Expenditures in 2005 such as capital expenditures, research and
development costs and other operating expenses have been financed by cash
generated from operating activities of continuing operations. The Company
anticipates that it will not require any material capital expenditures for
property, plant or equipment in 2006. At December 31, 2005, the Company
estimates that it had expended approximately $100,000 for capital expenditures
for property, plant and equipment in 2005.

      Given our current financial condition and outstanding obligations, we are
uncertain as to our future sources of cash as we expect to encounter difficulty
accessing capital markets or obtaining financing from traditional lenders. We
expect that our liquidity position and ability to obtain cash from outside
sources will be materially impacted by the terms of the agreements we may enter
into with the holders of the Debentures and Key and the other factors enumerated
above under the heading "Factors which Affect or May Impact Our Current and
Future Operations."


                                     - 48 -
<PAGE>

Contractual Obligations.

      The following table summarizes our contractual obligations at December 31,
2004 (in thousands):

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------
                            Payments due by Period (in thousands)
-------------------------------------------------------------------------------------
                                        Less than   1-3         3-5         More than
                            Total       1 Year      Years       Years       5 Years
-------------------------------------------------------------------------------------
<S>                         <C>         <C>         <C>         <C>         <C>
Debentures                  $10,197     $10,197     $    --     $    --     $    --
-------------------------------------------------------------------------------------
Other Long-term Debt            167                     167          --          --
-------------------------------------------------------------------------------------
Royalties                     4,522       4,522          --          --          --
-------------------------------------------------------------------------------------
Sale/Leaseback                3,186         212         425         425       2,124
(Operating Lease)
-------------------------------------------------------------------------------------
Operating Lease                  14           7           7          --          --
                  Total     $18,086     $14,938     $   599     $   425     $ 2,124
-------------------------------------------------------------------------------------
</TABLE>

      Debentures consist of $6.1 million of convertible subordinated debentures
that became due April 15, 1999 and $4,097,000 of accrued interest associated
with these Debentures.

      Other long-term debt consists of a $167,000 note related to the purchase
of certain fixed assets. The purchase of these fixed assets was pursuant to a
development, manufacturing and supply agreement that the Company entered into
with a client company. Payment terms of the note are contingent upon certain
performance criteria under the agreement. One such performance criteria
applicable to the client company may result in the note being forgiven. We
estimate the earliest that the note may need to be repaid is in 2006.

      Royalties consist of the amount due to Key for royalties under the Key
License. We are uncertain as to what arrangements we can make for the payment of
these royalties. Because the Key License provides for payments based upon
products sold, we have excluded future royalty payments from the above table.

      The sale/leaseback (operating lease) consists solely of the December 2004
sale/leaseback agreement with York Realty Leasing LLC, the terms of which are
described in Item 12, below.

      In December 2004 we entered into a lease for office space in Suffern, New
York for a one year period commencing January 1, 2005, and renewed the lease for
an additional one year period commencing January 1, 2006. The annual rental was
$7,200, inclusive of utilities, for 2005 and will be $7,416 for 2006.

Liquidity and Operations Going Forward.

      The Company intends to continue its efforts to complete the necessary
steps in order to meet its future cash flow requirements and to continue its
pursuit of new products and contract manufacturing opportunities. Management's
plans in this regard include, but are not limited to, the following:


                                     - 49 -
<PAGE>

o     continue with preliminary negotiations with Key with respect to devising a
      plan to pay the royalties due under the Key License and possibly negotiate
      a new license agreement;

o     approach the Trustee of the Debentures to negotiate a payment plan which
      will allow for the normal operation of the Company's operations;

o     continue with existing projects whereby the Company is developing other
      transdermal products for client companies and where the Company will be
      the contract manufacturer of these products, if FDA approval is obtained;

o     form business alliances with other pharmaceutical companies in connection
      with the development and/or manufacture of new products;

o     raise additional working capital through borrowing or by issuing equity;
      and

o     evaluate new directions for the Company's operations.

      Management believes that actions presently being taken will need to be
further realigned or otherwise amended so that the Company will be in a position
to generate sufficient revenues to provide positive cash flows from operations
and meet its obligations as they become due. However, there can be no assurance
that this will occur.

Off-Balance Sheet Arrangements.

      We have not entered into any off-balance sheet arrangements.

Critical Accounting Policies.

      Our significant accounting policies are described in Note 2 of the Notes
to Consolidated Financial Statements, which were prepared in accordance with
accounting principles generally accepted in the United States of America.
Included within these policies are certain policies which contain critical
accounting estimates and, therefore, have been deemed to be "critical accounting
policies." Critical accounting estimates are those which require management to
make assumptions about matters that were uncertain at the time the estimate was
made and for which the use of different estimates, which reasonably could have
been used, or changes in the accounting estimates that are reasonably likely to
occur from period to period, could have a material impact on the presentation of
our financial condition, changes in financial condition or results of
operations. The Company has identified revenue recognition and legal matters as
its critical accounting policies.

Revenue Recognition.

      Revenue is recognized for product sales upon shipment when title and risk
of loss have transferred to the customer and when provisions for estimates,
including discounts, rebates, promotional adjustments, price adjustments,
returns, chargebacks, and other potential adjustments are reasonably
determinable. Accruals for these provisions are presented in the Consolidated
Financial Statements as reductions to net revenues and within other current
liabilities. Other current liabilities include $1,267,000 and $824,000 at
December 31, 2004 and 2003, respectively, for certain rebates and other
adjustments that are paid to customers.


                                     - 50 -
<PAGE>

      Provisions for estimated discounts, rebates, promotional and other credits
are estimated based on historical payment experience, historical relationship to
revenues, estimated customer inventory levels and contract terms. Such
provisions are determinable due to the limited number of assumptions and
consistency of historical experience. Others, such as price adjustments, returns
and chargebacks, require management to make more subjective judgments and
evaluate current market conditions. These provisions are discussed in further
detail below.

      Price Adjustments -- Price adjustments, which include shelf stock
adjustments, are credits issued to reflect decreases in the selling prices of
our products. Shelf stock adjustments are based upon the amount of product that
our customers have remaining in their inventories at the time of the price
reduction. Decreases in our selling prices are discretionary decisions made by
us to reflect market conditions. Amounts recorded for estimated price
adjustments are based upon specified terms with direct customers, and in the
case of shelf stock adjustments, estimates of inventory held by the customer.

      Returns -- Consistent with industry practice, we maintain a return policy
that allows our customers to return product within a specified period prior to
and subsequent to the expiration date. Our estimate of the provision for returns
is based upon our historical experience with actual returns, which is applied to
the level of sales for the period that corresponds to the period during which
our customers may return product. This period is known by us based on the shelf
lives of our products at the time of shipment.

      Chargebacks -- The provision for chargebacks is the most significant
estimate used in the recognition of revenue. The Company markets products
directly to wholesalers, distributors, retail pharmacy chains, mail order
pharmacies and group purchasing organizations. The Company also markets products
indirectly to independent pharmacies, managed care organizations, hospitals,
nursing homes and pharmacy benefit management companies, collectively referred
to as "indirect customers." The Company enters into agreements with its indirect
customers to establish contract pricing for certain products. The indirect
customers then independently select a wholesaler whom they actually purchase the
products at these contracted prices. Alternatively, certain wholesalers may
enter into agreements with indirect customers which establish contract pricing
for certain products which the wholesalers provide. Under either arrangement,
the Company will provide credit to the wholesaler for any difference between the
contracted price with the indirect party and the wholesaler's invoice price.
Such credit is called a chargeback, while the difference between the contracted
price and the wholesaler's invoice price is referred to as the chargeback rate.
The provision for chargebacks is based on expected sell-through levels by our
wholesaler customers to indirect customers, as well as estimated wholesaler
inventory levels. For the latter, in most cases, inventory levels are obtained
directly from certain of our largest wholesalers. Additionally, internal
estimates are prepared based upon historical buying patterns and estimated end
user demand. Such information allows us to estimate the potential chargeback
that we may ultimately owe to our customers given the quantity of inventory on
hand. We continually monitor our provision for chargebacks and evaluate our
reserve and estimates as additional information becomes available.

Legal Matters.

      The Company is involved in various legal proceedings, one of which
involves claims for substantial amounts. An estimate is made to accrue for a
loss contingency relating to any of these legal proceedings if it is probable
that a liability was incurred as of the date of the financial statements and the
amount of loss can be reasonably estimated. Because of the subjective nature
inherent in assessing the outcome of litigation and because of the potential
that an adverse outcome in a legal proceeding could have a material impact on
the Company's financial position or results of operations, such estimates are
considered to be critical accounting estimates. After review, it was determined
at December 31, 2004 that for each of the various legal proceedings in which we
are involved, the conditions mentioned above were not met. The Company will
continue to evaluate all legal matters as additional information becomes
available.


                                     - 51 -
<PAGE>

Recent Accounting Pronouncements.

      In January 2003, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable
Interest Entities ("FIN 46(R)"). FIN 46(R) addresses the consolidation of
business enterprises to which the usual condition (ownership of a majority
voting interest) of consolidation does not apply. FIN 46(R) focuses on
controlling financial interests that may be achieved through arrangements that
do not involve voting interests. It concludes that in the absence of clear
control through voting interests, a company's exposure (variable interest) to
the economic risks and potential rewards from the variable interest entity's
assets and activities are the best evidence of control. If an enterprise holds a
majority of the variable interests of an entity, it would be considered the
primary beneficiary. Upon consolidation, the primary beneficiary is generally
required to include assets, liabilities and non-controlling interests at fair
value and subsequently account for the variable interest as if it were
consolidated based on majority voting interest. As a result of FIN 46(R),
effective as of December 31, 2004, the Company's consolidated balance sheet
includes the assets and liabilities of York Realty Leasing LLC.

      In November 2004, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 151, Inventory Costs - an Amendment of ARB No. 43,
Chapter 4. SFAS 151 clarifies the accounting for abnormal amounts of idle
facility expense, freight, handling costs and spoilage. SFAS 151 also requires
that allocation of fixed production overhead costs be based on normal production
activity. The provisions of SFAS 151 are effective for inventory costs incurred
beginning in January 2006, with adoption permitted for inventory costs incurred
beginning in January 2005. Adoption of this Statement is not expected to have a
material effect on the Company's Consolidated Financial Statements.

      In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment.
SFAS 123(R) establishes standards for the accounting for transactions in which
an entity exchanges its equity instruments for goods and services. Under SFAS
123(R), companies will no longer be able to account for share-based compensation
transactions using the intrinsic method in accordance with APB No. 25,
Accounting for Stock Issued to Employees. Instead, companies will be required to
account for such transactions using a fair-value method and to recognize
compensation expense over the period during which an employee is required to
provide services in exchange for the award. In April 2005, the SEC delayed the
effective date of SFAS 123(R) to fiscal years beginning after June 15, 2005.
Management is currently assessing the impact that adoption of this Statement
will have on the Company's Consolidated Financial Statements.

      In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections - a Replacement of APB Opinion No. 20 and SFAS No. 3. SFAS 154
changes the requirements for the accounting for and reporting of a change in
accounting principle. This Statement applies to all voluntary changes in
accounting principle. SFAS 154 also applies to changes required by an accounting
pronouncement in the usual instance that the pronouncement does not include
specific transition provisions. The provisions of SFAS 154 are effective for
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. Adoption of this Statement is not expected to have a
material effect on the Company's Consolidated Financial Statements.


                                     - 52 -
<PAGE>

Inflation.

      We believe that our results of operations are not dependent upon moderate
changes in inflation rates.

ITEM 7. FINANCIAL STATEMENTS

      Health-Chem submits with this report the financial statements and related
information listed in the Index to Consolidated Financial Statements on page F-1
following this report's signature page.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

      On February 4, 2005, we retained the services of Demetrius & Company,
L.L.C. to serve as our independent accountant to audit our financial statements.
We had not retained an independent auditor since 2000. The engagement of
Demetrius & Company was approved by our Board of Directors.

      Prior to its engagement, we had not consulted with Demetrius & Company,
L.L.C. regarding the application of accounting principles to a specific
completed or contemplated transaction, or the type of audit opinion that would
be rendered on our financial statements. Moreover, we did not seek, and
Demetrius & Company, L.L.C. did not furnish, written or oral advice on any
matter that we considered an important factor in reaching a decision as to an
accounting, auditing or financial reporting issue.

      Demetrius & Company's offices are located at Wayne Interchange Plaza II,
155 Route 46, Wayne, New Jersey 07470.

ITEM 8A. CONTROLS AND PROCEDURES

      We maintain disclosure controls and procedures designed to ensure that
information required to be disclosed in our reports filed or submitted under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the SEC's rules and forms. As of the end of
the period covered by this Annual Report on Form 10-KSB, we carried out an
evaluation, under the supervision and with the participation of management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation,
management and our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures are effective. During the periods
covered by this Annual Report on Form 10-KSB, there was no change in our
internal control over financial reporting (as defined in Rule 13a-15(f) under
the Exchange Act) that materially effected, or is reasonably likely to
materially effect, our internal control over financial reporting.

ITEM 8B. OTHER INFORMATION

None


                                     - 53 -
<PAGE>

                                    PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT

Directors and Executive Officers.

      The following table sets forth certain information about our directors and
executive officers as of July 1, 2006:

--------------------------------------------------------------------------------
                                                                     Year First
                                                                     Became
Name                   Age    Position                               a Director
----                   ---    --------                               ----------
--------------------------------------------------------------------------------

Andy E. Yurowitz       71     Chairman of the Board, President,      2000
                              Chief Executive Officer and Director

--------------------------------------------------------------------------------
Ronald J. Burghauser   45     Chief Financial Officer, Treasurer
                              and Secretary

--------------------------------------------------------------------------------
Andrew J. Levinson     57     Director                               2000

--------------------------------------------------------------------------------
Manfred Mayerfeld      74     Director                               2000
--------------------------------------------------------------------------------

      The Company's directors are elected to hold office until the next annual
meeting of shareholders and until their respective successors have been elected
and qualified. The Company's officers serve at the pleasure of the Board of
Directors.

      Set forth below is biographical information concerning our directors and
executive officers for at least the past five years. All of the following
persons who are executive officers are also full-time employees.

