UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C.  20549





FORM
20-F





 ̈
            REGISTRATION
      STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT
      OF 1934


OR





x
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
      the fiscal year ended December 31,
2009





OR





 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For the
transition period from__________ to ____________





 ̈ SHELL COMPANY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934


Date of event requiring this shell
company report_______________





Commission
file number: 000-28508


Flamel
Technologies S.A.











Not
Applicable











Republic
of France











Parc
Club du Moulin a Vent


33,
avenue du Docteur Georges Levy


69693
Vénissieux Cedex France











Securities
registered or to be registered pursuant to Section 12(b) of the
Act.





Title of each class
                
                Name of Exchange
                  on which RegisteredOrdinary
      Shares, nominal value 0.122 Euros per share, represented by American
      Depositary Shares (as evidenced by American Depositary Receipts), each
      representing one Ordinary Share
                
                NASDAQ
      Global Market





Securities
registered or to be registered pursuant to Section 12(g) of the Act.
None.





Securities
for which there is a reporting obligation pursuant to Section 15(d) of the
Act.  None.





Indicate
the number of outstanding shares of each of the issuer’s classes of capital or
common stock as of the close of the period covered by the annual
report.





24 342
600 Ordinary Shares, nominal value 0.122 Euros per Ordinary Share





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.





Yes            ̈              No                 x





If this
report is an annual or transition report, indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934.





Yes            ̈              No                 x





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





Yes           x              No                  ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer.  See definition of
“accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act.:





Large
accelerated filer  ̈    Accelerated
filer x    Non-accelerated
filer  ̈





Indicate
by check mark which basis of accounting the registrant has used to prepare the
financial statements included in this filing:





US GAAP
x


International
Accounting Standards as Issued by the International Accounting Standards Board
 ̈


Other
 ̈





Indicate
by check mark which financial statement item the registrant has elected to
follow.





Item
17      ̈                 Item
18       x





If this
is an annual report, indicate by check mark whether the registrant is a shell
company (as defined in Rule 12b-2 of the Exchange Act).





Yes            ̈              No                 x





TABLE
OF CONTENTS





PART
      I
                1ITEM
      1. Identity of Directors, Senior Management and Advisers
                1ITEM
      2. Offer Statistics and Expected Timetable
                1ITEM
      3. Key Information
                1ITEM
      4.  Information on the Company
                15ITEM
      4A.  Unresolved Staff Comments
                37ITEM
      5.  Operating and Financial Review and Prospects
                37ITEM
      6.  Directors, Senior Management and Employees
                46ITEM
      7.  Major Shareholders and Related Party Transactions
                54ITEM
      8.  Financial Information
                55ITEM
      9.  The Offer and Listing
                56ITEM
      10.  Additional Information
                57ITEM
      11.  Quantitative and Qualitative Disclosures About Market
      Risk
                65ITEM
      12.  Description of Securities Other Than Equity
      Securities
                65ITEM
      12.A Debt Securities
                65ITEM
      12.B Warrants and Rights
                65ITEM
      12.C Other Securities
                65ITEM
      12.D American Depositary Shares
                65PART
      II
                66ITEM
      13.  Defaults, Dividend Arrearages and Delinquencies
                66ITEM
      14.  Material Modifications to the Rights of Security Holders and Use
      of Proceeds
                66ITEM
      15.  Controls and Procedures
                67ITEM
      16.  [Reserved]
                68ITEM
      16A.  Audit Committee Financial Expert
                68ITEM
      16B.  Code of Ethics
                68ITEM
      16C.  Principal Accountant Fees and Services
                68ITEM
      16D.  Exemptions from the Listing Standards for Audit
      Committees
                69ITEM
      16E.  Purchases of Equity Securities by the Issuer and Affiliated
      Purchasers
                69ITEM
      16F.  Change in Registrant’s Certifying Accountant
                69ITEM
      16G.  Corporate Governance
                69PART
      III
                71ITEM
      17.  Financial Statements
                71ITEM
      18.  Financial Statements
                71ITEM
      19.  Exhibits
                71


i





As used
herein, references to the Company, ‘we,’ ‘us,’ ‘our,’ the Registrant and Flamel
refer to Flamel Technologies S.A. and its consolidated subsidiary, Flamel
Technologies, Inc., unless the context indicates otherwise.  References to
Shares herein refer to (i) the Ordinary Shares of Flamel, nominal value 0.122
Euros per Ordinary Share (the ‘Ordinary Shares’) and (ii) Flamel’s American
Depositary Shares, each of which represents one Ordinary Share (‘ADSs’). 
The ADSs are evidenced by American Depositary Receipts (‘ADRs’).  Ordinary
Shares and ADSs are referred to herein as ‘Shares.’





The
following product or technology designations are trademarks of the Company:
Asacard®, Basulin®, Flamel Technologies®, Micropump®, Medusa®,
Trigger-LockTM.





Flamel
publishes its financial statements in U.S. dollars.  In this annual report,
references to ‘dollars’ or ‘$’ are to U.S. dollars and references to ‘Euros’ or
‘EUR’ or ‘€’ are to the currency of the European Union as used in the Republic
of France.  Except as otherwise stated herein, all monetary amounts in this
annual report have been presented in dollars.  Solely for the convenience
of the reader, this annual report contains translations of certain Euro amounts
into dollars at specified rates.  See ‘Item 3.  Key Information -
Exchange Rates’ for information regarding the rates of exchange between the Euro
and the dollar in each of the previous five years.


ii


SPECIAL NOTE REGARDING
FORWARD-LOOKING INFORMATION





This
annual report contains forward-looking statements.  We may make additional
written or oral forward-looking statements from time to time in filings with the
Securities and Exchange Commission or otherwise.  The words “will,” “may,”
“believe,” “expect,” “anticipate,” “estimate,” ”project” and similar expressions
identify forward-looking statements, which speak only as of the date the
statement is made.  Such forward-looking statements are within the meaning
of that term in Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934.  Although we
believe that our expectations are based on reasonable assumptions within the
bounds of our knowledge of our business and operations, our business is subject
to significant risks and there can be no assurance that actual results of our
development and manufacturing activities and our results of operations will not
differ materially from our expectations.  Factors that could cause actual
results to differ from expectations include, among others, those specified in
“Risk Factors” beginning on page 3, some of which are highlighted
below:





·
            we
      depend on a few customers for the majority of our revenues, and the loss
      of any one of these customers could reduce our revenues
      significantly.




·
            our
      revenues depend on pharmaceutical and biotechnology companies successfully
      developing products that incorporate our drug delivery
      technologies.




·
            although
      products that incorporate our drug delivery technologies may appear
      promising at their early stages of development and in clinical trials,
      none of these potential products may reach the commercial market for a
      number of reasons.




·
            we
      must invest substantial sums in research and development in order to
      remain competitive, and we may not fully recover these
      investments.




·
            we
      depend on key personnel to execute our business plan.  If we cannot
      attract and retain key personnel, we may not be able to successfully
      implement our business plan.




·
            if
      we cannot keep pace with the rapid technological change in our industry,
      we may lose business, and our drug delivery systems could become obsolete
      or noncompetitive.




·
            if
      we cannot adequately protect our technology and proprietary information,
      we may be unable to sustain a competitive
  advantage.




·
            our
      products and technologies may not gain market
  acceptance.




·
            if
      our third party collaborative partners face generic competition for their
      products, our revenues and royalties from such products may be adversely
      affected.




·
            healthcare
      reform and restrictions on reimbursements may limit our financial
      returns.




·
            products
      that incorporate our drug delivery technologies are subject to regulatory
      approval.  If our pharmaceutical and biotechnology company partners
      do not obtain such approvals, or if such approvals are delayed, our
      revenues may be adversely affected.




·
            we
      may face product liability claims related to participation in clinical
      trials or the use or misuse of our products or products that incorporate
      our technologies.




·
            third
      parties have claimed, and may claim in the future, that our technologies,
      or the products in which they are used, infringe on their rights and we
      may incur significant costs resolving these
  claims.




·
            if
      we use biological and hazardous materials in a manner that causes injury,
      we may be liable for significant
damages.




·
            our
      share price has been volatile and may continue to be
    volatile.


iii




·
            because
      we have a limited operating history, investors in our shares may have
      difficulty evaluating our
prospects.




·
            if
      we are not profitable in the future, the value of our shares may
      fall.




·
            our
      operating results may fluctuate, which may adversely affect our share
      price.




·
            we
      currently do not intend to pay dividends, and cannot assure shareholders
      that we will make dividend payments in the
  future.




·
            our
      largest shareholders own a significant percentage of the share capital and
      voting rights of the Company.





Forward-looking
statements are subject to inherent risks and uncertainties, some of which cannot
be predicted or quantified.  Future events and actual results could differ
materially from those set forth in, contemplated by or underlying the
forward-looking statements.  We undertake no obligation to update these
forward-looking statements as a result of new information, future events or
otherwise.  You should not place undue reliance on these forward-looking
statements.  Statements in this annual report including those set forth in
‘Risk Factors’ in this report, describe factors, among others, that could
contribute to or cause such differences.


iv


PART
I





ITEM
1. Identity of Directors, Senior Management and Advisers





Not
applicable.





ITEM
2. Offer Statistics and Expected Timetable





Not
applicable.





ITEM
3. Key Information





Selected
Financial Data





The
selected consolidated financial data as of and for each of the five years ended
December 31, 2009 are derived from the Consolidated Financial Statements of
the Company, which have been prepared in accordance with U.S. GAAP and audited
by  an independent registered accounting firm with the Public Company
Accounting Oversight Board (United States). The selected consolidated financial
data of the Company set forth below are qualified by reference to, and should be
read in conjunction with, ‘Item 5. Operating and Financial Review and Prospects’
and the Consolidated Financial Statements and the Notes related thereto
appearing elsewhere in this annual report.





Statement
of Operations Data*:


2005
                  
                  
                  2006
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2009Revenues
                  
                  $
                  23,598
                  
                  
                  $
                  23,020
                  
                  
                  $
                  36,654
                  
                  
                  $
                  38,619
                  
                  
                  $
                  42,118Cost
      and Expenses
                  
                  
                  (60,147
                  )
                  
                  
                  (59,740
                  )
                  
                  
                  (75,215
                  )
                  
                  
                  (51,801
                  )
                  
                  
                  (53,871
                  )Income
      (Loss) from Operations
                  
                  
                  (36,549
                  )
                  
                  
                  (36,720
                  )
                  
                  
                  (38,561
                  )
                  
                  
                  (13,182
                  )
                  
                  
                  (11,753
                  )Interest
      and foreign exchange gain (loss), net
                  
                  
                  4,103
                  
                  
                  
                  1,388
                  
                  
                  
                  1,221
                  
                  
                  
                  1,417
                  
                  
                  
                  342Other
      income
                  
                  
                  5,003
                  
                  
                  
                  131
                  
                  
                  
                  197
                  
                  
                  
                  181
                  
                  
                  
                  (28
                  )Income
      (loss) before income tax
                  
                  
                  (27,443
                  )
                  
                  
                  (35,201
                  )
                  
                  
                  (37,143
                  )
                  
                  
                  (11,584
                  )
                  
                  
                  (11,439
                  )Income
      tax benefit  (expense)¤
                  
                  
                  66
                  
                  
                  
                  -
                  
                  
                  
                  (594
                  )
                  
                  
                  (500
                  )
                  
                  
                  -Net
      income (loss)
                  
                  $
                  (27,377
                  )
                  
                  $
                  (35,201
                  )
                  
                  $
                  (37,737
                  )
                  
                  $
                  (12,084
                  )
                  
                  $
                  (11,439
                  )Income
      (Loss) from Operations per ordinary share
                  
                  $
                  (1.59
                  )
                  
                  $
                  (1.54
                  )
                  
                  $
                  (1.61
                  )
                  
                  $
                  (0.55
                  )
                  
                  $
                  (0.49
                  )Basic
      earnings (loss) per ordinary share
                  
                  $
                  (1.19
                  )
                  
                  $
                  (1.48
                  )
                  
                  $
                  (1.57
                  )
                  
                  $
                  (0.50
                  )
                  
                  $
                  (0.47
                  )Diluted
      earnings (loss) per ordinary share
                  
                  $
                  (1.19
                  )
                  
                  $
                  (1.48
                  )
                  
                  $
                  (1.57
                  )
                  
                  $
                  (0.50
                  )
                  
                  $
                  (0.47Basic
      weighted average number of shares outstanding (in
    thousands)
                  
                  
                  22,999
                  
                  
                  
                  23,812
                  
                  
                  
                  24,024
                  
                  
                  
                  24,082
                  
                  
                  
                  24,225Diluted
      weighted average number of shares outstanding (in
    thousands)
                  
                  
                  22,999
                  
                  
                  
                  23,812
                  
                  
                  
                  24,024
                  
                  
                  
                  24,082
                  
                  
                  
                  24,225Dividends
      per share
                  
                  
                  —





* in
thousands of U.S. dollars, except share and per share data


¤
Research and Development tax credit reclassified from Income tax benefit to Cost
and Expenses for  all periods presented (see Note 4 to the Consolidated
Financial Statements).


1





Balance 
Sheet Data*:





2005
                  
                  
                  2006
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2009Cash,
      Cash equivalents & Marketable securities
                  
                  $
                  83,774
                  
                  
                  $
                  62,771
                  
                  
                  $
                  41,062
                  
                  
                  $
                  37,078
                  
                  
                  $
                  44,068Working
      capital**
                  
                  
                  67,092
                  
                  
                  
                  55,465
                  
                  
                  
                  31,155
                  
                  
                  
                  38,934
                  
                  
                  
                  44,185Total
      assets
                  
                  
                  124,351
                  
                  
                  
                  114,894
                  
                  
                  
                  101,401
                  
                  
                  
                  91,861
                  
                  
                  
                  94,296Long
      term liabilities (excluding deferred revenues)
                  
                  
                  12,801
                  
                  
                  
                  20,504
                  
                  
                  
                  21,483
                  
                  
                  
                  22,859
                  
                  
                  
                  20,744Shareholders’
      equity
                  
                  
                  86,654
                  
                  
                  
                  73,026
                  
                  
                  
                  54,627
                  
                  
                  
                  48,546
                  
                  
                  
                  44,863





*(in
thousands of U.S. dollars)


**
(current assets - current liabilities)





Exchange
Rates:





Flamel
publishes its financial statements in dollars. However, currently a significant
portion of the Company’s expenses are denominated in Euros. For information
regarding the effects of currency fluctuations on the Company’s results, see
‘Item 5. Operating and Financial Review and Prospects.’





The
following table sets forth the high, low and average exchange rates for the Euro
against the U.S. dollar in each of the last five years and in each of the
previous six months.





Year Ended December 31,
                  Euro to U.S. Dollar:
                
                High
                
                
                Low
                
                
                Average Rate12009
                
                
                1.512
                
                
                
                1.2555
                
                
                
                1.39332008
                
                
                1.599
                
                
                
                1.246
                
                
                
                1.47062007
                
                
                1.4874
                
                
                
                1.2893
                
                
                
                1.370642006
                
                
                1.3331
                
                
                
                1.1826
                
                
                
                1.255672005
                
                
                1.3507
                
                
                
                1.1667
                
                
                
                1.24478





Previous Six Months,
                  Euro to U.S. Dollar:
                
                High
                
                
                Low
                
                
                Average Rate1April
      2010
                
                
                1.3615
                
                
                
                1.3245
                
                
                
                1.3406March
      2010
                
                
                1.3765
                
                
                
                1.3338
                
                
                
                1.3569February
      2010
                
                
                1.3984
                
                
                
                1.3489
                
                
                
                1.3686January
      2010
                
                
                1.4563
                
                
                
                1.3966
                
                
                
                1.4272December
      2009
                
                
                1.512
                
                
                
                1.4276
                
                
                
                1.4614November
      2009
                
                
                1.5083
                
                
                
                1.4658
                
                
                
                1.4914





The
exchange rate for the Euro against the U.S. dollar as of April 30, was $1.3315
to € 1.00.  The Company makes no representation that Euro amounts have
been, could have been or could be converted into dollars at any of the exchange
rates referred to herein as of a given date.




1 Annual totals represent the average
of the noon buying rates for Euros of each business day during the relevant
period. Monthly totals represent the average of the noon buying rates for Euros
for each business day during the relevant month.


2


Risk
Factors





Our business faces many risks. The
risks described below may not be the only risks we face. Additional risks that we do
not yet know of or that we currently believe are immaterial may also impair our
business operations. If any of the events or circumstances described in the
following risks actually occur, our business, financial condition or results of
operations could suffer, and the trading price of our securities could decline. As a
result, you should consider all of the following risks, together with all of the other
information in this Annual Report on Form 20-F, before deciding to invest
in our securities.





Risks
Relating to Our Business and Industry





We
depend on a few customers for the majority of our revenues, and the loss of any
one of these customers could reduce our revenues significantly.





We depend
on a few customers and partners for the majority of our revenues, particularly
GlaxoSmithKline but also Merck Serono, Pfizer and Baxter.  The termination
of our relationship with any of these major customers or partners and our
failure to broaden our customer base could cause our revenues to decrease
significantly and result in losses from our operations.  Further, we may be
unable to negotiate favorable business terms with customers and partners that
represent a significant portion of our revenues.  If so, our revenues and
gross profits, if any, may not grow as expected or may not grow at a rate
sufficient to make us profitable.





Our
revenues depend on pharmaceutical and biotechnology companies successfully
developing products that incorporate our drug delivery
technologies.





We market
and sell our technologies to third parties who incorporate our technologies into
their products.  We depend upon collaborative agreements with
pharmaceutical and biotechnology companies to develop, test, obtain regulatory
approval for and commercialize products that incorporate our drug delivery
technologies.  We currently have collaborative agreements or relationships
with GlaxoSmithKline, Merck Serono, Pfizer, Baxter and other pharmaceutical and
biotechnology companies whose identities remain confidential.





The
number of products that our partners successfully develop under these
collaborative agreements will affect our revenues.  We cannot control the
timing and other aspects of the development or marketing by our pharmaceutical
and biotechnology company partners of their products that incorporate our
technologies and may not be informed by our partners concerning the timing and
other aspects of their development or marketing efforts.  The failure of
one or more of our partners to develop successful products that incorporate our
technologies or to perform as we expect under our agreements with them could
have a material adverse effect on our business, financial condition and results
of operations.  We face risks relating to our collaborative agreements,
including risks that:





·
            our
      collaborative agreements may not result in any new commercial
      products;




·
            the
      existing commercial products developed under our collaborative agreements
      may not be successful;




·
            our
      pharmaceutical and biotechnology company partners may not successfully
      market any commercial products;




·
            we
      may not be able to meet the milestones established in our current or
      future collaborative agreements;




·
            we
      may not be able to successfully develop new drug delivery technologies
      that would be attractive to potential pharmaceutical or biotechnology
      company partners;




·
            our
      collaborative partners may terminate their relationships with us;
      and




·
            our
      collaborative partners may enter bankruptcy or otherwise
      dissolve.


3


Although
products that incorporate our drug delivery technologies may appear promising at
their early stages of development and in clinical trials, none of these
potential products may reach the commercial market for a number of
reasons.





Successful
research and development of pharmaceutical products is difficult, expensive, and
time consuming.  Many product candidates fail to reach the market.  We
intend to continue to enhance our current technologies and pursue additional
proprietary drug delivery technologies.  Our success will depend on the
discovery and the successful commercialization of products that can utilize our
drug delivery technologies.  If products using our technologies fail to
reach the commercial market, our revenues would be adversely
affected.





Even if
our technologies appear promising during various stages of development, there
may not be successful commercial applications developed for them for a number of
reasons, including:





·
            the
      FDA (Food and Drug Administration) the European Medicines Agency (EMA) or
      an institutional review board, or our pharmaceutical or biotechnology
      partners may delay or halt clinical
trials;




·
            our
      pharmaceutical or biotechnology partners may face slower than expected
      rate of patient recruitment and enrollment in clinical
    trials;




·
            our
      technologies or our pharmaceutical and biotechnology company partners’
      products may be found to be ineffective or cause harmful side effects, or
      may fail during any stage of pre-clinical testing or clinical
      trials;




·
            we
      may not find pharmaceutical or biotechnology companies to adopt the
      technologies or, if partnered, the business strategy of our partner may
      change;




·
            our
      pharmaceutical and biotechnology company partners may find that certain
      products using our technologies cannot be manufactured on a commercial
      scale and, therefore, may not be economical to
  produce;




·
            our
      pharmaceutical and biotechnology company partners may determine that
      managed care providers are unwilling or unable to reimburse patients at an
      economically attractive level for products under development;
      or




·
            products
      that use our technologies could fail to obtain approval or, if approved,
      fail to achieve market acceptance or be precluded from commercialization
      by proprietary rights of third
parties.




We
must invest substantial sums in research and development in order to remain
competitive, and we may not fully recover these investments.





To be
successful in the highly competitive pharmaceutical industry, we must commit
substantial resources each year to research and development in order to develop
new products.  In 2009, we spent $ 30.4 million on research and
development.  Our ongoing investments in research and development for
future products could result in higher costs without a proportionate increase in
revenues.  The research and development process is lengthy and carries a
substantial risk of product failure.  If our research and development does
not yield sufficient new products that achieve commercial success, our future
operating results may be adversely affected.





We
depend upon a single site to manufacture our products, and any interruption of
operations could have a material adverse effect on our business.





All of
our manufacturing currently takes place in our production facilities located in
Pessac, France.  A significant interruption of operations at this facility
for any reason, such as fire, flood or other manmade or natural disaster or a
failure to obtain or maintain required regulatory approvals, could have a
material adverse effect on our business, financial condition and results of
operations.  In case of a disruption, we may need to establish alternative
manufacturing sources for our products, and this would likely lead to
substantial production delays as we build or locate replacement facilities and
seek to satisfy necessary regulatory obligations, including obtaining a
successful inspection by the FDA .  If this occurs, we may be unable to
satisfy contractual obligations with our pharmaceutical or biotechnology
partners in a timely manner.


4





We
depend on a limited number of suppliers for certain raw materials used in our
products, and any failure to deliver sufficient supplies could interrupt our
production process and could have a material adverse affect on our
business.





We
purchase a number of raw materials used in our products from a limited number of
suppliers, including a single supplier for certain key ingredients.  If the
supplies of these materials were interrupted for any reason, our manufacturing
and marketing of certain products could be delayed.  These delays could be
extensive and expensive, especially in situations where a substitution was not
readily available or required regulatory approval.  For example, an
alternative supplier may be required to pass an inspection by the FDA for
compliance with current Good Manufacturing Practices (cGMP) requirements before
we may incorporate that supplier’s ingredients into our manufacturing. We expect
to continue relying on our current suppliers for the foreseeable future. 
Failure to obtain adequate supplies in a timely manner could have a material
adverse effect on our business, financial condition and results of
operations.





We
depend on key personnel to execute our business plan.  If we cannot attract
and retain key personnel, we may not be able to successfully implement our
business plan.





Our
success depends in large part upon our ability to attract and retain highly
qualified personnel.  During our operating history, we have assigned many
key responsibilities within our Company to a relatively small number of
individuals, each of whom has played key roles in executing various important
components of our business.  We do not maintain material key person life
insurance for any of our key personnel.  If we lose the services of Stephen
H. Willard our Chief Executive Officer, or Rafael Jorda, our Chief Operating
Officer, we may have difficulty executing our business plan in the manner we
currently anticipate.  Further, because each of our key personnel plays
more than one role in respect of numerous components of our business, the loss
of any one or more of such individuals could have an adverse effect on our
business.





If
our competitors develop and market drug delivery technologies or related
products that are more effective than ours, or obtain regulatory approval and
market such technology or products before we do, our commercial opportunity will
be diminished or eliminated.





Competition
in the pharmaceutical and biotechnology industry is intense and is expected to
increase.  We compete with academic laboratories, research institutions,
universities, joint ventures, and other pharmaceutical and biotechnology
companies, including other companies developing drug delivery systems.  Our
Medusa technology competes with technologies from companies such as Alkermes,
Inc., Enzon Pharmaceuticals, Human Genome Sciences, Nektar Therapeutics, and
SkyePharma, plc. Companies with oral drug delivery technology that can compete
with our Micropump technology include Durect, Depomed, Biovail and Andrx
Corporation. We also compete generally with other drug delivery, biotechnology
and pharmaceutical and biotechnology companies that develop alternative drug
delivery technologies or new drug research and testing.





Many of
these competitors have substantially greater financial, technological,
manufacturing, marketing, managerial and research and development resources and
experience than we do.  Furthermore, acquisitions of competing drug
delivery companies by large pharmaceutical companies could enhance our
competitors’ resources.  Accordingly, our competitors may succeed in
developing competing technologies and products, obtaining regulatory approval
and gaining market share for these products more rapidly than we
do.





Additionally,
new chemical entities could be developed that, if successful, could compete
against our technologies or products.  Among the many experimental
therapies being tested in the United States and in Europe, there may be some
that we do not now know of that may compete with our drug delivery systems or
products in the future.  These chemical entities and new products may be
safer or may work better than our technologies or products.  Our
collaborators could choose a competing drug delivery system to use with their
drugs instead of one of our drug delivery systems.





If
we cannot keep pace with the rapid technological change in our industry, we may
lose business, and our drug delivery systems could become obsolete or
noncompetitive.





Our
success depends, in part, on maintaining a competitive position in the
development of products and technologies in a rapidly evolving field. 
Major technological changes can happen quickly in the biotechnology and
pharmaceutical industries.  If we cannot maintain competitive products and
technologies, our current and potential pharmaceutical and biotechnology company
partners may choose to adopt the drug delivery technologies of our
competitors.  Our competitors may succeed in developing competing
technologies or obtaining governmental approval for products before us, and the
products of our competitors may gain market acceptance more rapidly than our
products.  Such rapid technological change, or the development by our
competitors of technologically improved or different products, could render our
drug delivery systems obsolete or noncompetitive.


5





If
we cannot adequately protect our technology and proprietary information, we may
be unable to sustain a competitive advantage.





Our
success depends, in part, on our ability to obtain and enforce patents for our
products, processes and technologies and to preserve our trade secrets and other
proprietary information.  If we cannot do so, our competitors may exploit
our innovations and deprive us of the ability to realize revenues and profits
from our developments.





Any
patent applications we may have made or may make relating to our potential
products, processes and technologies may not result in patents being
issued.  Patent law relating to the scope of claims in the pharmaceutical
field in which we operate is continually evolving and can be the subject of some
uncertainty.  The laws providing patent protection may change in a way that
would limit protection.  Our current patents may not be exclusive, valid or
enforceable.  They may not protect us against competitors that challenge
our patents, such as companies that submit drug marketing applications to the
FDA, the EMA, or the competent authorities of EU Member States that rely, at
least in part, on safety and efficacy data from our products or our business
partners’ products (e.g., abbreviated new drug applications), obtain patents
that may have an adverse effect on our ability to conduct business or are able
to circumvent our patents.  The scope of any patent protection may not be
sufficiently broad to exclude competing products.  Our collaborations with
third parties expose us to risks that they will claim intellectual property
rights on our inventions or fail to keep our unpatented technology
confidential.





We may
not have the necessary financial resources to enforce our patents. 
Further, patent protection once obtained is limited in time, after which
competitors may use the covered technology without obtaining a license from
us.  Because of the time required to obtain regulatory marketing approval,
the period of effective patent protection for a marketed product is frequently
substantially shorter.





To
protect our trade secrets and proprietary technologies and processes, we rely,
in part, on confidentiality agreements with our employees, consultants and
advisors.  These agreements may not provide adequate protection for our
trade secrets and other proprietary information in the event of any unauthorized
use or disclosure, or if others lawfully develop the information.  If these
agreements are breached, we cannot be certain that we will have adequate
remedies.





Our
products and technologies may not gain market acceptance.





The
competitive nature of our industry could adversely affect market acceptance of
our products or the use of our drug delivery technologies.  Our products,
technologies and product candidates, even if we and our pharmaceutical and
biotechnology company partners obtain the necessary regulatory approval to
market our products and products that incorporate our technologies, may not gain
market acceptance among physicians, patients, healthcare payers and the medical
community.





The degree of market acceptance of any
product, technology or product candidate will depend on a number of factors,
including:





·
            the
      effectiveness of our marketing
strategy;




·
            demonstration
      of the clinical efficacy and safety of the product or
      technology;




·
            no
      evidence of undesirable side effects which delay or extend
      trials;




·
            no
      regulatory delays or other regulatory
actions;




·
            its
      cost-effectiveness;




·
            its
      potential advantage over alternative treatment methods;
  and




·
            the
      marketing and distribution support it
receives.




If any of
our products or technologies fail to achieve market acceptance, our ability to
generate revenue will be limited, which would have a material adverse effect on
our business.


6





If
we or our collaborative partners are required to obtain licenses from third
parties, our revenues and royalties on any commercialized products could be
reduced.





The
development of some of our products may require the use of technology developed
by third parties.  The extent to which efforts by other researchers have
resulted or will result in patents and the extent to which we or our
collaborative partners are forced to obtain licenses from others, if available,
on commercially reasonable terms is currently unknown.  If we or our
collaborative partners must obtain licenses from third parties, fees must be
paid for such licenses.  These fees would reduce the revenues and royalties
we may receive on commercialized products that incorporate our
technologies.





If
our third party collaborative partners face generic competition for their
products, our revenues and royalties from such products may be adversely
affected.





Some of
our third party collaborative partners may utilize our drug delivery
technologies in products with exclusive rights secured by patents or other
means.  These rights are limited in time and do not always provide
effective protection for their products.  If our collaborative partners are
unable to protect their products’ exclusivity, generic competition may erode
their market share, undermine the profitability of their products and limit the
royalties we could collect from product sales.  In the near term, the
expiration of Hatch-Waxman exclusivity for Coreg CR in April 2010 could open
Coreg CR to generic competition, which may negatively affect the royalties we
could collect in the future.  To date, we have generated more revenues from
Coreg CR than any other product sold using our drug delivery
technology.





Healthcare
reform and restrictions on reimbursements may limit our financial
returns.





Our
ability to successfully commercialize our products and technologies may depend
on the extent to which the government health administration authorities, private
health insurers and other third party payers will reimburse consumers for the
cost of these products, which affects the volume of drug products sold by
pharmaceutical and biotechnology companies that incorporate our technology into
their products.  Third party payers are increasingly challenging both the
need for, and the price of, novel therapeutic drugs and uncertainty exists as to
the reimbursement status of newly approved therapeutics.  The commercial
success of our products depends in part on the conditions under which products
incorporating our technology are reimbursed.  Adequate third party
reimbursement may not be available for such drug products to enable us to
maintain price levels sufficient to realize an appropriate return on our
investments in research and product development, which could materially and
adversely affect our business.  We cannot predict the effect that changes
in the healthcare system, especially cost containment efforts, may have on our
business.  In particular, it is difficult to predict the effect of the
recently enacted health care reform legislation in the United States, which is
still subject to legislative change.  Any such changes may adversely affect
our business.





Ongoing
current credit and financial market conditions may exacerbate certain risks
affecting our business





We rely
on third parties for several important aspects of our business.  For
example, we depend upon collaborators for both manufacturing and royalty revenue
and the clinical development of collaboration products and we may rely upon
several single source providers of raw materials for the manufacture of our
products.  Due to the ongoing limited availability of global credit and the
disruption in the financial markets, there may be a disruption or delay in the
performance of our third-party contractors, suppliers or collaborators.  If
such third parties are unable to satisfy their commitments to us, our business
would be adversely affected.





Fluctuations
in foreign currency exchange rates may cause fluctuations in our financial
results.





For the
year ended December 31, 2009 we derived 36.0% of our total revenues from
transactions in U.S. dollars, but have 85.7 % of our cash and cash equivalents,
all of our marketable securities, and the majority of our expenses denominated
in Euros.  As a result, our financial results could be significantly
affected by fluctuations of the euro relative to the U.S. dollar.  The
Company does not engage in substantial hedging activities with respect to the
risk of exchange rate fluctuations, although it does, from time to time,
purchase Euros against invoiced dollar receivables.  Any strengthening in
the U.S. dollar relative to the euro would have a negative effect on our balance
sheet while a weakening in the U.S. dollar relative to the euro would have a
positive effect.  See ‘Quantitative and Qualitative Disclosures About
Market Risk’ on page 65 for more information on the impact of currency exchange
rate fluctuations.


7





Risks Relating to Regulatory and Legal
Matters





Products
that incorporate our drug delivery technologies are subject to regulatory
approval.  If our pharmaceutical and biotechnology company partners do not
obtain such approvals, or if such approvals are delayed, our revenues may be
adversely affected.





In the
United States, the federal government, principally the FDA, and state and local
government agencies regulate all pharmaceutical products, including existing
products and those under development.  Our pharmaceutical and biotechnology
company partners may experience significant delays in expected product releases
while attempting to obtain regulatory approval for products incorporating our
technologies.  If our partners are not successful, our revenues and
profitability may decline.  We cannot control, and our pharmaceutical and
biotechnology company partners cannot control, the timing of regulatory approval
for any of these products, or if approval is obtained at all.





Applicants
for FDA approval often must submit extensive clinical and pre-clinical data as
well as information about product manufacturing processes and facilities and
other supporting information to the FDA.  Varying interpretations of the
data obtained from pre-clinical and clinical testing could delay, limit or
prevent regulatory approval of a drug product. The FDA also may require us or
our partners to conduct additional pre-clinical studies or clinical
trials.  For instance, we do not anticipate the necessity to conduct
individual toxicity and carcinogenicity tests for each product that we develop
using the Medusa nano-particulate technology.  Due to their special
properties, however, nanoparticle formulations may pose different issues of
safety or effectiveness than non-nanoscale products.  With that in mind,
the FDA may require additional toxicology tests and clinical trials to confirm
the safety and effectiveness of product candidates using the Medusa technology,
which would impact development plans for product candidates.





Changes
in FDA approval policy during the development period, or changes in regulatory
review for each submitted new product application, also may delay an approval or
rejection of an application.  For instance, under the Food and Drug
Administration Amendments Act of 2007 (“FDAAA”), our partners may be required to
develop risk evaluations and mitigation strategies, or REMS, to ensure the safe
use of their product candidates.  If the FDA disagrees with our partners’
REMS proposals, it may be more difficult and costly for our partners to obtain
regulatory approval for their product candidates.  Similarly, FDAAA
provisions may make it more likely that the FDA will refer a marketing
application for a new product to an advisory committee for review, evaluation,
and recommendation as to whether the application should be approved.  This
review can add to the time to approval and, although the FDA is not bound by the
recommendation of an advisory committee, objections or concerns expressed by an
advisory committee may cause the FDA to delay or deny approval.





The FDA
has substantial discretion in the approval process and may disagree with our or
our partners’ interpretations of data and information submitted in an
application, which also could cause delays of an approval or rejection of an
application.  Even if the FDA approves a product, the approval may limit
the uses or indications for which a product may be marketed, restrict
distribution of the product, or require further studies.


The FDA
also can withdraw product clearances and approvals for failure to comply with
regulatory requirements or if problems follow initial marketing.





Manufacturers
of drugs, including the active pharmaceutical ingredients, also must comply with
applicable current cGMP requirements, both as a condition of approval and for
continued authority to manufacture and distribute products.  Our
manufacturing facilities and those of our pharmaceutical and biotechnology
company partners may be required to pass a pre-approval inspection by the FDA,
and will be subject to periodic inspection after that, all intended to ensure
compliance with cGMP.  The cGMP requirements govern quality control of the
manufacturing process and documentation policies and procedures, and we and our
pharmaceutical and biotechnology company partners will need to ensure that all
of our processes, methods, and equipment are compliant with cGMP.  We will
be obligated to expend time, money, and effort in production, record keeping,
and quality control to assure that the product meets applicable specifications
and other requirements.  If we, our pharmaceutical and biotechnology
company partners or suppliers of key ingredients, cannot comply with these
practices, the sale of our products or products developed by our partners that
incorporate our technologies may be suspended.  This would reduce our
revenues and gross profits.


8


If our
products or products that incorporate our technologies are marketed in other
jurisdictions, we and the partners with whom we are developing our technologies
must obtain required regulatory approvals from foreign regulatory agencies and
comply with extensive regulations regarding safety, quality and efficacy. 
The related obligations are as demanding as those imposed by the FDA. If
approvals to market our products or our partners’ products are delayed, if we or
our partners fail to receive these approvals or previously received approvals
are withdrawn, our revenues would be reduced.  We may be required to incur
significant costs in obtaining or maintaining foreign regulatory
approvals.





Commercial
products incorporating our technologies are subject to continuing regulation,
and we and our pharmaceutical and biotechnology company partners may be subject
to adverse consequences if we or they fail to comply with applicable
regulations.





We and
our partners will continue to be subject to extensive regulatory requirements
for products and product candidates that incorporate our technologies, even if
they receive regulatory approval.  These regulations are wide-ranging and
govern, among other things:





·
            adverse
      drug experiences and other reporting
  requirements;




·
            product
      promotion and marketing;




·
            product
      manufacturing, including cGMP
compliance;




·
            record
      keeping;




·
            distribution
      of drug samples;




·
            required
      post-marketing studies or clinical
trials;




·
            authorization
      renewal procedures




·
            compliance
      with any required REMS;




·
            updating
      safety and efficacy information;




·
            use
      of electronic records and signatures;
and




·
            changes
      to product manufacturing or
labeling.





If we or
our partners fail to comply with these laws and regulations, the FDA, the
European Commission, competent authorities of EU Member States, or other
regulatory organizations, may take actions that could significantly restrict or
prohibit commercial distribution of products that incorporate our technologies.
If the FDA, the European Commission, competent authorities of EU Member States
determine that we are not in compliance with these laws and regulations, they
can, among other things:





·
            issue
      warning letters;




·
            impose
      fines;




·
            seize
      products or order recalls;




·
            issue
      injunctions to stop future sales of
products;




·
            refuse
      to permit products to be imported into, or exported out of, the United
      States or the European Union;




·
            suspend
      or limit our production;




·
            withdraw
      approval of marketing applications;


9




·
            order
      the competent authorities of EU Member States  to withdraw national
      authorization;  and




·
            initiate
      criminal prosecutions.




Regulatory
reforms may adversely affect our ability to sell our products
profitably.





From time
to time, the United States Congress and the Council of the European Union and
the European Parliament adopt changes to the statutes that the FDA and the
European Commission enforce in ways that could significantly affect our
business.  In addition, the FDA and the European Commission often issue new
regulations or guidance, or revises or reinterprets its current regulations and
guidance in ways that may significantly affect our business and our
products.  It is impossible to predict whether legislative changes will be
enacted or FDA or EU regulations, guidance or interpretations changed, and what
the impact of any such changes may be.





It is
possible, however, that such changes could have a significant impact on the path
to approval of products incorporating our technologies or of competing products,
and to our obligations and those of our partner pharmaceutical and biotechnology
companies.   For example, the FDAAA contains a number of provisions
that strengthen the FDA’s regulatory authority in various areas, including
clinical trial registration and results reporting; pharmacovigilance and other
safety-related issues; and post-approval clinical study requirements.  More
recently, the Patient Protection and Affordable Care Act became law.  Among
other things, this statute creates an abbreviated pathway to FDA approval of
“biosimilar” biological products that can include a determination that a product
is interchangeable with a previously approved biological product.




Certain
companies to which we have licensed our technology are subject to extensive
regulation by the FDA and other regulatory authorities.  Their failure to
meet strict regulatory requirements could adversely affect our
business.





Companies
to which we have licensed our technology are subject to extensive regulation by
the FDA, other domestic regulatory authorities, and equivalent foreign
regulatory authorities, particularly the European Commission.  Those
regulatory authorities may conduct periodic audits or inspections of the
companies’ facilities to monitor compliance with applicable regulatory
standards.  If the FDA or another regulatory authority finds that a company
has failed to comply with applicable regulations, the authority can institute a
wide variety of enforcement actions, including warning letters or untitled
letters; fines and civil penalties; delays in clearing or approving, or refusal
to clear or approve, products; withdrawal or suspension of approval of products;
product recall or seizure; order the competent authorities of EU Member States
to withdraw national authorization; orders for physician notification or device
repair, replacement or refund; interruption of production; operating
restrictions; injunctions; and criminal prosecution.  Any adverse action by
an applicable regulatory agency could lead to unanticipated expenditures to
address or defend such action, and may impair those companies’ ability to
produce and market their products, which could significantly impact the
royalties that we receive from them.




We
may face product liability claims related to participation in clinical trials or
the use or misuse of our products or products that incorporate our
technologies.