      Andy E. Yurowitz has served as Chairman of the Board of Directors of the
Company since February 2000. Mr. Yurowitz has also served as Chairman of the
Board of Directors of Transderm Laboratories Corporation since February 2000.

      Ronald J. Burghauser, a certified public accountant, has served as Chief
Financial Officer, Treasurer and Secretary of the Company since November 2003.
From May 2002 through October 2003, Mr. Burghauser was Controller of the
Company. From April 1999 through September 2001, Mr. Burghauser was Chief
Financial Officer for Oakworks, Inc., a manufacturer of therapeutic equipment.

      Andrew J. Levinson has been a practicing attorney for more than
twenty-nine years. From September 2002 to the present, Mr. Levinson has been
counsel to Greenberg & Kahr in New York City. Previously he was a partner in
Phillips Nizer, LLP from March 2001 to August 2002.

      Manfred Mayerfeld retired from teaching in 1991. Since then he has been
active in real estate investing and property management.


                                     - 54 -
<PAGE>

Section 16(a) Beneficial Ownership Reporting Compliance

      Section 16(a) of the Securities Act of 1934 requires the Company's
officers and directors, and greater than 10% stockholders, to file reports of
ownership and changes in ownership of its securities with the SEC. Copies of the
reports are required by SEC regulation to be furnished to the Company. Based on
management's review of these reports during the year ended December 31, 2004,
none of the reports required to be filed were filed on a timely basis.
Management advises that it will endeavor to cause its officers and directors to
file all required Section 16(a) reports within thirty days of the date hereof.

Code of Ethics

      Our Board of Directors has adopted a Code of Ethics that applies to our
Chief Executive Officer, our Chief Financial Officer and to the other senior
management and senior financial staff of our company. Our Code of Ethics
complies with the requirements imposed by the Sarbanes-Oxley Act of 2002 and the
rules and regulations issued thereunder for codes of ethics applicable to such
officers. Our Board of Directors has reviewed and will continue to evaluate its
role and responsibilities with respect to the new legislative and other
requirements of the SEC. Interested persons can obtain a copy of our Code of
Ethics, without charge and upon request, by writing to the Company's Secretary
at: Health-Chem Corporation, 101 Sinking Springs Lane, Emigsville, PA 17318.

ITEM 10. EXECUTIVE COMPENSATION

Directors' Compensation

      The Company does not compensate its employee directors for services
rendered as directors. The Company reimburses non-employee directors for travel
and related expenses for attending board meetings. Effective January 1, 2006,
non-employee directors receive $1,250 per month, an additional fee of $1,000 for
each board meeting attended in person, $500 for each board meeting attended
telephonically and $500 for each committee meeting attended that is
independently scheduled. Effective January 1, 2006, the Company's outside
directors will receive an annual award of 20,000 stock options under the
Company's equity incentive plan. These awards are granted quarterly on the first
business day of each calendar quarter, with an exercise price equal to the
market price on such date. During the period January 2000 through December 2005,
non-employee directors received no fees and only were reimbursed was for travel
and related expenses for attending board meetings.

Executive Compensation

      The following Summary Compensation Table sets forth certain information
concerning the annual and long-term compensation of the person serving as the
Company's chief executive officer and each other executive officer who received
annual compensation in excess of $100,000 during the last two fiscal years
(collectively, the "Named Executives").


                                     - 55 -
<PAGE>

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------
                                                         SUMMARY COMPENSATION TABLE
------------------------------------------------------------------------------------------------------------------------------
                                                                                Long Term Compensation
------------------------------------------------------------------------------------------------------------------------------
                                    Annual Compensation                   Awards                     Payouts
------------------------------------------------------------------------------------------------------------------------------
                                                                          Restricted  Securities
                                                           Other Annual   Stock       Underlying                  All Other
Name and                            Salary       Bonus     Compensation   Award(s)    Options/SARs   LTIP         Compensation
Principle Position         Year     ($)          ($)       ($)            ($)         (#)            Payouts ($)  ($)(2)
------------------------------------------------------------------------------------------------------------------------------
<S>                        <C>      <C>          <C>       <C>            <C>         <C>            <C>          <C>
Andy Yurowitz,
President, Chief           2004     $145,974
Executive Officer
and Chairman               2003     $142,100
------------------------------------------------------------------------------------------------------------------------------
Ronald J. Burghauser,
Chief
Financial
Officer                    2004     $117,036     $  4,600                                                         $  1,583
------------------------------------------------------------------------------------------------------------------------------
Kenneth Brody,
Former
Chief
Financial
Officer (1)                2003     $116,000                                                                      $  1,746
------------------------------------------------------------------------------------------------------------------------------
Donald E. Kauffman,
Former Vice President      2004     $112,800                                                                      $  1,613
Transderm Laboratories
Corp. and Hercon
Laboratories Corp.         2003     $128,558                                                                      $  1,868
------------------------------------------------------------------------------------------------------------------------------
Richard L. Bulwicz,
Manager - Quality
Operations                 2004     $ 97,575     $  3,900                                                         $  1,412
------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1)   Mr. Brody resigned as our Chief Financial Officer in November 2003 and was
      replaced by Mr. Burghauser in the same month

(2)   Consists of the Company matching contributions under our 401(K) plan and
      the term cost value of all excess group life insurance policies on behalf
      of the Named Executives.


                                     - 56 -
<PAGE>

Option Grants 1999-2004.

      The following table presents certain information concerning stock options
granted to the Named Executives under our various stock option plans and
currently outstanding from 1999, the last year for which we filed an annual
report under the Securities Exchange Act of 1934, through 2004:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------
                                                                                 Option/SAR Grants 1999 - 2004
-----------------------------------------------------------------------------------------------------------------------------
                                                                                       Individual Grants
-----------------------------------------------------------------------------------------------------------------------------
                                       Number of Securities      % of Total Options/SARs     Exercise or
                                       Underlying Options/SARs   Granted to Employees in     Base Price
Name                   Year Granted    Granted (#)               Fiscal Year                 ($/Sh)           Expiration Date
-----------------------------------------------------------------------------------------------------------------------------
<S>                        <C>           <C>                        <C>                       <C>             <C>
Andy Yurowitz              2002          837,500                    45.38%                    $0.100          April 18, 2007

Manfred Mayerfeld          2002          958,000                    51.91%                    $0.100          April 18, 2007

Ken Brody                  2002           50,000                     2.71%                    $0.100          April 18, 2007
</TABLE>

Aggregated Option Exercises 1999-2004 and Fiscal Year End Option Values as of
December 31, 2004

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
                                                                                           Value of Unexercised
                                                                 Number of Securities      In-the-Money
                                                                 Underlying Unexercised    Options at
                                                                 Options at 12/31/04       12/31/04 (2)
                        Shares Acquired        Value             Exercisable/              Exercisable/
Name                    on Exercises (#) (1)   Realized ($) (1)  Unexercisable (#)         Unexercisable ($)
----                    --------------------   ----------------  -----------------         -----------------
---------------------------------------------------------------------------------------------------------------
<S>                             <C>                   <C>        <C>                       <C>
Andy E. Yurowitz                --                    --         837,500/0                 0/0
---------------------------------------------------------------------------------------------------------------
Kenneth E. Brody                --                    --         50,000/0                  0/0
---------------------------------------------------------------------------------------------------------------
Murray Lieber                   --                    --         100,000/0                 0/0
---------------------------------------------------------------------------------------------------------------
</TABLE>

(1)   None of the Named Executives exercised any stock options during the period
      1999 through 2004.

(2)   Based upon the last sales price of the Company's common stock reported as
      traded in 2004 on the Pink Sheets minus the respective option exercise
      price.


                                     - 57 -
<PAGE>

Equity Compensation Plan Information.

      The following table sets forth additional information as of December 31,
2004 concerning shares of our common stock that may be issued upon the exercise
of options and other rights under our existing equity compensation plans,
divided between plans approved by our stockholders and plans not submitted to
our stockholders for approval. The information includes the number of shares
covered by, and the weighted average exercise price of, outstanding options and
the number of shares remaining available for future grants excluding the shares
to be issued upon exercise of outstanding options, warrants, and other rights.

                      Equity Compensation Plan Information

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------------
Plan Category                              (a)                            (b)                              (c)
                              Number of securities to be           Weighted-average         Number of securities available
                              issued upon exercise of              exercise price of        for future issuance under equity
                              outstanding  options, warrants       outstanding              compensation plans (excluding
                              and rights                           options, warrants        securities reflected in column (a))
                                                                   and rights
-------------------------------------------------------------------------------------------------------------------------------
<S>                           <C>                                  <C>                                      <C>
Equity compensation
plans approved
by security holders
-------------------------------------------------------------------------------------------------------------------------------
Equity compensation           4,086,587 (1)                        $0.177
plans not approved
by security holders
-------------------------------------------------------------------------------------------------------------------------------

Total                         4,086,587                            $0.177                                   0
-------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1)   At certain times, the Board of Directors deemed it beneficial to the
      Company to issue specific amounts of stock options to selected option
      holders. These option grants were for specific purposes, as follows: (i)
      1,845,500 options granted to option holders who loaned funds to the
      Company; (ii) 1,100,000 options granted to option holders who provided
      consulting services to the Company; (iii) 691,087 options granted to a
      former mortgage holder as part of the contract in obtaining a mortgage;
      (iv) 250,000 options granted to non-employee directors in lieu of the
      directors receiving compensation for attending board meetings; (v) 100,000
      options granted to a former employee upon his separation from the Company;
      and (vi) 100,000 options granted to a director as an incentive.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
         RELATED STOCKHOLDER MATTERS.

      The following table sets forth information, as of May 1, 2006 with respect
to the beneficial ownership of our common stock by each person known by us to be
the beneficial owner of more than 5% of the outstanding common stock, by each of
our officers and directors, and by all of our officers and directors as a group.

      For the purpose of this table, the beneficial ownership of a person
includes shares as to which that person has sole or shared voting or investment
power as well as shares that the person has the right to acquire within 60 days
(such as upon conversion of convertible securities or exercise of warrants or
options) as of May 1, 2006. For the purpose of calculating the ownership
percentages for each person listed, we have considered to be outstanding both
the total number shares actually outstanding on May 1, 2006 and the total number
of shares that various people then had the right to acquire within 60 days of
said date.


                                     - 58 -
<PAGE>

--------------------------------------------------------------------------------
                                   Number of Shares
                                   Beneficially
Name and Address                   Owned as of                   Percent
of Beneficial Owner (1)            May 1, 2006 (2)               of Class (3)
-----------------------            ---------------               ------------
--------------------------------------------------------------------------------
Andy E. Yurowitz                      2,444,700(4)                  19.91%

--------------------------------------------------------------------------------
Manfred Mayerfeld                     1,814,789(5)                  14.62%

--------------------------------------------------------------------------------
Andrew J. Levinson                      210,000(6)                   1.83%

--------------------------------------------------------------------------------
Ronald J. Burghauser                     75,780(7)                      *

--------------------------------------------------------------------------------
Marvin Speiser (8)                    2,304,674(8)                  20.14%
--------------------------------------------------------------------------------

   All directors and
   executive officers as a
   group (4 persons)                  4,545,269(9)                  34.28%
--------------------------------------------------------------------------------

(1)   Address is c/o Health-Chem Corporation, 101 Sinking Springs Lane,
      Emigsville, PA 17318.

(2)   The information concerning security holders is based upon information
      furnished to the Company by such security holder. Except as otherwise
      indicated, all of the shares are owned of record and beneficially and the
      persons identified have sole voting and dispositive power with respect
      thereto.

(3)   Based upon 11,443,424 shares of common stock outstanding on May 1, 2006.

(4)   Includes (i) 1,607,100 shares of common stock, (ii) 837,500 shares of
      common stock issuable upon the exercise of all stock options which are or
      exercisable within 60 days of the date hereof; and (iii) 100 shares where
      voting and/or dispositive power is shared with another individual.

(5)   Includes the following shares of common stock: (i) 755,600 shares: (ii)
      968,000 shares issuable upon the exercise of all stock options which are
      exercisable within 60 days of the date hereof; and (iii) 91,189 shares
      where voting and/or dispositive power is shared with another individual.

(6)   Includes the following shares of common stock: (i) 200,000 shares and (ii)
      10,000 shares issuable upon the exercise of all stock options exercisable
      within 60 days of the date hereof.

(7)   Includes 780 shares where voting and/or dispositive power is shared with
      another individual.

(8)   Includes the following shares of common stock: (i) 1,516,593 shares
      registered in the name of Laura Speiser; (ii) 512,763 shares registered in
      the name of Marvin Speiser (deceased); (iii) 266,664 shares registered in
      the name of Lauralei Investors, Inc., of which Marvin Speiser and his
      wife, Laura Speiser, are the sole stockholders; and (iv) 8,654 registered
      in the name of Robert Speiser. The Company has not been in contact with
      the Speisers since 1999 and has no knowledge of the relationship among
      family members.

(9)   Includes 1,815,500 shares of common stock issuable upon the exercise of
      options which are exercisable within 60 days of the date hereof.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

      In December 2004, the Company sold its real property, buildings,
improvements and equipment located in Emigsville, Pennsylvania to York Realty
Leasing LLC for a sale price of $1.9 million. Concurrent with the sale, the
Company entered into a 15-year lease for the property expiring in December 2019,
which can be extended by the Company for an additional five years. The agreement
provides for a Company repurchase option at a price of $1,995,000. The annual
lease cost during the initial 15 year term is $212,400. In December 2002, the
Company had received an appraisal for the real property, including the
structures and appurtenances, by Weinstein Realty Advisors, an independent real
estate agent located in York, Pennsylvania, which appraised the market value of
the real property and structures at $1,850,000. The proceeds from the sale were
used to satisfy a $1.6 million first mortgage associated with the property and
to substantially pay off a $367,500 Second Mortgage (the "Second Mortgage"). Mr.
Andy E. Yurowitz, the Company's Chairman of the Board, President, Chief
Executive Officer and a member of the Board of Directors, is a 50% owner of York
Realty Leasing LLC. The Company entered into the sale/leaseback arrangement with
York Realty Leasing LLC because it required cash and was unable to obtain a loan
or any other financing from an unaffiliated party on any basis.