The
testing, manufacturing and marketing of our products or products that
incorporate our drug delivery technologies 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.  Any indemnification that we have obtained, or may obtain, from
contract research organizations or pharmaceutical and biotechnology companies or
hospitals conducting human clinical trials on our behalf may not protect us from
product liability claims or from the costs of related litigation. 
Insurance coverage is expensive and difficult to obtain, and we may be unable to
obtain coverage in the future on acceptable terms, if at all.  Although we
currently maintain product liability and recall insurance in amounts we believe
to be commercially reasonable, we cannot be certain that the coverage limits of
our insurance policies or those of our strategic partners will be
adequate.  If we are unable to obtain sufficient insurance at an acceptable
cost, a product liability claim or recall could adversely affect our financial
condition.  Similarly, any indemnification we have obtained, or may obtain,
from pharmaceutical and biotechnology companies with whom we are developing our
drug delivery technologies may not protect us from product liability claims from
the consumers of those products or from the costs of related litigation. 
If we are subject to a product liability claim, our product liability insurance
may not reimburse us, or be sufficient to reimburse us, for any expenses or
losses we may suffer.  A successful product liability claim against us, if
not covered by, or if in excess of, our product liability insurance, may require
us to make significant compensation payments.  These payments would be
reflected as expenses on our statement of operations and reduce our
earnings.


10





Third
parties have claimed, and may claim in the future, that our technologies, or the
products in which they are used, infringe on their rights and we may incur
significant costs resolving these claims.





Third
parties have claimed, and may claim in the future, that the manufacture, use or
sale of our drug delivery technologies infringes on their patent rights. 
In response to such claims, we may have to seek licenses, defend infringement
actions or challenge the validity of those patents in court.  If we cannot
obtain required licenses, 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.  We may not have
identified, or be able to identify in the future, United States and foreign
patents that pose a risk of potential infringement claims.





Any
claims that our products infringe or may infringe proprietary rights of third
parties, with or without merit, could be time-consuming, result in costly
litigation or divert the efforts of our technical and management personnel, any
of which could disrupt our relationships with our partners and could
significantly harm our operating results.





We enter
into collaborative agreements with pharmaceutical and biotechnology companies to
apply our drug delivery technologies to drugs developed by others. 
Ultimately, we receive license revenues and product development fees, as well as
revenues from the sale of products incorporating our technology and
royalties.  The drugs to which our drug delivery technologies are applied
are generally the property of the pharmaceutical and biotechnology
companies.  Those drugs may be the subject of patents or patent
applications and other forms of protection owned by the pharmaceutical and
biotechnology companies or third parties.  If those patents or other forms
of protection expire, are challenged or become ineffective, sales of the drugs
by the collaborating pharmaceutical and biotechnology company may be restricted
or may cease.





If
we use biological and hazardous materials in a manner that causes injury, we may
be liable for significant damages.





Our
research and development activities involve the controlled use of potentially
harmful biological materials, hazardous materials and chemicals, and are subject
to federal, state, EU, national and local laws and regulations governing the
use, storage, handling and disposal of those materials and specified waste
products.  We cannot completely eliminate the risk of accidental
contamination or injury from the use, storage, handling or disposal of these
materials, including fires and/or explosions, storage tank leaks and ruptures;
and discharges or releases of toxic or hazardous substances.  These
operating risks can cause personal injury, property damage and environmental
contamination, and may result in the shutdown of affected facilities and the
imposition of civil or criminal penalties.  The occurrence of any of these
events may significantly reduce the productivity and profitability of a
particular manufacturing facility and adversely affect our operating
results.





We
currently maintain environmental liability, property, business interruption and
casualty insurance.  If we fail to comply with environmental regulations,
we could be subject to criminal sanctions and/or substantial liability for any
damages that result, and any such liability could be significant.





Risks
Relating to Ownership of Our Securities





Our
share price has been volatile and may continue to be volatile.





The
trading price of our shares has been, and is likely to continue to be, highly
volatile.  The market value of an investment in our shares may fall sharply
at any time due to this volatility.  In the year ended December 31,
2009, the
closing sale price of our ADSs as reported on the NASDAQ National Market ranged
from $3.99 to $9.67.  In the year ended December 31, 2008, the closing sale
price of our ADSs as reported on the NASDAQ National Market ranged from $3.68 to
$10.72.  The market prices for securities of drug delivery, biotechnology
and pharmaceutical companies historically have been highly volatile. 
Factors that could adversely affect our share price include:





·
            fluctuations
      in our operating results;




·
            announcements
      of technological collaborations, innovations or new products by us or our
      competitors;




·
            governmental
      regulations;


11




·
            developments
      in patent or other proprietary rights owned by us or
    others;




·
            public
      concern as to the safety of drugs developed by us or
    others;




·
            the
      results of pre-clinical testing and clinical studies or trials by us or
      our competitors;




·
            adverse
      events related to our products;




·
            lack
      of efficacy of our products;




·
            litigation;




·
            decisions
      by our pharmaceutical and biotechnology company partners relating to the
      products incorporating our
technologies;




·
            actions
      by the FDA, the EMA or national authorities of EU Member States in
      connection with submissions related to the products incorporating our
      technologies;




·
            the
      perception by the market of biotechnology and high technology companies
      generally; and




·
            general
      market conditions, including the impact of the current financial
      environment.




Because
we have a limited operating history, investors in our shares may have difficulty
evaluating our prospects.





We
recorded the first commercial sales of products using one of our polymer
technologies through our partner, Corning, in 1999.  Our first commercial
sales of a pharmaceutical compound incorporating our Micropump technology
occurred in March 2007 with the launch of Coreg CR.  We have had no
commercial sales to date of products incorporating our Medusa technology. 
Accordingly, we have only a limited operating history, which may make it
difficult to evaluate our prospects.  The difficulty investors may have in
evaluating our prospects may cause volatile fluctuations in the market price of
our shares as investors react to information about our prospects.  Since
1995, we have generated revenues from product development fees and licensing
arrangements and royalties.  Our business and prospects must be evaluated
in light of the risks and uncertainties of a company with a limited operating
history and, in particular, one in the pharmaceutical industry.





If
we are not profitable in the future, the value of our shares may
fall.





We have a
history of operating losses and have accumulated aggregate net loss from
inception of approximately $171.6 million through December 31, 2009.  If we
are unable to earn a profit in future periods, the market price of our stock may
fall.  The costs for research and product development of our drug delivery
technologies and general and administrative expenses have been the principal
causes of our net losses in over recent years.  Our ability to operate
profitably depends upon a number of factors, many of which are beyond our direct
control.  These factors include:





·
            the
      demand for our technologies and
products;




·
            the
      level of product and price
competition;




·
            our
      ability to develop new collaborative partnerships and additional
      commercial applications for our
products;




·
            our
      ability to control our costs;




·
            our
      ability to broaden our customer
base;




·
            the
      effectiveness of our marketing
strategy;




·
            the
      effectiveness of our partners’ marketing strategy for products which use
      our technology; and




·
            general
      economic conditions.


12





We
may require additional financing, which may not be available on favorable terms
or at all, particularly in light of the slow global economic recovery and its
negative effect  on the capital markets, and which may result in dilution
of our shareholders’ equity interest.





We may
require additional financing to fund the development and possible acquisition of
new drug delivery technologies and to increase our production capacity beyond
what is currently anticipated.  We may consume available resources more
rapidly than currently anticipated, resulting in the need for additional
funding.  If we cannot obtain financing when needed, or obtain it on
favorable terms, we may be required to curtail our plans to continue to develop
drug delivery technologies.  We may also elect to pursue additional
financing at any time to more aggressively pursue development of new drug
delivery technologies.  Obtaining additional financing may be difficult in
light of the slow global economic recovery and extremely tight capital
markets.  Other factors that will affect future capital requirements and
may require us to seek additional financing include:





·
            the
      development and acquisition of new products and
    technologies;




·
            the
      progress of our research and product development
  programs;




·
            results
      of our collaborative efforts with current and potential pharmaceutical and
      biotechnology company partners; and




·
            the
      timing of, and amounts received from, future product sales, product
      development fees and licensing revenue and
  royalties.




If
adequate funds are not available, we may be required to significantly reduce or
refocus our product development efforts, resulting in loss of sales, increased
costs, and reduced revenues.





Our
operating results may fluctuate, which may adversely affect our share
price.





Fluctuations
in our operating results may lead to fluctuations, including declines, in our
share price.  Our operating results may fluctuate from period to period due
to a variety of factors, including:





·
            demand
      by consumers for the products we
produce;




·
            new
      product introductions;




·
            pharmaceutical
      and biotechnology company ordering
patterns;




·
            the
      number of new collaborative agreements into which we
  enter;




·
            the
      number and timing of product development milestones that we achieve under
      collaborative agreements;




·
            the
      level of our development activity conducted for, and at the direction of,
      pharmaceutical and biotechnology companies under collaborative agreements;
      and




·
            the
      level of our spending on new drug delivery technology development and
      technology acquisition, and internal product
  development.




Variations
in the timing of our revenue and expenses could also cause significant
fluctuations in our operating results from period to period and may result in
unanticipated earning shortfalls or losses.





We
are subject to different corporate disclosure standards that may limit the
information available to holders of our ADSs.





As a
foreign private issuer, we are not required to comply with the notice and
disclosure requirements under the Securities Exchange Act of 1934, as amended,
or the Exchange Act, relating to the solicitation of proxies for shareholder
meetings.  Although we are subject to the periodic reporting requirements
of the Exchange Act, the periodic disclosure required of non-United States
issuers under the Exchange Act is more limited than the periodic disclosure
required of United States issuers. Therefore, there may be less publicly
available information about us than is regularly published by or about other
public companies in the United States.


13





We
currently do not intend to pay dividends, and cannot assure shareholders that we
will make dividend payments in the future.





The
Company has never declared or paid a cash dividend on any of its capital stock
and does not anticipate declaring cash dividends in the foreseeable
future.  Declaration of dividends on our shares will depend upon, among
other things, future earnings, if any, the operating and financial condition of
our business, our capital requirements, general business conditions and such
other factors as our Board of Directors deems relevant.





Judgments
of United States courts, including those predicated on the civil liability
provisions of the federal securities laws of the United States, may not be
enforceable in French courts.





An
investor in the United States may find it difficult to:





·
              effect
      service of process within the United States against us and our non-United
      States resident directors and
officers;


·
              enforce
      United States court judgments based upon the civil liability provisions of
      the United States federal securities laws against us and our non-United
      States resident directors and officers in France;
  or


bring an
original action in a French court to enforce liabilities based upon the United
States federal securities laws against us and our non-United States resident
directors and officers.




Holders
of ADSs have fewer rights than shareholders and have to act through the
Depositary to exercise those rights.





Holders
of ADSs do not have the same rights as shareholders and accordingly, cannot
exercise rights of shareholders against us.  The Bank of New York Mellon,
as depositary (the “Depositary”),
is the registered shareholder of the deposited shares underlying the ADSs, and
therefore holders of ADSs will generally have to exercise the rights attached to
those shares through the Depositary.  We will use reasonable efforts to
request that the Depositary notify the holders of ADSs of upcoming votes and ask
for voting instructions from them.  If a holder fails to return a voting
instruction card to the Depositary by the date established by it for receipt of
such voting instructions, or if the Depositary receives an improperly completed
or blank voting instruction card, or if the voting instructions included in the
voting instruction card are illegible or unclear, then such holder will be
deemed to have instructed the Depositary to vote its shares and the Depositary
shall vote such shares in favor of any resolution proposed or approved by our
Board of Directors and against any resolution not so proposed or
approved.





Preferential
subscription rights may not be available for United States persons.





Under
French law, shareholders have preferential rights to subscribe for cash
issuances of new shares or other securities giving rights to acquire additional
shares on a pro rata basis.  United States holders of our securities (which
might not be shares but ADRs) may not be able to exercise preferential
subscription rights for their securities unless a registration statement under
the Securities Act is effective with respect to such rights or an exemption from
the registration requirements imposed by the Securities Act is available. We
may, from time to time, issue new shares or other securities giving rights to
acquire additional shares (such as warrants) at a time when no registration
statement is in effect and no Securities Act exemption is available. If so,
United States holders of our securities will be unable to exercise any
preferential rights and their interests will be diluted. We are under no
obligation to file any registration statement in connection with any issuance of
new shares or other securities.





For
holders of our shares in the form of ADSs, the Depositary may make these rights
or other distributions available to holders after we instruct it to do in the
United States. If we fail to do this and the Depositary determines that it is
impractical to sell the rights, it may allow these rights to lapse. In that case
the holders will receive no value for them.




Our
largest shareholders own a significant percentage of the share capital and
voting rights of the Company.





At
December 31, 2009, O.S.S. Capital Management LP and BVF, Inc., our two largest
shareholders, held approximately 13.1% and 14.5% of our issued share capital.
See “Item 7. Major Shareholders and Related Party Transactions — A. Major
Shareholders.” To the extent these shareholders continue to hold a large
percentage of our share capital and voting rights, they will remain in a
position to exert heightened influence in the election of the directors [and
officers] of the Company and in other corporate actions that require
shareholders’ approval.


14





ITEM
4.  Information on the Company





General
Overview





We are a
biopharmaceutical company principally engaged in the development of two unique
polymer-based drug delivery technologies.  Our nanoparticle Medusa
technology is designed to provide controlled release following injection of
therapeutic proteins, peptides and other large and small molecules.  We
also have developed a microparticule adaptation of the Medusa platform which we
believe offers important advantages in the delivery of smaller proteins and
peptides.  Our Micropump technology is a multiparticle technology for oral
administration of small molecule drugs with applications in controlled-release,
taste-masking and bioavailability enhancement.  Our Trigger-Lock®
technology is an adaptation of Micropump designed to minimize the misuse and
abuse of medications subject to abuse.





Our
Business Model





We
develop specific applications of our controlled release technologies in
partnership with biotechnology and pharmaceutical companies.  Our business
model enables us to focus on our comparative advantages in polymer chemistry and
drug delivery while leveraging the expertise of partner companies in specific
indications, clinical and regulatory development, marketing, and sales.  We
generate revenues through license payments from our partners to develop products
using our drug delivery technologies, milestone payments for achieving certain
objectives in getting products to market and royalty payments based on product
sales.  Currently we are working with eight of the top twenty five
pharmaceutical companies in the world, based on annual healthcare revenue, and
on twenty five feasibility and license and development projects.  These
projects are being conducted across a wide range of indications and with both
novel and already-marketed molecules.  Twenty of these concern the Medusa
platform and four are for Micropump applications.  The remaining project
with a leading pain therapy company is an application of the Trigger Lock
platform using multiple molecules.





Recent
Developments





In June
2009 we entered into collaboration with Baxter International Inc. to create
controlled release applications of blood clotting factor replacement therapies
using our Medusa technology.  This collaboration includes work on
intravenous formulations.  Baxter paid technology access fees totaling €
2.5 million (or $3.6 million), will pay all development costs for the program
and has an exclusive right to negotiate a license to the Medusa platform for
these applications.  Based on sales, Baxter is the world leader in the
field of blood clotting factor replacement therapies.





In
February 2009, Merck Serono, a partner since 2007, exercised its option to
license the Medusa platform for the continued development of an already-marketed
therapeutic protein proprietary   Pursuant to the license Merck Serono
will pay all future development costs for the program as well as make payments
upon achievement of certain clinical and regulatory milestones and pay royalties
upon any sales of the product.





In
November 2009, Pfizer, who acquired Wyeth in October 2009, exercised its option
to license the Medusa technology.  In September 2007, Wyeth Pharmaceuticals
became a partner when we signed a license for the application of the Medusa
platform for the controlled release of an already marketed therapeutic
protein.  .  This election triggered a $1 million payment to Flamel
and Pfizer will pay all development costs of the program, including milestone
payments and royalties on any worldwide commercial sales.





The lead
product using our Micropump technology is Coreg CR, which we developed with
GlaxoSmithKline (GSK) and which is approved, marketed and sold in the United
States of America.  We began work with GSK in 2003, the product was
approved by FDA in October 2006 and launched in March 2007.  Pursuant to
the supply agreement with GSK, we produce Coreg CR microparticles on a cost plus
basis.  $23 million in milestone payments have been received from GSK to
date and Flamel still is eligible to receive an additional $2 million if certain
milestones are achieved.  Turnover of Coreg CR through December 31, 2009
amounted to $251 million on which we recognized royalty revenue of $8.8
million.  The Hatch-Waxman exclusivity period for Coreg CR ended on April
20, 2010.  It is possible that Coreg CR may experience generic competition
from one or more competitors following approval of an Abbreviated New Drug
Application (ANDA).  To date only one ANDA had been submitted to the U.S.
FDA, URL Pharma in March 2008 and it has not yet been reviewed.  A Citizen
Petition has  been submitted to the FDA that respectfully requests that the
FDA require any proposed generic formulations of Coreg CR to meet the same
requirements that the FDA required for the approval of Coreg CR, which is a
higher standard than is otherwise required under the minimum bioequivalence
regulations.


15





Applications
Under Development





Flamel
also has several important programs for which we do not currently have a 
partner.  An example of the potential of the Medusa platform to improve the
safety and efficacy of therapeutic proteins is our formulation of
Interferon-Alpha XL, a long acting formulation of Interferon-Alpha.  In
December 2009 the Agence
Nationale de Recherche sur le SIDA (AIDS) et les Hépatites Virales
(ANRS) initiated a
twelve week Phase 2 study comparing two dosage forms of our IFN-alpha XL plus
ribavirin versus Peg-Intron® plus
ribavirin in genotype 1 hepatitis C patients.  This builds on two previous
studies we conducted that demonstrated promising results of the formulation as
compared to Intron-A®
(immediate release interferon-alpha 2b, marketed by Schering Plough, since
acquired by Merck) and Peg-Intron®
(pegylated interferon-alpha 2b, also marketed by Schering Plough [now owned by
Merck]).  In both studies patients receiving our drug experienced fewer
adverse events than those receiving the comparator treatment.  Furthermore
in a study presented at the Annual Meeting for the European Association for the
Study of the Liver in Milan in April, 2008, the results showed a statistically
significant reduction in viral load after two weeks in the group comprising
genotype-1 naïve patients, and non-responder/relapsed patients, relative to
comparator treatment.





Our FT-105 program uses a microparticle
adaptation of our Medusa technology to meet the long-acting, ‘basal’ insulin
requirements of diabetic patients as opposed to the requirement for insulin
associated with meals.  In diabetics, large variations in blood glucose
levels over time can lead to serious, long-term complications including vision
impairment, foot ulcerations and kidney failure.    Theoretically, the
need for basal insulin implies a profile with minimal peak and trough
differences to minimize a diabetic’s hypoglycemia and hyperglycemia (low and
elevated blood glucose levels) episodes, particularly during the first hours
after insulin injections and during the sleeping hours.  FT-105 has been
shown to provide a controlled-release of fully human insulin over at least 48
hours with good bioavailablity and excellent local tolerance.





Long-acting
“basal” insulins already are available and have generated significant
sales.  Leading long-acting basal insulins, Lantus® (insulin
glargine, Sanofi-Aventis) and Levemir® (insulin
detemir, Novo Nordisk), had sales of $4.3 billion and $980 million respectively
in 2009.  In Type I diabetics, basal insulin is projected to represent 40%
of their required treatment.  Type II diabetics significantly out-number
Type I diabetics and often require only basal insulin.  Our FT-105 basal
insulin is designed to address the requirements of both these groups.  In
October 2007, we announced top-line results of the Phase I three-way crossover
trial of FT-105 conducted in eighteen healthy volunteers.  The results
showed a 48-hour controlled release of recombinant human insulin, with a very
flat curve as compared to Lantus, the current standard of care.





Corporate
Information





The
Company was incorporated as a société anonyme, a form of
corporation under the laws of the Republic of France, in August 1990 as Flamel
Technologies S.A. and its shares were quoted on the NASDAQ National Market in
1996.  Flamel’s principal place of business is located at Parc Club du
Moulin àVent,
33, avenue du Docteur Georges Lévy, 69693 Venissieux
Cedex, France, telephone number +33 472 78 34 34.  A list of the Company’s
significant subsidiaries can be found in Exhibit 8.1.





Market
Opportunity: The Need for Novel Drug Delivery Systems





Our
polymer delivery systems focus on the controlled release of therapeutic proteins
and peptides following injection and the oral administration of pharmaceutical
drugs, primarily those that are best absorbed in the small intestine.  The
pharmaceutical industry utilizes drug delivery technologies as a tool to improve
existing products as well as to overcome certain problems encountered in the
development of new products.  Drug delivery technologies enable
pharmaceutical companies to improve the safety and efficacy profiles of
innovative new therapeutic compounds, to improve patient compliance and
acceptance of existing drugs, to expand therapeutic indications of an existing
drug, and to gain competitive advantages for drugs facing patent
expirations.  The global market for advanced drug delivery systems was
projected to reach $139 billion in 2009 and grow at a compound rate of over 7%
thereafter, according to BCC Research.


16





Business
Strengths and Strategies





Our core
strength is as a science-based, market-focused innovator of controlled release
drug delivery systems.  The key elements of our strategy that enable us to
build upon our strengths are:





·
            to
      maximize the potential of our existing drug delivery
    systems;




·
            to
      develop additional drug delivery
technologies;




·
            to
      develop new formulations of proprietary compounds that we receive from
      additional partners;




·
            to
      leverage capabilities of pharmaceutical partners for clinical development
      and commercialization; and




·
            to
      identify additional compounds for unmet medical
  needs.




We
believe that we have a competitive advantage in developing controlled-release
formulations of proteins, peptides, and small molecules that improve dosing,
compliance and efficacy, while potentially reducing side-effects. We will
continue to partner our proprietary formulations with pharmaceutical companies
which have the clinical, regulatory and marketing resources to secure regulatory
approval and to commercialize these pharmaceuticals successfully.  We are
increasingly focused on working with pharmaceutical and biotechnology partners
at an earlier stage of development as we believe this removes the market-related
risk that has negatively affected our ability to partner internally-developed
products in the past.





Under our
partner agreements, our pharmaceutical company partners typically assume
responsibility for all clinical, regulatory and marketing costs and make
payments to us at the time the agreement is signed and upon the achievement of
significant technical, clinical and regulatory milestones.  We also
typically are entitled to receive ongoing royalty payments on the sales of
pharmaceuticals that incorporate our technologies.





Medusa
Delivery System for Therapeutic Proteins, Peptides and Other Large
Molecules





The use
of therapeutic agents based on biological proteins and peptides is projected to
grow significantly in the near future.  According to IMS, sales of
biologics were approximately $120 billion in 2008, nearly 17% of total
pharmaceutical turnover, and are expected to grow 11-12% annually, a growth rate
roughly double that of the overall pharmaceutical marketplace.  In the same
year five of the top fifteen best selling drugs were biologics, accounting for
26% of sales of these top fifteen.  With over 600 biotechnology drugs in
development, biologics are expected to continue to increase in
significance.





However,
biologics pose particular challenges for drug delivery, which we believe Medusa
is able to address.  Nearly all biologics need to be injected, and are
fragile entities relative to traditional small molecule drugs.  In
developing these products, a principal challenge is finding a suitable system
that can release the protein, peptide, or other large molecule at the optimal
therapeutic rate, and protect it from being unduly degraded without denaturing
it (i.e., causing a structural change that result in a loss of
bioactivity).





The
scientific challenges to developing such a controlled-release process for
protein-based drugs are significant.  For a polymer-based delivery system,
these constraints require a polymer that:





·
            has
      the required release properties once
delivered;




·
            is
      compatible with the protein or
peptide;




·
            keeps
      the structure of the protein
intact;




·
            protects
      the therapeutic agent during transit and delivery;
  and




·
            can
      be metabolized by the human body into harmless
  substances.


17


Responding
to these scientific challenges and to what we believe is a significant market
opportunity, we have developed Medusa, a system designed to optimize delivery of
proteins,  peptides and other large molecules in a controlled manner
following subcutaneous or intravenous injection.  Our approach utilizes a
proprietary system consisting of a polyaminoacid biopolymer comprised of only
one or two different amino acids grafted with vitamin E.  We have
engineered this polyaminoacid polymer to form nano-sized particles spontaneously
in water which then entrap the protein or peptide; all without the use of
solvents, surfactants, extreme  temperatures or pH, or other conditions
that might damage the biologic.  This ‘self-assembly’ process is
thermodynamically driven and until the polymer reaches saturation essentially
all the drug is entrapped.





Once
injected, Medusa forms a reservoir from which the drug is released over time as
a result of exchange with endogenous proteins.  The timing of this release
can be engineered to be short or as long as one to two weeks following a single
injection.





We have
found that the same polymer is potentially applicable across substantially all
therapeutic proteins and peptides, as well as other large molecules and even
small molecules.  One advantage of this “ubiquitous polymer” approach is
that we do not anticipate a need to conduct extensive individual toxicity and
carcinogenicity tests for each product that we develop using the
technology.  This is because the same polymer is used across multiple
products and the association between polymer and drug is a physical interaction
and not a chemical bond.  We have shown in animal studies that our
polyaminoacid polymer is neither immunogenic nor reactogenic. 
Nevertheless, further testing is necessary in each specific application of
Medusa to a drug to demonstrate that the product does not pose a potential risk
for human subjects.





Additionally,
we have demonstrated in recent years that the Medusa polymer may serve to
address certain issues that would otherwise limit development of potentially
promising large molecules.  Particularly, we have demonstrated that Medusa
formulations of certain large and small molecules with poor solubility have
solubility levels up to several thousand times greater than the native molecules
themselves.  These gains in solubility may offer our partners the potential
to develop molecules which they otherwise would discontinue.





Medusa
also has demonstrated the ability to  reduce protein aggregation. 
Protein aggregation is another threshold issue in drug development that often is
associated with greater immunological response in the body.  We believe the
ability to address both of these problems, poor solubility and protein
aggregation, is an important advantage to our partners.





Products
Under Development Based on the Medusa Technology





1.
            Interferon
      Alpha





We
believe that the Medusa delivery system has the potential to improve
formulations of many important biological drugs.   An example of the
potential of the Medusa platform to improve the safety and efficacy of
therapeutic proteins is our formulation of Interferon-Alpha XL. 
Interferon-alpha is a naturally occurring protein that the body uses as part of
its immune response and which is part of the current standard of care for the
treatment of Hepatitis C virus.  In December 2009 the Agence Nationale de Recherche sur le
SIDA et les Hépatites Virales (ANRS) initiated a twelve week
Phase 2 study comparing two dosage forms of our IFN-alpha XL plus ribavirin
versus Peg-Intron® plus
ribavirin in genotype 1 hepatitis C patients.  We have conducted two
previous studies that demonstrated promising results of the formulation as
compared to Intron-A®
(immediate release interferon-alpha 2b, marketed by Schering Plough, since
acquired by Merck) and Peg-Intron (pegylated interferon-alpha 2b, also marketed
by Schering Plough (Merck)).





Our first
study compared Interferon-Alpha XL with Intron-A.    The
dose-escalating study was conducted in 53 subjects with chronic hepatitis
C.  Thirty-nine participants were assigned to receive a single subcutaneous
injection of one of three escalating doses of IFN-alpha-XL (12 - 14 patients per
dose).  The three IFN-alpha-XL groups received an injection of 9 million
international units (MIU), 18 MIU, and 27 MIU, respectively.  A cohort of
14 patients received three subcutaneous injections of a standard dose of
Intron-A (3 MIU) over one week as a comparator.  All patients completed the
study, and no serious adverse events were reported.





Adverse
events were similar to what has been reported in other studies of interferon
therapy and were transient in duration and mild to moderate in severity. 
Patients receiving IFN-alpha-XL experienced fewer adverse events than patients
receiving Intron A, even when the weekly dosage of IFN-alpha-XL was at its
highest level.  Pharmacokinetic data demonstrate that the Medusa
formulation provides sustained release of IFN-alpha-XL over one
week.


18


The
second trial we completed compared our Interferon-Alpha XL with
Peg-Intron.  The full data set was presented at the Annual Meeting for the
European Association for the Study of the Liver in Milan in April, 2008. 
Results showed a statistically significant reduction in viral load after two
weeks in the group comprising genotype-1 naïve patients, and
non-responder/relapsed patients to pegylated interferon plus ribavirin. 
Importantly, these patients also benefitted with respect to tolerance of the
treatment, as reported adverse events were fewer in those patients administered
Interferon-Alpha XL than in those patients administered Peg-Intron.





The
worldwide market for leading interferon (alpha, beta and gamma) products
amounted to approximately $8.6 billion in 2009, and we expect this market to
grow in the future as researchers identify additional indications that may be
treated effectively using interferon drugs, as such proposed treatments gain
approval and as new suppliers emerge.   In 2009, interferon alpha
formulations accounted for approximately 30% of the worldwide market for
interferons.  We are in discussions regarding  licensing agreements
with interested parties for the further development of the Medusa platform with
respect to interferon-alpha.





2.
            FT-105 
      Long-acting Basal Insulin
Formulation





Our first
application of our proprietary Medusa technology microparticulate application is
a depot delivery formulation of insulin targeted to meet the long-acting,
‘basal’ insulin requirements of diabetic patients.





Insulin
Market





Insulin
serves to regulate the glucose level in the blood.  In a non-diabetic
person, the body produces insulin in large quantities after each meal to reduce
the resulting high glucose level.  In non-diabetics the body also produces
a small quantity of insulin every 15 minutes to ensure that a protective basal
level of insulin is maintained throughout the day.  To maintain similar
control over their glucose levels, diabetics who need insulin injections require
two different types of release profiles: a fast-acting insulin to be taken at
meal times, and a long-acting insulin to maintain a constant minimum (“basal”)
level of insulin, particularly throughout the night when patients do not inject
insulin.





Global
sales of leading insulin drugs were approximately $13.6 billion in 2009. 
Leading long-acting basal insulins, Lantus® (insulin
glargine, Sanofi-Aventis) and Levemir® (insulin
detemir, Novo Nordisk), are among the fastest growing insulins, with sales of
$4.3 billion and $980 million respectively in 2009 (together nearly 39% of the
global insulin market).  In Type I diabetics (those with Insulin Dependent
Diabetes Mellitus), basal insulin is projected to represent 40% of their
required treatment.  Type II diabetics (those with Non-Insulin Dependent
Diabetes Mellitus) significantly out-number Type I diabetics and often require
only basal insulin.  Our FT-105 basal insulin is designed to address the
requirements of both these groups.





The
Development of FT-105 basal insulin





Using a
microparticulate adaptation of our Medusa delivery system, we have been able to
form nanoparticles of human insulin and aggregate them to produce a long-acting,
injectable insulin formulation known as FT-105.  The microparticulate
formulation of Medusa polymer has a longer release profile than the
nanoparticles themselves.  We believe this is because following injection
the much larger microparticles sequester the insulin and protect it from being
susceptible to exchange with endogenous proteins.  These microparticles
then slowly disaggregate into nanoparticles which in turn release the insulin as
a result of exchange with endogenous protein.





In diabetics, large variations in blood
glucose levels over time can lead to serious, long-term complications including
vision impairment, foot ulcerations and kidney failure.   
Theoretically, the need for basal insulin implies a profile with minimal peak
and trough differences to minimize a diabetic’s hypoglycemia and hyperglycemia
(low and elevated blood glucose levels) episodes, particularly during the first
hours after insulin injections and during the sleeping hours.  FT-105 has
been shown to provide a controlled-release of fully human insulin over at least
48 hours with good bioavailablity and excellent local tolerance.  Among
FT-105’s potential advantages is the fact that it is a recombinant human insulin
with full bioactivity, both with respect to glucose control as well as with
respect to insulin's role as a modulator of growth factors, especially VEGF.
 VEGF plays an essential role in maintaining vascular
health.


19




In
October 2007, we announced top-line results of the Phase I three-way crossover
trial of FT-105 conducted in eighteen healthy volunteers. The trial used the
euglycemic clamp technique, whereby patients are requested to fast for
thirty-six hours and their levels of insulin and glycemia are monitored.
Pharamacodynamics were monitored for forty-eight hours through immunological
analysis. The results showed a 48-hour controlled release of recombinant human
insulin, with a very flat curve as compared to Lantus, the current standard of
care. These results are promising insofar as they support the Company’s thesis
that Medusa can be used to enable a basal insulin formulation that may be
administered to 100% of patients with true 24-hour glucose control and with a
lesser risk of hypoglycemia. The results also provide a proof of concept for the
microparticulate approach, which is an essential component of much of the work
that the company is undertaking in feasibility studies with partners who are
interested in controlling the release of smaller proteins and
peptides.





Other
Products Under Development Based on the Medusa Technology





Our
success in development of the “ubiquitous” Medusa polymer has generated numerous
feasibility study relationships with biotechnology and pharmaceutical partners
in the past two years. Currently we are working on twenty Medusa projects with
various pharmaceutical partners. These projects involve both novel and
already-marketed molecules. Flamel expects some of these projects to evolve into
license agreements as a function of many factors. These include the promise of
the molecule itself (particularly with respect to novel molecules there is a
high rate of attrition); the success of formulation work that we conduct for our
partners; the evolving strategy and marketing focus of our partners; and the
pharmaco-economics associated with the eventual product and the indication(s)
for which it is being developed.





The
twenty Medusa projects currently under development include those in our
relationships with Merck Serono, Pfizer, Baxter and several other top
twenty-five pharmaceutical companies. These relationships range from work on
marketed therapeutic proteins to novel proteins and peptides, and other novel
large molecules. We believe that our strategy of engaging in feasibility work
with a wide range of partners strengthens the Company, by diversifying our
development risks, improving our understanding of many cutting edge fields of
research, and engaging us in projects designed to extend the Medusa platform
into different indications and methods of delivery.


20


Micropump:
Delivery System for the Oral Administration of Drugs





Historically Flamel’s first drug
delivery platform, Micropump is aflexible technology for the controlled release
of small molecule drugs following oral administration. Micropump differs from
competing technologies in several important ways and offers a distinctive set of
features and benefits to patients and to our pharmaceutical partners. Micropump
provides:





·
            Extended
      drug absorption,




·
            Extended
      and controlled release,




·
            Delayed
      release profile is possible if
desired,




·
            Ability
      to target delivery to specific regions of the intestine if
      desired,




·
            Lower
      peak drug concentration, which can result in a reduced level of
      undesirable side effects,




·
            Reduced
      inter- and intra-subject
variability,




·
            Perfect
      dose proportionality,




·
            Ability
      to “fine tune” pharmacokinetic behavior by combining multiple release
      profiles if desired,




·
            Ability
      to combine multiple active ingredients but still keep them physically
      separate because they are in different microparticle formulations which
      are then mixed,




·
            Ability
      to develop easily multiple dose strengths based on one microparticle
      formulation,




·
            Possibility
      of release profile that is not accelerated in humans in the presence of
      alcohol,




·
            Taste
      masking which is useful for bitter or distasteful
  drugs,




·
            Multiple
      dosage forms including tablets, capsules, sachets, suspensions, and
      rapidly dissolving tablets,




·
            Stable
      liquid formulations are possible as well as dry suspensions that can be
      easily reconstituted with water creating liquid dosage
    forms,




·
            Components
      considered by regulatory authorities, including the US FDA, to be “GRAS” –
      Generally Regarded as Safe - and are listed on the FDA’s Center for Drug
      Evaluation and Research (CDER) database of inactive, acceptable
      pharmaceutical excipients,




·
            Commercial
      production capabilities,




·
            Rapid
      time to first testing in humans – approximately one year or less for known
      active pharmaceutical ingredients,




·
            Rapid
      development times: for example Coreg CR took 3.5 years from project
      inception to NDA filing and required only a 10 month review by the US
      FDA.





A Micropump tablet, capsule, sachet,
liquid formulation, or any other presentation form, contains 5,000 to 50,000
discrete microparticles which disassociate from one another in the intestine,
and each of which then acts as a miniature “drug pump”, releasing its drug
independently from all of the other individual microparticles. Because of the
statistics of large numbers, the large number of independently releasing
microparticles results in Micropump’s reduced inter- and intra-subject
variability relative to many competing technologies. It also enhances safety by
avoiding the problem of “dose dumping” (releasing all the drug at one time and
place) which can sometimes be experienced with competing systems that rely on
one or a small number of releasing vehicles.


21


The size range of Micropump
microparticles typically is between 100 and 500 micrometers. Each independent
microparticle comprises an inert core surrounded by the active drug, and coated
with a polymer which defines the controlled release properties. The composition
and thickness of the polymer coating, as well as the excipients used, can be
adjusted to regulate precisely the release profile, and therefore
pharmacokinetics, for that drug and therapeutic application. For most Micropump
applications we use a polymer coating which behaves and releases the same
irrespective of pH changes within the patient’s body. However, for certain
applications we also can utilize a special coating which does not allow
appreciable drug release at the low, acidic pH of the stomach, but only upon
experiencing the higher pH found in the intestine, and in fact we can regulate
this release to target the drug to different regions of the intestine when
desired. For certain other applications we can utilize a special coating which
provides a time delayed release if desired.





Because each dose consists of thousands
of discrete microparticles, the release kinetics are independent of dose, and it
is simple to produce multiple dose strengths. Micropump exhibits perfect dose
proportionality, and to double the dose, we simply double the number of
particles used. Also because of the discrete microparticle nature of the
product, we can produce different microparticle formulations of the same drug
with different release characteristics, including delayed release if desirable,
and then mix those formulations to precisely “fine tune” the desired release and
pharmacokinetic properties of the drug. This allows us extreme control to
achieve the optimum profile for a specific drug and therapeutic
target.





Also by virtue of the
multi-microparticle nature of Micropump, we easily can create “combination
products” which contain two or more discrete active pharmaceutical ingredients,
each of which is physically separate from the other drug based on the
independent polymer coating surrounding each microparticle, and each of which
will release with its own optimized, independent controlled release
profile.





It is possible to create a Micropump
formulation whose release profile is not accelerated in humans or biostudies by
the presence of alcohol. Also, the polymer coating on each microparticle results
in a “taste masking” effect which can be important for bitter or otherwise
distasteful drugs. This can be particularly important when developing
ready-to-use, stable liquid controlled-release formulations, an application for
which Micropump is one of the only systems in the world we are aware of suitable
for developing such formulations. We are exploring the use of such stable liquid
formulations particularly for pediatric and geriatric markets, but also for CNS
drugs where patient compliance is an issue.





The materials we use to formulate and
produce our Micropump products all are listed on the US FDA Center for Drug
Evaluation and Research database of inactive, acceptable excipients and are
“Generally Regarded as Safe” (GRAS) which means that we are not required to test
and demonstrate the safety of these materials, we simply can use them in our
products and reference the appropriate excipient master files at the regulatory
authorities.





This use of only GRAS components also
results in advantages of rapid development time. For most known (already
approved) active pharmaceutical ingredients, we can simulate reliably the
optimum release profile on our computers, quickly create those formulations, and
bring them directly into human clinical studies without ever having to perform
animal safety and efficacy studies.  As a result, the time to first testing
in humans typically is less than a year from program inception for known APIs.
And overall development times also are rapid; for Coreg CR it only took
approximately 3.5 years from program inception to complete all the necessary
formulation work and clinical testing and to file the New Drug Application,
which itself only required a 10 month review by FDA, which is rapid by industry
standards.





Trigger LockTM
is a special application based on our Micropump technology designed to provide a
technical solution to the serious societal problems of intentional and
unintentional abuse and misuse of narcotics and other dangerous, but
pharmaceutically important, drugs. This problem increasingly is receiving FDA
and Congressional attention in the United States and we believe our Trigger Lock
technology is ideally positioned to make it more difficult to abuse, misuse or
tamper with these drugs.





One
problem with some controlled-release technologies, which can present serious
problems with narcotic formulations even among patients not intentionally trying
to abuse or misuse the drug, is drug dumping in the presence of alcohol. Because
our Trigger Lock technology uses our Micropump approach, there is no drug
dumping seen in humans or biostudies.





Because
they are designed to provide effective drug levels for a prolonged period of
time, controlled-release narcotic formulations typically contain large amounts
of the active substance relative to immediate release forms. Controlled-release
narcotics therefore attract the attention of recreational drug users who
typically might grind a controlled-release formulation up into a powder,
dissolve it in water, filter and inject it to provide immediate availability of
the entire dose and the subsequent “rush” sought.


22


If a
Trigger Lock tablet or capsule is ground between spoons, with a commercial pill
pulverizer or even with a mortar and pestle, which is the most effective
technology typically used, the capsule or tablet will be successfully broken
down to the individual microparticles which are what make up the overall tablet.
However, each microparticle retains its polymer coating which is virtually
impervious to further crushing and so the narcotic remains sequestered and
unobtainable and the powder exhibits identical release characteristics as the
intact, overall tablet or capsule.





To
provide additional margins of safety and enhance the deterrents to misuse, we
add viscosifying agents such that if the microparticle powder obtained by
grinding is dissolved in a small volume of water it forms a gel and the
recreational drug user will be unable to pass it through a cotton ball or other
filter into a syringe for injection. Even with solvents other than water, such
as ethanol or ethanol/water mixtures, the mixtures obtained are highly viscous
and heterogeneous and less than 5% of the liquid can be recovered. Our testing
has shown that even if many tablets are crushed and extracted, less than 0.1% of
the narcotic is recovered.





Another
approach typically used by recreational drug users is to dissolve the controlled
release drug powder, obtained by crushing or grinding, into a large volume,
typically 50 to 100 ml, of water or alcohol and then drink the resulting
mixture, again providing a way to obtain most or all of the dose of narcotic in
an immediate release.  We defeat this possibility by adding a “quenching”
or “sequestering” agent that absorbs the narcotic as it comes out if the
microparticle powder is dissolved in a large volume of water or alcohol, and so
most of the drug is not immediately available even if a long time is allowed for
dissolution.





Nonetheless,
if the Trigger Lock capsule or tablet is taken by a patient as intended, the
drug is fully available to the patient over the time course and in the levels
intended. Furthermore, we can duplicate almost any existing controlled-release
narcotic formulation to produce a product which is as effective as the original
product, but much more resistant to intentional or unintentional misuse or
abuse.





Products
Based on the Micropump Technology





Our first
approved product using the Micropump platform is Coreg CR, which we have
developed with GSK.





Coreg
CR





Coreg CR
is an extended-release formulation of Coreg (carvedilol phosphate), a beta
blocker that is considered the standard of care for the treatment of moderate to
severe heart failure and left ventricular dysfunction following myocardial
infarction. Coreg CR was approved by the FDA on October 20, 2006 for use in the
treatment of moderate to severe congestive heart failure; left ventricular
dysfunction following myocardial infarction; and hypertension. We began work
with GSK on this program in 2003 and the product was launched in March 2007.
Pursuant to the supply agreement with GSK, we produce Coreg CR microparticles on
a cost plus basis. To date, we have received $23 million in milestone payments
from GSK and are eligible to receive an additional $2 million if certain
milestones are achieved. We also received royalties on Coreg CR in 2009 of $8.8
million based on net sales of $251 million as reported by GSK.





The
Hatch-Waxman exclusivity period for Coreg CR ended on April 20, 2010. It is
possible that Coreg CR may experience generic competition from one or more
competitors following approval of an Abbreviated New Drug Application (ANDA). To
date, only one ANDA has been submitted to the U.S. FDA, URL Pharma in March
2008, and it has not yet been reviewed. A Citizen Petition has been submitted to
the FDA that respectfully requests that the FDA require any proposed generic
formulations of Coreg CR to meet the same requirements that the FDA required for
the approval of Coreg CR, which is a higher standard than is otherwise required
under the minimum bioequivalence regulations.





Coreg
CR and the Market for Beta Blockers





Coreg and
Coreg CR are indicated for the treatment of congestive heart failure (CHF) as
well as for the treatment of left ventricular dysfunction following myocardial
infarction. Coreg and Coreg CR additionally are indicated for the treatment of
hypertension. Coreg is part of the standard of care for the treatment of heart
failure. Coreg and Coreg CR are the only beta blockers indicated for the severe
form of heart failure. Coreg initially attained this leadership position despite
the fact that it was not available in a once-daily formulation, unlike many
others of the beta blocker class. In general, many physicians prefer once-daily
formulations for their patients due to the compliance advantages that they may
offer, even though the CASPER study (Compliance and Quality of Life Study
Comparing Once-Daily Carvedilol CR and Twice-Daily Carvedilol IR in Patients
with Heart Failure) published in 2007 failed to prove a compliance advantage in
patients prescribed Coreg CR versus those prescribed immediate release Coreg,
according to the pre-defined criteria.




23




Earlier
generations of beta blockers were not widely used in the treatment of
hypertension because of perceived drawbacks. Perhaps the greatest of these
drawbacks was the fact that many other beta blockers, have been associated with
increased glycemia levels in Type II diabetic patients. By contrast, Coreg has
been proven clinically not to cause increased glycemia levels in diabetic
patients, of which there are over thirteen million Type II diabetic
hypertensives in the Unites States.  Type II diabetics who suffer from
hypertension are defined by the American Diabetes Association as suffering from
complicated hypertension, meaning that they are recommended to reduce their
blood pressure to a level of 130/80 (as opposed to 140/90 for essential
hypertension). Sixty-five percent of those suffering from Type II diabetes, it
is estimated, will require two or more anti-hypertensive agents.





Carvedilol
is a non-selective antagonist of Beta 1, Beta 2 andrenergic receptors and a
selective antagonist of Alpha 1 andrenergic receptors. It has been demonstrated
to have notable anti-inflammatory properties, in distinction to most other beta
blockers. Research further suggests that carvedilol possesses significant
anti-oxidative effects, which are beneficial to vascular
health.





Other
Products Under Development Based on Micropump Technology





From time
to time we have conducted Micropump feasibility studies on other proprietary
therapeutic compounds under limited, confidential agreements with the
pharmaceutical companies owning the rights to these compounds. We currently are
engaged in two such projects, one for a liquid formulation of an
already-marketed over-the-counter product and a second for a combination product
in the cardiovascular setting. Such contracts provide us with the possibility
for expanded relationships. Moreover, these relationships are invaluable insofar
as our potential partners often are able to identify opportunities for the
Micropump platform from their internal pipeline, opportunities which we would
not otherwise know.





Photochromic
Materials





Our broad
expertise in polymer science led to a long-term commercial relationship with
Corning. Under a contract research arrangement that existed since 1994, we have
worked with Corning to produce two generations of material for photochromic
lenses. The research and development activities ended in 2003 and we no longer
are focusing strategically on this market.





Photochromic
lenses automatically darken in the presence of sunlight and then revert to clear
when indoors. These eyeglass lenses, which are based on mineral material, have
been available for over 20 years, and Corning has been the dominant worldwide
supplier of these lenses since their introduction. However, as eyeglass lenses
have been increasingly made with plastic materials, there is an increasing
demand for photochromic lenses based on polymer (plastic)
materials.





During
1999, Corning launched SunSensor, a new, competitive photochromic eyeglass lens
product containing our technology. We began receiving royalties on the sales of
this product late in 1999. The amount of future royalties related to this and
other potential products resulting from this collaboration is dependent on
Corning’s marketing success.





Under the
terms of our current agreement with Corning, we continue to receive royalties on
sales of all products that contain intellectual property developed by the
collaboration. See ‘— Strategic Alliances — Corning: Photochromic
Materials.


24


Strategic
Alliances





In order
to develop and apply our technologies efficiently and effectively commercialize
the resulting products, we have entered into, and intend to continue to enter
into, collaborative arrangements with large biotechnology and pharmaceutical
company partners. Such arrangements typically provide funding for development
work and access to target compounds and related know-how and, ultimately,
provide distribution capabilities for any resulting products. Such arrangements
generally include termination provisions in the event either party decides that,
for strategic or other reasons, it does not wish to pursue the alliance. In many
of our agreements, particularly feasibility studies, we are precluded from
disclosing the identity of the partner and/or of the molecule(s) with which we
are collaborating. The major existing agreements we are able to disclose are as
follows:





Baxter
International, Inc.





In June
2009 we entered into collaboration with Baxter International Inc. to create
controlled release applications of blood clotting factor replacement therapies
using our Medusa technology. This collaboration includes work on intravenous
formulations. Baxter paid technology access fees totaling € 2.5 million (or $3.6
million), will pay all development costs for the program and has an exclusive
right to negotiate a license to the Medusa platform for these applications.
Baxter is the world leader, based on sales, in the field of blood clotting
factor replacement therapies.





GlaxoSmithKline





We began
work with GSK on a Micropump formulation of Coreg in 2003, the product was
approved by FDA on October 2006 and launched in March 2007. Pursuant to the
supply agreement with GSK, we produce Coreg CR microparticles on a cost plus
basis. To date, we have received $23 million in milestone payments from GSK and
are eligible to receive an additional $2 million if certain milestones are
achieved. Turnover of Coreg CR through December 31, 2009 amounted to $251
million on which we recognized royalty revenue of $8.8 million.





The
Hatch-Waxman exclusivity period for Coreg CR ended on April 20, 2010. It is
possible that Coreg CR may experience generic competition from one or more
competitors following approval of an Abbreviated New Drug Application (ANDA). To
date, only one ANDA has been submitted to the U.S. FDA, URL Pharma in March
2008, and it has not yet been reviewed. A Citizen Petition has been submitted to
the FDA that respectfully requests that the FDA require any proposed generic
formulations of Coreg CR to meet the same requirements that the FDA required for
the approval of Coreg CR, which is a higher standard than is otherwise required
under the minimum bioequivalence regulations.





Merck
Serono





In
December, 2007, we entered into a relationship with Merck Serono to develop a
controlled release formulation of an already-marketed Merck Serono product using
our Medusa technology platform. In February, 2009, Merck Serono exercised its
option to a development and license agreement for this program and paid an
upfront fee of € 5.0 million ($6.5 million). Pursuant to the license, Merck
Serono will pay all future development costs for the program as well as payments
upon achievement of certain clinical and regulatory milestones and royalties
upon any eventual sales of the product.





Pfizer





Since
December 2008, we have been engaged in work with Pfizer to assess the
applicability of the Medusa platform to certain molecules in development.
Additionally, in November 2009 Pfizer exercised its option to license the Medusa
technology for the development of a controlled release formulation of an
already-marketed protein. This election triggered a $1 million payment to us and
Pfizer will pay all development costs of the program, including milestone
payments and royalties on any worldwide commercial sales. The program was begun
in 2007 with Wyeth, which was acquired by Pfizer in October 2009.





Corning:
Photochromic Materials





Corning
S.A and Corning Incorporated (Corning) entered into an agreement with us in
March 1994 for the co-development of proprietary, polymer-based photochromic
eyeglass lens material to be sold by Corning to manufacturers of ophthalmic
lenses worldwide. The research and development activities ended in 2003. In
1999, Corning launched its first photochromic plastic eyeglass lens product
developed in collaboration with us, and we began receiving quarterly royalty
payments under this agreement. In 2009 we received approximately $370,000 in
royalties, the tenth full year of royalties for us for this
product.


25


Manufacturing





On
December 31, 1996, we acquired a 50,000-square foot pharmaceutical production
facility located in Pessac, France from SmithKline.  See ‘Item 4.  Key
Information — Description of Property.’ As part of the acquisition, Flamel
employed forty-two experienced plant personnel.





In 2004,
we built a new facility of 16,000 square feet adjacent to the existing facility
in Pessac for a total purchase price of $10.3 million. This new building
included 8,600 square feet for the Medusa technology with a new cGMP pilot
plant, extended synthesis capacity and increased capacity to manufacture
qualification and phase III batches at 10% of the commercial batch size. This
facility supports the production of polymer to meet the needs from projects such
as FT-105, interferon-alpha, and other projects based on our Medusa technology.
A further building of 2,900 square feet houses utilities and a
warehouse.





In 2005,
we expanded our facilities in preparation for the manufacture of Coreg CR
microparticles for GlaxoSmithKline as well as other Micropump-enabled
formulations. The new facility comprises 6,800 square feet and includes the
4,600 remaining square feet from the 2004 expansion.  The new Micropump
facility was constructed at a cost of $8.2 million. See page F-12 of our
consolidated financial statements.





The
Pessac facility provides us with the capability to manufacture its
pharmaceutical products. We believe that the facility and its operations are in
substantial compliance with current cGMP requirements, and the facility is
approved by U.S. and European drug agencies for production of certain
pharmaceutical products, including commercial quantities of our
microencapsulated drugs.  Such approval qualifies us to manufacture certain
approved pharmaceutical products for sale in most countries in Europe and the
U.S.





In the
past, in addition to production activities related to our core businesses, we
were able to build on our capabilities and experience with GlaxoSmithKline and
other pharmaceutical customers to engage in toll manufacturing for
pharmaceutical partners.  With its experienced workforce and cGMP
operations, we perform clinical batch manufacturing and process scale-up
services at the facilities and, up until the last quarter of 2005, performed
toll manufacturing of solid dosage forms, and analytical services for contract
customers.  Our production site at Pessac has now been producing Coreg CR
microparticles since the fourth quarter of 2006.





We
completed construction of a new 14,300 square foot facility, dedicated to
Micropump process development in 2008. This new area can either be used for
development or manufacturing work and was qualified in early 2008, increasing
our capacity from two lines to three. This facility has been partially funded by
our partner, GSK.




Patents
and Proprietary Technology





Patents
and other proprietary rights are essential to our business. All of our contracts
are dependent on our technology being patent protected. As a matter of policy we
seek patent protection of our inventions and trademarks and also rely upon trade
secrets, know-how, continuing technological innovations and licensing
opportunities to develop and maintain our competitive position.





Generally,
we first file a patent application covering an invention in France and in the
United States (provisional application). Within one year, we file a U.S. non
provisional patent application for that invention together with an international
patent application pursuant to the Patent Cooperation Treaty (PCT).





In
addition to seeking patent protection in the United States and France, to
further protect the inventions that we consider important to the development of
our business, from the PCT we will generally prosecute patent applications in
Europe, Japan, Canada, and key foreign markets on a selective basis: therefore,
in addition to the above-named countries, we also have patents granted or patent
applications pending in a number of other countries, including Mexico, Brazil,
China, India and South Korea.





In
selected cases, an invention developed jointly by Flamel Technologies and a
partner may be assigned to the partner. The information provided herein does not
include such patent applications.




26




The
Orange book lists patent number 6,022,562 pertaining to the method of
micro-encapsulation that is the basis for the Micropump platform, as covering
Coreg CR. This patent is held by Flamel Technologies and has an expiration date
of October 17, 2015. A second patent covering advances in the platform,
specifically concerning techniques to delay the release of active ingredient
after ingestion, has been filed with the U.S. PTO. This patent would expire in
2023 or later and is the subject of a notice of allowance in the European
Union.





Since
inception, we have been granted 464 patents. Among others, these include patents
that relate to microencapsulated aspirin (Asacard), microencapsulated active
principles (Micropump), methods of producing polyaminoacids for use in
delivering proteins and peptides, nanoparticles of polyaminoacids (Medusa) for
delivering proteins and peptides such as insulin, interferon and
interleukins.





During
2009, we were granted one hundred and twenty-six (126) new patents and filed for
five new patent applications with the French Patent Office and for corresponding
U.S. provisional patent applications. We have also filed three Patent
Cooperation Treaty (PCT) extensions of cases first filed in 2008 and also filed
for the corresponding direct U.S. non provisional patent
applications.





We can
offer no assurance that any patents issued to us will provide us with
competitive advantages or will not be infringed, challenged, invalidated or
circumvented by others, or that the patents or proprietary rights of others will
not have an adverse effect on our ability to do business.





There can
be no assurance that we will be granted patents in respect of the claims in any
of our currently pending or future patent applications, and we can offer no
assurance that in the event any claims in any of our issued patents are
challenged by one or more third parties, that any court or patent authority
ruling on such challenge will determine that such patent claims are valid and
enforceable or sufficiently broad in scope to protect our proprietary rights.
Also, the nature of the process for obtaining patents and the extent of
protection provided by patent laws varies from country to country. We can offer
no assurance, therefore, that the issuance to us in one country of a patent
covering an invention will be followed by the issuance to us in other countries
of patents covering the same invention or that any judicial interpretation of
such patents will be uniform in multiple jurisdictions. Furthermore, even if our
patents are determined to be valid, enforceable and broad in scope, we can offer
no assurance that competitors will not be able to design around such
patents.





Government
Regulation





The
design, testing, manufacturing and marketing of certain new or substantially
modified drugs, biological products or medical devices must be approved or
cleared by regulatory agencies under applicable laws and regulations, the
requirements of which may vary from country to country. This regulatory process
is lengthy, expensive and uncertain. In the United States, the FDA regulates
such products under various federal statutes, including the Federal Food, Drug,
and Cosmetic Act (FDCA) and the Public Health Service Act. Similar requirements
exist in the Member States of the European Union. There can be no assurance that
we or our collaborative partners will be able to obtain such regulatory
approvals or clearances on a timely basis, if at all, for any products under
development. Delays in receipt or failure to receive such approvals or
clearances, the revocation of previously received approvals or clearances, or
failure to comply with existing or future regulatory requirements could have a
material adverse effect on our business, financial condition and results of
operations.





We
believe our delivery systems, when used in conjunction with therapeutic
pharmaceuticals, will be subject to drug and biological product approval
requirements. In the United States, biological products, such as therapeutic
proteins and peptides, generally are subject to the same FDA regulatory
requirements as other drugs, although some differences exist. For example, for
some biological products a biologic license application (BLA) is submitted for
approval for commercialization instead of the new drug application (NDA) used
for other drugs. Also, unlike drug products, some biological products are
subject to FDA lot-by-lot release requirements and those approved under a BLA
currently cannot be the subject of abbreviated new drug applications (ANDAs).
Insulin, which is regulated as a drug product, typically has not been the
subject of ANDAs. However, the FDA is working on a variety of issues pertaining
to the possible development of generic versions of insulin and there can be no
assurance that this type of submission will continue to be unavailable for
insulin. Additionally, our delivery systems likely will be regulated by the FDA
as ‘combination products’ if they are used together with a biologic or medical
device. In order to facilitate pre-market review of combination products, the
FDA designates one of its centers to have primary jurisdiction for the
pre-market review and regulation of both components.





Photochromic
eyeglass lenses are regulated by the FDA as medical devices.




27




New
Drug and Biological Product Development and Approval Process





United
States




Regulation
by governmental authorities in the United States and other countries is a
significant factor in the development, manufacture, and marketing of biological
and drug products and in ongoing research and product development
activities.  The products of all of our pharmaceutical and biotechnology
partners will require regulatory approval by governmental agencies prior to
commercialization.  In particular, these products are subject to
manufacturing according to stringent cGMP quality principles, and rigorous,
pre-clinical and clinical testing and other pre-market approval requirements by
the FDA and regulatory authorities in other countries.  In the United
States, various statutes and regulations also govern or influence the
manufacturing, safety, labeling, storage, record keeping and marketing of
pharmaceutical and biological products.  The lengthy process of seeking
these approvals, and the subsequent compliance with applicable statutes and
regulations, require the expenditure of substantial resources.




The FDA’s
statutes, regulations, or policies may change and additional statutes or
government regulations may be enacted which could prevent or delay regulatory
approvals of biological or drug products.  We cannot predict the
likelihood, nature or extent of adverse governmental regulation that might arise
from future legislative or administrative action, either in the U.S. or
abroad.




Regulatory
approval, when and if obtained, may be limited in scope.  In particular,
regulatory approvals will restrict the marketing of a product to specific
uses.  Approved biological and other drugs, as well as their manufacturers,
are subject to ongoing review (including requirements and restrictions related
to record keeping and reporting, FDA approval of certain
changes in manufacturing processes or product labeling, product promotion and
advertising, andpharmacovigilance, which includes monitoring and
reporting adverse reactions, maintaining safety measures, and conducting dossier
reviews for marketing authorization renewal).  Discovery of previously
unknown problems with these products may result in restrictions on their
manufacture, sale or use, or in their withdrawal from the market.  Failure
to comply with regulatory requirements may result in criminal prosecution, civil
penalties, recall or seizure of products, total or partial suspension of
production or injunction, as well as other actions affecting the commercial
prospects of our pharmaceutical and biotechnology partners’ potential products
or uses or products that incorporate our technologies.  Any failure by our
pharmaceutical and biotechnology partners to comply with current or new and
changing regulatory obligations, and any failure to obtain and maintain, or any
delay in obtaining, regulatory approvals, could materially adversely affect our
business.





The
process for new drug and biological product development and approval has many
steps, including:




Chemical
and Formulation Development




Pharmaceutical
formulation taking into account the chemistry and physical characteristics of
the drug or biological substance is the beginning of a new product. If initial
laboratory experiments reveal that the concept for a new drug or biological
product looks promising, then, a variety of further development steps and tests
complying with internationally recognized guidance documents will have to be
continued, in order to provide for a product ready for testing in animals and,
after sufficient animal test results, also in humans.




Concurrent
with pre-clinical studies and clinical trials, companies must continue to
develop information about the properties of the drug product and finalize a
process for manufacturing the product in accordance with cGMP
requirements.  The manufacturing process must be capable of consistently
producing quality batches of the product, and the manufacturer must develop and
validate methods for testing the quality, purity and potency of the final
products.  Additionally, appropriate packaging must be selected and tested,
and stability studies must be conducted to demonstrate that the product does not
undergo unacceptable deterioration over its
shelf-life.


28


Pre-Clinical
Testing





Once a
biological or drug candidate is identified for development, the candidate enters
the pre-clinical testing stage. This includes laboratory evaluation of product
chemistry and formulation, as well as animal studies of pharmacology (mechanism
of action, pharmacokinetics) and toxicology which may have to be conducted over
lengthy periods of time, to assess the potential safety and efficacy of the
product as formulated.  Pre-clinical tests must be conducted in compliance
with good laboratory practice regulations and the Animal Welfare Act and its
regulations.  Violations of these laws and regulations can, in some cases,
lead to invalidation of the studies, requiring such studies to be
replicated.  In some cases, long-term pre-clinical studies are conducted
while clinical studies are ongoing.





Investigational
New Drug Application




USA: The
entire body of chemical or biochemical, pharmaceutical and pre-clinical
development work necessary to administer investigational drugs to human
volunteers or patients is summarized in an investigational new drug (IND)
application to the FDA.  The IND becomes effective if not rejected by the
FDA within 30 days after filing.  There is no assurance that the submission
of an IND will eventually allow a company to commence clinical trials.  All
clinical trials must be conducted under the supervision of a qualified
investigator in accordance with good clinical practice regulations  to
ensure the quality and integrity of clinical trial results and data.  These
regulations include the requirement that, with limited exceptions, all subjects
provide informed consent.  In addition, an institutional review board
(IRB), composed primarily of physicians and other qualified experts at the
hospital or clinic where the proposed studies will be conducted, must review and
approve each human study.  The IRB also continues to monitor the study and
must be kept aware of the study’s progress, particularly as to adverse events
and changes in the research.  Progress reports detailing the results of the
clinical trials must be submitted at least annually to the FDA and more
frequently if adverse events occur.  Failure to adhere to good clinical
practices and the protocols, and failure to obtain IRB approval and informed
consent, may result in FDA rejection of clinical trial results and data, and may
delay or prevent the FDA from approving the drug for commercial
use.




European Union:The European equivalent to the IND is the Investigational Medicinal
Product Dossier (IMPD) which likewise has to contain pharmaceutical,
pre-clinical and, if existing, previous clinical information on the drug
substance and product. An overall risk-benefit assessment critically analyzing
the non-clinical and clinical data in relation to the potential risks and
benefits of the proposed trial must also be included. The intended clinical
trial must be submitted for authorization by the regulatory authority(ies) of
each EU Member States in which the trial is intended to be conducted prior to
its commencement. The trial shall be conducted on the basis of the proposal as
approved by an Ethics Committee(s) in each EU Member State (EU equivalent to
IRBs) before the trial commences. Before submitting an application to the
competent authority, the sponsor must register the trial in the EudraCT database
where it will be provided with a unique EudraCT number from the EudraCT
database.




Clinical
Trials




Typically,
clinical testing involves the administration of the drug or biological product
first to healthy human volunteers and then to patients with conditions needing
treatment under the supervision of a qualified principal investigator, usually a
physician, pursuant to an FDA-reviewed (via the IND submission) ‘protocol,’ or
clinical plan. The protocol details matters such as a
description of the condition to be treated, the objectives of the study, a
description of the patient population eligible for the study and the parameters
to be used to monitor safety and efficacy.





Clinical trials are time-consuming and costly, and typically are conducted in
three sequential phases, which sometimes may overlap.  Phase I trials
consist of testing the product in a small number of patients or normal
volunteers, primarily for safety, in one or more dosages, as well as
characterization of a drug’s pharmacokinetic and/or pharmacodynamic
profile.  In phase II, in addition to safety, the product is studied in a
patient population to evaluate the product’s efficacy for the specific, targeted
indications and to determine dosage tolerance
and optimal dosage.Phase III trials typically involve additional testing
for safety and clinical efficacy in an expanded patient population at
geographically dispersed sites.  With limited exceptions, all patients
involved in a clinical trial must provide informed consent prior to their
participation.  Meeting clinical endpoints in early stage clinical trials
does not assure success in later stage clinical trials. Phase I, II, and III
testing may not be completed successfully within any specified time period, if
at all.




29




The FDA
monitors the progress of each clinical trial phase conducted under an IND and
may, at its discretion, reevaluate, alter, suspend or terminate clinical trials
at any point in this process for various reasons, including a finding that
patients are being exposed to an unacceptable health risk or a determination
that it is unethical to continue the study. The FDA can also request additional
clinical trials be conducted as a condition to product approval. The IRB and
sponsor also may order the temporary or permanent discontinuance of a clinical
trial at any time for a variety of reasons, particularly if safety concerns
arise.  Such holds can cause substantial delay and in some cases may
require abandonment of product development.  These clinical studies must be
conducted in conformance with the FDA’s bioresearch monitoring regulations
and/or internationally recognized guidance (such as ICH, or International
Conference on Harmonization).





New
Drug Application or Biological License Application





After the
completion of the clinical trial phases of development, if the sponsor concludes
that there is substantial evidence that the drug or biological candidate is
effective and that the drug is safe for its intended use, an NDA or BLA may be
submitted to the FDA.  The application must contain all of the information
on the drug or biological candidate gathered to that date, including data from
the pre-clinical and clinical trials, information pertaining to the preparation
of the drug or biologic, analytical methods, product formulation, details on the
manufacture of finished products, proposed product packaging, labeling and
stability (shelf-life).  NDAs and BLAs are often over 100,000 pages in
length. If FDA
determines that a risk evaluation and mitigation strategy (REMS) is necessary to
ensure that the benefits of the drug outweigh the risks, a sponsor may be
required to include as part of the application a proposed REMS, including a
package insert directed to patients, a plan for communication with healthcare
providers, restrictions on a drug’s distribution, or a medication guide to
provide better information to consumers about the drug’s risks and benefits.Submission of an NDA or BLA does not assure FDA approval for
marketing.




The FDA
reviews all submitted NDAs and BLAs before it accepts them for filing (the U.S.
prerequisite for dossier review).  It may refuse to file the
application andrequest additional information rather than accepting an
application for filing.  In this event, the application must be resubmitted
with the additional information.  The resubmitted application is also
subject to review before the FDA accepts it for filing.  Once the
submission is accepted for filing, the FDA begins an in-depth review of the NDA
or BLAto determine,
among other things, whether a product is safe and effective for its intended
use.  As part of this review, the FDA may refer the application to
an appropriate advisory committee, typically a panel of clinicians, for review,
evaluation and a recommendation.  Recent changes to the FDCA create a
strong presumption for advisory committee review for any drug containing an active
ingredient not previously approved. The FDA is not bound by the
recommendation of an advisory committee.  Under the Prescription Drug User
Fee Act (PDUFA), submission of an NDA or BLA with clinical data requires payment
of a fee.  In return, the FDA assigns a goal of 10 months from acceptance
of the application to return of a first ‘complete response,’ in which the FDA
may approve the product or request additional information. (Although PDUFA
also provides for a six-month “priority review” process, we do not anticipate it
applying to any of our products or our partners’ products.) There can be no
assurance that an application will be approved within the performance goal
timeframe established under PDUFA, if at all. If the FDA’s evaluation of the NDA
or BLA is not favorable, the FDA usually will outline the
deficiencies in the submission and request additional testing or information.
Notwithstanding the submission of any requested additional information, or even
in lieu of asking for additional information, the FDA may decide that the
marketing application does not satisfy the regulatory criteria for approvaland issue a complete response letter, communicating the agency’s decision
not to approve the application.




FDA
approval of an NDA or BLA will be based, among other factors, on the agency’s
review of the pre-clinical and clinical data submitted, a risk/benefit analysis
of the product, and an evaluation of the manufacturing processes and facilities.
Data obtained from clinical activities are not always conclusive and may be
susceptible to varying interpretations, which could delay, limit or prevent
regulatory approval. The FDA has substantial discretion in the approval process
and may disagree with an applicant’s interpretation of the data submitted in its
NDA or BLA. Among the conditions for NDA or BLA approval is the requirement that
each prospective manufacturer’s quality control and manufacturing procedures
conform to cGMP standards and requirements.  Manufacturing establishments
often are subject to inspections prior to NDA or BLA approval to assure
compliance with cGMPs and with manufacturing commitments made in the relevant
marketing application.


30


Other
Countries





Whether
or not FDA approval has been obtained, approval of a pharmaceutical product by
regulatory authorities must be obtained in any other country prior to the
commencement of marketing of the product in that country.  The approval
procedure may vary from country to country, can involve additional testing, and
the time required may differ from that required for FDA approval.  Under
European Union legislation, product authorization is granted for an initial
period of five years. The authorization may subsequently be renewed for an
unlimited period on the basis of a re-evaluation of the risk-benefit balance by
the competent authorizing authority. In the EU, marketing authorization of drugs
is according to either a centralized or decentralized procedure, generally
depending on the nature and type of drug.  Certain designated drugs may be
authorized only in accordance with the centralized procedure by the European
Commission following an opinion by the European Medicines Agency (EMA). The
centralized procedure is mandatory for pharmaceutical products developed by
means of biotechnological processes (recombinant DNA, controlled expression of
genes coding, hybridoma and monoclonal antibody methods), products containing
new actives substances indicated for the treatment of AIDS, cancer, diabetes and
neuro-degenerative diseases, orphan designated medicinal products and advanced
therapy products.  Other pharmaceutical products may be authorized in
accordance with the centralized procedure where it is demonstrated that they
contain new active substances or are demonstrated to have a significant
therapeutic benefit, or where they constitute a scientific or technical
innovation, or are in the interest of patients or animal health at Community
level. Where authorization is in accordance with the decentralized procedure,
approval is either by “mutual recognition,” whereby the authorization granted by
the competent authorities of one Member States are recognized by the authorities
of other Member States, or where the competent authorities of each Member State
authorize a product on the basis of an identical dossier, with, one national
authority taking care of the dossier intensively and coordinating
activities.  To the extent possible, clinical trials of our products are
designed to develop a regulatory package sufficient for multi-country European
Union approval.




Regulatory
approval of prices for certain drugs is required in France and in manyother
countries outside the United States.  In particular, many European
countries make the reimbursement of a product within the national social
security system conditional on the agreement by the seller not to sell the
product above a fixed price in that country. Also common is the unilateral
establishment of a reimbursement price by the national authorities, often
accompanied by the inclusion of the product on a list of reimbursable
products.  Related pricing discussions and ultimate governmental approvals
can take several months to years.  Some countries require periodic pricing
updates and renewals at intervals ranging from two to five years.  Some
countries also impose price freezes or obligatory price reductions. We cannot
assure you that, if regulatory authorities establish lower prices for any
product incorporating our technology in any one European country, this will not
have the practical effect of requiring our collaborative partner correspondingly
to reduce its prices in other European countries.  We can offer no
assurance that the resulting prices would be sufficient to generate an
acceptable return on our investment in our products.





Regulation
of Combination Drugs




Medical
products containing a combination of drugs, biological products or medical
devices may be regulated as ‘combination products’ in the United States.  A
combination product generally is defined as a product comprising components from
two or more regulatory categories (e.g., drug/device, device/biologic,
drug/biologic).  Each component of a combination product is subject to the
requirements established by the FDA for that type of component, whether a drug,
biologic or device.




To
determine which FDA center or centers will review a combination product
submission, companies may submit a request for assignment to the FDA. Those
requests may be handled formally or informally. In some cases, jurisdiction may
be determined informally based on FDA experience with similar products. However,
informal jurisdictional determinations are not binding on the FDA. Companies
also may submit a formal Request for Designation to the FDA Office of
Combination Products. The Office of Combination Products will review the request
and make its jurisdictional determination within 60 days of receiving a Request
for Designation.





In order
to facilitate pre-market review of combination products, the FDA designates one
of its centers to have primary jurisdiction for the pre-market review and
regulation of both components.  The determination whether a product is a
combination product or two separate products is made by the FDA on a
case-by-case basis.  It is possible that our delivery technologies, when
coupled with a drug, biologic or medical device component, could be considered
and regulated by the FDA as a combination product.




31




If the
primary mode of action is determined to be a drug, the product will be reviewed
by the Center for Drug Evaluation and Research (CDER) either in consultation
with another center or independently. If the primary mode of action is
determined to be a medical device, the product would be reviewed by Center for
Devices and Radiological Health (CDRH) either in consultation with another
center, such as CDER, or independently.  In addition, FDA could determine
that the product is a biologic and subject to the jurisdiction of the Center for
Biologic Evaluation and Research (CBER). In the European Union, drug
combinations, that is, drug products containing 2 or more drug substances each
of which has to contribute a proven advantage of therapy (e.g., synergism, less
adverse reactions) and are subject to drug regulations like all others. Products
combining drug substances or drugs with a device may be subject to device and/or
drug regulations, or may be classified as medical devices, depending on the
individual case.





Marketing
Approval and Reporting Requirements




If the
FDA approves an NDA or BLA, the product becomes available for physicians to
prescribe.  The FDA may require post-marketing studies, also known as phase
IV studies, as a condition of approval to develop additional information
regarding the safety of a product. These studies may involve continued
testing of a product and development of data, including clinical data, about the
product’s effects in various populations and any side effects associated with
long-term use. After approval, the FDA may require post-marketing studies or
clinical trials, as well as periodic status reports, if new safety information
develops. These post-marketing studies may include clinical trials to
investigate known serious risks or signals of serious risks or identify
unexpected serious risks. Failure to conduct these studies in a timely manner
may result in substantial civil fines.





In
addition, the FDA may require distribution to patients of a medication guide for
prescription products that the agency determines pose a serious and significant
health concern in order to provide information necessary to patients’ safe and
effective use of such products.





In the
European Union, the marketing authorization of a medicinal product may be made
conditional on the conduct of phase IV post-marketing studies. Failure to
conduct these studies can lead to the imposition of substantial fines. Moreover,
phase IV studies are often run by companies in order to obtain further
information on product efficacy and positioning on the market in view of
competitors.




Post-Marketing
Obligations




Any
products manufactured and/or distributed pursuant to FDA approvals are subject
to continuing regulation by the FDA, including recordkeeping requirements,
reporting of adverse experiences with the product, submitting other periodic
reports, drug sampling and distribution requirements, notifying the FDA and
gaining its approval of certain manufacturing or labeling changes, complying
with certain electronic records and signature requirements, submitting periodic
reports to the FDA, maintaining and providing updated safety and efficacy
information to the FDA, and complying with FDA promotion and advertising
requirements.





Drug and
biologics manufacturers and their subcontractors are required to register their
establishments with the FDA and certain state agencies, and to list their
products with the FDA.  The FDA periodically inspects manufacturing
facilities in the United States and abroad in order to assure compliance with
the applicable cGMP regulations and other requirements.  Facilities also
are subject to inspections by other federal, foreign, state or local
agencies.  In complying with the cGMP regulations, manufacturers must
continue to expend time, money and effort in recordkeeping and quality control
to assure that the product meets applicable specifications and other
post-marketing requirements.  Failure of the Company or our licensees to
comply with FDA’s cGMP regulations or other requirements could have a
significant adverse effect on the Company’s business, financial condition and
results of operations.




Also,
newly discovered or developed safety or efficacy data may require changes to a
product’s approved labeling, including the addition of new warnings and
contraindications, additional pre-clinical or clinical studies, or even in some
instances, revocation or withdrawal of the approval. Violations of regulatory
requirements at any stage, including after approval, may result in various
adverse consequences, including the FDA’s delay in approving or refusal to
approve a product, withdrawal or recall of an approved product from the market,
other voluntary or FDA-initiated action that could delay or restrict further
marketing, and the imposition of civil fines and criminal penalties against the
manufacturer and NDA or BLA holder. In addition, later discovery of previously
unknown problems may result in restrictions on the product, manufacturer or NDA
or BLA holder, including withdrawal of the product from the market. Furthermore,
new government requirements may be established that could delay or prevent
regulatory approval of our products under development, or affect the conditions
under which approved products are marketed.




32




The Food
and Drug Administration Amendments Act of 2007 provides the FDA with expanded
authority over drug products after approval. This legislation enhances the FDA’s
authority with respect to post-marketing safety surveillance, including, among
other things, the authority to require additional post-marketing studies or
clinical trials, labeling changes as a result of safety findings, registering
clinical trials, and making clinical trial results publicly
available.





In the
European Union, stringent pharmacovigilance regulations oblige companies to
appoint a suitably qualified and experienced Qualified Person resident in the
European Economic Area, prepare and submit to the competent authorities adverse
event reports within specific time lines, prepare Periodic Safety Update Reports
(PSURs) and provide other eventual supplementary information, report to
authorities at regular intervals and take adequate safety measures agreed with
regulatory agencies as necessary. Failure to undertake these obligations can
lead to the imposition of substantial fines.





Patent
Restoration and Exclusivity





Under the
Drug Price Competition and Patent Term Restoration Act of 1984, known as the
Hatch-Waxman Act, a portion of a product’s patent term that is lost during a
product’s clinical development and application review by the FDA may be
restored. Patent term restoration can return up to five years of patent term for
a patent that covers a new product or its use. The patent term restoration
period is generally one-half the time between the effective date of the IND and
the date of submission of the NDA, plus the time between the date of submission
of the NDA and the date of FDA approval of the product. Only one patent claiming
each approved product is eligible for restoration and the patent holder must
apply for restoration within 60 days of approval. The maximum period of
restoration cannot exceed 5 years, or restore the total remaining term of the
patent to greater than 14 years from the date of FDA approval of the
product. The
application for patent term extension is subject to approval by the U.S. Patent
and Trademark Office (USPTO), in conjunction with the FDA. It usually takes at
least six months to obtain approval of the application for patent term
extension, and there can be no guarantee that the application will be
granted.





The
Hatch-Waxman Act also created an abbreviated FDA review process for generic and
modified versions of pioneer (brand name) drug products, along with a period of
statutory protection, known as exclusivity, for new drugs approved under an NDA
by the FDA. After approval of a ‘new chemical entity,’ the FDA may not, for a
period of five years, accept an ANDA for a generic version of the drug, or an
NDA for a drug that is a modification of the innovator and seeks to rely, to
some degree, on FDA’s finding that the innovator is safe and effective. This
latter type of submission is known as a “505(b)(2) NDA.” After the period of
exclusivity has expired, the ANDA process permits a competitor to obtain
marketing approval for a generic version of the innovator by showing that the
generic product is bioequivalent to the innovator, and without submitting data
demonstrating the product’s safety and effectiveness. Similarly, a 505(b)(2) NDA
can also then be submitted for a drug that reflects a modification of the
innovator product, but seeks to rely on FDA’s previous findings as part of the
data demonstrating the new product’s safety and efficacy.





Hatch-Waxman
also provides three years of exclusivity for NDAs that, although not for a new
chemical entity, rely on the results of new clinical investigations (other than
bioavailability studies) that were essential to the FDA’s approval of the
application. Often, this applies to NDAs and NDA supplements seeking approval
for new indications, dosage forms, strengths, or conditions of use of previously
approved products. As a general proposition, the Hatch-Waxman exclusivities do
not bar the approval of full NDAs – that is, NDAs containing all the clinical
and other data necessary for FDA’s finding of safety and efficacy – for the same
active ingredient. In addition, the three-year exclusivity for new clinical
trials only bars applications for a product with the same characteristic as what
required the new clinical trials. For example, Coreg CR received three-year
exclusivity for the clinical trials that demonstrated the safety and efficacy of
the new, controlled-release dosage form; that exclusivity blocks other
controlled-release products.





When an
innovator product is approved, the applicant must identify for the FDA certain
patents related to the drug that is the subject of the approval. When an ANDA or
505(b)(2) NDA is submitted, the sponsor must notify the holder of the NDA for
the innovator drug that is the reference product and the holder of patents
listed with that innovator product, and make certifications regarding the
patents. If the sponsor asserts that the patents are invalid or not infringed by
the manufacture, sale or use of the new product (this is known as a “Paragraph
IV certification”), the ANDA or 505(b)(2) NDA can be submitted four years into
the five-year exclusivity. In addition, such a certification allows the NDA or
patent holder to bring a patent infringement suit, and that suit imposes a
30-month stay on approval of the ANDA or 505(b)(2) NDA. The discovery, trial and
appeals process in such suits can take several years. If the litigation is
resolved in favor of the generic applicant or the challenged patent expires
during the 30-month period, the stay is lifted and the FDA’s review of the
application may proceed. If a court finds the patent valid and infringed, the
ANDA or 505(b)(2) application may not be made approved until the expiration of
the patent. In addition, if the NDA holder or patent owner chooses not to sue
such an applicant within the 45-day window, the FDA may approve the ANDA or
505(b)(2) application whenever all of the other requirements for approval are
met.