                                     - 59 -
<PAGE>

      Since 1999, Andy Yurowitz, the Company's Chairman of the Board, President,
Chief Executive Officer and a member of the Board of Directors, either has
loaned funds or furnished the Company with cash for the purposes and on the
terms described below:

      o     During 2000 and 2001, Mr. Yurowitz provided the Company with an
            aggregate of $167,500 at various times and for various purposes
            including working capital, to pay creditors and to meet payroll.
            These loans accrued interest at the rate of 18% per annum, the
            amount charged by credit card companies for corporate expenses Mr.
            Yurowitz charged to his credit cards. The Company repaid the
            principal amount of the loans during 2001 and 2003 along with
            aggregate interest of $77,781. In addition to receiving interest on
            these loans, the Company granted to Mr. Yurowitz five-year options
            to purchase up to 837,500 shares of the Company's common stock (five
            options for each dollar loaned) at an exercise price of $0.10 which
            expire in April 2007.

      o     In 1999, Mr. Yurowitz expended $60,000 in connection with a
            successful proxy contest brought against Health-Chem in 1999 by a
            group led by him. The Company repaid the principal amount of this
            loan during 2001 and 2003 with interest of $31,770 (equal to 18% per
            annum).

      o     During 2001 and 2002, Mr. Yurowitz loaned the Company an aggregate
            of $107,500 which was secured by the Second Mortgage on the
            Company's real property and manufacturing equipment located at its
            facilities in Emigsville, Pennsylvania. This loan accrued interest
            at the rate of 12.5% per annum. The Company repaid the principal
            amount of this loan in December 2004 along with accrued interest of
            $41,526. As described below, certain other directors and officers
            participated in the loan to the Company which was secured by the
            Second Mortgage. In connection with this loan, the Company received
            an opinion dated August 15, 2001 from its financial advisor, KSH
            Investment Group Inc. ("KSH"), that the transaction was fair to the
            Company from a financial point of view. KSH also opined that at that
            time the Company's common stock had little or no value.

      Since 1999, Manfred Mayerfeld, a member of the Board of Directors, either
has loaned funds or furnished the Company with cash for the purposes and on the
terms described below:

      o     During 2000 and 2001, Mr. Mayerfeld provided the Company with an
            aggregate of $191,600 at various times and for various purposes
            including working capital, to pay creditors and to meet payroll.
            These loans accrued interest at the rate of 18% per annum. The
            Company repaid the principal amount of the loans during 2001 and
            2003 along with aggregate interest of $91,783 during 2004. In
            addition to receiving interest on these loans, the Company granted
            to Mr. Mayerfeld five-year options to purchase up to 958,000 shares
            of the Company's common stock (five options for each dollar loaned)
            at an exercise price of $0.10 which expire in April 2007.


                                     - 60 -
<PAGE>

      o     In 1999, Mr. Mayerfeld expended $40,000 in connection with a
            successful proxy contest brought against Health-Chem in 1999 by a
            group led by Mr. Yurowitz. The Company repaid the principal amount
            of this loan during 2004 with interest of $25,700 (equal to 18% per
            annum).

      o     During 2001, Mr. Mayerfeld loaned the Company an aggregate of
            $50,000 which was secured by the Second Mortgage on the Company's
            real property and manufacturing equipment located at its facilities
            in Emigsville, Pennsylvania. This loan accrued interest at the rate
            of 12.5% per annum. The Company repaid the principal amount of this
            loan in December 2004 along with accrued interest of $21,174 in
            January 2005.

      During 2001, Andrew Levinson, a member of the Board of Directors of
Health-Chem, loaned the Company $25,000 (before deducting the sum of $2,846
which was owed to him in connection with funds he advanced on the Company's
behalf in connection with the lease of an automobile by the Company) which it
utilized for various corporate purposes and which was secured by the Second
Mortgage on the Company's real property and manufacturing equipment located at
its facilities in Emigsville, Pennsylvania. This loan accrued interest at the
rate of 12.5% per annum. The Company repaid the principal amount of this loan in
December 2004 along with accrued interest of $10,818 in January 2005.

      Since 1999, Ken Brody, a former officer of Health-Chem, either had loaned
funds or furnished the Company with cash for the purposes and on the terms
described below:

      o     During 2001 and 2002, Mr. Brody provided the Company with an
            aggregate of $40,135 at various times and for various purposes
            including working capital, to pay creditors and to meet payroll. A
            number of the loans were repaid without interest. A loan for $10,000
            accrued interest at the rate of 18% per annum. The Company repaid
            the principal amount of this loan during 2002 along with aggregate
            interest of $2,670. In addition to receiving interest the $10,000
            loan, the Company granted to Mr. Brody five-year options to purchase
            up to 50,000 shares of the Company's common stock (five options for
            each dollar loaned) at an exercise price of $0.10 which expire in
            April 2007.

      o     During 2001 and 2002, Mr. Brody loaned the Company an aggregate of
            $60,000 which was secured by the Second Mortgage on the Company's
            real property and manufacturing equipment located at its facilities
            in Emigsville, Pennsylvania. This loan accrued interest at the rate
            of 12.5% per annum. The Company repaid the principal amount of this
            loan in December 2004 along with accrued interest of $22,803.


                                     - 61 -
<PAGE>

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
Exhibit                                                                              Location
No.           Description                                                            Reference
---           -----------                                                            ---------
------------------------------------------------------------------------------------------------------------------------------------
<S>           <C>                                                                    <C>
2             Plan of Reorganization and Asset Exchange Agreement                    Incorporated herein by reference to Exhibit
              dated as of June 30, 1995, by and among the Registrant,                2 to Registration Statement on
              Herculite Products, Inc. and Transderm Laboratories Corporation.       Form S-1 (Reg. No. 33-95080) for Transderm,
                                                                                     as filed with the Commission on July 28,
                                                                                     1995.
------------------------------------------------------------------------------------------------------------------------------------
3.1           Restated Certificate of Incorporation and amendments                   Incorporated herein by reference to
              of the Registrant.                                                     Exhibit No. 3 to the Registrant's Annual
                                                                                     Report on Form 10-K for the year ended
                                                                                     December 31, 1985.
------------------------------------------------------------------------------------------------------------------------------------
3.2           Certificate of Amendment of the Restated Certificate of                Incorporated herein by reference to
              Incorporation of the Registrant dated May 8, 1987.                     Exhibit No. 3.2 to the Registrant's
                                                                                     Annual Report on Form 10-K for the
                                                                                     year ended December 31, 1987.
------------------------------------------------------------------------------------------------------------------------------------
3.3           By-Laws of the Registrant.                                             Incorporated herein by reference to
                                                                                     Exhibit 3.3 to the Registrant's Annual
                                                                                     Report on Form 10-K for the year
                                                                                     ended December 31, 1991.
------------------------------------------------------------------------------------------------------------------------------------
4.1           Indenture between the Registrant and Bankers Trust Company dated as    Incorporated herein by reference to
              of April 15, 1981 relating to the Registrant's 10 3/8% Convertible     Exhibit No. 4.2 to the Registrant's
              Subordinated Debentures due 1999.                                      Registration Statement on Form S-7
                                                                                     (Reg. No. 2-71341) as filed with the
                                                                                     Commission on April 15, 1981.
------------------------------------------------------------------------------------------------------------------------------------
4.2           Form of 10 ?% Convertible Subordinated Debenture due April 15, 1999.   Incorporated herein by reference
                                                                                     to the Registrant's Registration Statement
                                                                                     on Form S-7 (Reg. No. 2-71341) as filed with
                                                                                     the Commission on April 15, 1981.
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                     - 62 -
<PAGE>

<TABLE>
------------------------------------------------------------------------------------------------------------------------------------
<S>           <C>                                                                    <C>
4.3           Common Stock Purchase Warrant for the purchase of up to 712,500        Filed herewith.
              shares of common stock issued by the Registrant in favor of Lazar &
              Company IG LLC.
------------------------------------------------------------------------------------------------------------------------------------
4.4           Common Stock Purchase Warrant for the purchase of up to 237,500        Filed herewith.
              shares of common stock issued by the Registrant in favor of Hillel
              Zakai.
------------------------------------------------------------------------------------------------------------------------------------
4.5           Common Stock Purchase Warrant for the purchase of up to 50,000         Filed herewith.
              shares of common stock issued by the Registrant in favor of Adam
              Epner.
------------------------------------------------------------------------------------------------------------------------------------
4.6           Registration Rights Agreement between the Registrant and Lazar &       Filed herewith.
              Company IG LLC dated December 2003.
------------------------------------------------------------------------------------------------------------------------------------
10.1          The 1986 Stock Option Plan as approved by the Registrant's             Incorporated herein by reference to
              Stockholders on April 26, 1986 and as amended by the Registrant's      Exhibit No. 10.7 to the Registrant's
              Board of Directors on December 30, 1987.                               Annual Report on Form 10-K for the
                                                                                     year ended December 31, 1987.
------------------------------------------------------------------------------------------------------------------------------------
10.2          Second Amendment to the 1986 Stock Option Plan as                      Incorporated herein by reference to
              approved by the Registrant's Board of Directors on May 6,              Exhibit 10.4 to the Registrant's Annual
              1993.                                                                  Report on Form 10-K for the year ended
                                                                                     December 31, 1993.
------------------------------------------------------------------------------------------------------------------------------------
10.3          The 1995 Performance Equity Plan.                                      Incorporated herein by reference to
                                                                                     Exhibit A to the Registrant's definitive
                                                                                     Proxy Statement dated March 1, 1995 in
                                                                                     connection with the Registrant's 1995 Annual
                                                                                     Meeting of Stockholders.
------------------------------------------------------------------------------------------------------------------------------------
10.4          Asset Acquisition Agreement dated April 28, 1995 between Hercon        Incorporated herein by reference to
              Environmental Corporation and Hercon Laboratories Corporation.         Exhibit 10.7 to Transderm Laboratories
                                                                                     Corporation's Registration Statement on
                                                                                     Form S-1 as filed with the Commission on
                                                                                     July 28, 1995.
------------------------------------------------------------------------------------------------------------------------------------
10.5          Modification Agreement dated August 31, 1995 by and between The        Incorporated herein by reference
              First National Bank of Maryland, the Registrant, Hercon Laboratories   to Exhibit 10.6(b) to Amendment No. 1
              Corporation, Herculite Products, Inc., Pacific Combining               to Transderm Laboratories Corporation's
              Corporation, Hercon Environmental Corporation and Transderm            Registration Statement on Form S-1 filed with
              Laboratories Corporation.                                              the Commission on September 6, 1995.
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                     - 63 -
<PAGE>

<TABLE>
------------------------------------------------------------------------------------------------------------------------------------
<S>           <C>                                                                    <C>
10.6          $7,000,000 principal amount Subordinated Promissory Note of Hercon     Incorporated herein by reference to
              Laboratories Corporation.                                              Exhibit 10.8 to Amendment No. 1 to Transderm
                                                                                     Laboratories Corporation's Registration
                                                                                     Statement on Form S-1 filed with the
                                                                                     Commission on September 6, 1995.
------------------------------------------------------------------------------------------------------------------------------------
10.7          Corporate Services Agreement dated as of August 31, 1995 between the   Incorporated herein by reference to
              Registrant and Transderm Laboratories Corporation.                     Exhibit 10.9 to Amendment No. 1 to Transderm
                                                                                     Laboratories Corporation's Registration
                                                                                     Statement on Form S-1 filed with the
                                                                                     Commission on September 6, 1995 .
------------------------------------------------------------------------------------------------------------------------------------
10.8          Tax Sharing Agreement dated as of August 31, 1995 between the          Incorporated herein by reference to
              Registrant and Transderm.                                              Exhibit 10.10 to Amendment No. 1 to
                                                                                     Transderm Laboratories Corporation's
                                                                                     Registration Statement on Form S-1 filed
                                                                                     with the Commission on September 6, 1995.
------------------------------------------------------------------------------------------------------------------------------------
10.9          Second Modification Agreement dated as of October 11, 1995 by and      Incorporated herein by reference to
              among the Registrant, Hercon Laboratories Corporation, Herculite       Exhibit 10.5 to the Registrant's
              Products, Inc., Pacific Combining Corporation, Hercon Environmental    Quarterly Report for the for the Quarter
              Corporation and Transderm Laboratories Corporation.                    ended September 30, 1995
------------------------------------------------------------------------------------------------------------------------------------
10.10         Loan and Security Agreement dated as of October 11, 1995 by and        Incorporated herein by reference to
              among the Registrant, Hercon Laboratories Corporation, Herculite       Exhibit 1 to the Registrant's Current Report
              Products, Inc., Pacific Combining Corporation, Hercon Environmental    on Form 8-K filed with the Commission on
              Corporation and Transderm Laboratories Corporation and The First       October 11, 1995.
              National Bank of Maryland.
------------------------------------------------------------------------------------------------------------------------------------
10.11         Revolving Credit, Term Loan and Security Agreement dated as of         Incorporated herein by reference to
              January 9, 1997 by and among the Registrant, Hercon Laboratories       Exhibit 1 to the Registrant's Current
              Corporation, Herculite Products, Inc., Pacific Combining               Report on Form 8-K dated January 22, 1997.
              Corporation, Hercon Environmental Corporation, Transderm
              Laboratories Corporation and IBJ Schroder Bank & Trust Company.
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                     - 64 -
<PAGE>