33




The
protection provided by listed patents and Hatch-Waxman exclusivities can be
extended by six months if a company studies the drug in a pediatric population
in response to a written request from the FDA.  The trial results do not
need to show efficacy in the pediatric population studied; rather, if the trial
is deemed to fairly respond to the request, the additional protection is
granted.  Coreg CR has received such pediatric exclusivity, which extends
the three-year new clinical trial exclusivity it previously obtained, as well as
the protection of the listed patents.  The statutory provision permitting
the award of pediatric exclusivity expires on October 1, 2012, and there can be
no guarantee that Congress will reauthorize this provision, or do so without
significant changes.





The
Hatch-Waxman construct applies only to conventional chemical drug compounds,
sometimes referred to as small molecule compounds approved under an NDA. On
March 23, 2010, however, the Patient Protection and Affordable Care Act became
law. Among other things, it creates an abbreviated pathway to FDA approval of
“biosimilar” biological products approved under a BLA, such as growth factors,
interferons and certain other that includes the possibility of FDA designating a
biological product as interchangeable with a previously approved product. The
statute also provides innovator biological products with a 12-year exclusivity
period during which no “biosimilar” products may be approved. The impact of this
new law will be seen as it is implemented, by promulgation of regulations and
other administrative and judicial actions, but such an abbreviated approval
process could adversely affect biological products that incorporate our
technologies.





Regulation
of Medical Devices





United
States





In the
United States, medical devices are classified into Class I, II or III on the
basis of the controls deemed by the FDA to be reasonably necessary to ensure
their safety and effectiveness. Class I devices are subject to general controls
(e.g., labeling, and adherence to cGMPs) and Class II devices are subject to
special controls (e.g., performance standards, postmarket surveillance, patient
registries, and FDA guidelines). Generally, Class III devices are those which
must require premarket approval by the FDA to ensure their safety and
effectiveness (e.g., life-sustaining, life-supporting and implantable devices or
those found not to be substantially equivalent to legally marketed
devices).





Other
Countries





The
marketing of medical devices in the EU is governed by a variety of EU
legislative provisions, the application of which depends on the intended use and
the classification of the device. Although medical devices are not subject to
authorization by the national authorities of EU Member States, manufacturers
must ensure that the device complies with requirements with respect to design,
safety, performance and manufacture. Devices are, in addition, often subject to
existing or future national regulation on pricing and reimbursement, which
varies from country to country.





The
manufacturer of a medical device cannot add a CE mark, which is a mandatory mark
for certain products sold in the EU, to the device unless it is demonstrated to
comply with the obligations concerning safety and performance requirements of
the EU medical device legislation. In order to demonstrate compliance, the
manufacturing facility and the medical device must undergo conformity assessment
by a notified body. The nature of this assessment will depend on the class of
the product. Once all the necessary conformity assessment tasks have been
completed, the CE Mark may be affixed on the products concerned. Although Member
States must accept for marketing medical devices bearing a CE Marking without
imposing further requirements related to product safety and performance,
national regulatory authorities who are required to enforce compliance with
requirements of the EU medical device legislation may restrict, prohibit and
recall CE Marked medical devices if they consider, on the basis of available
information that they are unsafe. Member countries can impose additional
requirements as long as they do not exceed the obligations provided for in EU
medical device legislation or constitute technical barriers to trade. Within the
European Union, premarket compliance for certain devices must be supported by
clinical data of a type and to the extent set out by the European Union
directives. When the CE mark has been placed on a medical device its
manufacturer must comply with a strict vigilance system. This includes
establishment of a vigilance reporting system in accordance with the Guidance
provided by the European Commission, which is intended to ensure that reportable
adverse events are reported to the competent authority, that information is
collected and maintained and that regular reporting obligations are
fulfilled.




34




Other
Regulation




Controlled Substances Act.
Our Trigger-Lock technology is designed to control the release of narcotics and
other active ingredients subject to abuse. Narcotics are “controlled substances”
under the Controlled Substances Act. The federal Controlled Substances Act
(CSA), Title II of the Comprehensive Drug Abuse Prevention and Control Act of
1970, regulates the manufacture and distribution of narcotics and other
controlled substances, including stimulants, depressants and hallucinogens. The
CSA is administered by the Drug Enforcement Administration (DEA), a division of
the U.S. Department of Justice, and is intended to prevent the abuse or
diversion of controlled substances into illicit channels of
commerce.





Any
person or firm that manufactures, distributes, dispenses, imports, or exports
any controlled substance (or proposes to do so) must register with the DEA. The
applicant must register for a specific business activity related to controlled
substances, including manufacturing or distributing, and may engage in only the
activity or activities for which it is registered. The DEA conducts periodic
inspections of registered establishments that handle controlled substances.
Failure to comply with relevant DEA regulations, particularly as manifested in
the loss or diversion of controlled substances, can result in regulatory action
including civil penalties, refusal to renew necessary registrations, or
proceedings to revoke those registrations. In certain circumstances, violations
can lead to criminal prosecution. In addition to these federal statutory and
regulatory obligations, there may be state and local laws and regulations
relevant to the handling of controlled substances or listed
chemicals.





cGMP.Current Good
Manufacturing Practices (cGMP) rules apply to the manufacturing of drugs and
medical devices. Our manufacturing facilities and laboratories are subject to
inspection and regulation by French regulatory authorities in accordance with
applicable EU provisions governing cGMP and may also be subject to the United
States’ and other countries’ regulatory agencies. Mutual recognition agreements
for government inspections exist between the United States, the European Union,
Canada, Australia and New Zealand.





In
addition to regulations enforced by the FDA, we are also subject to French, U.S.
and other countries’ rules and regulations governing permissible laboratory
activities, waste disposal, handling of toxic, dangerous or radioactive
materials and other matters. Our research and development involves the
controlled use of hazardous materials, chemicals, viruses and various
radioactive compounds. Although we believe that our safety procedures for
handling and disposing of such materials comply with the standards prescribed by
French, U.S. and other foreign rules and regulations, the risk of accidental
contamination or injury from these materials cannot be completely
eliminated.





Healthcare
Reimbursement





In both
U.S. and foreign markets, sales of our potential products as well as products of
pharmaceutical and biotechnology companies that incorporate our technology into
their products, if any, will depend in part on the availability of reimbursement
by third-party payers, such as government health administration authorities,
private health insurers and other organizations. The U.S. market for
pharmaceutical products is increasingly being shaped by managed care
organizations, pharmacy benefit managers, cooperative buying organizations and
large drugstore chains. Third-party payers are challenging the price and cost
effectiveness of medical products and services. Uncertainty particularly exists
as to the reimbursement status of newly approved healthcare products. There can
be no assurance reimbursement will be available to enable us to maintain price
levels sufficient to realize an appropriate return on our product development
investment. Legislation and regulations affecting the pricing of pharmaceuticals
may change before our proposed products are approved for marketing and any such
changes could further limit reimbursement for medical products and
services.


35


Competition





We
compete with academic laboratories, research institutions, universities, joint
ventures, and other pharmaceutical and biotechnology companies, including other
companies developing drug delivery systems. Some of these competitors are also
our business partners.





There are
other companies developing sustained release drug delivery systems and oral
delivery systems. There could be new chemical entities that are being developed
that, if successful, could compete against our technologies or products. Among
the many experimental therapies being tested in the United States and in Europe,
there may be some that we do not now know of that may compete with our drug
delivery systems or products in the future. These chemical entities and new
products may turn out to be safer or may work better than our technologies or
products. Our collaborators could choose a competing drug delivery system to use
with their drugs instead of one of our drug delivery systems.





Many of
our competitors have substantially greater experience and research and
development, manufacturing, marketing, financial and managerial resources than
we do. Moreover, there can be no assurance that our competitors will not obtain
patent protection or other intellectual property rights that would make it
difficult or impossible for us to compete with their products. Furthermore,
acquisitions of competing drug delivery companies by large pharmaceutical
companies could enhance our competitors’ resources. Accordingly, our competitors
may succeed in developing competing technologies and products, obtaining
regulatory approval and gaining market share for these products more rapidly
than we do.





Further,
major technological changes can happen quickly in the biotechnology and
pharmaceutical industries. Such rapid technological change, or the development
by our competitors of technologically improved or different products, could
render our drug delivery systems obsolete or noncompetitive.





Additionally,
the competitive nature of our industry could adversely affect market acceptance
of our products or the use of our drug delivery technologies. Our products and
technologies may not gain market acceptance among physicians, patients,
healthcare payers and the medical community. The degree of market acceptance of
any product candidate that we develop will depend on a number of factors,
including:





·
            demonstration
      of its clinical efficacy and
safety;




·
            its
      cost-effectiveness;




·
            its
      potential advantage over alternative treatment methods;
  and




·
            the
      marketing and distribution support it
receives.




Description
of Property





Our
corporate headquarters and the research center are located in Venissieux, France
(a suburb of Lyon) in six adjacent leased facilities totaling approximately
60,000 square feet.  One building of approximately 13,000 square feet
houses research laboratories, including equipment dedicated to polymer
characterization and analytical research.  The lease on this facility will
expire in 2013.  A second facility comprising approximately 13,000 square
feet houses equipment dedicated to our Micropump technology which expires
in 2015. The third and fourth facilities of approximately 10,000 square feet
combined house our administrative offices.  The leases on these facilities
expire in 2010 and 2013 and we expect to renew the lease that expires in 2010.
The fifth facility of approximately 6,800 square feet houses analytical
laboratories and quality control, with a lease expiring at the end of 2013. The
sixth facility of approximately 20,000 square feet houses a biological
laboratory and research laboratories with equipment for organic synthesis and
polymerization, polymer formulation and small scale processing.  The lease
on this facility expires at the end of 2014.


36


In 1996,
we acquired a pharmaceutical production facility from SmithKline, which now
comprises approximately 103,900 square feet of facilities located in Pessac,
France.  The plant is housed on a 470,000 square foot lot in an industrial
park not far from the Bordeaux airport.  Since acquiring the plant, we have
added a new manufacturing site with spray-coating equipment and a clean room for
the synthesis of biopolymers.  The facility has been audited by European
and U.S. drug agencies and is, we believe, cGMP compliant.  It is qualified
to manufacture pharmaceutical products that can be sold in most countries in
Europe and the U.S.  The value of the facility is recorded in our financial
books at the value of the liabilities corresponding to the retirement
indemnities of the plant staff that we assumed at the time of the plant
purchase, plus the additional investments made by us, less the depreciation and
appropriate amortization.





In 2004,
we built a new facility of 16,000 square feet on our existing site in Pessac for
a total purchase price of $10.3 million. This new building included 8,600 square
feet for the Medusa technology with a new cGMP pilot plant, extended synthesis
capacity and increased capacity to manufacture qualification and phase III lots
at 10% of the commercial batch size. This facility was successfully inspected by
the French Agency (AFSAPPS) in June 2008 and recorded officially as a GMP
excipient manufacturing  facility. We directly own this
facility.





In 2006,
we completed the expansion of our facilities at our site in Pessac in
preparation for the manufacture of Coreg CR microparticles for GlaxoSmithKline
as well as other Micropump enabled formulations. The new facility comprises
6,800 square feet and houses two suites of equipment, as well as a dedicated
warehouse, analytical control laboratory and a technical area with air
compressor units, refrigeration units for solvents, and heat boiler.  The
buildings associated with the new Micropump facility, which we own directly,
were constructed at a cost of $8.2 million and has been manufacturing commercial
quantities of the product since the fourth quarter of 2006. The facility is
approved by U.S. and European drug agencies for production of certain
pharmaceutical products, including commercial quantities of our
microencapsulated drugs.  Such approval qualifies us to manufacture certain
approved pharmaceutical products for sale in most countries in Europe and the
U.S.





In the
fourth quarter of 2006, we commenced the expansion of our Micropump Pilot
Development facilities at our site in Pessac, increasing the available area by
14,300 square feet and renovating a further 4,500 square feet. This expansion
was completed in early 2008 for a total purchase price of $14.7 million of which
a significant proportion was funded by our partner, GSK.  The new facility
houses administrative offices and process development areas which can be
utilized for the production of both clinical and commercial batches, thus
increasing our production capacity from two lines to three. We own the facility
directly.





ITEM
4A. Unresolved Staff Comments




Not
applicable




ITEM
5. Operating and Financial Review and Prospects




The
following should be read in conjunction with ‘Item 3. Key Information’ and the
Company’s Financial Statements and the Notes related thereto appearing elsewhere
in this Annual Report. See also ‘Item 11. Quantitative and Qualitative
Disclosures About Market Risk.’





Overview





Flamel is
a biopharmaceutical company principally engaged in the development of two unique
polymer based delivery systems for medical applications. Our core technologies
are focused on improving delivery properties of existing products. We have
established long-term development and commercialization partnerships with
leading biopharmaceutical companies to maximize the breadth of our technology
and leverage the capabilities of our partners.





Over the
course of 2008 and 2009 we have sought to diversify our revenue stream, through
additional agreements with the top pharmaceutical companies across a diverse
number of domains and on both new and marketed molecules. This diversification
complements the activity and revenues generated by Coreg CR and commercialized
by our partner GlaxoSmithKline (GSK). The diversification of the product,
project and customer portfolio is critical to our ongoing success and our goal
is to maintain a fairly steady number of externally funded feasibility programs
in our pipeline to replace the programs that may be licensed or which do not
move forward for further development. As of 2009, revenues generated by our
partner GSK amounted to 60% compared with 68% in 2008.




37




Throughout
2009, our scientists have been dedicated to executing the research programs
signed with our partners and fundamental research programs on which we have
obtained government funding. The majority of these programs are early stage and
pre-clinical programs. In 2009 Merck Serono exercised an option in a development
and license agreement for a controlled release formulation of an
already-marketed Merck Serono product using our Medusa technology platform and
Pfizer equally executed an option to license the Medusa technology for the
development of a controlled release formulation of an already-marketed protein.
In addition, we have signed a number of new feasibility agreements during 2009
such that we are currently working with eight of the top twenty five
pharmaceutical companies in the world, based on annual healthcare revenue, and
on twenty feasibility and license and development projects across both our
Medusa and Micropump technology platforms. The development and addition of a
number of projects over 2009 have contributed to the increase in research and
development revenues. We have had to increase our research and development
expenditure in order to execute these projects in a timely manner. We expect to
maintain this strategy in the future and support programs that partners decide
to pursue for development, while continuing to invest in internal research
programs to develop our next generation technology platforms.





Operating
expenses have increased marginally in 2009. This increase was driven
predominantly by an increase in research and development, which we refer to as
R&D in this Form 20-F, expenditures in order to support our growing
portfolio. We continue to maintain an aggressive approach to cost controls and
are committed to challenging our costs on non-core activities. As projects
advance to later stage development we would expect to see an ongoing increase in
R&D expenditure, in line with a corresponding increase in associated
revenues. Non-cash expenses relative to stock based compensation, amounted to
$5.6 million in 2009 compared with $8.3 million in 2008.





As in
2008, investment in property and equipment in 2009 has been limited to small
equipment required to support our research and development
activities.





As in
previous years, the majority of the Company’s expenses were incurred in Euros,
since the Company’s base of operations is in France. However, a portion of
revenues were, and will continue to be, denominated in U.S. dollars, see ‘Item
11. Quantitative and Qualitative Disclosures about Market Risk’. The Company’s
functional currency is the Euro, whereas the reporting currency is the U.S.
dollar. Conversion of the Company’s financial accounts to U.S. dollars for
reporting purposes is calculated in accordance with the value of the Euro to the
U.S. dollar. See ‘Item 3. Key Information – Exchange Rates. As such, the
Financial Statements are translated as follows: (1) asset and liability accounts
at year-end rates, (2) income statement accounts at quarterly weighted average
exchange rates for the year (3) cash flow statement quarterly weighted average
exchange rates for the year, and (4) shareholders' equity accounts at historical
rates. Consequently, the variation in the Euro relative to the U.S. dollar has
an impact on the interpretation of the financial statements, which may differ
from the underlying variations in the functional currency. For example, the
weakening of the Euro relative to the U.S. dollar has resulted in a 5.3%
decrease in the average value of the Euro relative to the US dollar between 2008
and 2009. However, the closing value of the Euro relative to the U.S. dollar has
increased by 3.5% resulting in a corresponding increase in amounts represented
in the balance sheet as of December 31, 2009, compared with December 31, 2008.
The Company does not engage in substantial hedging activities with respect to
the risk of exchange rate fluctuations, although it does, from time to time,
purchase Euros against invoiced dollar receivables. There is no outstanding
hedging agreement as of December 31, 2009.





In
certain instances we may compare expenses from one period to another in this
Annual Report on Form 20-F using comparable currency exchange rates in order to
assess our underlying performance before taking into account exchange
fluctuations. To present this information, prior period expenses are converted
into U.S. dollars at current year average exchange rates rather than exchange
rates for the prior fiscal year. For example, if SG&A expenses were €9.6
million in each of fiscal year 2009 and fiscal year 2008, we would report $13.3
million of SG&A expenses in fiscal year 2009 (based on the quarterly
weighted average exchange rates during 2009) and $14.1 million in fiscal year
2008. The comparable currency presentation would translate the fiscal 2008
expenses using the fiscal 2009 exchange rates and indicate that underlying
expenses were flat rather than decreasing by $0.7 million, as would be reported
in the financial statements under U.S. GAAP. We use figures prepared on a
comparable currency basis for internal analysis and communicate similarly
externally, since we believe this appropriate in order to analyze variations in
expenditure from one period to another. However, figures provided on a
comparable currency basis are unaudited and are not measurements under U.S.
GAAP.


38


Flamel’s
business is subject to substantial risks, including the uncertainties associated
with the research and development of new products or technologies, the length
and uncertainty linked to the results of clinical trials and regulatory
procedures, uncertainties relating to collaborative arrangements with large
companies, difficulties in the scale-up and manufacturing of its products, and
the uncertainty relating to the market acceptance of new products based on its
technologies. The time required for the Company to achieve sustained
profitability, and consequently, the amount of future losses, is highly
uncertain. Operating losses may also fluctuate from quarter to quarter as a
result of differences in timing of revenues recognized or expenses incurred. See
‘Item 3. Key Information - Risk Factors.’





The
Company has incurred substantial losses since its inception, and through
December 31, 2009, had an accumulated deficit of approximately $171.6 million.
Flamel expects to maintain its investment in its research and development
activities while being vigilant in ensuring that investments are limited in
non-core activities. Thus, there can be no assurance that the Company will not
continue to incur losses in the short term. The Company intends to pursue the
strategy adopted over the last two years to maintain the pipeline of feasibility
agreements. The pursuit of these agreements into full license and development
agreements is dependent on decisions of our partners, which is subject to much
uncertainty. We will continue to tightly control expenses and investments in
non-critical areas, but as and when projects advance beyond the feasibility
stage our research and development costs are expected to increase. However, our
intention is for such increase to be largely financed either by our partners or
either by government grants that are available to us to fund our own internal
research.





Critical
Accounting Policies




Revenue
Recognition




Revenue
includes upfront licensing fees, milestone payments for R&D achievements,
and reimbursements of research and development costs. Where agreements have more
than one deliverable, a determination is made as to whether the license and
R&D elements should be recognized separately or combined into a single unit
of account in accordance with Accounting Standards Codification 605-25 Revenue
Arrangements with Multiple Deliverables. In general, the different elements of
these arrangements are recognized as one unit of accounting, as the Company does
not have objective and verifiable evidence of the fair value of the undelivered
items in the arrangement and because of the interrelated nature of license and
R&D activities.





The
Company uses a Multiple Attribution Model, referred to as the milestone-based
method:





-
              As
      milestones relate to discrete development steps (i.e. can be used by the
      co-development partners to decide whether to continue the development
      under the agreement), the Company views that milestone events have
      substance and represent the achievement of defined goals worthy of the
      payments. Therefore, milestone payments based on performance are
      recognized when the performance criteria are met and there are no further
      performance obligations.


-
              Non-refundable
      technology access fees received from collaboration agreements that require
      the Company's continuing involvement in the form of development efforts
      are recognized as revenue ratably over the development
    period.


-
              Research
      and development work is compensated at a non-refundable hourly rate for a
      projected number of hours. Revenue on such agreements is recognized at the
      hourly rate for the number of hours worked as the research and development
      work is performed. Costs incurred under these contracts are considered
      costs in the period incurred. Payments received in advance of performance
      are recorded as deferred revenue and recognized in revenue as services are
      rendered.





The
Company recognizes revenue from product sales when there is persuasive evidence
that an arrangement exists, delivery has occurred, the price is fixed and
determinable, and collectibility is reasonably assured.





The
Company receives royalty revenues under a license agreement with a third party
that sells products based on technology developed by the Company. There are no
future performance obligations on the part of the Company under this license
agreement. The license agreements provide for the payment of royalties to the
Company based on sales of the licensed product. The Company records these
revenues based on actual sales that occurred during the relevant period and
classified these revenues in ‘Other Revenues’.





The
Company signs feasibility study agreements. Revenue is recognized over the term
of the agreement as services are performed.




39




The
Company receives financial support for various research and investment projects
from governmental agencies.  Revenue from conditional grants related to
specific development projects is recognized as an offset to operating expenses
when all conditions stated in the grant have been met and the funding has been
received.  Revenue from unconditional grants for research and development
projects are recognized as an offset to research and development expense on a
pro-rata basis over the duration of the program. Funding can be received to
finance certain research and development projects which are repayable on
commercial success of the project. In the absence of commercial success, the
Company is released of its obligation to repay the funds and the funds are
recognized in the Income Statement as ‘Other Income’.





The
Company receives financial support for capital investment programs from
partners. Revenue from these operations is amortized on apro-rata basis over the expected life
of the related assets and reflected as an offset of the depreciation of the
related assets in the consolidated statement of operations.





The
Company benefits from tax credits on a percentage of eligible research and
development costs. These tax credits can be refundable in cash and are not
contingent upon future taxable income. As explained in note 4 to the
Consolidated Financial
Statements, the company determined that the research tax credit should be
classified as a research and development grant and the tax credit is recognized
as an offset to research and development expense.





Translation
of Financial Statements





The
reporting currency of the Company is the U.S. dollar and the functional currency
of the Company is the Euro. As such, the Financial Statements are translated for
reporting purposes as follows: (1) asset and liability accounts at year-end
rates, (2) income statement accounts at weighted average exchange rates for the
year, and (3) shareholders' equity accounts at historical rates. Corresponding
translation gains or losses are recorded in shareholders'
equity.


40





Results
of Operations





Years Ended December 31,
2009, 2008 and 2007





Operating
Revenues





The
Company had total revenues of $42.1million in 2009, $38.6 million in 2008 and
$36.7 million in 2007.




Amounts
      in millions of U.S. Dollars2009
                                    
                                    
                                    2008
                                    
                                    
                                    2007LICENSE AND RESEARCH
    REVENUES
                                    
                                    
                                    20.8
                                    
                                    
                                    
                                    13.2
                                    
                                    
                                    
                                    10.3RESEARCH
                                    
                                    
                                    
                                    
                                    13.6
                                    
                                    
                                    
                                    9.4
                                    
                                    
                                    
                                    5.5Research
                                    
                                    GSK
      Coreg CR
                                    
                                    
                                    
                                    
                                    
                                    
                                    1.1
                                    
                                    
                                    
                                    1.9Merck
      Serono
                                    
                                    
                                    5.9
                                    
                                    
                                    
                                    2.9Baxter
      International
                                    
                                    
                                    0.3Pfizer
                                    
                                    
                                    0.8Wyeth
      Pharmaceuticals
                                    
                                    
                                    0.9
                                    
                                    
                                    
                                    1.5
                                    
                                    
                                    
                                    0.3RHEI
      Pharmaceuticals
                                    
                                    
                                    
                                    
                                    
                                    
                                    0.1
                                    
                                    
                                    
                                    0.1Undisclosed
      Partners
                                    
                                    
                                    5.7
                                    
                                    
                                    
                                    3.8
                                    
                                    
                                    
                                    3.2LICENSES
                                    
                                    
                                    
                                    
                                    7.2
                                    
                                    
                                    
                                    3.8
                                    
                                    
                                    
                                    4.8Up
      Front Payment
                                    
                                    GSK
      Coreg CRMerck-Serono
                                    
                                    
                                    1.5
                                    
                                    
                                    
                                    2.5Baxter
      International
                                    
                                    
                                    1.0Wyeth
      Pharmaceuticals
                                    
                                    
                                    0.4
                                    
                                    
                                    
                                    0.6
                                    
                                    
                                    
                                    0.2RHEI
      Pharmaceuticals
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    0.2Undisclosed
      Partners
                                    
                                    
                                    0.2
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    0.4Milestones
                                    
                                    GSK
      Coreg CR
                                    
                                    
                                    3.9
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    4.0Merck
      Serono
                                    
                                    
                                    
                                    
                                    
                                    
                                    0.7Undisclosed
      Partners
                                    
                                    
                                    0.2TOTAL
                                    
                                    
                                    
                                    
                                    20.8
                                    
                                    
                                    
                                    13.2
                                    
                                    
                                    
                                    10.3GSK
      Coreg CR
                                    
                                    
                                    3.9
                                    
                                    
                                    
                                    1.1
                                    
                                    
                                    
                                    5.9Merck
      Serono
                                    
                                    
                                    7.4
                                    
                                    
                                    
                                    6.1Baxter
      International
                                    
                                    
                                    1.3Pfizer
                                    
                                    
                                    0.8Wyeth
      Pharmaceuticals
                                    
                                    
                                    1.3
                                    
                                    
                                    
                                    2.1
                                    
                                    
                                    
                                    0.5RHEI
      Pharmaceuticals
                                    
                                    
                                    
                                    
                                    
                                    
                                    0.1
                                    
                                    
                                    
                                    0.3Undisclosed
      Partners
                                    
                                    
                                    6.1
                                    
                                    
                                    
                                    3.8
                                    
                                    
                                    
                                    3.6





In 2009,
license and research revenue from the Company’s various partners totalled $20.8
million. License and research revenue in 2008 and 2007 totalled $13.2 million
and $10.3 million, respectively. In 2008, research and development revenue
totalled $9.4 million and license revenue totalled $3.8 million. In 2007,
research and development revenue totalled $5.5 million and license revenue
totalled $4.8 million.  License and research revenues in 2009 have grown
significantly compared with 2008 as a result of the execution of additional
feasibility agreements and the pursuit of our programs signed with Merck Serono,
Pfizer, Baxter International and Wyeth Pharmaceuticals.





Research
and development revenues in 2009 consisted primarily of $5.9 million from
MerckSerono, $0.9 million from Wyeth Pharmaceuticals, $0.8 million from Pfizer
and $5.7 from undisclosed partners. Research and development revenues in 2008
consisted primarily of $2.9 million from Merck Serono, $1.5 million from Wyeth
Pharmaceuticals, $1.1 million from GSK and $3.8 million from undisclosed
partners. Research and development revenues in 2007 consisted primarily of $1.9
million from GSK, and $3.2 million from undisclosed partners.




41




License
revenues in 2009 consisted primarily of a $3.9 million milestone payment from
GSK, $1.5 million from Merck Serono (amortization of up-front payment) and $1
million from Baxter International (amortization of up-font payment). License
revenues in 2008 consisted primarily of $3.2 million from Merck Serono (of which
$2.5 million represents amortization of up-front payments) and $0.6 million from
Wyeth Pharmaceuticals (amortization of up-font payment). License revenues in
2007 consisted primarily of $4.0 million from GSK following the achievement of
specific milestones.





In 2009,
product sales and services revenues totaled $11.9 million, $13.5 million in 2008
and $19.8 million in 2007, all of which relate to the sale of Coreg CR
microparticles to GSK. Revenues from the sale of Coreg CR microparticles are
determined on a cost plus basis, in accordance with the supply agreement and
product requirements from GSK.





Other
revenues of $9.4 million in 2009, $11.8 million in 2008 and $6.6 million in 2007
consisted primarily of royalties from GSK related to the sale of Coreg CR and to
a lesser extent royalties from Corning related to the sale of photochromic
lenses, incorporating Flamel’s technology.





Operating
Expenses





The
Company had total costs and expenses of $53.9 million in 2009, $51.8 million in
2008 and $75.2 million in 2007.





As in previous years, in 2009 the
majority of costs were incurred on research and development. R&D costs
totaled $30.4 million in 2009, $29.3 million in 2008 and $41.3 million in 2007.
At comparable exchange rates research and development costs increased by $2.6
million in 2009 compared with 2008. The increase in R&D expenses is a direct
result of the pursuit of a number of projects into development phase and
preparation of human trials, while maintaining a steady portfolio of feasibility
projects. In order to maintain these projects and meet timelines and objectives
agreed with our partners we have had to increase the number of personnel
dedicated to our research activities.  Research and development costs
include stock based compensation expense of $2.1 million in 2009, $4.1 million
in 2008 and $5.7 million in 2007.





As of
December 31, 2009, Flamel had total research tax credits receivable of $11.9
million. In 2008, the Company obtained an advance secured against the tax
credits generated in 2005, 2006 and 2007 for a total of $8.0 million. This
advance would normally have been received as cash payments of $5.1 million in
2009, $2.5 million in 2010 and $2.4 million in 2011. In 2009, the Company
received reimbursement of the 2005 tax credit for a total amount of $4.4 million
and reimbursed the advance of $4.0 million. In the second quarter of 2009,
subsequent to a temporary modification of the tax legislation enabling immediate
reimbursement of the prior year tax credit, the Company received reimbursement
of the 2008 tax credit for a total of $5.8 million. The Company earned a
research and development credit of $6.6 million in 2009, $7.0 million in 2008
and $2.3 million in 2007. The Company expects to receive reimbursement of the
2009 tax credit in the first half of 2010 due to the prolongation of tax
regulation enabling immediate reimbursement of the asset.





The
Company has increased the number of employees dedicated to research and
development activities over the course of 2009 in order to resource both license
and development projects signed in 2009 and the increasing number of feasibility
projects. The Company has spent almost $4.0 million on pre-clinical and clinical
studies in 2009 compared with $2.4 million in 2008. This increase has been
financed predominantly by partners and funding from government sources. The
increase in clinical and pre-clinical costs is driven by development work
related to the ongoing project with Merck Serono and cost of clinical study
batches required to conduct the 12 week phase 2 clinical study on Interferon
Alpha, which was initiated in December, 2009.





Costs of
products and services sold were $10.1 million in 2009, $9.6 million in 2008 and
$17.3 million in 2007. These costs relate solely to the supply of commercial
quantities of microparticles of CoregCR to GSK and the availability of relevant
production capacity. The fluctuation in costs year-to-year is the result of the
variation in production requirements with 2007 representing costs associated for
the supply of product in line with expected uptake of the product on launch. In
2008 and 2009, costs have declined in line with ongoing demand for the
product.





Selling,
general and administrative (SG&A) expenses, amounted to $13.3 million in
2009, $12.9 million in 2008 and $16.6 million in 2007. SG&A expenses
included stock based compensation expense of $3.3 million in 2009, $3.7 million
in 2008 and $5.8 million in 2007. SG&A expenses in 2009 have increased by
$1.1million over 2008 expenses at comparable exchange rates. In 2008, SG&A
costs were offset by the reversal of a provision for risk on social charges on
stock options in 2008, effectively reducing SG&A by $2.0 million. On a
comparable basis SG&A costs have decreased by $0.9 million in 2009 compared
to 2008 as a result of continued efforts to tightly control
expenses.


42


Non-Operating
Items





Interest
income and realized gains on the sale of monetary SICAVs (Sociétés d’Investissement à Capital
Variable) were $0.4 million in 2009, $1.4 million in 2008 and $1.7
million in 2007. The decrease in interest income in 2009 is a direct result of
the significant reduction in interest rates year over year despite the increase
in average cash balances. Interest expense was $100,000 in 2009, $18,000 in 2008
and $16,000 in 2007 and is primarily related to the interest applicable to the
Company’s equipment leases and, for 2009, interest incurred on the advance
received from Oseo, a French government agency, and secured against future
research tax credits (see Note 12.1 to the Consolidated Financial
Statements).





Foreign
exchange loss for 2009 was $83,000 compared with a gain of $3,000 in 2008 and a
loss of $0.5 million in 2007. These exchange gains and losses are generated by
transactions denominated in foreign currency and in particular revenues
denominated in USD. The variation in foreign exchange gain/loss results from the
volume of operations in foreign currency and the variation in exchange rates
over the year.





Other
income in 2009 consisted of a number of miscellaneous items as is the case in
2008 and 2007.





Given the
generation of tax losses in 2009 no income tax expense was incurred. In 2008 and
2007 withholding tax was incurred on royalty revenues received from GSK in
accordance with the license agreement for a total of $0.5 million in 2008 and
$0.6 million in 2007.





As of
December 31, 2009, the Company had $144.0 million in French net operating
loss carry-forwards. The above carry-forwards can be utilized against future
operating income indefinitely.





Net
Income/Loss





For the
year ended December 31, 2009, the Company reported a net loss of $11.4 million
or ($0.47) per share. For the year ended December 31, 2008, the Company reported
a net loss of $12.1 million or ($0.50) per share. For the year ended December
31, 2007, the Company reported a net loss of $37.7 million or ($1.57) per
share.





Liquidity
and Capital Resources





On
December 31, 2009 the Company had $8.7 million in cash and cash equivalents and
$35.4 million in marketable securities as compared with $27.0 million in cash
and cash equivalents and $10.1 million in marketable securities on December 31,
2008 and $26.3 million in cash and cash equivalents and $14.7 million in
marketable securities on December 31, 2007. The increase in the level of cash
and cash equivalents and marketable securities is a direct result of the
increase in the project portfolio generating significant upfront payments
including €5.0 million ($6.5 million) from Merck Serono and €2.5 million ($3.6
million) from Baxter International.





Net cash
provided from operating activities was $8.2 million as of December 31, 2009
compared with net cash used in operating activities of ($7.5) million as of
December 31, 2008 and ($19.2) million as of December 31, 2007. As of December
31, 2009 net cash generated in operating activities reflected a net loss of
$11.4 million offset by non-cash movements of $8.9 million, including $5.9
million of depreciation on property and equipment, $5.5 million relative to
stock compensation expense and $2.5 million of grants recognized to the income
statement. The significant increase in cash provided from operating activities
is driven by the increase in deferred revenue subsequent to upfront payments
from Merck Serono for €5 million ($6.5 million) and from Baxter International
for €2.5 million ($3.6 million) and the rapid reimbursement of the 2009 research
tax credit for $5.8 million effectively reducing the research and tax credit
receivables. The decrease in net cash used for operating activities as of
December 31, 2008 compared with the period ended December 31, 2007 is
principally as a result of the significant improvement in net loss, offset by
the variation in working capital, this latter generating cash utilization of
$9.3 million in 2008 compared with cash provided of $1.9 million in
2007.





Net cash
used by investing activities was ($24.3) million in 2009 compared with net cash
provided by investing activities of $0.9 million in 2008.  Investing
activities included proceeds from the sale of marketable securities for $161.0
million and purchase of marketable securities for $138.5 million. The increase
in proceeds from sales of marketable securities results from the Company’s
efforts to maximize returns on available funds and as such has transferred
certain investments into marketable securities rather than short term fixed
deposits. A total of $1.8 million has been investment in property and equipment
in 2009, for the purchase of small equipment to support ongoing research and
development activities.  Net cash provided by investing activities in
2008 amounted to $0.9 million and the Company invested $3.5 million in the
purchase of property and equipment.  Net cash used by investing
activities in 2007 amounted to ($13.2) million and the Company invested $11.3
million in the purchase of property and equipment to increase production
capacity from two production lines to three.


43





Net cash
used by financing activities was $1.6 million in 2009 and included reimbursement
of the advance from Oseo of ($4.0) million, secured against the 2005 research
tax credit.  In 2009 grants were received from different government
agencies for a total of$2.2 million.  These funds were dedicated
principally  to investment in various research activities.  Net cash
provided by financing activities was $8.9 million in 2008 and included an
advance of $8.5 million from Oseo secured against future research and
development tax credits.  In 2007, net cash provided by financing
activities amounted to $3.0 million in 2007 and included $2.1 million received
from GSK to sponsor part of the extension of facilities to increase production
capacity from two lines to three and $0.8 million of conditional and
unconditional grants received from government agencies.





Since its inception, the Company’s
operations have consumed substantial amounts of cash and may continue to do so
in the short term.  The Company believes that ongoing research and product
development programs are adequately funded for the next year and believe current
working capital to be sufficient for the Company’s present requirements. 
The Company also believes current financial resources and cash from various
grants, royalty payments and licenses will be sufficient to meet the Company’s
cash requirements in the near future.  We believe the Company to have
sufficient funds to finance operations and cash requirements for at least the
next twelve months.





As of
December 31, 2009, the Company held marketable securities classified as
available-for-sale and recorded at fair value. Total marketable securities
totaled $35.4 million at December 31, 2009 and $10.0 million at December 31,
2008.




As of
December 31, 2009, the Company had loans of $1.70 million from Oseo, an agency
of the French government that provides financing to French companies for
research and development, and $2.1 million advance from the French Ministry of
Industry for a ‘Proteozome’ research project.  These loans do not bear
interest and are repayable only in the event that the research is successful
technically or commercially. (See Note 14 to the Consolidated Financial
Statements).




In
addition, in 2004, Flamel and GlaxoSmithKline entered into a four year supply
agreement whereby Flamel agreed to supply GlaxoSmithKline with commercial
supplies of product.  The provisions of the agreement include payments to
Flamel of $20.7 million to support the costs and capital expenditure relative to
the creation of a manufacturing area for the production of commercial supply of
the product.  The capital expenditure consists of both buildings and
fixtures, and production equipment.  Flamel will have immediate title to
the building and fixtures and title to production equipment vests with
GlaxoSmithKline for the duration of the supply agreement.




If the
Company breaches the supply agreement through gross negligence, GlaxoSmithKline
can choose to terminate the supply agreement.  The occurrence of this event
is deemed remote given the Company’s ability to perform under supply
arrangements based on our historical experience.  In the event of a breach
and a decision to terminate the agreement, all payments received become
repayable to GlaxoSmithKline and Flamel will receive immediate title to all
production equipment.




Upon
cessation of the supply agreement, in the normal course, GSK will pass title to
all production equipment to Flamel without cost of any kind.  The supply
agreement has been extended until the end of 2010.





A total
of $8.2 million has been spent on the acquisition of buildings and fixtures and
a total of $11.1 million has been spent on behalf of GSK for the purchase of
production equipment.  All funds received for completion of the
manufacturing area have been used to purchase both equipment and facilities
prior to December 31, 2006.  The funds received from GSK to finance the
acquisition of assets owned by Flamel are classified as a current liability for
$0.8 million and as a long term liability for $5.4 million.  The total
liability is being amortized on a pro-rata basis over the expected life of the
related assets and reflected as an offset of the depreciation of the related
assets.


44


In July
2006, the supply agreement was supplemented by an agreement with GSK to partly
sponsor the expansion of facilities at Pessac from two lines to three in
anticipation of an expected increase in demand for the product.  The
provisions of the agreement include payments to Flamel of $8.1 million to
partially support the acquisition of equipment, building and fixtures on which
Flamel will have immediate title. GSK will have exclusive use of part of the
facilities in order to meet demand requirements for a period of time.  As
of December 31, 2007, all installments due under the agreement were
received.  As of December 31, 2009 these funds are classified as a current
liability for $1.3 million and as a long term liability for $4.3 million. 
The liability is being amortized on a pro-rata basis over the expected life of
the assets and proportionally based on funding received compared with the total
value of the related assets.  The amortization of the liability is
reflected as an offset of the depreciation of the related assets.





In
December 2008, the Company obtained an advance from OSEO, a French governmental
agency supporting innovation, for $8.0 million secured against research tax
credits due to the Company by the tax authorities for expenditure incurred in
2005, 2006 and 2007. Two advances were obtained.  The first amount of $4.3
million, and secured against the 2005 research tax credit of $5.1 million, was
reimbursed in 2009.  The second amounts to $3,741,000 and is secured
against the research credit tax from 2006 and 2007 totaling $4,880,000. 
This advance matures in 2010, with a possibility to renew the financing. 
The interest rate applied is the monthly average of the Euro Interbank Offered
Rate (EURIBOR) plus 0.8%. As of December 31, 2009 the total liability amounted
to $3,872,000 of which $1,944,000 is classified as short term.





The
contractual cash obligations of the Company are as follows:





Payments Due Per Period(in thousands of U.S.)
                          
                          Total
                          
                          
                          Less than
                            1 year
                          
                          
                          1 to 3
                            years
                          
                          
                          3 to 5
                            years
                          
                          
                          More than
                            5 yearsLong-Term Debt Obligations (see Note
      14)
                          
                          $
                          3,806
                          
                          
                          $
                          862
                          
                          
                          $
                          1,922
                          
                          
                          $
                          483
                          
                          
                          $
                          539Capital Lease Obligations (see Note
      15)
                          
                          $
                          113
                          
                          
                          $
                          43
                          
                          
                          $
                          70
                          
                          
                          
                          -
                          
                          
                          
                          -Operating Leases Obligations (see Note
      21.2)
                          
                          $
                          4,119
                          
                          
                          $
                          1,297
                          
                          
                          $
                          2,016
                          
                          
                          $
                          628
                          
                          
                          $
                          178Other Long-Term Liabilities reflected on the
      Registrant’s Balance Sheet under GAAP (see Note 19)
                          
                          $
                          2,208
                          
                          
                          $
                          54
                          
                          
                          $
                          405
                          
                          
                          $
                          588
                          
                          
                          $
                          1,161Total Contractual Cash
      Obligations
                          
                          $
                          10,246
                          
                          
                          $
                          2,256
                          
                          
                          $
                          4,413
                          
                          
                          $
                          1,699
                          
                          
                          $
                          1,878





Future
interest payments included in capital lease obligations amount to a total of
$14,000.





Off-Balance
Sheet Arrangements





As of
December 31, 2009, the Company has no off-balance sheet
arrangements.


45





ITEM
6.  Directors, Senior Management and Employees





Directors
and Senior Management





The
following table sets forth the name and position of the directors of the
Registrant as of December 31, 2009.





Name
                        
                        Position
                        
                        Year of
                          Initial
                          AppointmentElie
      Vannier (1) (2)
                        
                        Non-Executive
      Chairman of the Board of Directors
                        
                        2005Dr.
      Frank J.T Fildes (2) (4)
                        
                        Director
                        
                        2008Frédéric
      Lemoine (2) (3)
                        
                        Director
                        
                        2005Lodewijk
      J.R. de Vink (1) (3)
                        
                        Director
                        
                        2006John
      L. Vogelstein(1) (3)
                        
                        Director
                        
                        2005Stephen
      H. Willard (5)
                        
                        Chief
      Executive Officer and Director
                        
                        2000








(2) 
Member of the Audit Committee


(3)
Member of the Nominating and Corporate Governance Committee


(4)
Nominated in February 2008 in replacement of Cor Boonstra


(5)
Appointed as a Director in 2001





The
following table sets forth the name and position of the executive officers and
senior managers of the Registrant for the year ended December 31,
2009.





Name
                      
                      Position
                      
                      Year of
                        Initial
                        AppointmentRafael
      Jorda
                      
                      Executive
      Vice President and  Chief Operating Officer
                      
                      1991Jeffery
      S. Vick
                      
                      Chief
      Business Officer
                      
                      2009Christian
      Kalita
                      
                      Directeur
      Général Délégué Pharmacien Responsable (Chief Pharmacist)
                      
                      2005Siân
      Crouzet
                      
                      Principal
      Financial Officer
                      
                      2005Yves
      Bourboulou
                      
                      Industrial
      Director
                      
                      2005Martine
      Capelle
                      
                      Human
      Resources Director
                      
                      2006Catherine
      Castan
                      
                      Director
      of R&D Micropump
                      
                      1992You
      Ping Chan
                      
                      Director
      of Chemistry Department
                      
                      1992Roger
      Kravtzoff
                      
                      Preclinical
      and Early Clinical Development Director
                      
                      2002Nigel
      McWilliam
                      
                      Director
      of Business Development
                      
                      2005Rémi
      Meyrueix
                      
                      Director
      of Physico-Chemistry
                      
                      1990Charles
      Mosseri-Marlio
                      
                      Director
      of Strategic Planning and Investor Relations
                      
                      2004Raphaëlle
      Portella
                      
                      Legal
      Counsel, France
                      
                      2006David
      Weber
                      
                      Supply
      Chain Director
                      
                      2004







The term
of office of each of the directors expires at the year 2009 ordinary
shareholders meeting.  With the exception of Mr. Willard, our Chief
Executive Officer, all of the directors are independent as defined in NASDAQ
Marketplace Rule 5605 (a)(2).


46


In
accordance with French law governing a société anonyme, the Company
is managed by its Board of Directors and by its Directeur Général (Chief
Executive Officer), who has full executive authority to manage the affairs of
the Company, subject to the prior authorization of the Board of Directors or of
the Company’s shareholders for certain decisions expressly specified by
law.  In addition, the Directeur Général may submit
to the Board of Directors the nomination of one or more, but not more than five
(5) Directeurs Généraux
Délégués.





The Board
of Directors reviews and monitors Flamel’s economic, financial and technical
strategies.  In addition, under French law, the Board of Directors prepares
and presents the year-end French statutory accounts of the Company to the
shareholders and convenes shareholders’ meetings.  French law provides that
the Board of Directors be composed of no fewer than three and not more than 18
members, each of whom must be a shareholder of the Company.  The actual
number of directors must be within such limits and may be provided for in the
statuts, our bylaws, or
determined by the shareholders at the annual general meeting of
shareholders.  The number of directors may be increased or decreased only
by decision of the shareholders.  No more than a third of directors may be
over the age of seventy.





Under
French law, a director may be an individual or a legal entity.  A legal
entity that serves as a director must appoint an individual, as a ‘permanent
representative,’ who represents such legal entity on the Board.  There is
no limitation, other than applicable age limits, on the number of terms that a
director may serve.  Directors are elected by the shareholders and serve
until the expiration of their respective terms, or until their resignation,
death or removal, with or without cause, by the shareholders.  Vacancies
which exist on the Board of Directors: (i) because of the resignation or death
of a director, may be filled by the Board of Directors pending the next
shareholders’ meeting, if the number of remaining directors after such
resignation or death exceeds the minimum number of directors set forth in the
Articles of Association; (ii) for whatever reason, must be filled by the Board
of Directors within three months of such vacancy, if the number of remaining
directors after such vacancy is less than the minimum number of directors set
forth in the Articles of Association but exceeds the minimum legal requirement;
and (iii) for whatever reason, must be filled immediately at a shareholders’
meeting if the number of directors after such vacancy is less than the minimum
legal requirement.





The
Company’s Board of Directors currently consists of six members, five of whom are
outside directors and whom we believe bring broad experience to
Flamel:





·
            Elie
      Vannier, Chairman of the Board of Directors of the Company, former Group
      Managing Director of WALLY and former Chief Operating Officer of
      GrandVision SA, Director of Ingénico, Famar, Conbipel and Deputy Chairman
      of the Supervisory Board Groupe
Loret,




·
            Frank
      Fildes, former Senior Vice President: Head of Global Development for
      AstraZeneca, PLC, Director of ProStrakan Group PLC and Fildes Partners
      Ltd, and a Fellow of the Royal Society of Medicine and the Royal Society
      of Chemistry.




·
            Frédéric
      Lemoine, Chairman of Executive Board of Wendel and former Chairman of the
      Supervisory Board of Areva; Director of Groupama, Vice-Chairman and
      Director of Bureau Veritas, Director of Legrand and Compagnie Saint
      Gobain,




·
            Lodewijk
      J.R. de Vink, former President of Schering Plough International, former
      Chairman and Chief Executive Officer of Warner Lambert, Inc., Director of
      Alcon, Roche, and member of the International Advisory Board of Sotheby’s
      and Member of the European Advisory Council of Rothschild;
      and,




·
            John
      L. Vogelstein, who is  former President of Warburg Pincus and a
      Senior Advisor  of Warburg Pincus and Chairman of New Providence
      Asset Management;  Chairman of the New York City Ballet, Chairman of
      Prep for Prep, Vice Chairman of the Overseers Board of The Leonard N.
      Stern School of Business at New York University, Chairman of Third Way,
      Director of the Jewish Museum.


47


Board
Practices





Non-executive
Directors of the Company receive fees for their services and are entitled to
subscribe for warrants (as described in Note 17.3 to our Consolidated Financial
Statements).  Directors’ fees and warrants are proposed by the Board of
Directors and are submitted for the approval of shareholders at the annual
general shareholders’ meeting. Non-executive directors are reimbursed, upon
request, for expenses incurred in attending Board meetings.  Upon
termination, no benefits are provided to non-executive directors.





All
directors are elected by the shareholders at each ordinary shareholder’s meeting
approving the annual French statutory accounts of the Company.  A quorum of
the Board consists of one-half of the members of the Board of Directors, and
actions are generally approved by a vote of the majority of the members present
or represented by other members of the Board of Directors.  The Chairman of
the Board does not have the ability to cast a deciding vote in the event of a
tie vote.  A director may give a proxy to another director, but a director
cannot represent more than one other director at any particular meeting. 
Members of the Board of Directors represented by another member at meetings do
not count for purposes of determining the existence of a quorum.





Directors
are required to comply with applicable law and Flamel’s statuts.  Under French
law, directors are liable for violations of French legal or regulatory
requirements applicable to ‘societes anonymes’, violation
of the Company’s statuts or
mismanagement.  Directors may be held liable for such actions both
individually and jointly with the other directors.





French
law requires that companies having at least 50 employees for a period of 12
consecutive months have a Comité d’Entreprise (Employee
Representation Committee) composed of representatives elected from among the
personnel.  The Employee Representation Committee was formed in 1997. 
Two of those representatives are entitled to attend all meetings of the Board of
Directors of the Company and shareholder’s meeting, but they do not have any
voting rights.





The Board
has a Compensation Committee comprised of solely independent directors, namely
Lodewijk J.R. de Vink (Chairman of the Committee), John L. Vogelstein and Elie
Vannier.  The Compensation Committee makes recommendations to the Board on
the compensation of the executive officers of the Company, including the Chief
Executive Officer.  The Board makes the final decisions on
compensation.  The Board has an Audit Committee comprised of solely
independent directors, namely Frédéric Lemoine (Chairman of the Committee),
Frank J.T.Fildes and Elie Vannier.  The Audit Committee recommends to the
Board the selection of Flamel’s independent auditors and reviews the findings of
the auditors and operates in accordance with the Audit Committee Charter, which
is reviewed annually.  The Board has a Nominating and Corporate Governance
Committee, composed of solely independent directors, namely John L.Vogelstein
(Chairman of the Committee), Frédéric Lemoine and Lodewijk J.R. de Vink. Each of
the Compensation Committee, Audit Committee, and Nominating and Corporate
Governance Committee has a written charter.  The Audit Committee Charter
outlines the roles and responsibilities of the Audit Committee which includes
appointment, compensation and oversight of the work of any registered public
accounting firm employed by the Company and review of all related party
transactions.  The Audit Committee also assists the Board in oversight of:
(1) the integrity of the financial statements of the Company; (2) the adequacy
of the Company’s system of internal controls; (3) compliance by the Company with
legal and regulatory requirements; (4) the qualifications and independence of
the Company’s independent auditors; and (5) the performance of the Company’s
independent and internal auditors.  The Company also has an informal
Scientific Advisory Board.





The Chief
Executive Officer of Flamel has full executive authority to manage the affairs
of Flamel and has broad powers to act on behalf of Flamel and to represent
Flamel in dealings with third parties, subject only to those powers expressly
reserved by law or corporate resolutions of the Board of Directors or the
shareholders.  The Chief Executive Officer determines, and is responsible
for the implementation of the goals, strategies and budgets of Flamel, which are
reviewed and monitored by the Board of Directors.  The Board of Directors
has the power to appoint and remove, at any time, the Chief Executive
Officer.


48


Compensation of Directors and
Officers





During
2009, the amount of compensation paid or accrued for the benefit of executive
officers of the Company and its subsidiaries for services in all capacities was
$893,837 for Stephen H. Willard. In the event of termination of employment of Mr
Willard by the Company, other than for gross misconduct, Mr. Willard is entitled
to receive an amount of $500,000. Executive directors do not receive
compensation for their service in that capacity.





On June
24, 2009, a shareholders’ meeting approved a total amount of annual attendance
fees to be allocated to the Board of 325,000 Euros, all of which was
subsequently distributed. For the fiscal year 2009 a total amount of 297,917
Euros ($415,077) was paid or accrued for the benefit of non-executives for their
services in that capacity.





Senior
Management and Executive Officers





The
Company’s senior management includes the following individuals:





Stephen
H. Willard is our Chief Executive Officer and also serves on our Board of
Directors.  Prior to being asked to serve in his present capacity by the
Board of Directors in June of 2005, Mr. Willard was Flamel’s Chief Financial
Officer and General Counsel.  Immediately prior to joining us in August,
2000, Mr. Willard was employed as a vice president of Biovail, a pharmaceutical
company.  He also worked as an investment banker at Credit Suisse First
Boston and as an attorney with Gibson, Dunn & Crutcher LLP and Shearman
& Sterling LLP.  He is a graduate of Yale Law School (1985) and
Williams College (1982).  He is a Director of E-Trade Financial
Corporation.





Rafael
Jorda is our Chief Operating Officer and Executive Vice President.  Mr.
Jorda joined us in 1991 and specializes in chemical engineering and in the
structure-property relationships of materials.  From 1986 to 1990, he
worked as a research and development scientist on controlled-released and
biopolymers at Rhone-Poulenc.





Jeffery
S. Vick is our Chief Business Officer. Mr. Vick joined us in February 2009 and
has more than 20 years experience in the business and research side of the
biotechnology industry in both Europe and the US.  Prior to joining Flamel,
Mr. Vick was Chief Executive Officer of Silence Therapeutics.  Mr. Vick
previously held senior management positions with Centelion SAS, a wholly-owned
subsidiary of Sanofi-Aventis; Genset SA; Cytovia, Inc; and DepoTech Corporation
and worked with Sanderling Venture Capital for two years.  Mr. Vick holds
an MBA from Stanford, an MS Chemistry from the University of California, San
Diego, and a BS Chemistry from the University of Virginia.





Christian
Kalita is our Chief Pharmacist and Director of Quality Assurance  and
Regulatory Affairs . Mr Kalita worked previously at Skye Pharma as Director
of Quality for Europe. He also worked from 1990 to 2000 for Merck Lipha and
Merck generics in different roles as Chief Pharmacist, head of quality control
management and Head of Industrial Affairs.





Siân
Crouzet became our Principal Financial Officer in March 2008.  Mrs. Crouzet
previously worked as Financial Controller France for McCormick & Company
Inc.  She also worked five years as an external auditor with Ernst and
Young.  She is a UK Chartered Accountant and a graduate of Bradford
University.





Yves
Bourboulou is our Technical Director and Pessac Plant Director.  He worked
previously as Plant manager at Pharmacia and Fresenius Kabi.  He previously
held various senior pharmaceutical positions including as Quality assurance
Director and Chief Pharmacist.  He has more than 20 years experience in
pharmaceutical production; quality and development.





Martine
Capelle is our Human Resources Director and joined us in 2006.  She
previously worked for the Danone group for 15 years in different Human
Resource functions and roles and prior to that she worked as Human Relations
manager for two automobile plants.  She is a graduate of Lyon Human
Sciences University.





Catherine
Castan is our R&D Oral Dosage Forms Director.Mrs. Castan joined us in 1992
after having spent four years at Sanofi Recherche. She is a graduate of Ecole
Nationale Supérieure de Chimie de Montpellier and has a PHD in polymer
chemistry, applied in drug delivery.





You-Ping
Chan is our Chemistry Department Director.  Mr. Chan received his Ph.
D in Chemistry from Université Louis Pasteur, Strasbourg in 1990. 
After spending a year as a post-doctoral associate at the Massachusetts
Institute of Technology, he joined us in 1992 as a researcher in polymer
science.  He currently manages research and development in
the field of biocompatible polymers for drug delivery and heads
the analytical research group.


49





Roger
Kravtzoff is our Pharmaceutical Development Director.  Mr. Kravtzoff
received his Doctorat-es Sciences in Biochemistry from Tours
University (France ) in 1988 and has a broad expertise in drug delivery
system.  In 1985, he joined Centre Regional de Transfusion Sanguine as a
research engineer, and in 1991, he became a scientist associate director in a
subsidiary  of the French National Blood Center, Novacell.  He joined
Biovector Therapeutics in 1993 and worked as a Project Director.  He joined
us in June 2002 and is currently managing our pre-clinical and clinical
development regulatory affairs.





Nigel
McWilliam is our Director of Business Development. Mr. McWilliam has a Bachelors
degree in Science from the University of Dundee. He spent almost 20 years with
Dow Corning Corporation's Health Care Businesses in commercial positions in
Europe and the U.S. In 1993 he became President of Leiras Inc., the U.S.
subsidiary of a Finnish pharmaceutical company (now part of Bayer-Schering, AG).
In 1996 he was appointed CEO of Veos Ltd., then a privately held female health
company, which he helped to take public on London's AIM market in 1999. Nigel
moved back to the U.S. to take the position of Senior V.P. Business Development
at SkyePharma in 2000. Nigel joined Flamel as Director of Business Development
in Flamel's Washington office in August 2005.





Rémi
Meyrueix is our Director of Physico-Chemistry.  Mr. Meyrueix holds the
degree of engineer in physics and a doctoral thesis in physics, which he
received from the Polytechnic Institute of Grenoble in 1977 and 1980,
respectively.  He worked at Rhone Poulenc from 1982 to 1990 and joined us
in early 1991 as a research engineer.  He is now managing the
Nanotechnology platform in Venissieux, France.





Charles
Mosseri-Marlio is our Director of Strategic Planning and Investor Relations,
having previously served as Associate General Counsel.  Mr. Mosseri-Marlio
joined us in 2004 after working as a portfolio manager of Baldwin Brothers, Inc,
a U.S. Investment Advisory firm.  Mr. Mosseri-Marlio received his JD in
1994 from the University of Colorado.





Raphaëlle
Portella is our French Legal in-house Counsel and
joined us in April 2006. Mrs. Portella previously worked
as Head of the Corporate and Business Law Department for ADIA (Adecco
Group) for almost 10 years.  She graduated from Lyon University with a
master (DESS) in Business Law.





David
Weber is our Supply Chain Director. He has more than ten years experience in
purchasing and operations management at various international companies
including Garrett (Honeywell group) and Isringhausen. Before joining us he was
Vice President and Cofounder of Pertinence Data Intelligence.





Options
to Purchase Securities from the Company





On June
24, 2009 the shareholders of the Company authorized the issuance of up to
250,000 warrants reserved to a category of beneficiaries comprising the
Directors of the Company who are not officers and/or employees of the Company,
including the Chairman, of which 250,000 have been subscribed for.





On June
24, 2009 the Board of Directors authorized the Directors of the Company, Mssrs.,
de Vink, Fildes, Lemoine, Vannier and Vogelstein, to subscribe to 50,000
warrants each for a subscription price of 0.74 Euros per warrant ($1.03)2. 
Each warrant is exercisable to purchase one Share at a price of 4.50 Euros
($6.29)2.





On June
24, 2009 the shareholders of the Company authorized the issuance of new shares
which authorizes the Board of Directors to award and issue up to 200,000 shares
free to officers and employees of the company as compensation for services
rendered.  Under the terms of the awards the shares are definitively owned
by the beneficiaries two years following their allocation and the beneficiaries
are required to retain the shares for a further two years.


50





Free
Share Awards Granted and Warrants Subscribed from January 1, 2009 to April 30,
2010





Warrants
                    
                    
                    Stock
                      Options
                    
                    
                    Exercise
                      Price in
                      Euros €
                    
                    
                    Exercise
                      Price in
                      USD $2
                    
                    Expiration
                    
                    Free
                      Share
                      AwardsVannier
                    
                    
                    50,000
                    
                    
                    
                    
                    
                    
                    4.50
                    
                    
                    
                    6.29
                    
                    June
      2013De
      Vink
                    
                    
                    50,000
                    
                    
                    
                    
                    
                    
                    4.50
                    
                    
                    
                    6.29
                    
                    June
      2013Fildes
                    
                    
                    50,000
                    
                    
                    
                    
                    
                    
                    4.50
                    
                    
                    
                    6.29
                    
                    June
      2013Lemoine
                    
                    
                    50,000
                    
                    
                    
                    
                    
                    
                    4.50
                    
                    
                    
                    6.29
                    
                    June
      2013Vogelstein
                    
                    
                    50,000
                    
                    
                    
                    
                    
                    
                    4.50
                    
                    
                    
                    6.29
                    
                    June
      2013Autant
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,000Bardet
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2,500Bonnet-Gonnet
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,000Borel
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2,500Bourboulou
                    
                    
                    
                    
                    
                    
                    5,000
                    
                    
                    
                    5.06
                    
                    
                    
                    7.46
                    
                    December
      2019
                    
                    
                    10,000Boutherin-Falson
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,000Capelle
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    6,000Castan
                    
                    
                    
                    
                    
                    
                    5,000
                    
                    
                    
                    5.06
                    
                    
                    
                    7.46
                    
                    December
      2019
                    
                    
                    6,000Chan
                    
                    
                    
                    
                    
                    
                    5,000
                    
                    
                    
                    5.06
                    
                    
                    
                    7.46
                    
                    December
      2019
                    
                    
                    8,000Commaret
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,000Constancis
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    4,000Crouzet
                    
                    
                    
                    
                    
                    
                    10,000
                    
                    
                    
                    5.06
                    
                    
                    
                    7.46
                    
                    December
      2019
                    
                    
                    12,000Fernandez
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    6,000Franoux
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,000Gorria
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    4,000Guest
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,000Jorda
                    
                    
                    
                    
                    
                    
                    75,000
                    
                    
                    
                    5.06
                    
                    
                    
                    7.46
                    
                    December
      2019
                    
                    
                    25,000Kalita
                    
                    
                    
                    
                    
                    
                    5,000
                    
                    
                    
                    5.06
                    
                    
                    
                    7.46
                    
                    December
      2019
                    
                    
                    8,000Kravtzoff
                    
                    
                    
                    
                    
                    
                    10,000
                    
                    
                    
                    5.06
                    
                    
                    
                    7.46
                    
                    December
      2019
                    
                    
                    10,000Lemercier
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,000Marlio
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    6,000McWilliam
                    
                    
                    
                    
                    
                    
                    10,000
                    
                    
                    
                    5.06
                    
                    
                    
                    7.46
                    
                    December
      2019
                    
                    
                    10,000Meyrueix
                    
                    
                    
                    
                    
                    
                    5,000
                    
                    
                    
                    5.06
                    
                    
                    
                    7.46
                    
                    December
      2019
                    
                    
                    9,000Nicolas
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    4,000Portella
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    6,000Prevot
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2,500Pouliquen
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,000Vialas
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    4,500Vick
                    
                    
                    
                    
                    
                    
                    100,000
                    
                    
                    
                    4.03
                    
                    
                    
                    5.17
                    
                    December
      2018
                    
                    
                    25,00010,000Weber
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    6,000Willard
                    
                    
                    
                    
                    
                    
                    100,000
                    
                    
                    
                    5.06
                    
                    
                    
                    7.46
                    
                    December
      2019
                    
                    
                    45,000





(2) 
Historical value at date of grant




51




Employees





As of
December 31, 2009, Flamel had 302 full-time employees.  The following
table sets forth the number of employees for each of the last three years based
in their principal geographic locations.


Employees





Venissieux (1)
                  
                  
                  Pessac (2)
                  
                  
                  U.S. (3)
                  
                  
                  TotalYear
      End2007
                  
                  
                  130
                  
                  
                  
                  168
                  
                  
                  
                  4
                  
                  
                  
                  3022008
                  
                  
                  130
                  
                  
                  
                  151
                  
                  
                  
                  3
                  
                  
                  
                  2842009
                  
                  
                  150
                  
                  
                  
                  149
                  
                  
                  
                  3
                  
                  
                  
                  302





(1) 
Primarily engaged in research activities


(2) 
Primarily engaged in technical and pharmaceutical development activities and
manufacturing


(3) 
Primarily engaged in administrative and marketing activities





The
Company’s future will depend on its ability to attract and retain highly
qualified personnel.  The Company believes that its employee relations are
good.  As required by French law, the Company has created an Employee
Representation Committee (‘Comite d’Entreprise’)
composed of representatives elected from among the personnel.  Two of these
representatives are entitled to attend certain meetings of the Board of
Directors of the Company, but they do not have any voting rights.





Share
Ownership





The
following table sets forth the share ownership of directors, executive officers
and senior managers as of the date indicated:





OWNERSHIP
OF SHARES AS OF APRIL 30, 2010




% of
                            
                            
                            
                            
                            
                            
                            
                            
                            Exercise
                            
                            
                            ExerciseOrdinary
                            
                            
                            
                            
                            
                            
                            
                            
                            Price in
                            
                            
                            Price in
                            
                            
                            
                            
                            
                            FreeShares
                            
                            
                            Shares
                            
                            
                            
                            
                            
                            Number of
                            
                            
                            Euros
                            
                            
                            USD (2)
                            
                            
                            
                            
                            
                            Share
                            
                            
                            
                            
                            
                            TotalName
                            
                            Owned
                            
                            
                            Outstanding
                            
                            
                            Warrants
                            
                            
                            Options
                            
                            
                            €
                            
                            
                            $
                            
                            
                            Expiration
                            
                            
                            Awards
                            
                            
                            Total
                            
                            
                            %Vannier
                            
                            
                            1
                            
                            
                            
                            0.00
                            %
                            
                            
                            25,000
                            
                            
                            
                            
                            
                            
                            
                            20.54
                            
                            
                            
                            27.83
                            
                            
                            May
      201050,000
                            
                            
                            
                            
                            
                            
                            
                            6.57
                            
                            
                            
                            10.20
                            
                            
                            June
      201250,000
                            
                            
                            
                            
                            
                            
                            
                            4.5
                            
                            
                            
                            6.29
                            
                            
                            June
      2013
                            
                            
                            
                            
                            
                            
                            
                            125,001
                            
                            
                            
                            0.44
                            %De
      Vink
                            
                            
                            1
                            
                            
                            
                            0.00
                            %
                            
                            
                            25,000
                            
                            
                            
                            
                            
                            
                            
                            20.54
                            
                            
                            
                            27.83
                            
                            
                            May
      201050,000
                            
                            
                            
                            
                            
                            
                            
                            6.57
                            
                            
                            
                            10.20
                            
                            
                            June
      201250,000
                            
                            
                            
                            
                            
                            
                            
                            4.5
                            
                            
                            
                            6.29
                            
                            
                            June
      2013
                            
                            
                            
                            
                            
                            
                            
                            125,001
                            
                            
                            
                            0.44
                            %Fildes
                            
                            
                            1
                            
                            
                            
                            0.00
                            %
                            
                            
                            50,000
                            
                            
                            
                            
                            
                            
                            
                            6.57
                            
                            
                            
                            10.20
                            
                            
                            June
      201250,000
                            
                            
                            
                            
                            
                            
                            
                            4.5
                            
                            
                            
                            6.29
                            
                            
                            June
      2013
                            
                            
                            
                            
                            
                            
                            
                            100,001
                            
                            
                            
                            0.35
                            %Lemoine
                            
                            
                            1
                            
                            
                            
                            0.00
                            %
                            
                            
                            25,000
                            
                            
                            
                            
                            
                            
                            
                            20.54
                            
                            
                            
                            27.83
                            
                            
                            May
      201050,000
                            
                            
                            
                            
                            
                            
                            
                            6.57
                            
                            
                            
                            10.20
                            
                            
                            June
      201250,000
                            
                            
                            
                            
                            
                            
                            
                            4.5
                            
                            
                            
                            6.29
                            
                            
                            June
      2013
                            
                            
                            
                            
                            
                            
                            
                            125,001
                            
                            
                            
                            0.44
                            %Vogelstein
                            
                            
                            100,001
                            
                            
                            
                            0.41
                            %
                            
                            
                            25,000
                            
                            
                            
                            
                            
                            
                            
                            20.54
                            
                            
                            
                            27.83
                            
                            
                            May
      201050,000
                            
                            
                            
                            
                            
                            
                            
                            6.57
                            
                            
                            
                            10.20
                            
                            
                            June
      201250,000
                            
                            
                            
                            
                            
                            
                            
                            4.5
                            
                            
                            
                            6.29
                            
                            
                            June
      2013
                            
                            
                            
                            
                            
                            
                            
                            225,001
                            
                            
                            
                            0.79
                            %Willard
                            
                            
                            125,001
                            
                            
                            
                            0.51
                            %
                            
                            
                            
                            
                            
                            
                            40,000
                            
                            
                            
                            6.4
                            
                            
                            
                            4.99
                            
                            
                            December
      201025,000
                            
                            
                            
                            6.4
                            
                            
                            
                            5.73
                            
                            
                            December
      201030,000
                            
                            
                            
                            1.09
                            
                            
                            
                            0.99
                            
                            
                            September
      2011195,000
                            
                            
                            
                            2.33
                            
                            
                            
                            2.04
                            
                            
                            March
      2012200,000
                            
                            
                            
                            4.32
                            
                            
                            
                            4.62
                            
                            
                            March
      2013100,000
                            
                            
                            
                            20.81
                            
                            
                            
                            25.27
                            
                            
                            December
      2013150,000
                            
                            
                            
                            14.81
                            
                            
                            
                            19.70
                            
                            
                            December
      2014100,000
                            
                            
                            
                            16.23
                            
                            
                            
                            19.35
                            
                            
                            December
      2015100,000
                            
                            
                            
                            25.39
                            
                            
                            
                            33.46
                            
                            
                            December
      201675,000
                            
                            
                            
                            4.03
                            
                            
                            
                            5.17
                            
                            
                            December
      2018100,000
                            
                            
                            
                            5.06
                            
                            
                            
                            7.46
                            
                            
                            December
      2019
                            
                            
                            
                            85,000
                            
                            
                            
                            1,325,001
                            
                            
                            
                            4.63
                            %




(2)  Historical value at date of
grant




52




OWNERSHIP OF SHARES AS OF APRIL 30,
2010 continued


% of
                          
                          
                          
                          
                          
                          
                          
                          
                          Exercise
                          
                          
                          ExerciseOrdinary
                          
                          
                          
                          
                          
                          
                          
                          
                          Price in
                          
                          
                          Price in
                          
                          
                          
                          
                          
                          FreeShares
                          
                          
                          Shares
                          
                          
                          
                          
                          
                          Number of
                          
                          
                          Euros
                          
                          
                          USD (2)
                          
                          
                          
                          
                          
                          Share
                          
                          
                          
                          
                          
                          TotalName
                          
                          Owned
                          
                          
                          Outstanding
                          
                          
                          Warrants
                          
                          
                          Options
                          
                          
                          €
                          
                          
                          $
                          
                          
                          Expiration
                          
                          
                          Awards
                          
                          
                          Total
                          
                          
                          %Bourboulou
                          
                          
                          10,000
                          
                          
                          
                          0.04
                          %
                          
                          
                          
                          
                          
                          
                          50,000
                          
                          
                          
                          13.08
                          
                          
                          
                          17.49
                          
                          
                          May
      201520,000
                          
                          
                          
                          12.86
                          
                          
                          
                          15.83
                          
                          
                          September
      20156,500
                          
                          
                          
                          25.39
                          
                          
                          
                          33.46
                          
                          
                          December
      20165,000
                          
                          
                          
                          5.06
                          
                          
                          
                          7.46
                          
                          
                          December
      2019
                          
                          
                          
                          17,000
                          
                          
                          
                          108,500
                          
                          
                          
                          0.38
                          %Capelle
                          
                          
                          6,800
                          
                          
                          
                          0.03
                          %
                          
                          
                          
                          
                          
                          
                          25,000
                          
                          
                          
                          13.97
                          
                          
                          
                          17.65
                          
                          
                          June
      20163,750
                          
                          
                          
                          25.39
                          
                          
                          
                          33.46
                          
                          
                          December
      2016
                          
                          
                          
                          11,000
                          
                          
                          
                          46,550
                          
                          
                          
                          0.16
                          %Castan
                          
                          
                          9,000
                          
                          
                          
                          0.04
                          %
                          
                          
                          
                          
                          
                          
                          3,000
                          
                          
                          
                          1.09
                          
                          
                          
                          0.99
                          
                          
                          September
      20115,000
                          
                          
                          
                          9.88
                          
                          
                          
                          11.66
                          
                          
                          June
      201340,000
                          
                          
                          
                          20.81
                          
                          
                          
                          25.27
                          
                          
                          December
      201320,000
                          
                          
                          
                          12.86
                          
                          
                          
                          15.83
                          
                          
                          September
      201520,000
                          
                          
                          
                          16.23
                          
                          
                          
                          19.35
                          
                          
                          December
      20156,000
                          
                          
                          
                          25.39
                          
                          
                          
                          33.46
                          
                          
                          December
      20165,000
                          
                          
                          
                          5.06
                          
                          
                          
                          7.46
                          
                          
                          December
      2019
                          
                          
                          
                          11,000
                          
                          
                          
                          119,000
                          
                          
                          
                          0.42
                          %Chan
                          
                          
                          9,300
                          
                          
                          
                          0.04
                          %
                          
                          
                          
                          
                          
                          
                          5,000
                          
                          
                          
                          9.88
                          
                          
                          
                          11.66
                          
                          
                          June
      201320,000
                          
                          
                          
                          12.86
                          
                          
                          
                          15.83
                          
                          
                          September
      201520,000
                          
                          
                          
                          16.23
                          
                          
                          
                          19.35
                          
                          
                          December
      20154,500
                          
                          
                          
                          25.39
                          
                          
                          
                          33.46
                          
                          
                          December
      20165,000
                          
                          
                          
                          5.06
                          
                          
                          
                          7.46
                          
                          
                          December
      2019
                          
                          
                          
                          13,000
                          
                          
                          
                          76,800
                          
                          
                          
                          0.27
                          %Crouzet
                          
                          
                          6,810
                          
                          
                          
                          0.03
                          %
                          
                          
                          
                          
                          
                          
                          49,990
                          
                          
                          
                          12.86
                          
                          
                          
                          15.83
                          
                          
                          September
      20155,000
                          
                          
                          
                          16.23
                          
                          
                          
                          19.35
                          
                          
                          December
      20153,750
                          
                          
                          
                          25.39
                          
                          
                          
                          33.46
                          
                          
                          December
      201610,000
                          
                          
                          
                          5.06
                          
                          
                          
                          7.46
                          
                          
                          December
      2019
                          
                          
                          
                          19,750
                          
                          
                          
                          95,300
                          
                          
                          
                          0.33
                          %Fernandez
                          
                          
                          2,800
                          
                          
                          
                          0.01
                          %
                          
                          
                          
                          
                          
                          
                          25,000
                          
                          
                          
                          4.11
                          
                          
                          
                          4.15
                          
                          
                          December
      20125,000
                          
                          
                          
                          9.88
                          
                          
                          
                          11.66
                          
                          
                          June
      201320,000
                          
                          
                          
                          12.86
                          
                          
                          
                          15.83
                          
                          
                          September
      20155,000
                          
                          
                          
                          16.23
                          
                          
                          
                          19.35
                          
                          
                          December
      20153,750
                          
                          
                          
                          25.39
                          
                          
                          
                          33.46
                          
                          
                          December
      2016
                          
                          
                          
                          11,000
                          
                          
                          
                          72,550
                          
                          
                          
                          0.25
                          %Jorda
                          
                          
                          20,369
                          
                          
                          
                          0.08
                          %
                          
                          
                          
                          
                          
                          
                          20,000
                          
                          
                          
                          2.78
                          
                          
                          
                          2.49
                          
                          
                          December
      20115,000
                          
                          
                          
                          9.88
                          
                          
                          
                          11.66
                          
                          
                          June
      201360,000
                          
                          
                          
                          14.81
                          
                          
                          
                          19.70
                          
                          
                          December
      2014105,000
                          
                          
                          
                          12.86
                          
                          
                          
                          15.83
                          
                          
                          September
      201575,000
                          
                          
                          
                          16.23
                          
                          
                          
                          19.35
                          
                          
                          December
      201560,000
                          
                          
                          
                          25.39
                          
                          
                          
                          33.46
                          
                          
                          December
      201650,000
                          
                          
                          
                          4.03
                          
                          
                          
                          5.17
                          
                          
                          December
      201875,000
                          
                          
                          
                          5.06
                          
                          
                          
                          7.46
                          
                          
                          December
      2019
                          
                          
                          
                          45,000
                          
                          
                          
                          515,369
                          
                          
                          
                          1.80
                          %Kalita
                          
                          
                          5,000
                          
                          
                          
                          0.02
                          %
                          
                          
                          
                          
                          
                          
                          50,000
                          
                          
                          
                          16.23
                          
                          
                          
                          19.35
                          
                          
                          December
      20156,500
                          
                          
                          
                          25.39
                          
                          
                          
                          33.46
                          
                          
                          December
      20165,000
                          
                          
                          
                          5.06
                          
                          
                          
                          7.46
                          
                          
                          December
      2019
                          
                          
                          
                          15,000
                          
                          
                          
                          81,500
                          
                          
                          
                          0.28
                          %Kravtzoff
                          
                          
                          3,300
                          
                          
                          
                          0.01
                          %
                          
                          
                          
                          
                          
                          
                          5,000
                          
                          
                          
                          9.88
                          
                          
                          
                          11.66
                          
                          
                          June
      201330,000
                          
                          
                          
                          12.86
                          
                          
                          
                          15.83
                          
                          
                          September
      201520,000
                          
                          
                          
                          16.23
                          
                          
                          
                          19.35
                          
                          
                          December
      20154,500
                          
                          
                          
                          25.39
                          
                          
                          
                          33.46
                          
                          
                          December
      2016Lundstrom
                          
                          
                          
                          
                          
                          
                          0.00
                          %
                          
                          
                          
                          
                          
                          
                          100,000
                          
                          
                          
                          16.56
                          
                          
                          
                          20.40
                          
                          
                          June
      2016
                          
                          
                          
                          
                          
                          
                          
                          100,000
                          
                          
                          
                          0.35
                          %McWilliam
                          
                          
                          
                          
                          
                          
                          0.00
                          %
                          
                          
                          
                          
                          
                          
                          100,000
                          
                          
                          
                          12.86
                          
                          
                          
                          15.83
                          
                          
                          September
      20155,000
                          
                          
                          
                          16.23
                          
                          
                          
                          19.35
                          
                          
                          December
      201510,000
                          
                          
                          
                          25.39
                          
                          
                          
                          33.46
                          
                          
                          December
      201610,000
                          
                          
                          
                          5.06
                          
                          
                          
                          7.46
                          
                          
                          December
      2019
                          
                          
                          
                          20,000
                          
                          
                          
                          145,000
                          
                          
                          
                          0.51
                          %Meyrueix
                          
                          
                          5,525
                          
                          
                          
                          0.02
                          %
                          
                          
                          
                          
                          
                          
                          40,000
                          
                          
                          
                          4.87
                          
                          
                          
                          4.65
                          
                          
                          April
      201040,000
                          
                          
                          
                          2.78
                          
                          
                          
                          2.49
                          
                          
                          December
      20115,000
                          
                          
                          
                          9.88
                          
                          
                          
                          11.66
                          
                          
                          June
      201340,000
                          
                          
                          
                          14.81
                          
                          
                          
                          19.70
                          
                          
                          December
      201430,000
                          
                          
                          
                          12.86
                          
                          
                          
                          15.83
                          
                          
                          September
      201520,000
                          
                          
                          
                          16.23
                          
                          
                          
                          19.35
                          
                          
                          December
      20157,250
                          
                          
                          
                          25.39
                          
                          
                          
                          33.46
                          
                          
                          December
      20165,000
                          
                          
                          
                          5.06
                          
                          
                          
                          7.46
                          
                          
                          December
      2019
                          
                          
                          
                          14,000
                          
                          
                          
                          206,775
                          
                          
                          
                          0.72
                          %Marlio
                          
                          
                          1,700
                          
                          
                          
                          0.01
                          %
                          
                          
                          
                          
                          
                          
                          50,000
                          
                          
                          
                          19.2
                          
                          
                          
                          23.61
                          
                          
                          March
      201410,000
                          
                          
                          
                          12.86
                          
                          
                          
                          15.83
                          
                          
                          September
      20155,000
                          
                          
                          
                          16.23
                          
                          
                          
                          19.35
                          
                          
                          December
      20152,250
                          
                          
                          
                          25.39
                          
                          
                          
                          33.46
                          
                          
                          December
      2016
                          
                          
                          
                          11,000
                          
                          
                          
                          79,950
                          
                          
                          
                          0.28
                          %Portella
                          
                          
                          2,000
                          
                          
                          
                          0.01
                          %
                          
                          
                          
                          
                          
                          
                          2,750
                          
                          
                          
                          25.39
                          
                          
                          
                          33.46
                          
                          
                          December
      2016
                          
                          
                          
                          9,000
                          
                          
                          
                          13,750
                          
                          
                          
                          0.05
                          %Weber
                          
                          
                          2,000
                          
                          
                          
                          0.01
                          %
                          
                          
                          
                          
                          
                          
                          50,000
                          
                          
                          
                          12.02
                          
                          
                          
                          14.81
                          
                          
                          September
      20142,750
                          
                          
                          
                          25.39
                          
                          
                          
                          33.46
                          
                          
                          December
      2016
                          
                          
                          
                          9,000
                          
                          
                          
                          63,750
                          
                          
                          
                          0.22
                          %


53





ITEM
7.  Major Shareholders and Related Party Transactions





A. Major
Shareholders





The
following table sets forth as of April 30, 2010, the percentage of Ordinary
Shares owned by O.S.S. Capital Management LP, BVF, Inc.and Visium Asset
Management LP, the persons each known to beneficially own more than 5% of the
Company’s Ordinary Shares. The table set forth below is based on information
contained in Schedule 13/Ds or 13/Gs on file with the SEC.  Percentages are
calculated based on the total number of shares outstanding as of April 30, 2010:
24,422,600.