<TABLE>
------------------------------------------------------------------------------------------------------------------------------------
<S>           <C>                                                                    <C>
10.12         First Amendment to Revolving Credit, Term Loan and Security            Incorporated herein by reference to
              Agreement dated as of January 21, 1998 by and among the Registrant,    Exhibit 10.18(b) to the Registrant's
              Hercon Laboratories Corporation, Herculite Products, Inc., Pacific     Form 10-K for the year ended
              Combining Corporation, Hercon Environmental Corporation, Transderm     December 31, 1997.
              Laboratories Corporation and IBJ Schroder Business Credit
              Corporation (as successor in interest to IBJ Schroder & Trust
              Company).
------------------------------------------------------------------------------------------------------------------------------------
10.13         Second Amendment to Revolving Credit, Term Loan and                    Incorporated herein by reference to
              Security Agreement dated as of July 31, 1998 by and among the          Exhibit 6.(a) to the Registrant's Form
              Registrant, Hercon Laboratories Corporation, Herculite Products        10-Q for the quarter ended September
              Inc., Pacific Combining Corporation,  Hercon Environmental             30, 1998.
              Corporation, Transderm Laboratories Corporation and IBJ Schroder
              Business Credit Corporation.
------------------------------------------------------------------------------------------------------------------------------------
10.14         Waiver and Third Amendment to Revolving Credit, Term                   Incorporated herein by reference to
              Loan and Security Agreement dated as of January 11, 1999 by and        Exhibit 10.18(d) to the Registrant's
              among the Registrant, Hercon Laboratories Corporation, Herculite       Form 10-K for the year ended
              Products Inc., Pacific Combining Corporation,  Hercon Environmental    December 31, 1998.
              Corporation, Transderm Laboratories Corporation and IBJ Whitehall
              Business Credit Corporation.
------------------------------------------------------------------------------------------------------------------------------------
10.15         Consent and Fourth Amendment to Revolving Credit, Term Loan and        Incorporated herein by reference to
              Security Agreement dated as of March 24, 1999 by and among the         Exhibit 10.18(e) to the Registrant's
              Registrant, Hercon Laboratories Corporation, Herculite Products        Form 10-K for the year ended
              Inc., Pacific Combining Corporation,  Hercon Environmental             December 31, 1998.
              Corporation, Transderm Laboratories Corporation and IBJ Whitehall
              Business Credit Corporation.
------------------------------------------------------------------------------------------------------------------------------------
10.16         Amendment and Forbearance Agreements to Revolving Credit, Term Loan    Incorporated herein by reference to
              and Security Agreement dated as of April 14, 1999, May 14, 1999,       Exhibit 10.18(f) to the Registrant's
              June 21, 1999, July 15, 1999 and August 15, 1999 by and between the    Form 10-K for the year ended
              Registrant, Hercon Laboratories Corporation, Herculite Products        December 31, 1998.
              Inc., Pacific Combining Corporation,  Hercon Environmental
              Corporation, Transderm Laboratories Corporation and IBJ Whitehall
              Business Credit Corporation.
------------------------------------------------------------------------------------------------------------------------------------
10.17         Asset Purchase Agreement dated as of July 20, 1999 by and among        Incorporated herein by reference to Exhibit
              Herculite Products Inc., Hercon Environmental Corporation and          2.1 to the Company's Current Report on Form
              Aberdeen Road Company.                                                 8-K dated September 2, 1999.
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                     - 65 -
<PAGE>

<TABLE>
------------------------------------------------------------------------------------------------------------------------------------
<S>           <C>                                                                    <C>
10.18         License Agreement dated March 13, 2000 between Hercon Laboratories     Filed herewith.
              Corporation and Key Pharmaceuticals, Inc.
------------------------------------------------------------------------------------------------------------------------------------
10.19         Mortgage and Security Agreement dated May 23, 2000 between Transderm   Filed herewith.
              Laboratories Corporation and Mercury Capital Corp.
------------------------------------------------------------------------------------------------------------------------------------
10.20         Mortgage Note dated May 23, 2000 made by Transderm Laboratories        Filed herewith.
              Corporation in favor of Mercury Capital Corp.
------------------------------------------------------------------------------------------------------------------------------------
10.21         Guaranty of Registrant in favor of Mercury Capital Corp. dated May     Filed herewith.
              23, 2000.
------------------------------------------------------------------------------------------------------------------------------------
10.22         Assignment of Leases and Rents from Transderm Laboratories             Filed herewith.
              Corporation to Mercury Capital Corp. dated May 23, 2000.
------------------------------------------------------------------------------------------------------------------------------------
10.23         Mortgage Modification Agreement dated June 30, 2000 between            Filed herewith.
              Transderm Laboratories Corporation and Mercury Capital Corp.
------------------------------------------------------------------------------------------------------------------------------------
10.24         Mortgage Modification Agreement dated July 10, 2000 between            Filed herewith.
              Transderm Laboratories Corporation and Mercury Capital Corp.
------------------------------------------------------------------------------------------------------------------------------------
10.25         Assignment of Leases and Rents from Transderm Laboratories             Filed herewith.
              Corporation to Mercury Capital Corp. dated July 13, 2000.
------------------------------------------------------------------------------------------------------------------------------------
10.26         Guaranty of Registrant in favor of Mercury Capital Corp. dated July    Filed herewith.
              13, 2000.
------------------------------------------------------------------------------------------------------------------------------------
10.27         Sales Representative Agreement dated July 25, 2000 between Hercon      Filed herewith.
              Laboratories Corporation and Granard Pharmaceutical, LLP.
------------------------------------------------------------------------------------------------------------------------------------
10.28         Product Purchase Agreement dated February 28, 2001 between Hercon      Filed herewith.
              Laboratories Corporation and Ranbaxy Pharmaceuticals Inc. (portions
              of this Exhibit have been omitted pursuant to a request for
              confidential treatment and have been filed separately with the
              Commission).
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                     - 66 -
<PAGE>

<TABLE>
------------------------------------------------------------------------------------------------------------------------------------
<S>           <C>                                                                    <C>
10.29         Development Assistance Agreement dated February 28, 2001 between       Filed herewith.
              Hercon Laboratories Corporation and Ranbaxy Pharmaceuticals Inc.
              (portions of this Exhibit have been omitted pursuant to a request
              for confidential treatment and have been filed separately with the
              Commission).
------------------------------------------------------------------------------------------------------------------------------------
10.30         Finished Goods Supply Agreement dated February 28, 2001 between        Filed herewith.
              Hercon Laboratories Corporation and Ranbaxy Pharmaceuticals Inc.
              (portions of this Exhibit have been omitted pursuant to a request
              for confidential treatment and have been filed separately with the
              Commission).
------------------------------------------------------------------------------------------------------------------------------------
10.31         Amendment No. 1 to Sales Representative Agreement between Hercon       Filed herewith.
              Laboratories Corporation and Granard Pharmaceutical, LLP dated July
              24, 2001.
------------------------------------------------------------------------------------------------------------------------------------
10.32         Mortgage Note in the principal amount of $367,500 dated August 7,      Filed herewith.
              2001 among Transderm Laboratories Corporation and certain creditors,
              including affiliates of the Registrant and Transderm Laboratories
              Corporation.
------------------------------------------------------------------------------------------------------------------------------------
10.33         Collateral Agency and Intercreditor Agreement dated August 7, 2001     Filed herewith.
              among Transderm, certain creditors, including affiliates of the
              Registrant and Transderm Laboratories Corporation and Zackfoot
              Investments, LLC as collateral agent.
------------------------------------------------------------------------------------------------------------------------------------
10.34         Master Agreement dated as of February 15, 2002 among the Registrant,   Filed herewith.
              Leon Services, LLC, Jack Aronowitz and MA Associates
------------------------------------------------------------------------------------------------------------------------------------
10.35         Agreement dated May 22, 2002 among Zackfoot Investments, LLC, the      Filed herewith.
              holders of the Mortgage Note dated August 7, 2001 and Transderm
              Laboratories Corporation.
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                     - 67 -
<PAGE>

<TABLE>
------------------------------------------------------------------------------------------------------------------------------------
<S>           <C>                                                                    <C>
10.36         Promissory Note in the principal amount of $164,692.50  dated May      Filed herewith.
              22, 2002 among Transderm Laboratories Corporation and Zackfoot
              Investments, LLC and certain other lenders to Transderm Laboratories
              Corporation.
------------------------------------------------------------------------------------------------------------------------------------
10.37         Mortgage Note in the principal amount of $150,000 dated June 22,       Filed herewith.
              2002 made by Transderm Laboratories Corporation in favor of Albert
              David.
------------------------------------------------------------------------------------------------------------------------------------
10.38         Outline of Agreement between the Registrant and Jack Aronowitz, Leon   Filed herewith.
              Services LLC and Health-Chem Diagnostics, LLC, effective October 31,
              2003
------------------------------------------------------------------------------------------------------------------------------------
10.39         Development, Manufacturing and Supply Agreement dated June 10, 2004    Filed herewith.
              between Hercon Laboratories Corporation and Ranbaxy Pharmaceuticals
              Inc. (portions of this Exhibit have been omitted pursuant to a
              request for confidential treatment and have been filed separately
              with the Commission).
------------------------------------------------------------------------------------------------------------------------------------
10.40         Deed dated December 7, 2004 selling and transferring ownership of      Filed herewith.
              the land and building owned by Transderm Laboratories Corporation to
              York Realty Leasing LLC.
------------------------------------------------------------------------------------------------------------------------------------
10.41         Warranty Bill of Sale dated December 7, 2004 selling and               Filed herewith.
              transferring ownership of machinery and equipment owned by Hercon
              Laboratories Corporation to York Realty Leasing LLC.
------------------------------------------------------------------------------------------------------------------------------------
10.42         Commercial Lease Agreement dated December 7, 2004 by                   Filed herewith.
              and between York Realty Leasing LLC and Transderm
              Laboratories Corporation.
------------------------------------------------------------------------------------------------------------------------------------
10.43         Development, Manufacturing and Supply Agreement dated April 28, 2006   Filed herewith.
              between Hercon and Cure Therapeutics, Inc. (portions of this Exhibit
              have been omitted pursuant to a request for confidential treatment
              and have been filed separately with the Commission).
------------------------------------------------------------------------------------------------------------------------------------
14            Code of Ethics.                                                        Filed herewith.
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                     - 68 -
<PAGE>

<TABLE>
------------------------------------------------------------------------------------------------------------------------------------
<S>           <C>                                                                    <C>
21            Subsidiaries of the Registrant.                                        Filed herewith.
------------------------------------------------------------------------------------------------------------------------------------
31.1          Certification of Chief Executive Officer pursuant to Rule              Filed herewith.
              13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of
              the Sarbanes-Oxley Act of 2002.
------------------------------------------------------------------------------------------------------------------------------------
31.2          Certification of Chief Financial Officer pursuant to Rule              Filed herewith.
              13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of
              the Sarbanes-Oxley Act of 2002.
------------------------------------------------------------------------------------------------------------------------------------
32.1          Certification of Chief Executive Officer pursuant to 18 U.S.C.         Filed herewith.
              Section 1350, as adopted pursuant to Section 906 of the
              Sarbanes-Oxley Act of 2002.
------------------------------------------------------------------------------------------------------------------------------------
32.2          Certification of Chief Financial Officer pursuant to 18 U.S.C.         Filed herewith.
              Section 1350, as adopted pursuant to Section 906 of the
              Sarbanes-Oxley Act of 2002.
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(b) REPORTS ON FORM 8-K

During the quarter ended December 31, 2004 the Company did not file any reports
on Form 8-K.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Audit Fees

The aggregate fees billed by Demetrius & Company, L.L.C. for professional
services related to the audit of the Company's consolidated financial statements
for the fiscal years ended December 31, 2003 and 2004 were $152,891.

Audit-Related Fees

There were no fees billed by Demetrius & Company, L.L.C. for audit-related
services for the fiscal years ended December 31, 2003 or 2004.

Tax Fees

There were no fees billed by Demetrius & Company, L.L.C. for tax services during
the fiscal years ended December 31, 2003 or 2004.

All Other Fees

There were no fees billed by Demetrius & Company, L.L.C. for any other
professional services during the fiscal years ended December 31, 2003 or 2004.


                                     - 69 -
<PAGE>

                                   SIGNATURES

In accordance with Section 13 or 15(d) 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.

                                        HEALTH-CHEM CORPORATION

--------------------------------------------------------------------------------

Name and Capacity                                   Date
-----------------                                   ----

/s/ Andy E. Yurowitz                                July 7, 2006
---------------------------
By: Andy E. Yurowitz
Chairman of the Board,
President and Chief Executive
Officer (Principal Executive Officer)

--------------------------------------------------------------------------------

/s/ Ronald J. Burghauser                            July 7, 2006
---------------------------
By: Ronald J. Burghauser
Chief Financial Officer,
Treasurer and Secretary
(Principal Financial Officer)
(Principal Accounting Officer)
--------------------------------------------------------------------------------

In accordance with the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.

--------------------------------------------------------------------------------
        Person                           Capacity                     Date
        ------                           --------                     ----

--------------------------------------------------------------------------------
/s/ Andy E. Yurowitz         Chairman of the Board, President     July 7, 2006
------------------------     and Chief Executive Officer
Andy E. Yurowitz             (Principal Executive Officer) and
                             Director

--------------------------------------------------------------------------------
/s/ Ronald J. Burghauser     Chief Financial Officer,             July 7, 2006
------------------------     Treasurer and Secretary
Ronald J. Burghauser         (Principal Financial Officer)
                             (Principal Accounting Officer)

--------------------------------------------------------------------------------
/s/ Andrew J. Levinson       Director                             July 7, 2006
------------------------
Andrew J. Levinson

--------------------------------------------------------------------------------
/s/ Manfred Mayerfeld        Director                             July 7, 2006
------------------------
Manfred Mayerfeld

--------------------------------------------------------------------------------


                                     - 70 -
<PAGE>

                       SECURITIES AND EXCHANGE COMMISSION

                              Washington, DC 20549

                        ---------------------------------

                             HEALTH-CHEM CORPORATION

                        ---------------------------------

                            FORM 10-KSB ANNUAL REPORT

                           FOR THE FISCAL YEARS ENDED:

                           DECEMBER 31, 2004 AND 2003

                       ----------------------------------

                              FINANCIAL STATEMENTS

                       ----------------------------------

<PAGE>

ITEM 7. FINANCIAL STATEMENTS

Index to Consolidated Financial Statements.