Identity of Person or Group
                  
                  Amount of Ordinary
                    Shares Owned
                  
                  
                  Percentage
                    of ClassBVF,
      Inc.
                  
                  
                  3,538,774
                  (1)
                  
                  
                  14.49
                  %O.S.S.
      Capital Management LP
                  
                  
                  3,200,000
                  (2)
                  
                  
                  13.10
                  %Visium
      Asset Management LP
                  
                  
                  1,850,516
                  (3)
                  
                  
                  7.58
                  %







(1)
            Information
      as to the amount and nature of beneficial ownership was obtained from the
      Schedule 13G/A filed with the SEC on February 10, 2010 by Biotechnology
      Value Fund, L.P. (“BVF”).  As of the close of business on December
      31, 2009, (i) BVF beneficially owned 775,319 ADRs, (ii) Biotechnology
      Value Fund II, L.P. (“BVF2”) beneficially owned 537,935 ADRs, (iii) BVF
      Investments, L.L.C. (“BVLLC”) beneficially owned 2,011,308 ADRs and (iv)
      Investment 10, L.L.C. (“ILL10”) beneficially owned 214,212 ADRs. BVF
      Partners L.P. (“Partners”), as the general partner of BVF and BVF2, the
      manager of BVLLC and the investment adviser of ILL10, may be deemed to
      beneficially own the 3,538,774 ADRs beneficially owned in the aggregate by
      BVF, BVF2, BVLLC and ILL10.  BVF Inc., as the general partner of
      Partners, may be deemed to beneficially own the 3,538,774 ADRs
      beneficially owned by Partners.  Mr.  Mark N. Lampert, as a
      director and officer of BVF Inc., may be deemed to beneficially own the
      3,538,774 ADRs beneficially owned by BVF Inc.   The address of
      BVF is 900 N. Michigan Avenue, Suite 1100, Chicago, IL
    60611.


(2)
            Information
      as to the amount and nature of beneficial ownership was obtained from the
      Schedule 13G filed with the SEC on March 31, 2010 by O.S.S. Capital
      Management LP (“OCM”).  OCM shares beneficial ownership with Oscar S.
      Schafer & Partners I LP in respect of 209,827 Ordinary Shares, Oscar
      S. Schafer & Partners II LP in respect of 1,796,744 Ordinary Shares,
      O.S.S. Overseas Fund Ltd. in respect of 1,111,348 Ordinary Shares, O.S.S.
      Advisors LLC in respect of 2,006,571 Ordinary Shares and Schafer Brothers
      LLC and Oscar S. Schafer in respect of all 3,200,000 Ordinary
      Shares.  Additionally, Mr. Oscar S. Schafer beneficially owns 50,000
      shares over which he has sole voting and dispositive power.  The
      address of OCM is 605 Third Ave, New York NY
  10158.


(3)
            Information
      as to the amount and nature of beneficial ownership was obtained from the
      Schedule 13G filed with the SEC on April 9, 2010 by Visium Asset
      Management, LP (“VAM”), which reports dispositive power over 1,850,516
      Ordinary Shares.   Visium Balanced Master Fund, LTD, JG Asset,
      LLC and Jacob Gottlieb share dispositive power over the 1,850,516 Ordinary
      Shares held by VAM.  The address for VAM is 950 Third Avenue, 29th
      Floor, New York, New York 10022.





The
Company’s major shareholders do not have different voting rights. To the best of
our knowledge, Flamel Technologies is not directly or indirectly owned or
controlled by another corporation, by any government, or by any other natural or
legal person.  We are not aware of any arrangement that may at a subsequent
date result in a change of control.  As of April 30, 2010, the Company has
183 Ordinary shareholders of record including the Bank of New York. 
Approximately 98.7% of the Company’s outstanding shares are represented by
American Depositary Shares (ADS).  1.24% of the Ordinary Shares are held in
France.  One record holder resides in France.


54




Significant
changes in the percentage ownership held of record by any of our major
shareholders in the last three years, as reported to the SEC, were as
follows:




Major Shareholder
                                              
                                              Filing Date
                                              
                                              Ownership
                                                PercentageBVF,
      Inc.
                                              
                                              January
      24, 2008
                                              
                                              
                                              10.12
                                              %BVF
      Partners L.P.
                                              
                                              October
      17, 2008
                                              
                                              
                                              18.99
                                              %February
      2, 2009
                                              
                                              
                                              15.88
                                              %February
      10, 2010
                                              
                                              
                                              14.49
                                              %O.S.S.
      Capital Management LP
                                              
                                              February
      14, 2007
                                              
                                              
                                              17.60
                                              %Schafer
      Brothers LLC
                                              
                                              August
      31, 2007
                                              
                                              
                                              26.12
                                              %Oscar
      S. Schafer
                                              
                                              February 
      22, 2010
                                              
                                              
                                              23.52
                                              %March
      31, 2010
                                              
                                              
                                              13.10
                                              %Visium
      Asset Management L.P.
                                              
                                              April
      9, 2010
                                              
                                              
                                              7.58
                                              %Knoll
      Capital Management L.P.
                                              
                                              February
      11, 2008
                                              
                                              
                                              9.27
                                              %Fred
      Knoll
                                              
                                              February
      17, 2009
                                              
                                              
                                              5.22
                                              %January
      29, 2010
                                              
                                              
                                              3.61
                                              %Greenlight
      Capital Management
                                              
                                              February
      14, 2008
                                              
                                              
                                              7.84
                                              %February
      13, 2009
                                              
                                              
                                              0.00
                                              %Silver
      Point Capital L.P.
                                              
                                              October
      29, 2007
                                              
                                              
                                              5.20
                                              %February
      14, 2008
                                              
                                              
                                              6.23
                                              %February
      17, 2009
                                              
                                              
                                              0.00
                                              %





B. Related
Party Transactions





For the
year ended December 31, 2009, and as of April 30, 2010, the Company is not aware
of any related party transaction requiring disclosure pursuant to this
section.





C. Interests
of Experts and Counsel





Not
applicable





ITEM
8.  Financial Information





Financial
Statements





The
financial statements contained in this Annual Report begin on page
F-1.





Legal
Proceedings





While we
may be engaged in various claims and legal proceedings in the ordinary course of
business, we are not involved (whether as a defendant or otherwise) in and we
have no knowledge of any threat of, any litigation, arbitration or
administrative or other proceeding which management believes will have a
material adverse effect on our consolidated financial position or results of
operations.


55


On
November 9, 2007 a putative class action was filed in the United States District
Court for the Southern District of New York against the Company and certain of
its current and former officers entitled Billhofer v. Flamel Technologies, et
al.  The complaint purports to allege claims arising under the
Securities Exchange Act of 1934 based on certain public statements by the
Company concerning, among other things, a clinical trial involving Coreg CR and
seeks the award of damages in an unspecified amount.  By Order dated
February 11, 2008, the Court appointed a lead plaintiff and lead counsel in the
action.  On March 27, 2008, the lead plaintiff filed an amended complaint
which continued to name as defendants the Company and two previously named
officers and asserted the same claims based on the same events as alleged in the
initial complaint.  On May 12, 2008, the Company filed a motion to
dismissthe action, which the
Court denied by Order dated October 1, 2009.  The action is  now
in the discovery phase pursuant to a schedule approved by the Court
in a Case Management Order, signed December 9, 2009.  The Company
intends to vigorously defend itself in the action.  Neither of the two
individual defendants named in the amended complaint have been served in the
action.




On August
27, 2007, a New York court denied Flamel U.S. jurisdiction in a lawsuit filed
against Gérard Soula by the Company.   This decision has not had and
is not expected to have a materially adverse effect upon the
Company.





Dividend
Policy





The
Company has never declared or paid a cash dividend on any of its capital stock
and does not anticipate declaring cash dividends in the foreseeable
future.




ITEM
9.  The Offer and Listing





The
principal trading market for the Company’s securities in ADSs is the NASDAQ
National Market.  Each ADS represents one Share, nominal value 0.122
Euros.  Each ADS is evidenced by an ADR.  The Bank of New York is the
Depositary for the ADRs.  As of December 31, 2009, there were 24,021,939
ADSs outstanding in the United States.  At such date, there were 34 holders
of ADSs on record.  As of December 31, 2009, there were 24,342,600 Shares
outstanding.





The
following table shows the high and low closing sales prices of the ADSs on the
NASDAQ Market for the periods indicated.





Price Per ADS (U.S.$)Year
                  
                  High
                  
                  
                  Low2005
                  
                  
                  21.37
                  
                  
                  
                  12.252006
                  
                  
                  34.88
                  
                  
                  
                  16.72007
                  
                  
                  36.97
                  
                  
                  
                  8.172008
                  
                  
                  10.80
                  
                  
                  
                  3.682009
                  
                  
                  9.67
                  
                  
                  
                  3.99


56





Price Per ADS (U.S.$)Quarter Ended
                  
                  High
                  
                  
                  Low1st 
      Quarter, 2007
                  
                  
                  36.97
                  
                  
                  
                  25.602nd 
      Quarter, 2007
                  
                  
                  29.87
                  
                  
                  
                  20.973rd 
      Quarter, 2007
                  
                  
                  24.39
                  
                  
                  
                  8.994th 
      Quarter, 2007
                  
                  
                  12.03
                  
                  
                  
                  8.171st 
      Quarter, 2008
                  
                  
                  10.65
                  
                  
                  
                  8.382nd
      Quarter, 2008
                  
                  
                  10.80
                  
                  
                  
                  9.183rd 
      Quarter, 2008
                  
                  
                  10.06
                  
                  
                  
                  7.204th 
      Quarter, 2008
                  
                  
                  7.25
                  
                  
                  
                  3.681st 
      Quarter, 2009
                  
                  
                  6.77
                  
                  
                  
                  3.992nd
      Quarter, 2009
                  
                  
                  7.00
                  
                  
                  
                  5.843rd 
      Quarter, 2009
                  
                  
                  9.67
                  
                  
                  
                  7.004th 
      Quarter, 2009
                  
                  
                  9.49
                  
                  
                  
                  7.001st 
      Quarter, 2010





Price Per ADS (U.S.$)Month Ended
                  
                  High
                  
                  
                  LowNovember
      30, 2009
                  
                  
                  9.01
                  
                  
                  
                  7.05December
      31, 2009
                  
                  
                  8.04
                  
                  
                  
                  7.00January
      31, 2010
                  
                  
                  8.85
                  
                  
                  
                  7.515February
      28, 2010
                  
                  
                  8.6
                  
                  
                  
                  7.58March
      31, 2010
                  
                  
                  7.58
                  
                  
                  
                  9.60April
      30, 2010
                  
                  
                  9.06
                  
                  
                  
                  8.52




ITEM
10.  Additional Information





Memorandum
and Articles of Association





For a
general description of these documents, see ‘Description of Share Capital’ in
the Company’s registration statement on Form F-1, as filed with the U.S.
Securities and Exchange Commission on April 19, 1996, registration number
333-03854, which is incorporated by reference.  There have been no changes
to these documents.  No more than a third of Directors may serve over the
age of seventy.





Ownership
of Shares by Non-European Union Persons





A
‘declaration administrative’ or administrative declaration is required in The
Republic of France to be filed with the French Ministry of the Economy, Finance
and the Budget at the time of the acquisition of a controlling interest in
Flamel by any non-EU resident or group of non-EU residents acting in concert or
by any EU resident controlled by a non-EU resident.  With respect to the
acquisition (by a EU resident or a non-EU resident) of a controlling interest in
a company that could affect ‘public health,’ the administrative declaration is
replaced by a procedure that requires prior declaration of the acquisition to
the French Ministry of Economy, Finance and the Budget with the ability for such
Ministry to oppose the investment during a one-month period.  As it is a
pharmaceutical company, the acquisition of a controlling interest in Flamel
could be deemed to affect ‘public health.’





Under
existing administrative rulings, ownership of 20% or more of a listed company’s
share capital is regarded as a controlling interest, but a lower percentage may
be held to be a controlling interest in certain circumstances (such as when the
shareholder has the ability to elect members of the board of directors). 
No administrative declaration is required where an EU resident or group of EU
residents acts in concert to acquire a controlling interest in Flamel provided
that the acquiring party or parties satisfy the requirements of EU
residency.





Under
French law, there is no limitation on the right of non-resident or foreign
shareholders to vote securities of a French company.


57


Material
Contracts





The
Company has no material contracts on file with the SEC.





Exchange
Controls





The
payment of any dividends to foreign shareholders must be effected through an
authorized intermediary bank.  All registered banks and credit
establishments in the Republic of France are authorized intermediaries. 
Under current French exchange control regulations, there are no limitations on
the amount of cash payments that may be remitted by Flamel to residents of the
United States.  Laws and regulations concerning foreign exchange controls
do require, however, that all payments or transfers of funds made by a French
resident to a non-resident be handled by an authorized intermediary
bank.





Taxation





The
following is a description of certain French and U.S. federal tax consequences
of owning and disposing of Flamel Ordinary Shares or Flamel ADSs.  This
description may only be relevant to holders of Flamel Ordinary Shares or Flamel
ADSs who are not residents of France and do not hold their shares in connection
with a permanent establishment or a fixed base in France through which the
holders carry on a business or perform personal services.





This
description may not address all aspects of French tax laws that may be relevant
in light of the particular circumstances of individual holders of Flamel
Ordinary Shares or Flamel ADSs.  It is based on the applicable tax laws,
regulations and judicial decisions as of the date of this annual report, and on
the Conventionbetween the United States
of America and the Republic of France for the Avoidance of Double Taxation and
the Prevention of Fiscal Evasion with respect to Taxes on Income and Capital
dated as of August 31, 1994 entered into force on December 30, 1995, and
the 2004 Protocol amending the Treaty which entered into force on
December 21, 2006, all of which are subject to change, possibly with
retroactive effect, or different interpretations. On January 13, 2009, the
United States and France signed an additional Protocol (the “New Protocol”) amending the
Treaty.  This discussion also takes into account the New Protocol entered
into force on December 23, 2009.  The New Protocol enters into force with
respect to taxes withheld at source  on January 1, 2009 and with respect to
all other taxes on January 1, 2010.  This discussion refers to the treaty
between the United States and France described above, the Protocol, and the New
Protocol together as the ‘Treaty’.





The
following description of tax consequences should be considered only as a summary
and does not purport to be a complete analysis of all potential tax effects of
the purchase or ownership of the Flamel Ordinary Shares or Flamel ADSs. This
summary does not address all potential tax implications that may be relevant as
a holder, in light of particular circumstances.





Tax Consequences to Non-U.S.
HoldersThe following discussion applies to holders of Flamel
Ordinary Shares that are not ‘U.S. Holders,’ as defined below.  Holders of
Flamel Ordinary Shares should consult their tax advisor concerning the French
tax consequences.





Taxation
on Sale or Disposal of Flamel Ordinary Shares





Generally,
a holder of Flamel Ordinary Shares will not be subject to any French income tax
or capital gains tax when the holder sells or disposes of Flamel Ordinary Shares
if both of the following apply:





·
              the
      holder is not a French resident for French tax
  purposes;




·
            the
      holder has held not more than 25% of Flamel’s dividend rights, known as
      droits aux bénéfices sociaux, at any time during the preceding five years,
      either directly or indirectly;
and




·
            Flamel
      is not considered as a real estate
company




If a
double tax treaty between France and the country of residence of a holder of
Flamel Ordinary Shares contains more favorable provisions, a holder may not be
subject to any French income tax or capital gains tax when the holder sells or
disposes of any Flamel Ordinary Shares, even if one or both of the above
statements does not apply to the holder.


58





Subject
to various conditions, foreign states, international organizations and a number
of foreign public bodies are not considered as French residents for these
purposes.





Transfers
of a listed company’s shares will not be subject to French registration or
transfer taxes, unless the transfer is effected by means of a written agreement
that is executed within France. Should such written agreement be executed within
France, a registration duty of 3% on the higher of either the purchase price or
the market value of the transferred shares would be due, with a maximum duty of
€5,000 per transaction.





Taxation
of Dividends





In
France, companies may only pay dividends out of income remaining after tax has
been paid.





a)
            French
      Resident Individuals





French
resident individuals receiving dividends are entitled to (i) a 40% rebate
applied to the gross amount of the dividends received meaning
that dividends are assessed to income tax at progressive rate (with a maximum
rate of 40%) but only for 60% of their amount and (ii) an additional annual tax
allowance (abattement fixe
annuel) equal to €1,525 for single individuals or married persons subject
to separate taxation and €3,050 for married couples and members of a union
agreement subject to joint taxation2, and (iii) a tax credit
(crédit d’impôt)3 equal to 50% of the
dividends received, but with an overall annual cap of €230 for married couples
and members of a union agreement subject to joint taxation or, €115 for single
individuals or married persons subject to separate taxation.





As from
January 1 2008, there is also an option to subject dividends to a final levy at
a rate of 18% (in practice, 30.1% after taking into account the 12.1% social
taxes including the newly enacted contribution Revenu de Solidarité Activeapplicable since January 1st,
2009).





b)
            Non-Residents





French
companies must, in principle, deduct a 25% withholding tax from dividends paid
to non-residents.  As from January 1, 2008, the rate of this withholding
tax has been reduced to 18% for dividends paid to EU, Norway and Iceland
residents.





In
addition, the French Amended Finance Bill for 2009 provides for new
anti-avoidance rules regarding transactions concluded with non-cooperative
jurisdictions.  As a consequence, dividends distributed to non-cooperative
jurisdictions residents as of March 1, 2010, as per the criteria defined by the
French tax code, would be subject to a 50% withholding tax.





Under
most tax treaties between France and other countries, the rate of this
withholding tax may be reduced or eliminated in some circumstances. 
Generally, if dividends are subject to a French withholding tax, a holder who is
a non-French resident is subsequently entitled to a tax credit in that holder’s
country of residence for the amount of tax actually withheld.





However,
France has entered into tax treaties with various countries under which
qualifying residents are entitled to obtain from the French tax authorities a
reduction (generally to 15% or 5%) or an elimination of the French withholding
tax.





According
to the French tax guidelines 5 I-2-06 dated January 12, 2006, non-French
resident individual shareholders who are currently benefiting from a treaty
providing for the transfer of the abolished avoir fiscalwill benefit
from the above-mentioned crédit d’impôtcapped at €230
or €115 depending on the marital status of this shareholder in respect of
dividends paid as from January 1, 2005.





2


3 This tax
credit should be applied after the above mentioned 40% rebate and annual
allowance.


59





The
following countries, French overseas territories, known as Territoires
d’Outre-Mer, and other territories have entered into income tax treaties with
France that provide for the transfer of the crédit d’impôt (referred
to in the tax treaties asavoir fiscal):




Australia
                
                Ghana
                
                Malaysia
                
                Niger
                
                TogoAustria
                
                Iceland
                
                Mali
                
                Norway
                
                TurkeyBelgium
                
                India
                
                Malta
                
                Pakistan
                
                UkraineBolivia
                
                Israel
                
                Mauritius
                
                Saint-Pierre
      et Miquelon
                
                United
      KingdomBrazil
                
                Italy
                
                Mayotte
                
                Senegal
                
                United
      StatesBurkina
      Faso
                
                Ivory
      Coast
                
                Mexico
                
                Singapore
                
                VenezuelaCanada
                
                Japan
                
                Namibia
                
                South
      KoreaEstonia
                
                Latvia
                
                Netherlands
                
                SpainFinland
                
                Lithuania
                
                New
      Caledonia
                
                SwedenGabon
                
                Luxembourg
                
                New
      Zealand
                
                Switzerland





Except for the United States, none of
the countries or territories listed above has a Treaty granting benefits to
holders of Flamel ADSs, as opposed to Ordinary Shares. Accordingly, this
discussion of treaty benefits does not apply to Flamel ADS holders.  If
these arrangements apply to a shareholder, Flamel will withhold tax from the
dividend at the lower rate, provided that the shareholder has established,
before the date of payment of the dividend, that the shareholder is entitled to
the lower rate and has complied with the filing formalities.  Otherwise,
Flamel must withhold tax at the full rate of 25% (for other than  European
Union, Iceland, or Norway residents) or 18% (for European Union, Iceland, or
Norway residents), and the shareholder may subsequently claim the excess tax
paid.





Estate
and Gift Tax





France
imposes estate and gift tax on shares of a French company that are acquired by
inheritance or gift, this tax applying without regards to the residence of the
transferor.  However, France has entered into estate and gift tax treaties
with certain countries pursuant to which, provided that certain conditions are
met, residents of the treaty country may be exempt from such tax or obtain a tax
credit.





Non-residents
should consult their own tax advisors whether French estate and gift tax would
apply to them and whether they might be able to claim an exemption or tax credit
pursuant to an applicable tax treaty.





Wealth
Tax





French
individual residents are taxable on their worldwide assets.  Non-resident
individuals may be subject to French wealth tax (impôt de solidarité sur la
fortune) only on their assets which are located in France.  However,
financial investments made by non-resident individuals, other than in real
estate companies, are exempt from wealth taxes as long as the individuals own
less than 10% of the French company’s capital stock, either directly or
indirectly, provided that their shares do not enable them to exercise influence
on the French company.





Even if
these conditions are not satisfied, a non-French resident holder may be exempt
from French wealth tax if such holder is entitled to more favourable provisions
pursuant to a double tax treaty between France and the holder’s country of
residence.





Tax
Consequences to U.S. Holders





The
following is a summary of the principal U.S. federal income tax considerations
that are likely to be material to the ownership and disposition of Flamel
Ordinary Shares or Flamel ADSs by a U.S. Holder.  A “U.S. Holder” is a
beneficial owner of the Flamel Ordinary Shares or Flamel ADSs who is (i) an
individual citizen or resident of the United States; (ii) a corporation created
or organized in the United States or under the laws of the United States or any
political subdivision thereof; (iii) an estate whose income is includible in
gross income for United States federal income tax purposes regardless of its
source; or (iv) a trust whose administration is subject to the primary
supervision of a United States court and over which one or more United States
persons have the authority to control all substantial decisions of the
trust.  If an entity that is treated as a partnership for United States
federal income tax purposes holds Flamel Ordinary Shares or Flamel ADSs, the tax
treatment of a partner of such partnership will generally depend on the status
of the partner and upon the activities and organization of the
partnership.  If you are a partner of such a partnership you are urged to
consult your tax advisor.  This discussion does not apply to a U.S. Holder
who is also a resident of France for French tax purposes.


60





This
summary is based in part upon the representations of the custodian and the
assumption that each obligation in the Depositary Agreement with the Bank of New
York relating to our ADRs and any related agreement will be performed in
accordance with its terms.





The
following is a general summary of the principal tax effects on U.S. Holders for
purposes of U.S. federal income tax and French tax, if all of the following four
points apply:





·
              the
      U.S. Holder owns, directly, indirectly, or constructively, less than 10%
      of Flamel’s share capital;




·
            the
      U.S. Holder is entitled to the benefits of the Treaty (including under the
      ‘limitations on benefits article of the
  Treaty);




·
            the
      U.S. Holder holds Flamel Shares as capital assets;
    and




·
            the
      U.S. Holder’s functional currency is the U.S.
  dollar.




For
purposes of the Treaty and the U.S. Internal Revenue Code of 1986, Holders of
Flamel ADSs will be treated as the owner of the Flamel Ordinary Shares
represented by such ADSs.





Special
rules may apply to United States expatriates, insurance companies, pass-through
entities and investors in such entities, tax-exempt organizations, financial
institutions, persons subject to the alternative minimum tax, securities
broker-dealers and persons holding their Flamel Ordinary Shares or Flamel ADSs
as part of a conversion transaction, among others.  Those special rules are
not discussed in this annual report.





Holders
of Flamel Ordinary Shares or Flamel ADSs should consult their own tax advisers
as to the particular tax consequences to them of owning Flamel Ordinary Shares
or Flamel ADSs, including their eligibility for benefits under the Treaty, the
applicability and effect of U.S. federal, state, local, foreign and other tax
laws and possible changes in tax law.





Taxation
of Dividends





Withholding
Tax  Dividends paid to non-residents by French companies are subject
to an 25% French withholding tax.  Under the Treaty, this withholding tax
is reduced to 15% if a U.S. Holder’s ownership of Flamel Shares is not
effectively connected with a permanent establishment or a fixed base that the
U.S. Holder has in France.





Dividends
paid to a U.S. Holder by French companies are immediately subject to a reduced
rate of 15%, provided that such U.S. Holder establishes before the date of
payment that he is a U.S. resident under the Treaty by completing and providing
the depositary with a simplified certificate (the “Certificate”) in accordance
with the French tax guidelines (4 J–1-05 released on February 25, 2005). 
Dividends paid to a U.S. Holder that has not filed the Certificate before the
dividend payment date will be subject to French withholding tax at the rate of
25%.  The tax withheld in excess of 15% can be reclaimed, provided that
such U.S. Holder duly completes and provides the French tax authorities with the
relevant form described in the tax guidelines mentioned above (the “Form”) before December 31 of
the second calendar year following the year during which the dividend is
paid.  U.S. Pension Funds and other Tax-Exempt Entities are subject to the
same general filing requirements as the U.S. Holders except that they may be
required to supply additional documentation evidencing their entitlement to
these benefits.





The
Certificate and the Form, together with instructions, will be provided by the
depositary to all U.S. Holders registered with the depositary.  The
depositary will arrange for the filing with the French Tax authorities of all
Certificates properly completed and executed by U.S. Holders of Shares and
returned to the depositary in sufficient time that they may be filed with French
Tax authorities before the distribution so as to obtain an immediate reduced
withholding tax rate.


61





U.S.
individual holders, who are residents of the United States for purposes of the
Treaty, may also claim the crédit d’impôtcapped at €230
or €115 depending on the marital status of this taxpayer, after application of
the 15% withholding tax.  This specific provision applies to any of the
following U.S. Holders (if the ownership of Flamel Shares is not effectively
connected with a permanent establishment or a fixed base that the U.S. Holder
has in France):





·
              the
      U.S. Holder is an individual or other non-corporate holder that is a
      resident of the United States for purposes of the
  Treaty;




·
            the
      U.S. Holder is a U.S. corporation, other than a regulated investment
      company;




·
            the
      U.S. Holder is a U.S. corporation which is a regulated investment company,
      provided that less than 20% of the U.S. Holder’s shares are beneficially
      owned by persons who are neither citizens nor residents of the United
      States; or




·
            the
      U.S. Holder is a partnership or trust that is a resident of the United
      States for purposes of the Treaty, but only to the extent that the U.S.
      Holder’s partners, beneficiaries or grantors would qualify as ‘eligible’
      under one of the first two points in this
  list.




U.S. Income
Tax.  For U.S. federal income tax purposes, the gross amount of a
dividend and any crédit
d’impôt (referred to in the Treaty as avoir fiscal), including
any French tax withheld, will be included in each U.S. Holder’s gross income as
dividend income when payment is received by them (or the custodian, if the U.S.
Holder owns Flamel ADSs), to the extent they are paid or deemed paid out of
Flamel’s current or accumulated earnings and profits as calculated for U.S.
federal income tax purposes.  Dividends paid by Flamel will not give rise
to any dividends received deduction.  They will generally constitute
foreign source ‘passive’ income for foreign tax credit purposes.  For
certain recipients, as a general matter, dividends will constitute foreign
source ‘general’ income with respect to dividends received after December 31,
2006, or ‘financial services’ income with respect to dividends received before
January 1, 2007, in either case for foreign tax credit purposes.





Under
current U.S. federal tax law, amounts distributed as dividends by Flamel with
respect to Flamel Shares or Flamel ADSs paid to you in taxable years beginning
before January 1, 2011will be eligible to be treated as “qualified dividend
income” that is subject to a U.S. federal income tax at the same preferential
rates as long-term capital gains, provided that certain minimum holding period
and other requirements are met and Flamel is not treated as a PFIC (as defined
below under the section titled “PFIC Status”).





Also for
U.S. federal income tax purposes, the amount of any dividend paid in Euros,
including any French withholding taxes, will be equal to the U.S. dollar value
of the Euro on the date the dividend is included in income, regardless of
whether the payment is in fact converted into U.S. dollars.  A U.S. Holder
will generally be required to recognize U.S. source ordinary income or loss when
the U.S. Holder sells or disposes of the Euros.  A U.S. Holder may also be
required to recognize foreign currency gain or loss if that U.S. Holder receives
a refund under the Treaty of tax withheld in excess of the Treaty rate. 
This foreign currency gain or loss will generally be U.S. source ordinary income
or loss.





To the
extent that any dividends paid exceed Flamel’s current and accumulated earnings
and profits as calculated for U.S. federal income tax purposes, the distribution
will be treated as follows:





·
              First,
      as a tax-free return of capital, which will cause a reduction in the
      adjusted basis of a U.S. Holder’s Flamel Ordinary Shares or Flamel
      ADSs.  This adjustment will increase the amount of gain, or decrease
      the amount of loss, which a U.S. Holder will recognize if such U.S. Holder
      later disposes of those Flamel Ordinary Shares or Flamel ADSs, as the case
      may be.




·
            Second,
      the balance of the dividend in excess of the adjusted basis will be taxed
      as capital gain recognized on a sale or
  exchange.




French
withholding tax imposed on the dividends a U.S. Holder receives and on any crédit d’impôt(referred to
in the Treaty as avoir
fiscal)at
15% under the Treaty generally is treated as payment of a foreign income
tax.  A U.S. Holder may take this amount as a credit or deduction against
the U.S. Holder’s U.S. federal income tax liability.  The foreign tax
credit is subject to various conditions and limitations, including minimum
holding period requirements.   Special rules apply in determining the
foreign tax credit limitation with respect to dividends that are subject to the
maximum 15% tax rate.


62





To the
extent a refund of French tax withheld with respect to dividends (including
crédit
d’impôt (referred to in the Treaty as avoir fiscal)) is available
under the Treaty or under French law, the amount of tax withheld that is
refundable will not be eligible for credit against your U.S. federal income tax
liability.





Taxation
of Capital Gains





French Tax.A U.S. Holder who is a resident of the United States for purposes of the
Treaty  will not be subject to French tax on any capital gain if such U.S.
Holder sells or exchanges its Flamel Ordinary Shares or Flamel ADSs, unless the
U.S. Holder has a permanent establishment or fixed base in France and the Flamel
Ordinary Shares or Flamel ADSs the U.S. Holder sold or exchanged were
attributable to that permanent establishment or fixed base. Special rules apply
to individuals who are residents of more than one country.





U.S. Income
Tax.In general, for U.S. federal income tax purposes, a U.S.
Holder will recognize capital gain or loss if the U.S. Holder sells or exchanges
its Flamel Ordinary Shares or Flamel ADSs.  Any such gain or loss generally
will be U.S. source gain or loss.  If a U.S. Holder is an individual, any
capital gain will generally be subject to U.S. federal income tax at
preferential rates if the U.S. Holder meets applicable minimum holding period
requirements.





PFIC
Status.  Flamel believes that it will not be treated as a passive
foreign investment company, or PFIC, for U.S. federal income tax purposes, for
the current taxable year or for future taxable years.  However, an actual
determination of PFIC status is factual and cannot be made until the close of
the applicable taxable year.  Flamel will be a PFIC for any taxable year in
which either:





·
              75%
      or more of its gross income is passive income;
  or




·
            its
      assets which produce passive income or which are held for the production
      of passive income amount to at least 50% of the value of its total assets
      on average.




If Flamel
were to become a PFIC, the tax consequences applicable to distributions on
Flamel Ordinary Shares and Flamel ADSs, and any gains a U.S. Holder realizes
when the U.S. Holder disposes of such Flamel Ordinary Shares or Flamel ADSs, may
be less favorable to the U.S. Holder.  In addition, a U.S. Holder would be
required to file Form 8621 with respect to its interest in Flamel.  Each
U.S. Holder should consult its own tax advisors regarding the PFIC rules and
their effect on the U.S. Holder if they purchase Flamel Ordinary Shares or
Flamel ADSs.





French
Estate and Gift Taxes





Under
‘The Convention Between the United States of America and the French Republic for
the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Estates, Inheritance and Gifts of November 24, 1978,’ if a
U.S. Holder transfers their Flamel Shares by gift, or if they are transferred by
reason of the U.S. Holder’s death, that transfer will only be subject to French
gift or inheritance tax if one of the following applies:





·
              the
      U.S. Holder is domiciled in France at the time of making the gift, or at
      the time of the U.S. Holder’s death;
or




·
            the
      U.S. Holder used the Flamel Shares in conducting a business through a
      permanent establishment or fixed base in France, or the U.S. Holder held
      the Flamel Shares for that
use.




French
Wealth Tax





The
French wealth tax does not generally apply to Flamel Shares if the U.S. Holder
is a ‘resident’ of the United States for purposes of the Treaty. It will be the
case if the Flamel U.S. Holder does not own a substantial interest (participation substantielle).
Pursuant to article 23 §2 of the Treaty, “an individual is considered to have a
substantial interest if he or she owns, alone or with related persons, directly
or indirectly, shares, rights, or interests the total of which gives right to at
least 25% of the corporate earnings”.


63


Health
Care and Reconciliation Act of 2010





The
Health Care and Reconciliation Act of 2010 requires that, in certain
circumstances, certain U.S. Shareholders that are individuals, estates, and
trusts pay a 3.8% tax on "net investment income," which includes, among other
things, dividends on and gains from the sale or other disposition of stock,
effective for taxable years beginning after December 31, 2012.  Prospective
investors should consult their own tax advisors regarding this new
legislation.





United
States Information Reporting and Backup Withholding





Dividend
payments made by us to a U.S. Holder in respect of Flamel Ordinary Shares or
Flamel ADSs and proceeds from the sale or disposal of a U.S. Holder’s Flamel
Ordinary Shares or Flamel ADSs may be subject to information reporting to the
Internal Revenue Service.





U.S.
federal backup withholding generally is a withholding tax (currently imposed at
a rate of 28%) on some payments to persons that fail to furnish required
information.  Backup withholding will not apply to a U.S. Holder who
furnishes a correct taxpayer identification number or certificate of foreign
status and makes any other required certification, or who is otherwise exempt
from backup withholding.  Any U.S. persons required to establish their
exempt status generally must file Internal Revenue Service Form W-9, entitled
Request for Taxpayer Identification Number and Certification.  Amounts
withheld as backup withholding may be credited against a U.S. Holder’s U.S.
federal income tax liability.  A U.S. Holder generally may obtain a refund
of any excess amounts withheld under the backup withholding rules by filing the
appropriate claim for refund with the Internal Revenue Service and furnishing
any required information within the appropriate amount of time.




Recently
Enacted Legislation Related to Disclosure of Information with Respect to Foreign
Financial Assets





Recently
enacted legislation in the U.S. requires a U.S. Holder that holds an interest in
“specified foreign financial assets” to disclose information to the IRS related
to these holdings.  These new disclosure requirements are effective for
taxable years beginning after March 18, 2010, and apply for any year in which
the aggregate value of all such holdings is greater than $50,000.  For
these purposes, “specified foreign financial assets” may include (i) depository
or custodial account maintained by foreign financial institutions and foreign
investment vehicles, (ii) interests in, or securities issued by, non-U.S.
persons, and (iii) other financial instruments or contracts held for investment
where the issuer or counterparty is a non-U.S. person.  In addition, a U.S.
Holder may be required to furnish information to avoid a presumption that the
aggregate value of the U.S. Holder’s holdings of specified foreign financial
assets is in excess of $50,000.  A U.S. Holder who fails to comply with
these requirements may be subject to penalties.  As is common with new
legislation, the application of these requirements in any particular
circumstance may not be entirely clear.  Investors should consult their own
tax advisors regarding the effect of this legislation in their particular
circumstances.





Documents
on Display





Flamel is
subject to the informational requirements of the Securities Exchange Act of
1934, as amended, and, in accordance with those requirements, files reports and
other information with the U.S. Securities and Exchange Commission.  Copies
of reports and other information, when so filed, may be inspected free of charge
and may be obtained at prescribed rates at the public reference facility
maintained by the SEC at 100 F Street, N.E., Washington, D.C. 20549. 
Please call the SEC at 1-800-SEC-0330 for further information on the public
reference rooms.  You may also access documents filed with the SEC at its
website www.sec.gov. 
Certain of the reports that the Company files with the Commission may be
available from time to time on the Company’s internet website, at www.flamel.com. 
Flamel is not incorporating the contents of its or the SEC’s websites or the
website of any other person into this document.


64


ITEM
11.  Quantitative and Qualitative Disclosures About Market
Risk





The
Company conducts a portion of its business transactions in U.S. dollars. 
For the year ended December 31, 2009 revenues denominated in U.S. dollars
represented 36.0% of total revenues.  As a result, the Company’s financial
results could be significantly affected by the fluctuation of the Euro relative
to the U.S. dollar.  Specifically, 27.8% of the Company’s cash and cash
equivalents, totalling $2.4 million as of December 31, 2009, and all of the
Company’s marketable securities, totalling $35.4 million, as of December 31,
2009, are denominated in Euros, as are the vast majority of the Company’s
expenses.  If the dollar were to strengthen by 10% versus the Euro, there
would be a corresponding negative effect on these items of $3.4 million in our
balance sheet.  Conversely, if the dollar were to weaken by 10% versus the
Euro, there would be a positive effect on these items of $4.2 million in our
balance sheet.  See ‘Item 5. Operating and Financial Review and Prospects -
Overview.’





The
Company is not exposed to interest rate risk.





ITEM
12.  Description of Securities Other Than Equity Securities





ITEM
12.A Debt Securities




Not
applicable.





ITEM
12.B Warrants and Rights




Not
applicable.





ITEM
12.C Other Securities




Not
applicable.





ITEM
12.D American Depositary Shares




Charges
of Depositary





The
Company will pay fees, reasonable expenses and out-of-pocket charges of the
depositary and those of any registrar only in accordance with agreements in
writing entered into between the Depositary and the Company from time to
time.  The following charges shall be incurred by any party depositing or
withdrawing shares or by any party surrendering receipts or to whom receipts are
issued (including, without limitation, issuance pursuant to a stock dividend or
stock split declared by the Company or an exchange of stock regarding the
receipts or deposited securities or a distribution of receipts pursuant to the
terms of the deposit agreement):





-
            taxes
      and other governmental charges


-
            any
      applicable registration or transfer
fees


-
            any
      cable, telex and facsimile transmission charges as provided in the deposit
      agreement


-
            any
      expenses incurred in the conversion of foreign
  currency


-
            $5.00
      (or less) per 100 ADSs (or portion thereof) for the execution and delivery
      of Receipts and surrender of
receipts


-
            $0.02
      or less per ADS (or portion thereof) for any cash distribution pursuant to
      the deposit agreement


-
            $1.50
      or less per certificate for a receipt or transfer of a
    receipt


-
            A
      fee equivalent to the fee that would be payable if securities distributed
      to you had been shares and the shares had been deposited for issuance of
      ADSs


65





PART
II





ITEM
13.  Defaults, Dividend Arrearages and Delinquencies





There has
not been any material default with respect to any indebtedness of the
Company.





ITEM
14.  Material Modifications to the Rights of Security Holders and Use of
Proceeds





Not
applicable.


66


ITEM
15.  Controls and Procedures




Disclosure
Controls and Procedures





The
Company’s Chief Executive Officer and Principal Financial Officer have evaluated
the effectiveness of the Company’s disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as amended) as of December 31, 2009.  Based on this evaluation, the
Chief Executive Officer and Principal Financial Officer of the Company concluded
that the Company’s disclosure controls and procedures were effective as of
December 31, 2009.








Changes in
Internal Control over Financial Reporting





There
have been no changes in the Company’s internal control over financial reporting
that occurred during the Company’s fiscal year ended December 31, 2009 that has
materially affected, or is reasonable likely to materially affect, the Company’s
internal control over financial reporting.





Management
Report on Internal Control over Financial Reporting





The
management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) of
the Company.





The
internal control over financial reporting at the Company was designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
accounting principles generally accepted in the United States of America.
Internal control over financial reporting includes those policies and procedures
that:





•
            pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of the assets of the
      Company;





•
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with accounting
      principles generally accepted in the United States of
    America;





•
            provide
      reasonable assurance that receipts and expenditures of the Company are
      being made only in accordance with authorization of management and
      directors of the Company; and





•
            provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of assets that could have a
      material effect on the consolidated financial
  statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with policies or procedures may deteriorate.