                                                                            PAGE
                                                                            ----

Report of Independent Registered Public Accounting Firm                      F-2

Consolidated Balance Sheets - December 31, 2004 and 2003               F-3 & F-4

Consolidated Statements of Operations
  Years Ended December 31, 2004 and 2003                                     F-5

Consolidated Cash Flow Statements
  Years Ended December 31, 2004 and 2003                               F-6 & F-7

Consolidated Statements of Stockholders' Deficiency
 and Comprehensive Income <Loss>
  Years Ended December 31, 2004 and 2003                                     F-8

Notes to Consolidated Financial Statements                           F-9 to F-27


                                      F-1
<PAGE>

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Stockholders
Health-Chem Corporation


We have audited the  accompanying  consolidated  balance  sheets of  Health-Chem
Corporation and Subsidiaries ("Health-Chem" or the "Company") as of December 31,
2004 and 2003 and the related consolidated statements of operations, cash flows,
and  stockholders'  deficiency  for the two years then  ended.  These  financial
statements   are   the   responsibility   of   Health-Chem's   management.   Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

We conducted our audits in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement.  An audit includes examining, on a
test basis,  evidence  supporting  the amounts and  disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all  material  respects,  the  consolidated  financial  position of  Health-Chem
Corporation and Subsidiaries at December 31, 2004 and 2003, and the consolidated
results of their  operations  and their cash flows for the two years then ended,
in conformity with accounting principles generally accepted in the United States
of America.

The  accompanying  financial  statements  have been  prepared  assuming that the
Company will continue as a going concern. As more fully described in Note 3, the
Company is in default of  payments to its  bondholders  and  licensors,  and has
working capital  deficiencies  that raise substantial doubt about its ability to
continue as a going concern.  Management's  plans  concerning  these matters are
also  described  in  Note  3.  The  financial  statements  do  not  include  any
adjustments that might result from the outcome of this uncertainty.


s / s DEMETRIUS & COMPANY, L.L.C.
Wayne, New Jersey
May 31, 2006


                                      F-2
<PAGE>

                             HEALTH-CHEM CORPORATION
                           CONSOLIDATED BALANCE SHEETS
                      (In thousands, except share amounts)

                        ASSETS                                 December 31,
                                                             2004         2003
CURRENT ASSETS
   Cash                                                     $   928      $   676
   Accounts receivable, net of allowances for
     doubtful accounts                                        2,985          886
   Due from factor                                              110          169
   Inventories                                                1,302          766
   Other current assets                                         125          144
                                                            -------      -------
     Total Current Assets                                     5,450        2,641
                                                            -------      -------

PROPERTY, PLANT AND EQUIPMENT
   Land                                                         120          120
   Buildings                                                  2,734        2,734
   Equipment and leasehold improvements                       8,323        8,473
   Construction-in-progress                                     254           78
                                                            -------      -------
     Total Property, Plant and Equipment                     11,431       11,405
   Less accumulated depreciation and amortization             9,484        9,260
                                                            -------      -------
     Net Property, Plant and Equipment                        1,947        2,145
                                                            -------      -------

NON-CURRENT ASSETS                                               46          104
                                                            -------      -------

TOTAL ASSETS                                                $ 7,443      $ 4,890
                                                            =======      =======

Consolidated Balance Sheets are continued on the next page.


See Notes to Consolidated Financial Statements.


                                      F-3
<PAGE>

                             HEALTH-CHEM CORPORATION
                     CONSOLIDATED BALANCE SHEETS, CONTINUED
                      (In thousands, except share amounts)

           LIABILITIES AND STOCKHOLDERS' DEFICIENCY              December 31,
                                                               2004       2003

CURRENT LIABILITIES
   Accounts payable                                          $ 1,411    $ 1,366
   Royalties payable                                           4,522      2,928
   Current portion of 10.375% convertible subordinated
    debentures                                                 6,100      6,100
   Accrued interest on convertible subordinated
    debentures                                                 4,097      3,464
   Other liabilities                                           1,657      1,411
   Current portion of long-term debt                               0      2,007
   Income taxes payable                                           75         75
                                                             -------    -------
     Total Current Liabilities                                17,862     17,351
                                                             -------    -------

LONG-TERM LIABILITIES
   Long-term debt                                                167          0
   Payable to York Realty Leasing LLC members                  1,736          0
   Minority interest                                             133          3
                                                             -------    -------
                                                               2,036          3

COMMITMENTS

STOCKHOLDERS' DEFICIENCY
   Preferred stock, par value $.01 per share;
     1,000,000 shares authorized, none issued                      0          0
   Convertible special stock, nonvoting, par value
     $.01 per share; 750,000 shares authorized;
     738,667 shares issued, all of which are
     held in treasury                                              7          7
   Common stock, par value $.01 per share;
     50,000,000 shares authorized; 17,934,056
     shares issued; 11,443,424 shares outstanding
     in 2004 and 2003                                            179        179
   Additional paid-in capital                                 18,915     18,915
   Accumulated deficit                                       <23,922>   <23,931>
                                                             -------    -------
     Subtotal                                                 <4,821>    <4,830>
   Less treasury stock, at cost                               <7,634>    <7,634>
                                                             -------    -------
     Total Stockholders' Deficiency                          <12,455>   <12,464>
                                                             -------    -------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY               $ 7,443    $ 4,890
                                                             =======    =======


See Notes to Consolidated Financial Statements.


                                      F-4
<PAGE>

                            HEALTH-CHEM CORPORATION
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                    (In thousands, except per share amounts)

                                                                 Year Ended
                                                                December 31,
                                                              2004        2003
REVENUE:
  Net sales                                                 $ 9,192     $ 7,896
  Cost of goods sold                                          6,248       5,987
                                                            -------     -------
  Gross profit                                                2,944       1,909
                                                            -------     -------

OPERATING EXPENSES:
  Selling, general and administrative                         1,646       1,821
  Research and development                                      414         418
  Interest, net                                                 909       1,016
                                                            -------     -------
    Total operating expenses                                  2,969       3,255
                                                            -------     -------

LOSS FROM OPERATIONS                                            <25>     <1,346>
  Product development income                                    239          31
  Other income <expense> - net                                   55           0
                                                            -------     -------

INCOME <LOSS> FROM CONTINUING OPERATIONS BEFORE
 TAXES AND DISCONTINUED OPERATIONS                              269      <1,315>
  Income tax benefit                                              0           0
                                                            -------     -------
INCOME <LOSS> FROM CONTINUING OPERATIONS BEFORE
 DISCONTINUED OPERATIONS                                        269      <1,315>
  Loss from discontinued operations, net of tax                <260>       <658>
                                                            -------     -------

NET INCOME <LOSS>                                           $     9     $<1,973>
                                                            =======     =======

Earnings <loss> per common share (basic & diluted):
  Continuing operations                                     $   .02     $  <.11>
  Discontinued operations                                      <.02>       <.06>
                                                            -------     -------
NET EARNINGS <LOSS> PER SHARE                               $   .00     $  <.17>
                                                            =======     =======

Average number of common shares outstanding:
  Basic                                                      11,443      11,443
  Diluted                                                    11,443      11,443


See Notes to Consolidated Financial Statements.


                                      F-5
<PAGE>

                             HEALTH-CHEM CORPORATION
                        CONSOLIDATED CASH FLOW STATEMENTS
                                 (In thousands)

                                                                  Year Ended
                                                                 December 31,
                                                               2004       2003
CASH FLOWS FROM OPERATING ACTIVITIES OF
 CONTINUING OPERATIONS:
Net income <loss>                                            $     9    $<1,973>
 Add: Loss from discontinued operations,
  net of taxes                                                   260        658
                                                             -------    -------
Income <loss> from continuing operations                         269     <1,315>
Adjustments to reconcile income <loss> from
 continuing operations to net cash provided by
 operating activities of continuing operations:
  Depreciation and amortization                                  224        388
  Loss on disposal of property, plant & equipment                  0          5
Changes in:
  Accounts receivable                                         <2,099>      <552>
  Due from factor                                                 59        <36>
  Inventories                                                   <536>      <159>
  Other current assets                                            19        <31>
  Other non-current assets                                        58        <31>
  Accounts payable                                                45        385
  Royalties payable                                            1,594      1,518
  Accrued interest on convertible debentures                     633        633
  Other liabilities                                              246        583
                                                             -------    -------
Net cash provided by operating activities of
 continuing operations                                           512      1,388
                                                             -------    -------

CASH FLOWS FROM INVESTING ACTIVITIES OF
 CONTINUING OPERATIONS:
Additions to property, plant and equipment                       <26>      <188>
                                                             -------    -------
Net cash used for investing activities of
 continuing operations                                           <26>      <188>
                                                             -------    -------

CASH FLOWS FROM FINANCING ACTIVITIES OF
 CONTINUING OPERATIONS:
Long-term debt proceeds                                        1,903          0
Long-term debt payments                                       <2,007>      <522>
Minority interest contributions                                  130          0
                                                             -------    -------
Net cash provided by <used for> financing
 activities of continuing operations                              26       <522>
                                                             -------    -------


Consolidated Cash Flow Statements are continued on the next page.


                                      F-6
<PAGE>

                             HEALTH-CHEM CORPORATION
                  CONSOLIDATED CASH FLOW STATEMENTS, CONTINUED
                                 (In thousands)

                                                                  Year Ended
                                                                 December 31,
                                                               2004       2003

DISCONTINUED OPERATIONS:
Net cash provided by Pacific Combining operating
 activities                                                        0          1
                                                             -------    -------

Cash used for Health-Chem Diagnostics operating
 activities                                                     <278>      <668>
Adjustment to reconcile cash used for
 Health-Chem Diagnostics operating activities
 to net cash used for Health-Chem Diagnostics
 operating activities:
  Depreciation and amortization                                   18          9
                                                             -------    -------
Net cash used for Health-Chem Diagnostics
 operating activities                                           <260>      <659>
                                                             -------    -------
Net cash used for discontinued operations                       <260>      <658>
                                                             -------    -------

NET INCREASE IN CASH                                             252         20
Cash at beginning of year                                        676        656
                                                             -------    -------
Cash at end of year                                          $   928    $   676
                                                             =======    =======

Supplemental Disclosures of Cash Flow Information:
 Cash paid during the year for:
  Interest                                                   $   359    $   263
  Income taxes                                                     0          0


See Notes to Consolidated Financial Statements.


                                      F-7
<PAGE>

                             HEALTH-CHEM CORPORATION
      CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY AND COMPREHENSIVE
                                 INCOME <LOSS>
                     YEARS ENDED DECEMBER 31, 2004 AND 2003
                                 (In thousands)

<TABLE>
<CAPTION>
                              Conver-                 Addi-
                               tible                  tional      <Accumu-
                              Special      Common     Paid-In      lated      Treasury
                               Stock       Stock      Capital      Deficit>    Stock        Total
<S>                           <C>         <C>         <C>         <C>         <C>         <C>
Balance, January 1, 2003      $      7    $    179    $ 18,915    $<21,958>   $ <7,634>   $<10,491>

Comprehensive loss 2003                                             <1,973>                 <1,973>
                              --------    --------    --------    --------    --------    --------

Balance, December 31, 2003    $      7    $    179    $ 18,915    $<23,931>   $ <7,634>   $<12,464>

Comprehensive income 2004                                                9                       9
                              --------    --------    --------    --------    --------    --------

Balance, December 31, 2004    $      7    $    179    $ 18,915    $<23,922>   $ <7,634>   $<12,455>
                              ========    ========    ========    ========    ========    ========
</TABLE>


See Notes to Consolidated Financial Statements.


                                      F-8
<PAGE>

                             HEALTH-CHEM CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                     YEARS ENDED DECEMBER 31, 2004 AND 2003

1.    Nature of Operations

Health-Chem Corporation  ("Health-Chem") and its subsidiaries  (collectively the
"Company")  are  engaged  in  the  development,  manufacture  and  marketing  of
transdermal  drug delivery  systems.  Since 1986, the Company has manufactured a
transdermal  nitroglycerin patch which was the first such product introduced for
the generic  market in the United States.  This product is used for  transdermal
relief of vascular and cardiovascular  symptoms related to angina pectoris.  The
Company  sells  the  transdermal   nitroglycerin   patch  to  distributors   and
wholesalers who distribute it in the United States.

In addition to its transdermal nitroglycerin products, the Company is developing
other  transdermal  products  for  client  companies  and  will be the  contract
manufacturer  of these  products if United  States Food and Drug  Administration
("FDA")  approval  is  obtained.  The  Company  is also  conducting  a number of
feasibility  studies  on  drugs  to be  developed  independently  or for  client
companies and pursuing additional contract  manufacturing  opportunities.  There
can be no assurance that FDA filings for  additional  products will be submitted
or that FDA approval for any additional products will be obtained.

2.    Summary of Significant Accounting Policies

a.    Principles of Consolidation

The  accompanying  consolidated  financial  statements  include the  accounts of
Health-Chem  Corporation  and  those  of  its  wholly-owned  and  majority-owned
subsidiaries.  As of December 31, 2004, the  consolidated  financial  statements
also include a Variable  Interest  Entity  ("VIE"),  York Realty Leasing LLC, of
which  Health-Chem  Corporation is the primary  beneficiary as further described
below. All intercompany accounts and transactions, including those involving the
VIE, have been eliminated in consolidation.

In December 2004, the Company sold its real  property,  buildings,  improvements
and equipment located in Emigsville, Pennsylvania to York Realty Leasing LLC for
a sale price of $1.9 million. Concurrent with the sale, the Company entered into
a  15-year  lease for the  property  expiring  in  December  2019,  which can be
extended by the Company for an additional five years. The agreement provides for
a Company  repurchase  option at a price of  $1,995,000.  The annual  lease cost
during the initial 15 year term is $212,400.  In December  2002, the Company had
received an  appraisal  for the real  property,  including  the  structures  and
appurtenances,  which  appraised the market value of the property at $1,850,000.
The proceeds  from the sale were used to satisfy a $1.6 million  first  mortgage
associated  with the property  and to  substantially  pay off a $367,500  second
mortgage,  a portion of which was held by related  parties.  Andy Yurowitz,  the
Company's Chairman of the Board, President, Chief Executive Officer and a member
of the  Board of  Directors,  is a 50% owner of York  Realty  Leasing  LLC.  The
Company entered into the sale/leaseback arrangement with York Realty Leasing LLC
because it was  unable to  negotiate  a like  transaction  with an  unaffiliated
party. As of December 31, 2004, this sale/leaseback  transaction represented the
only  business  activity of York realty  Leasing  LLC. As a result of  Financial
Interpretation  46(R),   effective  as  of  December  31,  2004,  the  Company's
consolidated  balance sheet  includes the assets and  liabilities of York Realty
Leasing LLC. Subsequent to December 31, 2004, York Realty Leasing LLC obtained a
$1.4 million mortgage on this property with a financial institution.