The
Company’s management assessed the effectiveness of the company’s internal
control over financial reporting as of December 31, 2009.  Management
based this assessment on criteria for effective internal control over financial
reporting described in “Internal Control – Integrated Framework” issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on this
assessment, management determined that, as of December 31, 2009, the
Company maintained effective internal control over financial reporting. 
Management reviewed the results of its assessment with the Audit Committee of
the Board of Directors.





Attestation
report of registered public accounting firm




The
effectiveness of the Company’s internal control over financial reporting has
been audited by PricewaterhouseCoopers, an independent registered accounting
firm, as stated in their report on the Company’s internal control over reporting
as of December 31, 2009, which is included herein.


See
report of PricewaterhouseCoopers, an independent registered accounting firm,
included within the financial statements on page F-2.


67




ITEM
16.  [Reserved]





ITEM
16A.  Audit Committee Financial Expert





The Board
has determined that Elie Vannier and Frédéric Lemoine  are ‘audit committee
financial experts,’ as defined by the rules of the SEC.  Messrs Vannier and
Lemoine are ‘independent’ as defined by the NASDAQ Marketplace
Rules.





ITEM
16B.  Code of Ethics





The Board
adopted a written Code of Ethics which applies to the Chief Executive Officer,
Chief Operating Officer and senior financial officers.  The principles set
forth in our Code of Ethics are intended to promote the honest and ethical
conduct of our principal executive officer, the principal financial officer, the
principal accounting officer or controller, or persons performing similar
functions.  The Code of Ethics was filed as exhibit 11.1 to our annual
report on Form 20-F for the year ended December 31, 2003, on April 26,
2004.





ITEM
16C.  Principal Accountant Fees and Services





The
following is a summary of the fees billed to Flamel by PricewaterhouseCoopers
for professional services rendered for the fiscal years ended December 31, 2009
and 2008:





Fee Category
                  
                  Fiscal 2009 Fees
                    (Euros)
                  
                  
                  Fiscal 2008 Fees
                    (Euros)Audit
      Fees
                  
                  
                  198,000
                  
                  
                  
                  199,800Audit-Related
      Fees
                  
                  
                  10,500
                  
                  
                  
                  9,500Tax
      Fees
                  
                  
                  -All
      Other Fees
                  
                  
                  -
                  
                  
                  
                  0Total
      Fees
                  
                  
                  208,500
                  
                  
                  
                  209,300





All
fees were billed in Euros.  Using the average exchange rate of 1.393265 U.S
dollars per Euro for 2009 and 1.47059 U.S dollars per Euro for 2008, audit fees
equaled $290,496 for Fiscal 2009 and $307,794 for Fiscal 2008.





Audit Fees.Consists of fees billed for professional services rendered for the audit
of the Company’s consolidated financial statements, review of the interim
consolidated financial statements included in quarterly reports and review of
internal controls over Financial Reporting.





Audit-Related
Fees.Consists of fees billed for assurance and related services by
the principal accountant that are reasonably related to the performance of the
audit or review of Flamel’s consolidated financial statements.





Tax Fees.Consists of fees billed for professional services for tax compliance, tax
advice and tax planning.





All Other Fees.There were no fees billed for professional services in fiscal years 2009
and 2008  that are not included in one of the above
categories.


68





Audit Committee’s
Pre-Approval Policies and Procedures





Our Audit
Committee nominates and engages our independent auditors to audit our financial
statements.  See also ‘Item 6. Directors, Senior Management and
Employees – Board Practices – Committees of the Board of
Directors.’  In 2005, our Audit Committee adopted a revised policy
requiring management to obtain the Committee’s approval before engaging our
independent auditors to provide any other audit or permitted non-audit services
to us or our subsidiaries.  Pursuant to this policy, which is designed
to assure that such engagements do not impair the independence of our auditors,
the Audit Committee annually pre-approves, in accordance with an audit plan,
specific audit and non-audit services in the categories Audit Service,
Audit-Related Services, Tax Consulting Services, and Other Services that may be
performed by our auditors.  All of the fees to the principal
accountants were approved by the Audit Committee pursuant to paragraph
(c)(7)(i)(C) of Rule 2-01 of Regulation S-X in 2005.  Our Principal
Financial Officer reviews all individual management requests to engage our
auditors as a service provider in accordance with this policy and, if the
requested services are permitted pursuant to the audit plan approved by the
Audit Committee and are less than €10,000, approves the request
accordingly.  In the event of a request for services pursuant to the
audit plan in excess of €10,000 and less than €20,000, the Chairman of the Audit
Committee approves the request.  Any services in excess of €20,000 are
to be pre-approved by the Audit Committee.  We inform the Audit
Committee about all approvals made by the Principal Financial Officer or
Chairman of the Audit Committee at the following Audit Committee
meeting.  The chairman of our Audit Committee is not permitted to
approve any engagement of our auditors if the services to be performed either
fall into a category of services that are not permitted by applicable law or the
services would be inconsistent with maintaining the auditors’
independence.




ITEM
16D.  Exemptions from the Listing Standards for Audit
Committees




Not
applicable.




ITEM
16E.  Purchases of Equity Securities by the Issuer and Affiliated
Purchasers




Not
applicable.




ITEM
16F.  Change in Registrant’s Certifying Accountant




Not
applicable.




ITEM
16G.  Corporate Governance




The
Company is exempt from NASDAQ’s quorum requirements applicable to meetings of
shareholders. In keeping with French law and generally accepted business
practices in France, the presence in person or by proxy of shareholders having
not less than 20% (in case of an ordinary general meeting or an extraordinary
general meeting deciding upon any capital increase by capitalization of
reserves) or 25% (in the case of an extraordinary general meeting) of the Shares
is necessary for a quorum. If a quorum is not present at any meeting, the
meeting is adjourned. Upon recommencement of an adjourned meeting, there is no
quorum requirement in the case of an ordinary general meeting or an
extraordinary general meeting deciding upon any capital increase by
capitalization of reserves. The presence in person or by proxy of shareholders
having not less than 20% of the Shares is necessary for a quorum in the case of
any other type of extraordinary general meeting.




The
Company also has been granted an exemption from former NASDAQ Marketplace Rule
4350(g), now Rule 5620 (b).   The French Commercial Code does not
require that we solicit or provide proxy statements for meetings of
shareholders.  In accordance with the French Commercial Code and our
statuts, we inform
shareholders of all meetings in a public notice, which notice states the
requirements for admission to the meeting.  Meeting the Nasdaq
requirement to solicit proxies and provide proxy statements for shareholder
meetings would be contrary to accepted business practice in France.





All
Related Party Transactions are reviewed by the Board of Directors as part of
French Legal requirements and documented, audited and approved by the
shareholders at each ordinary shareholder’s meeting approving the annual French
statutory accounts of the Company.





Under
French law, the committees of our Board of Directors are advisory only, and
where the Nasdaq requirements would vest certain decision-making powers with
specific committees by delegation (e.g., nominating or audit committees), our
Board of Directors remains under French law the only competent body to take such
decisions, albeit taking into account the recommendation of the relevant
committees.  Additionally, under French corporate law, it is the
shareholder meeting of the Company that is competent to appoint our auditors
upon the proposal of our Board of Directors.


69




In
addition to the oversight role of our Compensation Committee for questions of
management compensation including by way of equity, under French law any option
plans or other share capital increases, whether for the benefit of top
management or employees, may only be adopted by the Board of Directors pursuant
to and within the limits of a shareholder resolution approving the related
capital increase and delegating to the Board the authority to implement such
operations.





As a
‘foreign private issuer’ under the U.S. securities laws, our Chief Executive
Officer and our Principal Financial Officer issue the certifications required by
§302 and §906 of the Sarbanes Oxley Act of 2002 on an annual basis (with the
filing of our annual report on U.S. Form 20-F) rather than on a quarterly basis
as would be the case of a U.S. corporation filing quarterly reports on U.S. Form
10-Q.


70





PART
III




ITEM
17.  Financial Statements




Not
applicable. See ‘Item 18. Financial Statements.’





ITEM
18.  Financial Statements




The
following financial statements, together with the reports of Independent
registered accounting firm thereon, are filed as part of this Annual
Report:




Reports
      of independent registered public accounting firms
                    F-2Consolidated
      Balance Sheets as of December 31, 2008 and 2009
                    F-4Consolidated
      Statement of Operations for the Years Ended December 31, 2007, 2008 and
      2009
                    F-5Consolidated
      Statements of Shareholders’ Equity for the Years Ended December 31, 2007,
      2008 and 2009
                    F-6Consolidated
      Statements of Cash Flows for the Years Ended December 31,  2007,
      2008 and 2009
                    F-7Notes
      to Consolidated Financial Statements
                    F-8





See pages
F-1 through F-31 incorporated herein by reference





The
registrant undertakes to provide to each shareholder requesting the same a copy
of each exhibit referred to herein upon payment of a reasonable fee limited to
the registrant’s reasonable expenses in furnishing such exhibit.





ITEM
19.  Exhibits




EXHIBIT INDEX


ExhibitNumber
            
            Description1.1
            
            Revised
      Statutsor bylaws
      of the Company (Filed herewith)2.1
            
            Deposit
      Agreement among Flamel, The Bank of New York, as Depositary, and holders
      from time to time of American Depositary Shares issued thereunder
      (including as an exhibit the form of American Depositary
      Receipt)  (1)8.1
            
            List
      of Subsidiaries (Filed herewith)11.1
            
            Code
      of Ethics for CEO (Directeur Général), Delegated Managing Directors
      (Directeurs Generaux Delegues) and Senior Financial
      Officers  (2)12.1
            
            Certification
      of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the
      Securities Exchange Act, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002 (Filed herewith)12.2
            
            Certification
      of the Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of
      the Securities Exchange Act, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002 (Filed herewith)13.1
            
            Certification
      of the Chief Executive Officer pursuant to USC Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Furnished
      herewith)13.2
            
            Certification
      of the Principal Financial Officer pursuant to USC Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
      (Furnished herewith)23.1
              23.2
            
            Consent
      of PricewaterhouseCoopers Audit (Filed herewith)
              Consent
      of Ernst & Young Audit (Filed herewith)
              .





(1)
Incorporated by reference to Post-Effective Amendment No. 1 to the Company’s
registration statement on Form F-6 filed July 26, 2001, as amended
(No. 333-12790).


(2)
Incorporated by reference to the Company’s Annual Report on Form 20-F for the
year ended December 31, 2003, filed on April 26, 2004.


71




FLAMEL
TECHNOLOGIES S.A.
  INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS




PageReport
      of Independent Registered Public Accounting Firm, PricewaterhouseCoopers
      Audit
            F-2Report
      of Independent Registered Public Accounting Firm, Ernst & Young
      Audit
            F-3Consolidated
      Balance Sheets as of December 31, 2008 and 2009
            F-4Consolidated
      Statements of Operations for the Years Ended December 31, 2007, 2008 and
      2009
            F-5Consolidated
      Statements of Shareholders’ Equity for the years Ended December 31, 2007,
      2008 and 2009
            F-6Consolidated
      Statements of Cash flows for the Years Ended December 31, 2007, 2008 and
      2009
            F-7Notes
      to Consolidated Financial Statements
            F-8


F-1




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the
Board of Directors and Shareholders





In our
opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of shareholders’ equity and of cash flows
present fairly, in all material respects, the financial position of Flamel
Technologies SA and its subsidiary at December 31, 2009 and 2008, and the
results of their operations and their cash flows for each of the two years
in the period ended December 31, 2009 in conformity with accounting
principles generally accepted in the United States of America. Also in our
opinion, the Company maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2009, based on criteria
established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).





The
Company's management is responsible for these financial statements, for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting,
included in Management's Report on Internal Control over Financial Reporting,
appearing on page 67 of the 2009 Annual Report to Shareholders. Our
responsibility is to express opinions on these financial statements and on the
Company's internal control over financial reporting based on our integrated
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 audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation.





Our
audits of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, and testing and evaluating the design and
operating effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we considered necessary
in the circumstances. We believe that our audits provide a reasonable basis for
our opinion.





A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (i) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company;
(ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management
and directors of the company; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a material effect on the
financial statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.




Lyon,
France, May 7, 2010




PricewaterhouseCoopers
Audit




Represented
by


Bernard
Rascle




F-2




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the
Board of Directors and Shareholders,





We have
audited the accompanying consolidated statements of operations, shareholders'
equity and cash-flows of Flamel Technologies S.A. for the year ended December
31, 2007. These financial statements are the responsibility of the company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.





We
conducted our audit 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 statements presentation. We believe that our audit provides a
reasonable basis for our opinion.





In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated results of operations and cash flows of
Flamel Technologies S.A. for the year ended December 31, 2007 in conformity with
U.S. generally accepted accounting principles.




Lyon,
France




May 7,
2008




ERNST
      & YOUNG AuditRepresented
      byJean-Luc
      Desplat




F-3




FLAMEL
TECHNOLOGIES S.A.
 
 CONSOLIDATED
BALANCE SHEETS
 (Amounts
in thousands of dollars except share data)


December 31,Note
                                
                                
                                2008
                                
                                
                                2009ASSETSCurrent
      assets:Cash
      and cash equivalents
                                
                                
                                6
                                
                                
                                $
                                27,021
                                
                                
                                $
                                8,716Marketable
      securities
                                
                                
                                7
                                
                                
                                
                                10,057
                                
                                
                                
                                35,352Accounts
      receivable (net of allowance of $147 and $152 at December 31, 2008 and
      2009 respectively)
                                
                                
                                
                                
                                
                                
                                6,979
                                
                                
                                
                                8,675Inventory
                                
                                
                                8
                                
                                
                                
                                1,837
                                
                                
                                
                                1,072Research
      and development tax credit receivable current portion
                                
                                
                                18
                                
                                
                                
                                11,114
                                
                                
                                
                                9,400Prepaid
      expenses and other current assets
                                
                                
                                9
                                
                                
                                
                                2,181
                                
                                
                                
                                3,626Total
      current assets
                                
                                
                                
                                
                                
                                
                                59,189
                                
                                
                                
                                66,841Property
      and equipment, net
                                
                                
                                10
                                
                                
                                
                                27,601
                                
                                
                                
                                24,759Other
      assets:Research
      and development tax credit receivable less current portion
                                
                                
                                18
                                
                                
                                
                                4,880
                                
                                
                                
                                2,484Other
      long-term assets
                                
                                
                                
                                
                                
                                
                                191
                                
                                
                                
                                212Total
      assets
                                
                                
                                
                                
                                
                                $
                                91,861
                                
                                
                                $
                                94,296LIABILITIES
      AND SHAREHOLDERS’ EQUITYCurrent
      liabilities:Current
      portion of long-term debt
                                
                                
                                14
                                
                                
                                
                                684
                                
                                
                                
                                862Current
      portion of capital lease obligations
                                
                                
                                15
                                
                                
                                
                                69
                                
                                
                                
                                33Accounts
      payable
                                
                                
                                
                                
                                
                                
                                5,760
                                
                                
                                
                                6,366Current
      portion of deferred revenue
                                
                                
                                13
                                
                                
                                
                                798
                                
                                
                                
                                3,862Advances
      from customers
                                
                                
                                
                                
                                
                                
                                587
                                
                                
                                
                                851Accrued
      expenses
                                
                                
                                11
                                
                                
                                
                                5,905
                                
                                
                                
                                6,318Other
      current liabilities
                                
                                
                                12
                                
                                
                                
                                6,452
                                
                                
                                
                                4,604Total
      current liabilities
                                
                                
                                
                                
                                
                                
                                20,255
                                
                                
                                
                                22,896Long-term
      debt, less current portion
                                
                                
                                14
                                
                                
                                
                                2,269
                                
                                
                                
                                2,944Capital
      lease obligations, less current portion
                                
                                
                                15
                                
                                
                                
                                96
                                
                                
                                
                                66Deferred
      revenue, less current portion
                                
                                
                                13
                                
                                
                                
                                201
                                
                                
                                
                                6,033Other
      long-term liabilities
                                
                                
                                12
      - 19
                                
                                
                                
                                20,494
                                
                                
                                
                                17,494Total
      long-term liabilities
                                
                                
                                
                                
                                
                                
                                23,060
                                
                                
                                
                                26,537Commitments
      and contingencies:
                                
                                
                                
                                
                                
                                
                                -
                                
                                
                                
                                -Shareholders'
      equity :
                                
                                
                                17Ordinary
      shares: 24,205,350 issued and outstanding at December 31, 2008 and
      24,342,600 at December 31, 2009 (shares authorised 28,713,090) at nominal
      value of 0.122 euro
                                
                                
                                
                                
                                
                                
                                3,516
                                
                                
                                
                                3,540Additional
      paid-in capital
                                
                                
                                
                                
                                
                                
                                193,085
                                
                                
                                
                                198,498Accumulated
      deficit
                                
                                
                                
                                
                                
                                
                                (160,205
                                )
                                
                                
                                (171,644
                                )Accumulated
      other comprehensive income
                                
                                
                                
                                
                                
                                
                                12,150
                                
                                
                                
                                14,469Total
      shareholders' equity
                                
                                
                                
                                
                                
                                
                                48,546
                                
                                
                                
                                44,863Total
      liabilities and shareholders' equity
                                
                                
                                
                                
                                
                                $
                                91,861
                                
                                
                                $
                                94,296




F-4


FLAMEL
TECHNOLOGIES S.A.
 
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 (Amounts
in thousands of dollars except share data)
  Year ended December 31,Note
                          
                          
                          2007
                          
                          
                          2008
                          
                          
                          2009Revenue:License
      and research revenue
                          
                          
                          3
                          
                          
                          $
                          10,307
                          
                          
                          $
                          13,247
                          
                          
                          $
                          20,815Product
      sales and services
                          
                          
                          2
                          
                          
                          
                          19,768
                          
                          
                          
                          13,549
                          
                          
                          
                          11,871Other
      revenues
                          
                          
                          
                          
                          
                          
                          6,579
                          
                          
                          
                          11,823
                          
                          
                          
                          9,432Total
      revenue
                          
                          
                          
                          
                          
                          
                          36,654
                          
                          
                          
                          38,619
                          
                          
                          
                          42,118Costs
      and expenses:Cost
      of products and services sold
                          
                          
                          
                          
                          
                          
                          (17,320
                          )
                          
                          
                          (9,621
                          )
                          
                          
                          (10,118
                          )Research
      and development
                          
                          
                          
                          
                          
                          
                          (41,269
                          )
                          
                          
                          (29,269
                          )
                          
                          
                          (30,416
                          )Selling,
      general and administrative
                          
                          
                          
                          
                          
                          
                          (16,626
                          )
                          
                          
                          (12,911
                          )
                          
                          
                          (13,337
                          )Total
                          
                          
                          
                          
                          
                          
                          (75,215
                          )
                          
                          
                          (51,801
                          )
                          
                          
                          (53,871
                          )Income
      (loss) from operations
                          
                          
                          
                          
                          
                          
                          (38,561
                          )
                          
                          
                          (13,182
                          )
                          
                          
                          (11,753
                          )Interest
      expense
                          
                          
                          
                          
                          
                          
                          (16
                          )
                          
                          
                          (18
                          )
                          
                          
                          (100
                          )Interest
      income
                          
                          
                          
                          
                          
                          
                          1,691
                          
                          
                          
                          1,432
                          
                          
                          
                          525Foreign
      exchange gain (loss)
                          
                          
                          
                          
                          
                          
                          (454
                          )
                          
                          
                          3
                          
                          
                          
                          (83
                          )Other
      income
                          
                          
                          
                          
                          
                          
                          197
                          
                          
                          
                          181
                          
                          
                          
                          (28
                          )Income
      (loss) before income taxes
                          
                          
                          
                          
                          
                          
                          (37,143
                          )
                          
                          
                          (11,584
                          )
                          
                          
                          (11,439
                          )Income
      tax
                          
                          
                          18
                          
                          
                          
                          (594
                          )
                          
                          
                          (500
                          )Net
      income (loss)
                          
                          
                          
                          
                          
                          $
                          (37,737
                          )
                          
                          $
                          (12,084
                          )
                          
                          $
                          (11,439
                          )Earnings
      (loss) per shareBasic
      earnings (loss) per share
                          
                          
                          
                          
                          
                          $
                          (1.57
                          )
                          
                          $
                          (0.50
                          )
                          
                          $
                          (0.47
                          )Diluted
      earnings (loss) per share
                          
                          
                          16
                          
                          
                          $
                          (1.57
                          )
                          
                          $
                          (0.50
                          )
                          
                          $
                          (0.47
                          )Weighted
      average number of shares outstanding (in thousands) :Basic
                          
                          
                          
                          
                          
                          
                          24,024
                          
                          
                          
                          24,082
                          
                          
                          
                          24,225Diluted
                          
                          
                          
                          
                          
                          
                          24,024
                          
                          
                          
                          24,082
                          
                          
                          
                          24,225




F-5




FLAMEL
TECHNOLOGIES S.A.
 
 CONSOLIDATED
STATEMENTS OF SHAREHOLDERS’ EQUITY
 (Amounts
in thousands of dollars except share data)


AccumulatedOtherAdditional
                    
                    
                    
                    
                    
                    Comprehen-Ordinary
      Shares
                    
                    
                    Paid-in
                    
                    
                    Accumulated
                    
                    
                    sive
      Income
                    
                    
                    Shareholders'Shares
                    
                    
                    Amount
                    
                    
                    Capital
                    
                    
                    Deficit
                    
                    
                    (Loss)
                    
                    
                    EquityBalance
      at January 1, 2007
                    
                    
                    23,990,590
                    
                    
                    $
                    3,480
                    
                    
                    $
                    173,479
                    
                    
                    $
                    (110,384
                    )
                    
                    $
                    6,451
                    
                    
                    $
                    73,026Subscription
      of warrants
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    362
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    362Issuance
      of ordinary shares on exercise of stock -options
                    
                    
                    61,000
                    
                    
                    
                    10
                    
                    
                    
                    197
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    207Stock-based
      compensation expense
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    11,135
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    11,135Net
      loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (37,737
                    )
                    
                    
                    
                    
                    
                    
                    (37,737
                    )Unrealized
      losses on available- for-sale securities
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    17
                    
                    
                    
                    17Foreign
      currency translation adjustment
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    7,617
                    
                    
                    
                    7,617Comprehensive
      loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    (30,103
                    )Balance
      at December 31, 2007
                    
                    
                    24,051,590
                    
                    
                    $
                    3,490
                    
                    
                    $
                    185,173
                    
                    
                    $
                    (148,121
                    )
                    
                    $
                    14,085
                    
                    
                    $
                    54,627Subscription
      of warrants
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    354
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    354Issuance
      of ordinary shares on exercise of stock -options
                    
                    
                    55,010
                    
                    
                    
                    10
                    
                    
                    
                    176
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    186Issuance
      of ordinary shares on vesting of free shares (note 17.5)
                    
                    
                    98,750
                    
                    
                    
                    16
                    
                    
                    
                    (16
                    )
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    -Stock-based
      compensation expense
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    7,398
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    7,398Net
      loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (12,084
                    )
                    
                    
                    
                    
                    
                    
                    (12,084
                    )Foreign
      currency translation adjustment
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (1,935
                    )
                    
                    
                    (1,935
                    )Comprehensive
      loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    (14,019
                    )Balance
      at December 31, 2008
                    
                    
                    24,205,350
                    
                    
                    $
                    3,516
                    
                    
                    $
                    193,085
                    
                    
                    $
                    (160,205
                    )
                    
                    $
                    12,150
                    
                    
                    $
                    48,546Subscription
      of warrants
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    262
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    262Issuance
      of ordinary shares on exercise of stock -options
                    
                    
                    20,000
                    
                    
                    
                    3
                    
                    
                    
                    26
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    29Issuance
      of ordinary shares on vesting of free shares (note 17.5)
                    
                    
                    117,250
                    
                    
                    
                    21
                    
                    
                    
                    (21
                    )
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    -Stock-based
      compensation expense
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    5,146
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    5,146Net
      loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (11,439
                    )
                    
                    
                    
                    
                    
                    
                    (11,439
                    )Foreign
      currency translation adjustment
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2,319
                    
                    
                    
                    2,319Comprehensive
      loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    (9,120
                    )Balance
      at December 31, 2009
                    
                    
                    24,342,600
                    
                    
                    $
                    3,540
                    
                    
                    $
                    198,498
                    
                    
                    $
                    (171,644
                    )
                    
                    $
                    14,469
                    
                    
                    $
                    44,863


F-6




FLAMEL
TECHNOLOGIES S.A.
 
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 (Amounts
in thousands of dollars except share data)





Year ended December 31,2007
                  
                  
                  2008
                  
                  
                  2009Cash
      flows from operating activities:Net
      income (loss)
                  
                  $
                  (37,737
                  )
                  
                  $
                  (12,084
                  )
                  
                  $
                  (11,439
                  )Adjustments
      to reconcile net income (loss) to net cash provided by (used in) operating
      activities:Depreciation
      of property and equipment
                  
                  
                  6,198.0
                  
                  
                  
                  7,249
                  
                  
                  
                  5,917Loss
      (gain) on disposal of property and equipment
                  
                  
                  (39.0
                  )
                  
                  
                  -
                  
                  
                  
                  -Gains
      on sales of marketable securities
                  
                  
                  (318.0
                  )
                  
                  
                  (327
                  )
                  
                  
                  (153
                  )Grants
      recognized in other income and income from operations
                  
                  
                  (1,216.0
                  )
                  
                  
                  (1,360
                  )
                  
                  
                  (2,522
                  )Stock
      compensation expense
                  
                  
                  12,004.0
                  
                  
                  
                  8,286
                  
                  
                  
                  5,499Provision
      for losses on accounts receivable
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Increase
      (decrease) in cash from:Accounts
      receivable
                  
                  
                  1,167.0
                  
                  
                  
                  (2,392
                  )
                  
                  
                  (1,257
                  )Inventory
                  
                  
                  1,818.0
                  
                  
                  
                  (171
                  )
                  
                  
                  909Prepaid
      expenses and other current assets
                  
                  
                  2,054.0
                  
                  
                  
                  492
                  
                  
                  
                  (1,722
                  )Research
      and development tax credit receivable
                  
                  
                  (1,648.0
                  )
                  
                  
                  (1,494
                  )
                  
                  
                  4,064Accounts
      payable
                  
                  
                  (3,023.0
                  )
                  
                  
                  (258
                  )
                  
                  
                  32Deferred
      revenue
                  
                  
                  2,421.0
                  
                  
                  
                  (2,226
                  )
                  
                  
                  8,251Accrued
      expenses
                  
                  
                  (9.0
                  )
                  
                  
                  282
                  
                  
                  
                  453Other
      current liabilities
                  
                  
                  547.0
                  
                  
                  
                  (1,644
                  )
                  
                  
                  2,251Other
      long-term assets and liabilities
                  
                  
                  (1,460.0
                  )
                  
                  
                  (1,861
                  )
                  
                  
                  (2,088
                  )Net
      cash used in operating activities
                  
                  
                  (19,241
                  )
                  
                  
                  (7,508
                  )
                  
                  
                  8,195Cash
      flows from investing activities:Purchases
      of property and equipment
                  
                  
                  (11,272
                  )
                  
                  
                  (3,523
                  )
                  
                  
                  (1,770
                  )Proceeds
      from disposal of property and equipment
                  
                  
                  47
                  
                  
                  
                  -
                  
                  
                  
                  -Proceeds
      from sales of marketable securities
                  
                  
                  94,707
                  
                  
                  
                  75,216
                  
                  
                  
                  138,476Purchase
      of marketable securities
                  
                  
                  (96,713
                  )
                  
                  
                  (70,782
                  )
                  
                  
                  (160,968
                  )Net
      cash provided by (used in) investing activities
                  
                  
                  (13,231
                  )
                  
                  
                  911
                  
                  
                  
                  (24,262
                  )Cash
      flows from financing activities:Funding
      from partner GSK
                  
                  
                  2,056
                  
                  
                  
                  -
                  
                  
                  
                  -Reimbursment
      of loans or conditional grants
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (3,999
                  )Proceeds
      from loans or conditional grants
                  
                  
                  839
                  
                  
                  
                  8,467
                  
                  
                  
                  2,191Principal
      payments on capital lease obligations
                  
                  
                  (441
                  )
                  
                  
                  (272
                  )
                  
                  
                  (67
                  )New
      capital lease obligation
                  
                  
                  -
                  
                  
                  
                  147
                  
                  
                  
                  -Cash
      proceeds from issuance of ordinary shares and warrants
                  
                  
                  569
                  
                  
                  
                  540
                  
                  
                  
                  291Net
      cash provided by financing activities
                  
                  
                  3,023
                  
                  
                  
                  8,882
                  
                  
                  
                  (1,584
                  )Effect
      of exchange rate changes on cash and cash equivalents
                  
                  
                  3,935
                  
                  
                  
                  (1,577
                  )
                  
                  
                  (654
                  )Net
      increase (decrease) in cash and cash equivalents
                  
                  
                  (25,515
                  )
                  
                  
                  708
                  
                  
                  
                  (18,305
                  )Cash
      and cash equivalents, beginning of year
                  
                  
                  51,827
                  
                  
                  
                  26,313
                  
                  
                  
                  27,021Cash
      and cash equivalents, end of year
                  
                  $
                  26,312
                  
                  
                  $
                  27,021
                  
                  
                  $
                  8,716Supplemental
      disclosures of cash flow information:Income
      tax paid
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Interest
      paid
                  
                  
                  16
                  
                  
                  
                  18
                  
                  
                  
                  100Non
      cash transactions:Capital
      lease obligations incurred
                  
                  
                  -
                  
                  
                  
                  124
                  
                  
                  
                  -


F-7


FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS






1.Nature of business and
summary of significant accounting policies:





1.1.
Nature of
business:





Flamel
Technologies, S.A. (the "Company") is organized as a société anonyme, a form
ofcorporation
under the laws of The Republic of France. The Company was founded in 1990. The
Company is engaged in the development of advanced polymer technologies for
unique life science applications. The Company operates primarily in
France.





1.2.
Principles of consolidation:





The
accompanying consolidated financial statements were prepared in accordance with
U.S. generally accepted accounting principles (U.S. GAAP).





The
preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date
of the consolidated financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from those
estimates.





The
accompanying consolidated financial statements include the Company and its
wholly-owned subsidiary in the United States. All inter-company accounts and
transactions have been eliminated.





1.3.
Financial Accounting Standards
Board Accounting Standards Codification:





Effective
July 1, 2009, the Financial Accounting Standards Board (“FASB”) Accounting
Standards Codification (“ASC”) became the authoritative source of GAAP. All
existing FASB accounting standards and guidance were superseded by the ASC.
Instead of issuing new accounting standards in the form of statements, staff
positions and Emerging Issues Task Force abstracts, the FASB now issues
Accounting Standards. Updates that update the Codification Rules and
interpretive releases of the Securities and Exchange Commission (“SEC”) under
authority of federal securities laws continue to be additional sources of
authoritative GAAP for SEC registrants.





1.4.
Translation of financial statements of foreign entities and foreign currency
transactions:





The
reporting currency of the Company and its wholly-owned subsidiary is the U.S.
dollar as permitted by the SEC for a foreign private issuer (S-X Rule 3-20(a)).
All assets and liabilities in the balance sheets of the Company, whose
functional currency is the Euro, except those of the U.S. subsidiary whose
functional currency is the U.S. dollar, are translated into U.S. dollar
equivalents at exchange rates as follows: (1) asset and liability accounts at
year-end rates, (2) income statement accounts at weighted average exchange rates
for the year, and (3) shareholders' equity accounts at historical rates.
Corresponding translation gains or losses are recorded in shareholders'
equity.





Transaction
gains and losses are reflected in the statement of operations.





The
Company has not undertaken hedging transactions to cover its currency
translation exposure.





1.5.
Revenue recognition:





Revenue
includes upfront licensing fees, milestone payments for R&D achievements,
and reimbursements of research and development costs. Where agreements have more
than one deliverable, a determination is made as to whether the license and
R&D elements should be recognized separately or combined into a single unit
of account in accordance with Accounting Standards Codification 605-25, Revenue
Arrangements with Multiple Deliverables.  In general, the different
elements of these arrangements are recognized as one unit of accounting, as the
Company does not have objective and verifiable evidence of the fair value of the
undelivered items in the arrangement and because of the interrelated nature of
license and R&D activities.




F-8




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





The
Company uses a multiple attribution model, referred to as the milestone-based
method:





-
            As
      milestones relate to discrete development steps (i.e. can be used by the
      co-development partners to decide whether to continue the development
      under the agreement), the Company views that milestone events have
      substance and represent the achievement of defined goals worthy of the
      payments.  Therefore, milestone payments based on performance
      are recognized when the performance criteria are met and there are no
      further performance obligations.


-
            Non-refundable
      technology access fees received from collaboration agreements that require
      the Company's continuing involvement in the form of development efforts
      are recognized as revenue ratably over the development
    period.


-
            Research
      and development work is compensated at a non-refundable hourly rate for a
      projected number of hours. Revenue on such agreements is recognized at the
      hourly rate for the number of hours worked as the research and development
      work is performed. Costs incurred under these contracts are considered
      costs in the period incurred. Payments received in advance of performance
      are recorded as deferred revenue and recognized in revenue as services are
      rendered.





The
Company recognizes revenue from product sales when there is persuasive evidence
that an arrangement exists, delivery has occurred, the price is fixed and
determinable, and collectibility is reasonably assured.





The
Company receives royalty revenues under a license agreement with a third party
that sells products based on technology developed by the Company. There are no
future performance obligations on the part of the Company under this license
agreement. The license agreements provide for the payment of royalties to the
Company based on sales of the licensed product. The Company records these
revenues based on actual sales that occurred during the relevant period and
classified these revenues in ‘Other Revenues’.





The
Company signs feasibility study agreements. Revenue is recognized over the term
of the agreement as services are performed.





1.6.
Governmental Grants:





The
Company receives financial support for various research or investment projects
from governmental agencies.





The
Company recognizes conditional grants related to specific development projects
conditioned on completion of investment program and ongoing employment at the
facilities as an offset to operating expenses once all conditions stated in the
grant have been met.





The
Company recognizes unconditional grants for research and development (R&D)
projects requiring the collaboration of both private and public research
partners as an offset to R&D expense on a pro-rate basis over the duration
of the program.





The
Company receives funds to finance R&D projects. These funds are repayable on
commercial success of the project. In the absence of commercial success, the
Company is released of its obligation to repay the funds and as such the funds
are recognized in the Income Statement as ‘Other Income’.





1.7.
Research and development costs:





Research
and development (R&D) expenses comprise the following types of costs
incurred in performing R&D activities: salaries, allocated overhead and
occupancy costs, clinical trial and related clinical manufacturing costs,
contract and other outside service fees. Research and development expenditures
are charged to operations as incurred.





The
Company does not disclose research development costs per partner funded contract
and does not believe such disclosure would be material to
investors.





F-9




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


1.8.
Concentration of credit risk:





The
Company's cash and cash equivalents are deposited with HSBC, Crédit Lyonnais and
Crédit Agricole, major banks.





The
marketable securities are issued by institutions with strong credit
ratings.





The
Company’s revenues are derived mainly from collaborative research and
development contracts and supply agreements with pharmaceutical companies based
in Europe and the United States. All significant customers are discussed in Note
3.





The
Company performs ongoing credit evaluations of its customers and maintains
provisions for potential credit losses as considered necessary. The Company
generally does not require collateral. Historically, the Company has not
experienced significant credit losses on its customer accounts. The allowance
for doubtful accounts was $126,000 $147,000 and $152,000 at December 31, 2007,
2008 and 2009, respectively.





1.9.
Earnings per share:





Basic
earnings (loss) per share is computed by dividing net income (loss) by the
weighted average number of shares of common stock outstanding for the period.
Diluted earnings per share reflects potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the Company. The dilutive effects of the Company’s common
stock options and warrants is determined using the treasury stock method to
measure the number of shares that are assumed to have been repurchased using the
average market price during the period, which is converted from U.S. dollars at
the average exchange rate for the period. Such securities are not considered in
computing diluted loss per share as their effects would be
anti-dilutive.





1.10.
Cash and cash equivalents:





Cash and
cash equivalents consist of cash on hand, cash on deposit and fixed term deposit
being highly liquid investments with a maturity of three months or less at the
date of purchase.





1.11.
Marketable securities:





Marketable
securities consist of highly liquid investments in money market mutual funds.
Marketable securities are classified as available-for-sale securities in
accordance with ASC 320-10, "Accounting for Certain Investments in Debt and
Equity Securities" These investments are recorded at fair value, which is based
on quoted market prices.  Accordingly, unrealized gains and losses are
included in accumulated other comprehensive income until realized.





1.12.
Accounts Receivable:





Accounts
receivable are stated at amounts invoiced net of allowances for doubtful
accounts.The Company
makes judgments as to its ability to collect outstanding receivables and
provides allowances for the portion of receivables deemed uncollectible.
Provision is made based upon a specific review of all significant outstanding
invoices.





1.13. Inventories:





Inventories
consist principally of raw materials and finished products, which are stated at
the lower of cost or market value with cost determined under the first-in,
first-out ("FIFO") method. Raw materials used in the production of pre-clinical
and clinical products are expensed as research and development costs when
consumed. The Company establishes reserves for inventory estimated to be
obsolete, unmarketable or slow-moving on a case by case basis, equal to the
difference between the cost of inventory and estimated market value based upon
assumptions about future demand, technology and market conditions.





F-10




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


1.14.
Property and equipment:





Property
and equipment is stated at historical cost less accumulated depreciation.
Depreciation and amortization are computed using the straight-line method over
the following estimated useful lives:





Land
      and buildings
                20
      yearsLaboratory
      equipment
                4
      - 8 yearsOffice
      and computer equipment
                3
      yearsFurniture,
      fixtures and fittings
                5-10
      years





Assets
under capital leases are amortized over the economic lives of the assets.
Amortization of the carrying value of assets under capital leases is included in
depreciation expense.





1.15.
Impairment of Long-Lived Assets:





The
Company reviews the carrying value of its long-lived assets, including fixed
assets and intangible assets, for impairment whenever events or changes in
circumstances indicate that the carrying amount of such assets may not be fully
recoverable. Recoverability of long-lived assets is assessed by a comparison of
the carrying amount of the asset (or the group of assets, including the asset in
question, that represents the lowest level of separately-identifiable cash
flows) to the total estimated undiscounted future cash flows expected to be
generated by the asset or group of assets. If the future net undiscounted cash
flows is less than the carrying amount of the asset or group of assets, the
asset or group of assets is considered impaired and an expense is recognized
equal to the amount required to reduce the carrying amount of the asset or group
of assets to its then fair value. Fair value is determined by discounting the
cash flows expected to be generated by the asset, when the quoted market prices
are not available for the long-lived assets. Estimated future cash flows are
based on management assumptions and are subject to risk and
uncertainty.





1.16. Income
taxes:





The
Company accounts for income taxes in accordance with ASC 740. Under ASC 740,
deferred tax assets are determined based on the difference between the financial
reporting and tax basis of assets and liabilities, applying enacted statutory
tax rates in effect for the year in which the tax differences are expected to
reverse. 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. Deferred tax assets and
liabilities are adjusted for the effects of changes in the tax laws and rates on
the date of enactment.




1.17.
Employee stock options and warrants:





The
Company accounts for Stock based compensation based on grant-date fair value
estimated in accordance with  SAB 107, SAB 110 (ASC 505, ASC
718)


The
Company estimated the fair value of stock options and warrants using a
Black-Scholes option-pricing valuation model (“Black-Scholes
model”).


The
Company uses a simplified method to estimate the maturity. The Company
considered historical data was insufficient and irrelevant relative to the grant
of stock-options and warrants to a limited population and  the
simplified method was used to determine the expected term for stock-options and
warrants granted.





The
Company recognizes compensation cost, net of an estimated forfeiture rate, using
the accelerated method over the requisite service period of the
award.





F-11




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


1.18.
Comprehensive Income:





Other
comprehensive income for the Company consists both of foreign currency
translation adjustments and the recognition of the unrealized gains (losses)
related to available-for-sale securities. Each item is shown separately in the
consolidated statements of shareholders’ equity.





1.19.
Recent Accounting Pronouncements:





In
October 2009, the FASB issued a new accounting standard which amends guidance on
accounting for revenue arrangements involving the delivery of more than one
element of goods and/or services. This standard addresses the unit of accounting
for arrangements involving multiple deliverables and removes the previous
separation criteria that objective and reliable evidence of fair value of any
undelivered item must exist for the delivered item to be considered a separate
unit of accounting. This standard also addresses how the arrangement
consideration should be allocated to each deliverable. Finally, this standard
expands disclosures related to multiple element revenue arrangements. This
standard is effective for us beginning January 1, 2011. The Company is currently
evaluating the impact of this on the consolidated results of operations,
financial position or cash flows.