                                      F-9
<PAGE>

b.    Cash Equivalents

Money market funds and investment instruments with original maturities of ninety
days or less are considered cash equivalents.

c.    Concentrations of Credit Risk

Financial  instruments that potentially subject the Company to concentrations of
credit risk consist primarily of cash, cash equivalents and accounts receivable.

As of December 31, 2004,  the Company had cash  balances at a certain  financial
institution in excess of federally insured limits. However, the Company does not
believe that it is subject to unusual  credit risk beyond the normal credit risk
associated with commercial  banking  relationships.  The Company  mitigates this
risk by depositing its cash in high quality financial institutions.

To reduce credit risk, the Company  performs  ongoing credit  evaluations of its
customers'  financial  condition  but does  not  generally  require  collateral.
Approximately 78% and 54% of the accounts  receivable balances represent amounts
due from two customers at December 31, 2004 and 2003, respectively.

d.    Accounts Receivable

The Company manufactures and markets a transdermal  nitroglycerin patch which it
sells to customers for  distribution in the United States.  The Company has also
sold diagnostic products for distribution to customers in Germany and Italy. The
percentage of sales to each major customer who was  responsible  for 10% or more
of the total revenues is as follows:

                                                    Year Ended
                                                   December 31,
                                                2004          2003
                                                ----          ----
Customer A ............................          23%           15%
Customer B ............................          30%           34%

At December 31, 2004 and 2003, accounts  receivable of approximately  $2,333,000
and $480,000, respectively were from such customers.

Foreign sales,  consisting of sales to distributors  in Germany and Italy,  were
$181,752, or 2.2% of sales in 2003. There were no foreign sales in 2004.


                                      F-10
<PAGE>

The Company has historically provided financial terms to customers in accordance
with  what  management   views  as  industry   norms.   Financial   terms,   for
credit-approved  customers,  are generally on a net 30-61 day basis, though most
customers are entitled to a prompt payment discount. Management periodically and
regularly  reviews  customer account activity in order to assess the adequacy of
allowances  for  doubtful  accounts,   considering   factors  such  as  economic
conditions and each  customer's  payment  history and  creditworthiness.  If the
financial  condition  of our  customers  were to  deteriorate,  or if they  were
otherwise unable to make payments in accordance with management's  expectations,
we might have to increase  our  allowance  for doubtful  accounts,  modify their
financial terms and/or pursue alternative collection methods.

In January  2001,  the Company  entered into an agreement to sell certain of its
accounts  receivable  with full  recourse  to a factor,  Bay View  Funding.  The
agreement, as amended, allowed for a maximum amount of financing availability of
$1.5 million.  Under this agreement,  the Company sold, on a revolving basis, an
undivided  percentage  ownership  in certain  accounts  receivable.  As existing
receivables were collected, undivided interests in new eligible receivables were
sold. The amounts due from the factor were $110,000 and $169,000 at December 31,
2004 and  2003,  respectively.  Accounts  that  became  90 days past due were no
longer eligible to be sold and the Company had to repurchase the receivable. The
Company addresses the risk of loss associated with these repurchased receivables
in its allowance for doubtful  accounts.  Expenses incurred under this factoring
program  totaling  $243,000 and $132,000  for 2004 and 2003,  respectively,  are
included  on  the  selling,  general  and  administrative  expense  line  in the
Consolidated Statements of Operations. The Company terminated its agreement with
Bay View Funding in April 2005 because  management  believed that the Company no
longer needed the services of a factor.

e.    Inventories

Inventories are stated at lower of cost (first-in, first-out basis) or market.

f.    Property, Plant and Equipment

Property,  plant and equipment are recorded at cost. Maintenance and repairs are
charged to expense  as  incurred,  and costs of  improvements  are  capitalized.
Depreciation  and amortization  are provided using the  straight-line  method by
charges to operations over estimated useful lives of five to twenty-five  years.
The cost and related  accumulated  depreciation  of disposed  assets are removed
from the  applicable  accounts and any gain or loss is included in income in the
period of disposal.

g.    Impairment of Long-Lived Assets

The Company  reviews  long-lived  assets,  such as property and  equipment,  and
purchased intangibles subject to amortization, for impairment whenever events or
changes in  circumstances  indicate that the carrying amount of an asset may not
be recoverable,  in accordance with Statement of Financial  Accounting Standards
("SFAS")  No. 144,  Accounting  for the  Impairment  or  Disposal of  Long-Lived
Assets. Recoverability of assets to be held and used is measured by a comparison
of the carrying amount of an asset to estimated  undiscounted  future cash flows
expected  to be  generated  by the  asset.  If the  carrying  amount of an asset
exceeds its estimated  future cash flows, an impairment  charge is recognized by
the amount by which the carrying  amount of the asset  exceeds the fair value of
the asset.


                                      F-11
<PAGE>

h.    Fair Value of Financial Instruments

Management  believes  that  the  carrying  amounts  of the  Company's  financial
instruments,  including cash and cash equivalents, accounts receivable, accounts
payable,  and accrued  liabilities  approximate fair value due to the short-term
nature of these instruments. The carrying amount of the Company's long-term debt
approximates fair value because the underlying  instruments  reprice frequently.
In May 1999 the Company's convertible  subordinated debentures were delisted for
failure  to  meet  listing   requirements   and  therefore  a  market  value  is
unobtainable.

i.    Revenue Recognition

The Company  recognizes  revenue for product  sales upon shipment when title and
risk of loss pass to its customers and when provisions for estimates,  including
discounts,  rebates,  promotional  adjustments,   price  adjustments,   returns,
chargebacks,  and other potential  adjustments are reasonably  determinable.  No
revisions  were made to the  methodology  used in determining  these  provisions
during  the years  ended  December  31,  2004 and 2003.  The  following  briefly
describes the nature of each provision and how such provisions are estimated.

Discounts are  reductions to invoiced  amounts  offered to customers for payment
within a specified period and are estimated upon shipment  utilizing  historical
customer payment experience.

Rebates are offered to key customers to promote  customer  loyalty and encourage
greater product sales. These rebate programs provide that upon the attainment of
pre-established  volumes or the attainment of revenue milestones for a specified
period,  the customer  receives  credit  against  purchases.  Other  promotional
programs are  incentive  programs  periodically  offered to our  customers.  The
Company  is able to  estimate  provisions  for  rebates  and  other  promotional
programs based on the specific terms in each agreement at the time of shipment.

Consistent  with  industry  practice,  we  maintain a return  policy that allows
customers to return product within a specified period prior to and subsequent to
the  expiration  date.  The  Company's  estimate of the provision for returns is
based upon historical experience with actual returns.

Price adjustments,  which include shelf stock adjustments, are credits issued to
reflect decreases in the selling prices of products. Shelf stock adjustments are
based  upon the  amount of  product  which the  customer  has  remaining  in its
inventory at the time of the price  reduction.  Decreases in selling  prices are
discretionary  decisions  made by the  Company  to  reflect  market  conditions.
Amounts recorded for estimated price  adjustments are based upon specified terms
with direct customers, and in the case of shelf stock adjustments,  estimates of
inventory held by the customer.


                                      F-12
<PAGE>

The Company has agreements with certain indirect customers,  such as independent
pharmacies,  managed care organizations,  hospitals, nursing homes, governmental
agencies and pharmacy benefit  management  companies,  which establish  contract
prices for certain products.  The indirect customers then independently select a
wholesaler from whom they purchase the products at these contracted  prices. The
Company will provide credit to the  wholesaler  for any  difference  between the
contracted  price with the indirect  party and the  wholesaler's  invoice price.
Such credit is called a chargeback.  The provision for  chargebacks  is based on
expected  sell-through levels by our wholesaler customers to indirect customers,
as well as estimated wholesaler inventory levels.

Costs incurred for shipping and handling are recorded in cost of sales.

j.    Research and Development

Research and development costs are charged to operations as incurred.

k.    Income Taxes

Deferred tax assets and  liabilities  are provided for  differences  between the
financial  statement and tax bases of assets and liabilities that will result in
future taxable or deductible  amounts.  The deferred tax assets and  liabilities
are measured  using the enacted tax laws and rates  applicable to the periods in
which the differences are expected to affect taxable income.  Income tax expense
is computed as the tax  payable or  refundable  for the period plus or minus the
change  during the period in deferred tax assets and  liabilities.  Deferred tax
assets are reduced by a valuation  allowance when, in the opinion of management,
it is more likely than not that some  portion or all of the  deferred tax assets
will not be realized.

l.    Per Share Information

Basic and  diluted  earnings  per share are  computed  based  upon the  weighted
average number of common shares  outstanding  during each year after  adjustment
for any  dilutive  effect of the  Company's  stock  options.  Stock  options are
anti-dilutive for each of the years ended December 31, 2004 and 2003.

A reconciliation of the basic and diluted earnings per common share computations
for income for  continuing  operations for the years ended December 31, 2004 and
2003 is presented below (in thousands, except per share amounts):


                                      F-13
<PAGE>

<TABLE>
<CAPTION>
                                   2004                         2003
                        ---------------------------   ----------------------------
                         Income   Shares     Per      Income   Shares       Per
                         (Numer-  (Denom-   Share     (Numer-  (Denom-     Share
                          ator)   inator)   Amount     ator)    inator)    Amount
                        -------   -------   -------   -------   -------    -------
<S>                     <C>        <C>      <C>       <C>        <C>       <C>
Net income <loss>       $     9                       $<1,973>
                        -------                       -------

Basic Earnings
Per Common Share
 Net income <loss>
 applicable to common
 stockholders                 9    11,443   $   .00    <1,973>   11,443    $  <.17>
                                            =======                        =======

Effect of Dilutive
Securities
 Stock options                          0         0                   0          0
                                  -------   -------             -------    -------

Diluted Earnings
Per Common Share
 Net income <loss>
 applicable to common
 stockholders           $     9    11,443   $   .00   $<1,973>   11,443    $  <.17>
                        =======   =======   =======   =======   =======    =======
</TABLE>

m.    Stock Options

In accordance  with SFAS No. 123,  Accounting for Stock-Based  Compensation  and
SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure,
the Company accounts for its stock option plans under the  intrinsic-value-based
method as defined in APB No. 25,  Accounting for Stock Issued to Employees.  The
following table illustrates the effect on net earnings and earnings per share if
the Company had applied the fair value recognition provisions of SFAS No. 123 to
stock-based employee compensation (in thousands, except per share amounts):

                                                                Year Ended
                                                               December 31,
                                                              2004       2003

Net income <loss>, as reported:                              $     9    $<1,973>
Add: Stock-based compensation expense recognized
  under the intrinsic value method                                 0          0
Deduct: Stock-based compensation expense
  determined under fair value based method                                   <9>
                                                             -------    -------
Pro forma net income <loss>                                  $     9    $<1,982>
                                                             =======    =======

Net income <loss> per share:
  Basic - as reported                                        $   .00    $  <.17>
                                                             =======    =======
  Basic - pro forma                                          $   .00    $  <.17>
                                                             =======    =======
  Diluted - as reported                                      $   .00    $  <.17>
                                                             =======    =======
  Diluted - pro forma                                        $   .00    $  <.17>
                                                             =======    =======


                                      F-14
<PAGE>

n.    Use of Estimates in the Preparation of Financial Statements

The preparation of financial  statements in conformity  with generally  accepted
accounting principles 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.

o.    Recent Accounting Pronouncements

In January 2003, the Financial  Accounting  Standards Board ("FASB") issued FASB
Interpretation  No.  46  (revised  December  2003),  Consolidation  of  Variable
Interest  Entities  ("FIN  46(R)").  FIN 46(R)  addresses the  consolidation  of
business  enterprises  to which the usual  condition  (ownership  of a  majority
voting  interest)  of  consolidation  does  not  apply.  FIN  46(R)  focuses  on
controlling  financial interests that may be achieved through  arrangements that
do not  involve  voting  interests.  It  concludes  that in the absence of clear
control through voting interests,  a company's exposure  (variable  interest) to
the economic  risks and potential  rewards from the variable  interest  entity's
assets and activities are the best evidence of control. If an enterprise holds a
majority of the variable  interests  of an entity,  it would be  considered  the
primary  beneficiary.  Upon consolidation,  the primary beneficiary is generally
required to include  assets,  liabilities and  noncontrolling  interests at fair
value  and  subsequently  account  for  the  variable  interest  as if  it  were
consolidated  based on  majority  voting  interest.  As a result  of FIN  46(R),
effective as of December 31, 2004,  the  Company's  consolidated  balance  sheet
includes the assets and liabilities of York Realty Leasing LLC.

In November 2004, the FASB issued SFAS No. 151,  Inventory  Costs - an Amendment
of ARB No. 43, Chapter 4. SFAS 151 clarifies the accounting for abnormal amounts
of idle facility expense,  freight,  handling costs and spoilage.  SFAS 151 also
requires that allocation of fixed  production  overhead costs be based on normal
production  activity.  The  provisions  of SFAS 151 are  effective for inventory
costs incurred  beginning in January 2006, with adoption permitted for inventory
costs  incurred  beginning in January  2005.  Adoption of this  Statement is not
expected  to have a  material  effect on the  Company's  Consolidated  Financial
Statements.

In December  2004, the FASB issued SFAS No. 123(R),  Share-Based  Payment.  SFAS
123(R)  establishes  standards for the accounting for  transactions  in which an
entity  exchanges  its equity  instruments  for goods and  services.  Under SFAS
123(R), companies will no longer be able to account for share-based compensation
transactions  using  the  intrinsic  method  in  accordance  with  APB  No.  25,
Accounting for Stock Issued to Employees. Instead, companies will be required to
account  for  such  transactions  using a  fair-value  method  and to  recognize
compensation  expense  over the period  during  which an employee is required to
provide  services in exchange for the award.  In April 2005, the SEC delayed the
effective  date of SFAS 123(R) to fiscal  years  beginning  after June 15, 2005.
Management is currently  assessing  the impact that  adoption of this  Statement
will have on the Company's Consolidated Financial Statements.


                                      F-15
<PAGE>

In May  2005,  the FASB  issued  SFAS No.  154,  Accounting  Changes  and  Error
Corrections  - a  Replacement  of APB  Opinion  No.  20 and SFAS No. 3. SFAS 154
changes the  requirements  for the  accounting  for and reporting of a change in
accounting  principle.  This  Statement  applies  to all  voluntary  changes  in
accounting principle. SFAS 154 also applies to changes required by an accounting
pronouncement  in the usual  instance  that the  pronouncement  does not include
specific  transition  provisions.  The  provisions of SFAS 154 are effective for
accounting  changes and  corrections  of errors made in fiscal  years  beginning
after  December 15, 2005.  Adoption of this  Statement is not expected to have a
material effect on the Company's Consolidated Financial Statements.

3.    Going Concern

As of December 31, 2004,  the Company had  aggregate  debts and  liabilities  of
$19,932,000.   These  debts  and  liabilities   include  $10,197,000  due  under
outstanding  debentures  which became due in 1999 and under which the Company is
currently in default. Also included in these debts and liabilities is $4,522,000
of  royalties  due  under a license  agreement  with Key  Pharmaceuticals,  Inc.
("Key") which allows the Company to utilize certain technology incorporated into
our current  transdermal  patch  which has been  accumulating  since  2000.  The
Consolidated  Statement  of  Operations  for the year ended  December  31,  2004
includes  $633,000 of debenture  interest  expense and $1,594,000 of Key royalty
expense.  The Company has been able to continue as a going concern as the result
of not having  paid these  creditors.  The Company has been paying its debts and
liabilities not related to the debentures or the license on a current basis from
cash flow generated from  operations.  The Company does not have cash on hand to
repay the amount due under the debentures or the royalty  payment owed under the
license  agreement.  The  Company's  financial  condition  has prevented it from
securing financing or obtaining loans from which it could repay all or a portion
of the amounts due.

The Company is in default under several provisions of the debentures as a result
of its failure to have paid interest and principal when they became due in April
1999. Upon an event of default,  the trustee of the debentures or the holders of
at least 25% in aggregate  principal  amount of all  debentures  may declare the
outstanding  principal of the  debentures  plus all accrued and unpaid  interest
which shall become immediately due and payable. The Company is also in breach of
the Key license  agreement  for failing to pay royalties as they became due. The
Company's  default  under and  breach of this  license  agreement  entitles  the
licensor to  terminate  the  agreement.  If these  creditors  took legal  action
against  the  Company,  the  Company  would not be able to  continue  as a going
concern  unless  there was an  increase in  profitability  and/or an infusion of
additional  funds in order to meet these  obligations  for both the past amounts
due and ongoing amounts as they became due.


                                      F-16
<PAGE>

The Company  intends to continue its efforts to complete the necessary  steps in
order to meet its future cash flow  requirements  and to continue its pursuit of
new products and contract  manufacturing  opportunities.  Management's  plans in
this regard include, but are not limited to, the following:

      o     Continue  with the  preliminary  negotiations  entered into with Key
            with respect to devising a plan to pay the royalties due,  including
            possibly negotiating a new royalty agreement.
      o     Approach the trustee of the  debentures  to negotiate a payment plan
            which  will  allow  for  the  normal   operation  of  the  Company's
            operations.  Such a payment plan may include forgiveness of interest
            and converting the debentures into equity.
      o     Continue  with  existing  projects  where the Company is  developing
            other  transdermal  products  for  client  companies  and  where the
            Company will be the contract  manufacturer  of these products if FDA
            approval is obtained.
      o     Form business alliances with other  pharmaceutical  companies on the
            development and/or manufacturing of new products.
      o     Raise  additional  working  capital  through  borrowing  or  through
            issuing equity.
      o     Evaluate new directions for the Company.

Management  believes that actions  presently being taken will need to be further
realigned  or  otherwise  amended so that the  Company  will be in a position to
generate  sufficient revenues to provide positive cash flows from operations and
meet its obligations as they become due. However, there can be no assurance that
this will occur.  The  accompanying  consolidated  financial  statements  do not
include any adjustments that might result from the outcome of this uncertainty.

4.    Inventories (In thousands)
                                                           December 31,
                                                          2004         2003

            Raw materials                               $  525       $  487
            Finished goods and work in process             777          279
                                                        ------       ------
                                                        $1,302       $  766
                                                        ======       ======

5.    Other Liabilities (In thousands)

                                                            December 31,
                                                          2004         2003

Accrued chargebacks                                     $  682       $  557
Accrued rebates                                            454          193
Accrued audit fees                                         184          160
Accrued interest on the second mortgage                     32          111
Accrued interest on other related party debt               117          205
Accrued interest on other debt                               2            0
Accrued discounts                                           73           15
Allowance for returns                                       59           59
Other                                                       54          111
                                                        ------       ------
                                                        $1,657       $1,411


                                      F-17
<PAGE>

6.    Long-Term Debt

The Company's long-term debt balances are as follows (in thousands):

                                                                 December 31,
                                                               2004         2003

  10.375% convertible subordinated debentures,
    due April 15, 1999                                       $6,100       $6,100
  Less debentures purchased to meet
    sinking fund requirements                                     0            0
                                                             ------       ------
  Subtotal 10.375% convertible subordinated debentures        6,100        6,100
  Less current portion                                        6,100        6,100
                                                             ------       ------
  Total 10.375% convertible subordinated debentures          $    0       $    0
                                                             ======       ======

  Mortgage payable                                           $    0       $1,600
  Second mortgage payable - related party                         0          367
  Payable to York Realty Leasing LLC members                  1,736            0
  Note payable                                                  167            0
  Other - related party                                           0           40
                                                             ------       ------
  Subtotal other long-term debt                               1,903        2,007
  Less current portion                                            0        2,007
                                                             ------       ------
  Total Long-Term Debt                                       $1,903       $    0
                                                             ======       ======

Interest on the debentures is payable semi-annually. The debentures were subject
to redemption  through a sinking fund whereby the Company was required to redeem
at face value $1.5  million of the  debentures  each April 15, from 1991 through
1998. The balance of $8 million was due on April 15, 1999.  The debentures  were
convertible  into  shares of the  Company's  common  stock at  $19.52  per share
through April 15, 1999 and were  redeemable in whole or in part at par. In April
1999, the Company defaulted on its obligations to repay the remaining $8 million
in principal as well as the accrued  interest due on the debentures at maturity.
The Company made a $1.9 million  partial  repayment of its debt  obligations  in
respect  of the  debentures  out of the  proceeds  of the sale of the  assets of
Herculite Products, Inc. and Hercon Environmental Corporation,  two subsidiaries
of the Company,  in August 1999.  No additional  principal or interest  payments
with respect to the  debentures  have been made since April 1999. As of December
31,  2004 and 2003,  the  Company had  accrued  interest  on the  debentures  of
$4,097,000 and $3,464,000, respectively.

The terms of the  indenture  relating to the  debentures  restrict the Company's
ability to pay cash dividends and/or  repurchase its capital stock pursuant to a
formula based upon the consolidated net income of the Company and other factors.
Under the formula, at December 31, 2004, no amount was available for the payment
of dividends and/or the repurchase of capital stock.


                                      F-18
<PAGE>

In the spring of 2000,  the Company  obtained a $1.6  million  loan from Mercury
Capital  Corporation  at 15%  interest  per annum  secured by a mortgage  on the
Company's  Pennsylvania  facility. In December 2003, Mercury Capital Corporation
assigned this mortgage to William  Robbins.  In December  2004, the Company sold
its real property, buildings,  improvements and equipment located in Emigsville,
Pennsylvania  to York Realty  Leasing LLC for a sale price of $1.9 million.  The
proceeds  from the sale were used to satisfy  the $1.6  million  first  mortgage
noted above and to substantially pay off a $367,500 second mortgage. The Company
entered into the sale/leaseback arrangement with York Realty Leasing LLC because
it was unable to negotiate a like transaction with an unaffiliated  party.  Andy
Yurowitz,  the  Company's  Chairman  of the Board,  President,  Chief  Executive
Officer  and a member of the Board of  Directors,  is a 50% owner of York Realty
Leasing LLC.  William Robbins is also a 50% owner of York Realty Leasing LLC. In
addition to capital contributions that Messrs. Yurowitz and Robbins made to York
Realty  Leasing  LLC,  as of  December  31,  2004 each made loans to York Realty
Leasing LLC  totaling  $136,000  and $1.6  million,  respectively,  with William
Robbins'  loan being  evidenced  by the  mortgage.  York Realty  Leasing LLC has
classified  these two member loans of  $1,736,000  as long-term  and is accruing
interest of 15% per annum on both loans. As a result of Financial Interpretation
46(R),  effective as of December 31, 2004,  the Company's  consolidated  balance
sheet includes the assets and liabilities of York Realty Leasing LLC,  including
the $1,736,000 member loans.

In August 2001, the Company obtained a $367,500 loan from Zackfoot  Investments,
LLC at  12.5%  interest  per  annum  secured  by a  mortgage  on  the  Company's
Pennsylvania  facility.  This loan was repaid  during 2004.  Of the nine initial
investors in Zackfoot  Investments,  LLC, five were current or former members of
Health-Chem's  Board of  Directors  and one  investor  was a former  officer  of
Health-Chem  Corporation.  Each investor  received eight shares of the Company's
common stock for each dollar invested.

The $167,000 note relates to the purchase of certain fixed assets.  The purchase
of these fixed assets was pursuant to a  development,  manufacturing  and supply
agreement that the Company entered into with a client company.  Payment terms of
the note are contingent upon certain  performance  criteria under the agreement.
One such performance criteria applicable to the client company may result in the
note being  forgiven.  We  estimate  the  earliest  that the note may need to be
repaid is in 2006.

The $40,000 other  long-term  debt  represents an amount  Manfred  Mayerfeld,  a
current  member  of the  Board  of  Directors,  expended  in  connection  with a
successful  proxy contest brought against  Health-Chem  Corporation in 1999 by a
group  led by Andy  Yurowitz,  the  Company's  current  Chairman  of the  Board,
President,  Chief Executive Officer and a member of the Board of Directors.  The
Company repaid this loan, along with interest at 18% per annum, during 2004.

7.    Employee Benefit Plan

All  permanent,  full-time  non-union  employees  of the Company are eligible to
participate in  Health-Chem's  401(k) Plan (the "Plan")  following six months of
employment.  The  Plan  allows  eligible  employees  to defer up to 20% of their
income on a pre-tax basis  through  contributions  to the Plan.  The Company may
contribute for each participant a matching contribution equal to a percentage of
the  elective  contributions  made by the  participants.  The  decision  to make
matching  contributions and the amount of such  contributions  will be made each
year by the  Company.  These  Company  matching  contributions  were $13,000 and
$16,000 in 2004 and 2003, respectively.


                                      F-19
<PAGE>

8.    Commitments

In December 2004, the Company entered into a sale/leaseback  agreement with York
Realty Leasing LLC for the land,  buildings,  improvements  and equipment at the
Company's previously-owned  manufacturing facility in Emigsville,  Pennsylvania.
The term of the lease is for fifteen  years,  expiring in December  2019, can be
extended an additional five years and contains a repurchase  option. The selling
price was $1.9 million and annual lease payments are $212,400. The proceeds from
the sale were used to satisfy a $1.6 million first mortgage  associated with the
property and to substantially pay off a $367,000 second mortgage. The effects of
this sale/leaseback  agreement have been eliminated in consolidation as a result
of York Realty Leasing LLC being considered a Variable Interest Entity.

In December 2004, the Company  entered into a lease for office space in Suffern,
New York for a one year period commencing January 1, 2005, and renewed the lease
for an additional one year period commencing  January 1, 2006. The annual rental
was $7,200, inclusive of utilities, for 2005 and will be $7,416 for 2006.

Approximately  forty  percent  of  the  Company's  employees  are  covered  by a
collective  bargaining  agreement with a local unit of the Retail  Wholesale and
Department Store Union, AFL-CIO ("R.W.D.S.U.").  The R.W.D.S.U. agreement is for
a three year period ending  December 10, 2007. The contract is subject to annual
renewal  thereafter  and  acknowledges  that  the  R.W.D.S.U.  is the  exclusive
bargaining agent for the Company's regular production  employees,  excluding all
other  employees  including but not limited to  supervisors,  foremen,  clerical
employees,  time-keepers,  watchmen, guards, maintenance personnel and part-time
employees.

9.    Litigation

In  June  2004,  Plaintiffs  Jack  Aronowitz  and  his  companies,   Health-Chem
Diagnostics,  LLC  ("Diagnostics")  and  Leon  Services,  LLC  ("Leon")  filed a
Complaint and  subsequently,  an Amended Complaint in the United States District
Court  Southern  District of Florida  (the  "Court")  for breach of contract and
foreclosure of a security  interest against the Company.  The contracts at issue
were a Master Agreement along with an associated  License Agreement and Security
Agreement, executed jointly and dated February 15, 2002 (the "2002 Agreements"),
and a November 6, 2003 Outline Agreement (the "2003 Agreement")  terminating the
Company's  obligations  under the 2002 Agreements and effectuating a purchase of
certain  assets by the Company in exchange  for monies and a 25% equity stake in
Diagnostics.  The Company filed a counterclaim for breach of the 2003 Agreement,
based on  Plaintiffs'  failure  to render  payment  for the  assets  which  were
transferred to Plaintiffs,  as well as a claim for trademark  infringement.  The
Company also asserted a claim for a declaratory  judgment  determining  that the
2003 Agreement  superseded the 2002 Agreements,  consistent with the conclusions
in the Order.  The jury  rendered its verdict on November  21, 2005,  finding in
favor of  Plaintiffs  on the counts for breach of the 2002 and 2003  Agreements.
The jury found that  Plaintiffs were guilty of copyright  infringement,  but did
not find a breach of the 2003 Agreement on the part of  Plaintiffs.  On December
2, 2005,  the Court entered a Final Judgment and Order Closing Case, and ordered
judgment  on the  jury  verdict  in the  amount  of  $2,931,000.00  in  favor of
Plaintiffs  and against the  Company.  The Court also  entered  judgment for the
Company in the amount of  $25,000.00  for  trademark  infringement.  The Company
filed a Motion for  Judgment As A Matter Of Law, and  alternatively,  Motion for
New Trial.  On February  14, 2006 the Court  issued an Amended  Final  Judgment,
vacating the Court's December 2, 2005 Final Judgment and Order Closing Case. The
February 14, 2006 judgment  reduced the award to the Plaintiffs  Jack Aronowitz,
Health-Chem  Diagnostics,  LLC and Leon Services, LLC and against the Company to
the amount of $1.00.  The February 14, 2006 judgment also awarded  $25,000.00 to
the Company and against the Plaintiffs Jack Aronowitz,  Health-Chem Diagnostics,
LLC and Leon  Services,  LLC for trademark  infringement.  The February 14, 2006
judgment  also  included a  permanent  injunction  in favor of the  Company  and
against the Plaintiffs Jack  Aronowitz,  Health-Chem  Diagnostics,  LLC and Leon
Services, LLC to cease and desist any present or future use of the "Health-Chem"
trademark or any other marks similar to the Company's trademark. On February 27,
2006 the Plaintiffs  filed an appeal from the Court's  February 14, 2006 Amended
Final Judgment. The ultimate outcome of this litigation cannot be ascertained at
this time.


                                      F-20
<PAGE>

10.   Stockholders' Equity

a.    A summary of the shares of common and treasury stock is as follows:

                                                      Treasury Stock
                                              -----------------------------
                                 Common        Convertible       Common
                                 Stock        Special Stock      Stock
                              -------------   -------------   -------------

    Balance at 12/31/03          11,443,424         738,667       6,490,632

    Balance at 12/31/04          11,443,424         738,667       6,490,632

b.    Convertible special stock

The convertible special stock has the same rights as common stock except that it
is  nonvoting.  Each share is  convertible  into 1 1/3  shares of the  Company's
common  stock.   The  conversion   rate  is  subject  to  change  under  certain
circumstances. No shares of convertible special stock are outstanding.

c.    Reserved shares
                                                            Number of
        Purpose of Reservation                               Shares
        ----------------------                              ---------

      Conversion of convertible special stock                 984,889
      Stock option plans                                    4,086,587
                                                            ---------
      Total reserved shares                                 5,071,476
                                                            =========


                                      F-21
<PAGE>

11.   Stock Options

Options  granted under the Company's  various stock option plans are exercisable
for up to five  years  from the  grant  date.  A  summary  of the  status of the
Company's  plans as of December  31, 2004 and 2003 and changes  during the years
ended on those dates is presented below:

                                           2004                    2003
                                   ---------------------   ---------------------
                                   Weighted                Weighted
                                   Average                 Average
                                   Exercise                Exercise
                                    Shares       Price      Shares       Price
                                   ---------   ---------   ---------   ---------

Outstanding at
 beginning of year                 4,086,587   $     .17   3,986,587   $     .17

Granted                                    0                 100,000   $     .12

Exercised                                  0                       0

Forfeited                                  0                       0
                                   ---------               ---------

Outstanding at end
 of year                           4,086,587   $     .17   4,086,587   $     .17
                                   =========               =========

Options exercisable
 at year-end                       4,086,587               4,086,587

Weighted-average
 fair value of
 options granted
 during the year                               $     .00               $    .092

The fair value of each option  grant is estimated on the date of grant using the
Black-Scholes   option-pricing   model  with  the   following   weighted-average
assumptions used for grants in 2003; no dividend yield;  expected  volatility of
134.97%; risk-free interest rate of 2.06%; and expected lives of three years for
the 2003 option grants.

The  following  table  summarizes  information  about the Plan's  stock  options
outstanding at December 31, 2004:

                     Options Outstanding              Options Exercisable

                           Weighted-
                            Average     Weighted-                 Weighted-
 Range of      Number      Remaining     Average      Number       Average
 Exercise   Outstanding   Contractual   Exercise    Exercisable   Exercise
  Prices    at 12/31/04      Life         Price     at 12/31/04     Price
----------  -----------   -----------   ---------   -----------   ---------

  $.10        1,845,500    1.30 years      $.10       1,845,500      $.10
$.12-$.125    1,550,000    2.16 years      $.12       1,550,000      $.12
  $.50          691,087    0.42 years      $.50         691,087      $.50
              ---------    ----------      ----       ---------      ----

$.10-$.50     4,086,587    1.48 years      $.18       4,086,587      $.18
              =========    ==========      ====       =========      ====


                                      F-22
<PAGE>

12.   Taxes on Income (In thousands)
                                                                 Year Ended
                                                                December 31,
                                                                 2004      2003
Taxes on income include provision <benefit> for:
  Federal income taxes                                        $     0   $     0
  State and local income taxes                                      0         0
                                                              -------   -------
   Total                                                      $     0   $     0
                                                              =======   =======

Taxes on income are comprised of:
  Current                                                     $     0   $     0
  Deferred                                                          0         0
                                                              -------   -------
   Total                                                      $     0   $     0
                                                              =======   =======

A reconciliation of taxes on income to the federal statutory rate is as follows:
                                                                 Year Ended
                                                                December 31,
                                                                 2004      2003

  Tax <benefit> at statutory rate                             $     3   $  <671>
  Increase <decrease> resulting from:
   State and local taxes, net of federal
     tax benefit                                                    0       <99>
   Change in valuation allowance                                   <3>      770
                                                              -------   -------
  Tax provision <benefit>                                     $     0   $     0
                                                              =======   =======

At December 31, 2004 and 2003,  the deferred tax assets and  liabilities  result
from the following temporary differences and carryforwards:

                                                                 2004      2003
Deferred tax assets:
  Net operating and other tax loss
   carryforwards                                              $10,183   $10,240
  Stock-based compensation                                         51        51
                                                              -------   -------
     Total deferred tax assets                                 10,234    10,291
                                                              -------   -------

Deferred tax liabilities:
  Accelerated depreciation                                       <226>     <183>
                                                              -------   -------
     Total deferred tax liabilities                              <226>     <183>
                                                              -------   -------
Net deferred tax asset before valuation
 allowance                                                     10,008    10,108
Valuation Allowance                                           <10,008>  <10,108>
                                                              -------   -------

Net deferred tax asset                                        $     0   $     0
                                                              =======   =======

At December 31, 2004, the Company had approximately $30 million of net operating
loss carryforwards for federal income tax purposes which expire in various years
through 2020 and tax credit  carryforwards  that expire in various years through
2020. The Company also had net operating loss carryforwards in various states in
which the Company and its  subsidiaries  operate  which are  available to absorb
allocated  portions of future taxable  income for state tax purposes.  The state
operating loss  carryforwards  expire in various years through 2020. At December
31,  2004,   valuation   allowance   relating  to  tax  loss  carryforwards  was
$10,008,000.


                                      F-23
<PAGE>

13.   Interest, Net (In thousands)

                                               Year ended
                                              December 31,
                                             2004     2003

     Interest expense                       $  912   $1,017
     Interest income                            <3>      <1>
                                            ------   ------
                                            $  909   $1,016
                                            ======   ======

14.   Related Party Transactions

The consolidated  financial statements include the following items applicable to
related parties (in thousands):

                                                                December 31,
Balance Sheets:                                               2004         2003
                                                             ------       ------

10.375% convertible subordinated debentures
  held by directors and executive officers                   $  159       $  159

Second mortgage payable                                           0          242

Other long-term debt (See Note 6)                                 0           40

Payable to York Realty Leasing LLC members
  (See Note 6)                                                1,736            0

Accrued interest on the second mortgage                          32           69

Accrued interest on other related party debt                    117          205

                                                                  Year ended
                                                                 December 31,
  Income Statements:                                          2004         2003
                                                             ------       ------

  Interest, net                                              $   53       $  115


                                      F-24
<PAGE>

Second mortgage payable

In August 2001, the Company obtained a $367,500 loan from Zackfoot  Investments,
LLC at 12.5%  interest  secured  by a  mortgage  on the  Company's  Pennsylvania
facility.  This loan was repaid during 2004. At December 31, 2003, the following
related parties were owed principal of $242,500 with respect to this loan:

      Andy Yurowitz (Employee and Director)                       $107,500
      Manfred Mayerfeld (Director)                                  50,000
      Andrew Levinson (Director)                                    25,000
      Ken Brody (Former Employee)                                   60,000
                                                                  --------
                                                                  $242,500
                                                                  ========

Accrued interest on the second mortgage

In August 2001, the Company obtained a $367,500 loan from Zackfoot  Investments,
LLC at 12.5%  interest  secured  by a  mortgage  on the  Company's  Pennsylvania
facility.  This loan was repaid during 2004. At December 31, 2004 and 2003,  the
following related parties were owed interest with respect to this loan:

                                                        2004        2003
                                                       -------     -------

      Manfred Mayerfeld (Director)                     $21,000     $16,000
      Andrew Levinson (Director)                        10,000       8,000
      Andy Yurowitz (Employee and Director)                  0      29,000
      Ken Brody (Former Employee)                            0      16,000
                                                       -------     -------
                                                       $32,000     $69,000
                                                       =======     =======

Accrued interest on other related party debt

During 2000 and 2001,  Andy  Yurowitz  provided the Company with an aggregate of
$167,500 at various times and for various purposes including working capital, to
pay creditors and to meet payroll.  These loans accrued  interest at the rate of
18% per  annum,  the amount  charged  by credit  card  companies  for  corporate
expenses  Mr.  Yurowitz  charged to his credit  cards.  The  Company  repaid the
principal  amount of the loans  during 2001 and 2003.  In addition to  receiving
interest on these loans, the Company granted to Mr. Yurowitz  five-year  options
to purchase up to 837,500 shares of the Company's common stock (five options for
each dollar loaned) at an exercise price of $0.10 which expire in April 2007. In
1999,  Mr.  Yurowitz  expended  $60,000 in  connection  with a successful  proxy
contest brought  against  Health-Chem in 1999 by a group led by him. The Company
repaid the  principal  amount of this loan  during  2001 and 2003 with  interest
equal to 18% per annum.

During 2000 and 2001,  Manfred Mayerfeld  provided the Company with an aggregate
of $191,600 at various times and for various purposes including working capital,
to pay creditors and to meet payroll.  These loans accrued  interest at the rate
of 18% per annum.  The Company  repaid the principal  amount of the loans during
2001 and 2003 along with aggregate  interest of $91,783 during 2004. In addition
to  receiving  interest on these  loans,  the Company  granted to Mr.  Mayerfeld
five-year options to purchase up to 958,000 shares of the Company's common stock
(five options for each dollar loaned) at an exercise price of $0.10 which expire
in April 2007. In 1999,  Mr.  Mayerfeld  expended  $40,000 in connection  with a
successful  proxy contest brought against  Health-Chem in 1999 by a group led by
Mr.  Yurowitz.  The Company repaid the principal amount of this loan during 2004
with interest of $25,700 (equal to 18% per annum).


                                      F-25
<PAGE>

At December 31, 2004 and 2003, the following  related parties were owed interest
with respect to these loans:

                                                       2004         2003
                                                     --------     --------

      Manfred Mayerfeld (Director)                   $117,000     $114,000
      Andy Yurowitz (Employee and Director)                 0       91,000
                                                     --------     --------
                                                     $117,000     $205,000
                                                     ========     ========

Interest, net

Interest  expense with respect to related  parties for the years ended  December
31, 2004 and 2003 is presented below:

                                                          Year ended
                                                         December 31,
                                                       2004         2003

Manfred Mayerfeld - Other related party debt         $  3,000     $ 37,000
Andy Yurowitz - Other related party debt                    0       32,000
Second mortgage                                        36,000       46,000
York Realty Leasing LLC members                        14,000            0
                                                     --------     --------
                                                     $ 53,000     $115,000
                                                     ========     ========

15.   Minority Interest

A former president of Hercon Laboratories  Corporation maintains a 1.5% interest
in Hercon Laboratories Corporation and Hercon Environmental Corporation.  Equity
in Hercon Environmental Corporation has generated a $3,000 minority interest.

As a result of  Financial  Interpretation  46(R),  effective  as of December 31,
2004,  the  Company's   consolidated  balance  sheet  includes  the  assets  and
liabilities  of York Realty  Leasing LLC. Andy Yurowitz and William  Robbins are
each 50% owners of York Realty  Leasing LLC. As of December  31, 2004,  each had
contributed  $65,000  in capital  to York  Realty  Leasing  LLC.  This  $130,000
combined  capital has been  classified as a minority  interest on  Health-Chem's
balance sheet at December 31, 2004.


                                      F-26
<PAGE>

16.   Discontinued Operations

In June 2001,  management  sought to diversify the Company's  business to reduce
its  reliance  on  its  single  nitroglycerin   transdermal  patch  product  and
investigated  a variety of  strategies  which  could  initiate a new and ongoing
product  pipeline.  Toward that end, the Company purchased the key machinery and
equipment of TCPI,  Inc., a  Florida-based  manufacturer  of medical  diagnostic
products,  out of bankruptcy in December  2001.  In February  2002,  the Company
organized a division which entered into a series of agreements pursuant to which
(i) it  licensed  thirty  diagnostic  products  derived  from a common  platform
technology,  (ii) it  retained  the  inventor  of  these  products  to  continue
development  work and (iii)  arranged to  manufacture  the  products at a leased
premises  located  in  Pompano  Beach,  Florida.  The  new  diagnostic  division
purchased  pregnancy  test wands  manufactured  under the  licenses and launched
shipment of these  products to European  customers.  However,  the  division was
unable to  manufacture  the  pregnancy  test wands  utilizing  the  equipment it
purchased.   Moreover,  the  Company  brought  to  market  only  two  additional
diagnostic  products of the thirty it licensed and  generated  minimal  revenues
from  sales of  these  products.  After  sales of the  pregnancy  test  products
declined dramatically due to patent issues, and with continuing operating losses
and cash flow drains, the Company divested itself of this division in 2004.

The consolidated  financial  statements of the Company have been reclassified to
reflect the results of operations and net assets of this diagnostic  division of
the Company as  discontinued  operations in accordance  with generally  accepted
accounting principles.


                                      F-27