2.
Subcontracting agreement:





In
accordance with the terms of a supply agreement signed with GlaxoSmithKline in
December 2004 and renewed in May 2008 for the manufacture of Coreg CR
microparticles on a cost plus basis, the Company recognized as revenues from
product sales a total amount of $19,768,000 in 2007 , $13,549,000 in 2008 and
$11,871,000 in 2009. Costs include all amounts attributable to the availability
of production capacity for the manufacture of Coreg CR microparticles such as
direct and indirect labor, materials, outside services and
overhead.




3. License,
research and consulting agreements:





SB Pharma Puerto Rico
Inc.   (GSK)




In March
2003, Flamel Technologies and SB Pharma Puerto Rico Inc (GSK) entered into a
license agreement whereby the Company agreed to license its controlled-release
Micropump® in order to develop a new formulation for an undisclosed existing
product. This product was disclosed by GlaxoSmithKline, in March 2006, to be
carvedilol, which is marketed by GlaxoSmithKline as Coreg.




In 2007,
the Company recognized research and development revenues of $1,864,000. The
Company also recognized $4,000,000 of milestone payments and $5,943,000 of
royalties on GSK sales of Coreg CR.





In 2008,
the Company recognized research and development revenues of $1,070,000. The
Company also recognized $11,204,000 of royalties on GSK sales of Coreg
CR.





In 2009,
the Company recognized $ 3,857,000 of milestone payments and $8,808,000 of
royalties of Coreg sales.





In
December 2004, Flamel and GlaxoSmithKline (GSK) entered into a four year supply
agreement whereby Flamel agreed to supply GSK with commercial supplies of
product.  The provisions of the agreement include payments to Flamel
of $20,717,000 to support the costs and capital expenditure relative to the
creation of a manufacturing area for the production of commercial supply of the
product.  The capital expenditures consist of both buildings and
fixtures, and production equipment.  Flamel will have immediate title
to buildings and fixtures; however title to production equipment remains with
GSK for the duration of the supply agreement.




F-12




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


If the
Company breaches the supply agreement through gross negligence, GSK can choose
to terminate the supply agreement.  The likely occurrence of this
event is deemed remote given the Company’s ability to perform under supply
arrangements based on its historical experience.  In the event of a
breach and a decision to terminate the agreement, all payments received become
repayable to GSK and Flamel will receive immediate title to all production
equipment




Upon
cessation of the supply agreement, in the normal course of business, GSK will
pass title to all production equipment to Flamel without cost of any
kind.





A total
of $8,188,000 has been incurred on the acquisition of buildings and fixtures and
a total of $11,138,000 has been incurred on behalf of GSK for the purchase of
production equipment and associated costs. As of December 31, 2009, the funds
received from GSK to finance the acquisition of assets owned by Flamel are
classified in other current liabilities for $728,000 and in other long term
liabilities for $5,366,000.  The liability is amortized on a pro-rata
basis over the expected life of the related assets and reflected as an offset of
the depreciation of the related assets.





In July
2006, Flamel and GSK entered into a further agreement as a supplement to the
original supply agreement whereby GSK will partly sponsor the extension of the
existing facilities at Pessac from two lines to three. GSK will have exclusive
use of part of this equipment, in order to increase the production capacity of
Coreg CR microparticles. The total funding provided by GSK amounted to
$8.1million to finance the acquisition of equipments, buildings and fixtures.
The Company received all installments due under the agreement by December 31,
2007.  As of December 31, 2009 the funds received from GSK to finance
the extension were classified in other current liabilities for $1,285,000 and
long term liabilities for $4,282,000. The liability is amortized on a pro-rata
basis over the expected life of the assets and proportionally based on funding
received compared with the total value of the related assets. This amortization
is reflected as an offset of the depreciation of the related assets (see Note
12).





In May
2008, Flamel and GSK signed an amendment to the original supply agreement,
extending the supply of commercial supplies of the product through to end of
2010.





Wyeth
Pharmaceuticals





On
September 12, 2007 the Company entered into a development and license agreement
with Wyeth Pharmaceuticals, (‘Wyeth’) now part of Pfizer Inc, whereby the
Company agreed to license its Medusa technology for the development and
licensing of a marketed protein. The Company received an upfront fee and may
receive development fees, milestones and royalties on the product.  On
September 2, 2008 Wyeth confirmed their intention to pursue the development and
license agreement triggering a $500,000 payment. On November 4, 2009 Wyeth
exercised the option for the licensing of Flamel technology and paid
$1,000,000.





In
consideration of this agreement, the Company recognized research and development
revenues of $349,000 and $153,000 of amortization of the initial up-front
payment in 2007.





In 2008,
the Company recognized research and development revenues of $1,479,000. The
Company also recognized $528,000 of amortization of the up-front
payment.




In 2009,
the Company recognized research and development revenues of $863,000. The
Company also recognized $378,000 of amortization of up-front payment and option
payment.





Merck-Serono





On
December 20, 2007 Flamel Technologies entered into a relationship with
Merck-Serono, a division of Merck KGaA, to investigate the applicability of
Flamel's Medusa technology for the extended release of a therapeutic protein of
Merck-Serono's portfolio.





In
consideration of the agreement signed in 2007, Merck-Serono made an upfront
payment of $2.7 million for investigating the therapeutic protein, which has
been amortized over the initial feasibility period. In February 2009
Merck-Serono exercised the option to license our technology triggering a payment
of $ 6,500,000 (€5,000,000).





F-13




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


In 2007,
the Company recognized research and development revenues of $78,000 as
amortization of the initial up-front payment.





In 2008,
the Company recognized research and development revenues of $2,957,000. The
Company also recognized $735,000 of milestone payment and $2,521,000 of
amortization of the initial up-front payment.




In 2009,
the Company recognized research and development revenues of $5,905,000. The
Company also recognized $1,529,000 of amortization of the initial up-front and
option payments.




Baxter Healthcare
Inc





On June
19, 2009 the Companyentered into agreement
with Baxter Healthcare Inc, to formulate controlled release applications of
blood clotting factor replacement therapies using Flamel’s Medusa®
Technology. In consideration of this agreement the Company received an access
fee of $3,600,000 (€2,500,000). The company recognized research and development
revenues of $291,000 and $968,000 of amortization of the initial up-front
fee.





Pfizer
Inc




The
company has entered into a research collaboration with Pfizer Inc to assess the
applicability of the Medusa platform to certain molecules in
development.  Under this collaboration, the Company recognized
research and development revenues of $1,401,000 in 2008 and $836,000 in
2009.





Corning




In
December 1998, the Company signed a long-term research and product development
agreement with Corning France and Corning Incorporated. Pursuant to the terms of
this agreement, Flamel receives royalties on the sales of Corning products that
utilize Flamel’s innovations.





The
Company also recognized royalties on Corning’s sales of $636,000 in 2007,
$581,000 in 2008and $370,000 in 2009.




Others




The
Company recognized license and research and development revenues on several
feasibility studies with undisclosed partners for an amount of $3,705,000 in
2007, $2,556,000 in 2008 and $6,191,000 in 2009.  The increase in
revenues from undisclosed partners results from the increase in the number of
feasibility agreements executed year on year.




4.
Research and Development expenses




Due to a
worldwide increase in government tax incentives and recent developments and
changes in the calculation of the French research tax credit, the company
reviewed its analysis and presentation of the research tax credit. The company
determined in 2009 that the research tax credit should be classified as a
research and development grant as the tax credit is calculated based on a
percentage of eligible research and development costs, the tax credit can be
refundable in cash and it is not contingent upon future taxable income. As a
result, the research tax credit, amounting to $ 6,498,000  in 2009,
has been classified in research and development expense instead of income
tax.  The presentation for the 2008 and 2007 research tax credits
amounting to $6,978,000  and to $2,288,000, respectively, has also
been reclassified from income tax to research and development expense for
comparable presentation.




F-14




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


The table
hereafter shows the effect of this reclassification:




2007
                    
                    
                    2008
                    
                    
                    2009Before
                    
                    
                    After
                    
                    
                    Before
                    
                    
                    After
                    
                    
                    Before
                    
                    
                    AfterResearch
      and development expenses
                    
                    
                    (43,557
                    )
                    
                    
                    (41,269
                    )
                    
                    
                    (36,247
                    )
                    
                    
                    (29,269
                    )
                    
                    
                    (36,913
                    )
                    
                    
                    (30,416
                    )Income
      (loss) from operations
                    
                    
                    (40,849
                    )
                    
                    
                    (38,561
                    )
                    
                    
                    (20,160
                    )
                    
                    
                    (13,182
                    )
                    
                    
                    (18,250
                    )
                    
                    
                    (11,753
                    )Income
      tax
                    
                    
                    1,694
                    
                    
                    
                    (594
                    )
                    
                    
                    6,478
                    
                    
                    
                    (500
                    )
                    
                    
                    6,497
                    
                    
                    
                    -Net
      income (loss)
                    
                    
                    (37,737
                    )
                    
                    
                    (37,737
                    )
                    
                    
                    (12,084
                    )
                    
                    
                    (12,084
                    )
                    
                    
                    (11,439
                    )
                    
                    
                    (11,439
                    )




5.
Stock based compensation :




5.1
ASC 718




The
Company applies the provisions of  ASC 718, Securities and Exchange
Commission (“SEC”) Staff Accounting Bulletin n°107, Securities and Exchange
Commission (“SEC”) Staff Accounting Bulletin n°110 (ASC 505,),  in
accounting for its stock based compensation. The fair value of each option and
warrant granted during the year is estimated on the date of grant using the
Black-Scholes option pricing model.  Option valuation models require
the input of subjective assumptions and these assumptions can vary over time.
The weighted-average assumptions on grants made in each of the following years
were:




Year Ended December 312007
                    
                    
                    2008
                    
                    
                    2009Weighted-average
      expected life (years)
                    
                    
                    1.71
                    
                    
                    
                    3.73
                    
                    
                    
                    4.30Expected
      volatility rate
                    
                    
                    52.70
                    %
                    
                    
                    61.5
                    %
                    
                    
                    63.6
                    %Expected
      dividend yield
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Risk-free
      interest rate
                    
                    
                    4.83
                    %
                    
                    
                    2.57
                    %
                    
                    
                    2.02
                    %Forfeiture
      rate
                    
                    
                    5
                    %
                    
                    
                    5
                    %
                    
                    
                    -





Since no
stock options were granted in 2007, the weighted-average expected life for 2007
results solely from the grant of warrants, whose expected life is shorter than
that of stock options in accordance with conditions for vesting and exercise as
defined at time of grant, see Note 17.3 and 17.4.





We base
our determination of expected volatility predominantly on the implied volatility
of our traded options with consideration of our historical
volatilities.  Given the limited historical data and the grant of
stock options and warrants to a limited population, the simplified method has
been used to calculate the expected life.




Stock
based compensation expense recognized was as follows:
 
 (In
      thousands of U.S dollars except per
                      
                      
                      
                      
                      Free
      of charge shareshare
      data)
                      
                      Options
                      
                      
                      awards
                      
                      
                      Warrants
                      
                      
                      Total2007
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2007
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2007
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2007
                      
                      
                      2008
                      
                      
                      2009Research
      and development
                      
                      
                      4,598
                      
                      
                      
                      2,691
                      
                      
                      
                      1,532
                      
                      
                      
                      1,220
                      
                      
                      
                      1,454
                      
                      
                      
                      668
                      
                      
                      
                      (88
                      )
                      
                      
                      (5
                      )
                      
                      
                      -
                      
                      
                      
                      5,730
                      
                      
                      
                      4,141
                      
                      
                      
                      2,199Cost
      of goods sold
                      
                      
                      234
                      
                      
                      
                      150
                      
                      
                      
                      87
                      
                      
                      
                      223
                      
                      
                      
                      285
                      
                      
                      
                      119
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      457
                      
                      
                      
                      434
                      
                      
                      
                      206Selling,
      general and administrative
                      
                      
                      4,542
                      
                      
                      
                      2,412
                      
                      
                      
                      1,969
                      
                      
                      
                      317
                      
                      
                      
                      642
                      
                      
                      
                      532
                      
                      
                      
                      958
                      
                      
                      
                      657
                      
                      
                      
                      592
                      
                      
                      
                      5,817
                      
                      
                      
                      3,711
                      
                      
                      
                      3,093Total
      stock-based compensation expense
                      
                      
                      9,374
                      
                      
                      
                      5,253
                      
                      
                      
                      3,588
                      
                      
                      
                      1,760
                      
                      
                      
                      2,381
                      
                      
                      
                      1,319
                      
                      
                      
                      870
                      
                      
                      
                      652
                      
                      
                      
                      592
                      
                      
                      
                      12,004
                      
                      
                      
                      8,286
                      
                      
                      
                      5,499Effect
      on earnings per shareBasic
                      
                      
                      0.39
                      
                      
                      
                      0.22
                      
                      
                      
                      0.15
                      
                      
                      
                      0.07
                      
                      
                      
                      0.10
                      
                      
                      
                      0.05
                      
                      
                      
                      0.04
                      
                      
                      
                      0.03
                      
                      
                      
                      0.02
                      
                      
                      
                      0.50
                      
                      
                      
                      0.34
                      
                      
                      
                      0.23Diluted
                      
                      
                      0.39
                      
                      
                      
                      0.22
                      
                      
                      
                      0.15
                      
                      
                      
                      0.07
                      
                      
                      
                      0.10
                      
                      
                      
                      0.05
                      
                      
                      
                      0.04
                      
                      
                      
                      0.03
                      
                      
                      
                      0.02
                      
                      
                      
                      0.50
                      
                      
                      
                      0.34
                      
                      
                      
                      0.23


F-15




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


As of
December 31, 2009, the projected compensation expense related to non vested
options or warrants amounted to $4,445,000 and is expected to be recognized over
a weighted average period of 1.42 years.




5.2
Warrants




The
summary of warrants activity is as follows:




Weighted
      Average
                      
                      
                      Weighted
      AverageWarrants
                      
                      
                      Exercise
      Price in
                      
                      
                      Exercise
      Price inOutstanding
                      
                      
                      U.S dollars [1]
                      
                      
                      EurosBalance
      at January 1, 2007
                      
                      
                      378,000
                      
                      
                      $
                      19.05
                      
                      
                      €
                      15.53Warrants
      granted
                      
                      
                      125,000
                      
                      
                      $
                      27.83
                      
                      
                      €
                      20.54Warrants
      cancelled
                      
                      
                      2,500
                      
                      
                      $
                      16.18
                      
                      
                      €
                      12.34Balance
      at December 31, 2007
                      
                      
                      500,500
                      
                      
                      $
                      21.26
                      
                      
                      €
                      16.80Warrants
      granted
                      
                      
                      250,000
                      
                      
                      $
                      10.20
                      
                      
                      €
                      6.57Warrants
      cancelled
                      
                      
                      203,833
                      
                      
                      $
                      19.27
                      
                      
                      €
                      15.64Balance
      at December 31, 2008
                      
                      
                      546,667
                      
                      
                      $
                      16.94
                      
                      
                      €
                      12.55Warrants
      granted
                      
                      
                      250,000
                      
                      
                      $
                      6.29
                      
                      
                      €
                      4.50Warrants
      cancelled
                      
                      
                      166,167
                      
                      
                      $
                      20.67
                      
                      
                      €
                      16.78Balance
      at December 31, 2009
                      
                      
                      630,500
                      
                      
                      $
                      11.73
                      
                      
                      €
                      8.24[1]
      Historical exchange rate at date of grant




No
warrants were exercised in 2007, 2008 and 2009.




Exercise
prices and intrinsic value for warrants outstanding as of December 31, 2009 were
as follows:




Warrants
      Outstanding
                  
                  
                  Warrants
      ExercisableWeighted
                  
                  
                  Weighted
                  
                  
                  Weighted
                  
                  
                  
                  
                  
                  Weightedaverage
                  
                  
                  average
                  
                  
                  average
                  
                  
                  
                  
                  
                  averageRange
      of
                  
                  
                  
                  
                  remaining
                  
                  
                  exercise
                  
                  
                  intrinsic
                  
                  
                  
                  
                  
                  exercise
                  
                  
                  Weighted
      averageexercise
      prices
                  
                  Number
      of
                  
                  
                  contractual
                  
                  
                  price
      in
                  
                  
                  value
      in
                  
                  
                  Number
      of
                  
                  
                  price
      in
                  
                  
                  intrinsic
      value inin
      euros
                  
                  shares
                  
                  
                  life
                  
                  
                  euros
                  
                  
                  euros
                  
                  
                  shares
                  
                  
                  euros
                  
                  
                  euros0 to
      6.57
                  
                  
                  500,000
                  
                  
                  
                  2.95
                  
                  
                  
                  5.54
                  
                  
                  
                  0.64
                  
                  
                  
                  250,000
                  
                  
                  
                  6.57
                  
                  
                  
                  -12.34
      to 20.54
                  
                  
                  130,500
                  
                  
                  
                  0.28
                  
                  
                  
                  18.62
                  
                  
                  
                  -
                  
                  
                  
                  130,500
                  
                  
                  
                  18.62
                  
                  
                  
                  -630,500
                  
                  
                  
                  2.40
                  
                  
                  
                  8.24
                  
                  
                  
                  0.25
                  
                  
                  
                  380,500
                  
                  
                  
                  10.70
                  
                  
                  
                  -




The total
fair value of warrants vested during 2007 amounted to €878,000 or $1,204,000
(average exchange rate of the year).




The total
fair value of warrants vested during 2008 amounted to €492,000 or $724,000
(average exchange rate of the year).




The total
fair value of warrants vested during 2009 amounted to €651,000 or $908,000
(average exchange rate of the year).




Intrinsic
value represents the variance between the share price and the exercise price. As
of December 31, 2009 the aggregate intrinsic value of warrants outstanding
amounted to €159,000 or $229,000 (exchange rate at date of balance
sheet).




F-16




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




5.3 Stock
Options




The
activity under the option plans is as follows:




Weighted Average
                  
                  
                  Weighted AverageShares Available
                  
                  
                  Options Granted
                  
                  
                  Exercise Price in
                  
                  
                  Exercise Price infor Grant
                  
                  
                  and Outstanding
                  
                  
                  U.S dollars[1]
                  
                  
                  EurosBalance
      at January 1, 2007
                  
                  
                  346,250
                  
                  
                  
                  3,529,250
                  
                  
                  $
                  16.23
                  
                  
                  €
                  13.18Options
      authorized
                  
                  
                  500,000
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Granted
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  -
                  
                  
                  
                  (61,000
                  )
                  
                  $
                  2.33
                  
                  
                  €
                  2.48Forfeited
                  
                  
                  219,500
                  
                  
                  
                  (255,500
                  )
                  
                  $
                  17.73
                  
                  
                  €
                  14.06Balance
      at December 31, 2007
                  
                  
                  1,065,750
                  
                  
                  
                  3,212,750
                  
                  
                  $
                  16.37
                  
                  
                  €
                  13.31Options
      authorized
                  
                  
                  
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Granted
                  
                  
                  (125,000
                  )
                  
                  
                  125,000
                  
                  
                  $
                  5.17
                  
                  
                  €
                  4.03Exercised
                  
                  
                  -
                  
                  
                  
                  (55,010
                  )
                  
                  $
                  2.36
                  
                  
                  €
                  2.36Forfeited
                  
                  
                  (565,750
                  )
                  
                  
                  (477,750
                  )
                  
                  $
                  18.18
                  
                  
                  €
                  14.68Balance
      at December 31, 2008
                  
                  
                  375,000
                  
                  
                  
                  2,804,990
                  
                  
                  $
                  15.84
                  
                  
                  €
                  12.88Options
      authorized
                  
                  
                  
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Granted
                  
                  
                  (330,000
                  )
                  
                  
                  330,000
                  
                  
                  $
                  6.76
                  
                  
                  €
                  4.75Exercised
                  
                  
                  -
                  
                  
                  
                  (20,000
                  )
                  
                  $
                  0.99
                  
                  
                  €
                  1.09Forfeited
                  
                  
                  
                  
                  
                  
                  (4,000
                  )
                  
                  $
                  25.27
                  
                  
                  €
                  20.81Balance
      at December 31, 2009
                  
                  
                  45,000
                  
                  
                  
                  3,110,990
                  
                  
                  $
                  14.96
                  
                  
                  €
                  12.08




[1]
Historical exchange rate at date of grant




The total
intrinsic value of options exercised during 2007 amounted to €951,000 or
$1,285,000 (historical exchange rate at date of exercise).


The total
intrinsic value of options exercised during 2008 amounted to €181,000 or
$267,000 (historical exchange rate at date of exercise).


The total
intrinsic value of options exercised during 2009 amounted to €68,000 or $99,000
(historical exchange rate at date of exercise).





Stock
options outstanding at December 31, 2009, which expire from 2010 to 2019 had
exercise prices ranging from €1.09 to € 25.39. The weighted average remaining
contractual life of all options is 5.33 years. As of December 31, 2009, there
were 3,110,990 outstanding options at a weighted average exercise price of
€12.08, of which 2,597,740 were exercisable at a weighted average price
of  €12.91. Exercise prices and intrinsic value for options
outstanding as of December 31, 2009 were as follows:




Stock Options Outstanding
                  
                  
                  Stock Options ExercisableWeighted
                  
                  
                  
                  
                  
                  WeightedRange of
                  
                  
                  
                  
                  average
                  
                  
                  Weighted
                  
                  
                  average
                  
                  
                  
                  
                  
                  Weighted
                  
                  
                  Weightedexercise
                  
                  
                  
                  
                  remaining
                  
                  
                  average
                  
                  
                  intrinsic
                  
                  
                  
                  
                  
                  average
                  
                  
                  averageprices in
                  
                  Number of
                  
                  
                  contractual
                  
                  
                  exercise
                  
                  
                  value in
                  
                  
                  Number of
                  
                  
                  exercise
                  
                  
                  intrinsiceuros
                  
                  shares
                  
                  
                  life
                  
                  
                  price in euros
                  
                  
                  euros
                  
                  
                  shares
                  
                  
                  price in euros
                  
                  
                  value in euros0 to
      1.36
                  
                  
                  33,000
                  
                  
                  
                  1.73
                  
                  
                  
                  1.09
                  
                  
                  
                  4.05
                  
                  
                  
                  33,000
                  
                  
                  
                  1.09
                  
                  
                  
                  4.052.33
      to 2.77
                  
                  
                  255,000
                  
                  
                  
                  2.13
                  
                  
                  
                  2.43
                  
                  
                  
                  2.70
                  
                  
                  
                  255,000
                  
                  
                  
                  2.43
                  
                  
                  
                  2.704.03
      to 5.06
                  
                  
                  729,000
                  
                  
                  
                  6.95
                  
                  
                  
                  4.48
                  
                  
                  
                  0.65
                  
                  
                  
                  305,250
                  
                  
                  
                  4.34
                  
                  
                  
                  0.806.40
      to 7.58
                  
                  
                  125,000
                  
                  
                  
                  0.89
                  
                  
                  
                  6.78
                  
                  
                  
                  -
                  
                  
                  
                  125,000
                  
                  
                  
                  6.78
                  
                  
                  
                  -9.88
      to 12.02
                  
                  
                  193,500
                  
                  
                  
                  4.53
                  
                  
                  
                  11.10
                  
                  
                  
                  -
                  
                  
                  
                  193,500
                  
                  
                  
                  11.10
                  
                  
                  
                  -12.86
      to 16.23
                  
                  
                  1,163,990
                  
                  
                  
                  5.63
                  
                  
                  
                  14.47
                  
                  
                  
                  -
                  
                  
                  
                  1,154,740
                  
                  
                  
                  14.47
                  
                  
                  
                  -19.2
      to 25.39
                  
                  
                  611,500
                  
                  
                  
                  5.49
                  
                  
                  
                  22.61
                  
                  
                  
                  -
                  
                  
                  
                  531,250
                  
                  
                  
                  22.32
                  
                  
                  
                  -3,110,990
                  
                  
                  
                  5.33
                  
                  
                  
                  12.08
                  
                  
                  
                  0.42
                  
                  
                  
                  2,597,740
                  
                  
                  
                  12.91
                  
                  
                  
                  0.41





The total
fair value of options vested during 2007 amounted to €6,782,000 or $9,296,000
(average exchange rate of the year).





The total
fair value of options vested during 2008 amounted to €4,027,000 or $5,922,000
(average exchange rate of the year).


The total
fair value of options vested during 2009 amounted to €3,197,000 or $4,454,000
(average exchange rate of the year).





F-17




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




The
aggregate intrinsic value of options outstanding amounted to €1,298,000 or
$1,870,000. The aggregate intrinsic value of options exercisable amounted to
€1,066,000 or $1,536,000 (exchange rate at date of balance sheet).





5.4 Free share
award




The
activity under the free share award plans is as follows:




Free of ChargeFree of Charge
                  
                  
                  Share Award
                  
                  
                  Weighted Average
                  
                  
                  Weighted AverageShare Award
                  
                  
                  Granted and
                  
                  
                  Fair Value in U.S
                  
                  
                  Fair Value inAvailable for Grant
                  
                  
                  Outstanding
                  
                  
                  dollars[1]
                  
                  
                  EurosBalance
      at January 1, 2007
                  
                  
                  94,000
                  
                  
                  
                  106,000
                  
                  
                  $
                  33.46
                  
                  
                  €
                  25.39Authorized
                  
                  
                  200,000Granted
                  
                  
                  (130,000
                  )
                  
                  
                  130,000
                  
                  
                  $
                  8.54
                  
                  
                  €
                  5.80Forfeited
                  
                  
                  1,450
                  
                  
                  
                  (1,450
                  )
                  
                  $
                  33.46
                  
                  
                  €
                  25.39Balance
      at December 31, 2007
                  
                  
                  165,450
                  
                  
                  
                  234,550
                  
                  
                  $
                  19.64
                  
                  
                  €
                  14.53Options
      authorized
                  
                  
                  200,000Granted
                  
                  
                  (250,000
                  )
                  
                  
                  250,000
                  
                  
                  $
                  5.88
                  
                  
                  €
                  4.37Exercised
                  
                  
                  -
                  
                  
                  
                  (98,750
                  )
                  
                  $
                  33.46
                  
                  
                  €
                  25.39Forfeited
                  
                  
                  12,100
                  
                  
                  
                  (12,100
                  )
                  
                  $
                  20.48
                  
                  
                  €
                  15.19Balance
      at December 31, 2008
                  
                  
                  127,550
                  
                  
                  
                  373,700
                  
                  
                  $
                  6.76
                  
                  
                  €
                  4.85Options
      authorized
                  
                  
                  200,000Granted
                  
                  
                  (320,000
                  )
                  
                  
                  320,000
                  
                  
                  $
                  7.27
                  
                  
                  €
                  4.98Exercised
                  
                  
                  
                  
                  
                  
                  (117,250
                  )
                  
                  $
                  8.54
                  
                  
                  €
                  5.80Forfeited
                  
                  
                  3,100
                  
                  
                  
                  (3,100
                  )
                  
                  $
                  6.75
                  
                  
                  €
                  4.86Balance
      at December 31, 2009
                  
                  
                  10,650
                  
                  
                  
                  573,350
                  
                  
                  $
                  6.68
                  
                  
                  €
                  4.73




[1]
Historical exchange rate at date of grant




As of
December 31, 2007 the total fair value (or intrinsic value) of  Free
Share Award outstanding amounted to €3,409,000 or $4,608,000 (historical
exchange rate at date of grant).





As of
December 31, 2008 the total fair value (or intrinsic value) of Free Share Award
outstanding amounted to €1,753,000 or $2,399,000 (historical exchange rate at
date of grant).





As of
December 31, 2009 the total fair value (or intrinsic value) of Free Share Award
outstanding amounted to €2,710,000 or $3,830,000 (historical exchange rate at
date of grant).




F-18




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




6.
Cash and Cash Equivalents:




Cash
consists of cash on deposit and fixed term investments held in several major
banks, and cash on hand. The components of cash and cash equivalents were as
follows:




December 31,(In
      thousands of U.S . dollars)
                        
                        2008
                        
                        
                        2009HSBC
                        
                        $
                        7,573
                        
                        
                        $
                        7,044Credit
      Lyonnais
                        
                        
                        38
                        
                        
                        
                        27Credit
      Agricole
                        
                        
                        19,217
                        
                        
                        
                        1,458Other
                        
                        
                        192
                        
                        
                        
                        187Total
      cash and cash equivalents
                        
                        $
                        27,021
                        
                        
                        $
                        8,716




For the
year ended December 31, 2008 cash and cash equivalents included fixed term
deposits for $18,100,000 with maturities of less than ninety days.




7.
Marketable securities:




Marketable
securities are classified as available-for-sale securities and are recorded at
fair market value.  Unrealized gains and losses are recorded as other
comprehensive income in shareholder’s equity, net of income tax
effects.





For the
year ended December 31, 2007, 2008 and 2009 marketable securities amounted
respectively to $14,749,000, $10,058,000 and $35,353,000.





As of
December 31, 2007, December 31, 2008 and December 31, 2009 there were no
unrealized gains or losses.




Unrealized
      Gains(in
      thousands of U.S dollars)
                    
                    Fair
      value
                    
                    
                    Value
      at cost
                    
                    
                    (Losses)2008
                    
                    
                    2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008
                    
                    
                    2009Credit
      Agricole securities
                    
                    
                    3,359
                    
                    
                    
                    7,710
                    
                    
                    
                    3,359
                    
                    
                    
                    7,710
                    
                    
                    
                    -
                    
                    
                    
                    -Credit
      Lyonnais securities
                    
                    
                    47
                    
                    
                    
                    49
                    
                    
                    
                    47
                    
                    
                    
                    49
                    
                    
                    
                    -
                    
                    
                    
                    -HSBC
      securities
                    
                    
                    6,651
                    
                    
                    
                    27,593
                    
                    
                    
                    6,651
                    
                    
                    
                    27,593
                    
                    
                    
                    -
                    
                    
                    
                    -Total
                    
                    
                    10,057
                    
                    
                    
                    35,352
                    
                    
                    
                    10,057
                    
                    
                    
                    35,352
                    
                    
                    
                    -
                    
                    
                    
                    -




Gross
realized gains on sales of these available-for-sale securities amounted to
$318,000, $329,000 and $153,000 for the years ended December 31, 2007, 2008 and
2009 respectively.




F-19




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




Gross
      gains(in
      thousands of U.S dollars)
                  
                  Proceeds
      from sales
                  
                  
                  Purchase
      of securities
                  
                  
                  (Losses)2008
                  
                  
                  2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008
                  
                  
                  2009Credit
      Agricole securities
                  
                  
                  27,295
                  
                  
                  
                  33,932
                  
                  
                  
                  25,962
                  
                  
                  
                  37,624
                  
                  
                  
                  149
                  
                  
                  
                  45Credit
      Lyonnais securities
                  
                  
                  413
                  
                  
                  
                  188
                  
                  
                  
                  380
                  
                  
                  
                  188
                  
                  
                  
                  3
                  
                  
                  
                  -HSBC
      securities
                  
                  
                  47,508
                  
                  
                  
                  104,356
                  
                  
                  
                  44,440
                  
                  
                  
                  123,156
                  
                  
                  
                  175
                  
                  
                  
                  108Barclays
      securities
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Total
                  
                  
                  75,216
                  
                  
                  
                  138,476
                  
                  
                  
                  70,782
                  
                  
                  
                  160,968
                  
                  
                  
                  327
                  
                  
                  
                  153




8.
Inventory:




The
components of inventories were as follows:




December 31,(In
      thousands of U.S . dollars)
                      
                      2008
                      
                      
                      2009Raw
      materials
                      
                      
                      1,272
                      
                      
                      
                      1,072Finished
      goods
                      
                      
                      565
                      
                      
                      
                      -Inventories,
      net
                      
                      
                      1,837
                      
                      
                      
                      1,072




9.
Prepaid expenses and other current assets





The
components of prepaid expenses and other current assets were as
follows:




December 31,(In
      thousands of U.S . dollars)
                      
                      2008
                      
                      
                      2009Prepaid
      expenses
                      
                      
                      664
                      
                      
                      
                      945Grants
      recoverable
                      
                      
                      -
                      
                      
                      
                      1,039Valued-added
      tax recoverable
                      
                      
                      1,226
                      
                      
                      
                      1,143Advance
      to suppliers
                      
                      
                      291
                      
                      
                      
                      498Total
      Prepaid expenses and other current assets
                      
                      
                      2,181
                      
                      
                      
                      3,625




10.
Property and Equipment:





The
components of property and equipment were as follows:




December 31,(In
      thousands of U.S . dollars)
                      
                      2008
                      
                      
                      2009Land
      and buildings
                      
                      
                      10,895
                      
                      
                      
                      11,281Laboratory
      equipment
                      
                      
                      30,542
                      
                      
                      
                      31,713Office
      and computer equipment
                      
                      
                      3,856
                      
                      
                      
                      4,249Furniture,
      fixtures and fittings
                      
                      
                      20,218
                      
                      
                      
                      21,353Total
      property and equipment
                      
                      
                      65,511
                      
                      
                      
                      68,596Less
      accumulated depreciation and amortization
                      
                      
                      (37,910
                      )
                      
                      
                      (43,837
                      )Property
      and equipment, net
                      
                      
                      27,601
                      
                      
                      
                      24,759




F-20




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




Depreciation
expense related to property and equipment amounted to $6,198,000, $7,249,000 and
$5,917,000 for the years ended December 31, 2007, 2008 and 2009,
respectively.





Property
and Equipment include costs of $1,559,000 and $144,000 at December 31, 2008 and
2009 that are related to capitalized lease assets. Accumulated amortization of
these leased assets was approximately $1,453,000 and $83,000 at December
31, 2008 and 2009, respectively. Depreciation expense on assets held under
capital leases is included in total depreciation expense for the years ended
December 31, 2007, 2008 and 2009 and amounted to $315,000, $65,000 and $46,000
respectively.




11.
Accrued Expenses:




Accrued
expenses consist mainly of expenses related to bonuses, paid vacations,
compensatory leaves and related social charges.





Accrued
expenses comprises of the following:




December 31,(In
      thousands of U.S . dollars)
                    
                    2008
                    
                    
                    2009Accrued
      compensation
                    
                    
                    2,499
                    
                    
                    
                    2,543Accrued
      social charges
                    
                    
                    3,406
                    
                    
                    
                    3,775Total
      accrued expenses
                    
                    
                    5,905
                    
                    
                    
                    6,318




12. Other
current and Long Term liabilities:




12.1. Other
current liabilities:




Other
current liabilities comprise the following:





December 31,(In
      thousands of U.S . dollars)
                      
                      2008
                      
                      
                      2009Funding
      from partner GSK short term
                      
                      
                      1,813
                      
                      
                      
                      2,013R&D
      credit tax financing short term
                      
                      
                      4,272
                      
                      
                      
                      1,957Provision
      for costs
                      
                      
                      11
                      
                      
                      
                      -Employee
      service award provision short term
                      
                      
                      284
                      
                      
                      
                      375Valued-added
      tax payable
                      
                      
                      72
                      
                      
                      
                      272Total
      Other current liabilities
                      
                      
                      6,452
                      
                      
                      
                      4,617





In
connection with the supply agreement with GSK (see Note 3), the Company received
funds to finance facilities related assets.  A total of $8,188,000 has
been spent on the acquisition of buildings and fixtures and a total of
$11,138,000 has been spent on behalf of GSK for the purchase of production
equipment. As of December 31, 2009 the funds received from GSK to finance the
acquisition of assets owned by Flamel are classified as a current liability for
$728,000 and as a long term liability for $5,366,000.  In July 2006,
Flamel and GSK entered into a side agreement to the original agreement whereby
GSK will partially sponsor the extension of the Micropump development facility
(see Note 3).  This facility was completed in March
2008.  As of  December 31, 2007, the Company had received
all installments from GSK for financing of this project.  The total
installments amounted to $8,097,000.  As of December 31, 2009, the
funds received from GSK are classified as a current liability for $1,285,000 and
as a long term liability for $4,282,000 (see Note 12.2).





The
liability is amortized on a pro-rata basis over the expected life of the related
assets and reflected as an offset of the depreciation of the related assets (see
Note 3).




F-21




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




The
Service award provision is accrued over the respective service period (5, 10 and
15 years) using actuarial assumptions and calculations as for the lump sum
retirement indemnity (see Note 19).





For the
year ended December 31, 2008 the provision for service award amounted to
$1,627,000 of which $284,000 is short term. For the year ended December 31, 2009
the provision amounted to $2,296,000 of which $375,000 is short
term.





In
December 2008, the Company obtained an advance from OSEO, a governmental agency
supporting innovation, for $8,013,000 secured against the research tax credits
due to the company by the tax authorities for expenditure incurred in 2005, 2006
and 2007  (see Note 18). Two advances were obtained.  The
first amount for $4,272,000 and secured against the research tax credit from
2005 amounting to $5,114,000 was reimbursed in 2009.  The second
amounts to $3,741,000 and is secured against the research credit tax from 2006
and 2007 totaling $4,880,000.  This advance matures in 2010, with a
possibility to renew the financing.  The interest rate applied is the
monthly average of the Euro Interbank Offered Rate (EURIBOR) plus 0.8%. As of
December 31, 2008 the funding was classified as a short term liability for
$4,272,000 and as a long term liability for $3,741,000. As of December 31, 2009
the total liability amounted to $3,872,000 of which $1,944,000 is short
term.




12.2. Other
long term liabilities




Other
long term liabilities are composed of the following:




December 31,(In
      thousands of U.S . dollars)
                    
                    2008
                    
                    
                    2009Funding
      from partner GSK long term
                    
                    
                    11,494
                    
                    
                    
                    9,648Conditional
      grants
                    
                    
                    1,819
                    
                    
                    
                    1,765Provision
      for retirement indemnity (see note 19)
                    
                    
                    1,649
                    
                    
                    
                    2,208R&D
      credit tax financing long term (see note 12.1)
                    
                    
                    3,741
                    
                    
                    
                    1,916Employee
      service award provision long term
                    
                    
                    1,343
                    
                    
                    
                    1,921Other
                    
                    
                    448
                    
                    
                    
                    23Total
      Other long term liabilities
                    
                    
                    20,494
                    
                    
                    
                    17,481





Funding
from partner GSK long term amounted to $5,366,000 in connection with the supply
agreement signed in December 2004 and relates to the acquisition of buildings
and fixtures (see Note 12.1) and $4,282,000  in connection with the
side agreement to the original agreement, signed in July 2006.





Conditional
grants of $1.8 million in 2008 and 2009 were received from local authorities to
partly finance investments at Pessac.  The grants are conditional on
completion of the total investment programme and ongoing employment at the
facilities for a period of three to five years.  The Company
recognizes conditional grants as an offset to operating expenses once all
conditions stated in the grant have been met. As of December 31, 2009 the
Company recognized to the income statement conditional grants for $782,000 and
unconditional grants for a total of $1,740,000..




13. 
Deferred Revenue:




Current
portion of deferred revenue comprises of upfront licensing fees which are
recognized over the development period of the contract. For the year ended
December 31, 2008 deferred revenues amounted to $999,000 and $9,895,000 for the
year ended December 31, 2009.  The significant increase in deferred
revenues results from the upfront license fees received in 2009 of €5 million
from Merck Serono, €2.5 million from Baxter International and $1 million from
Wyeth Pharmaceuticals.




F-22




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


14. Long-term
Debt:




Long-term
debt comprises:




December 31,(In
      thousands of U.S . dollars)
                      
                      2008
                      
                      
                      2009Oseo
      Anvar loans (a)
                      
                      
                      901
                      
                      
                      
                      1,682French
      Ministry of Industry (b)
                      
                      
                      2,052
                      
                      
                      
                      2,124Total
                      
                      
                      2,953
                      
                      
                      
                      3,806Current
      portion
                      
                      
                      684
                      
                      
                      
                      862Long-term
      portion
                      
                      
                      2,269
                      
                      
                      
                      2,944





(a) OSEO
Anvar is an agency of the French government that provides financing to French
companies for research and development. At December 31, 2008 and 2009, the
Company had outstanding loans from Anvar of $901,000 and $1,682,000,
respectively for various programs. In 2009, the Company received $749,000 for a
new project   These loans do not bear interest and are repayable
only in the event the research project is technically or commercially
successful.   Potential repayment is scheduled to occur from 2010
through 2017.





(b) In
2002, the Company received a loan of $464,000 from the French Ministry of
Industry on a research project (the “Proteozome” project) related to the
development of new Medusa applications. Pursuant to the agreement, the Company
is granted a loan equal to 50% of the total expenses incurred on this project
over a three-year period beginning on January 2, 2002. The remainder of the
advance of $1,707,000 was received in 2005. One third of this loan is due for
repayment 2010 with the remainder due in 2011. The loan is non-interest bearing
and is repayable only in the event the research project is technically or
commercially successful.





Total
future payments on long-term debt for the years ending December 31
(assuming the underlying projects are commercially or technically successful for
governmental research loans) are as follows:





(In
      thousands of U.S . dollars)
                    
                    December 31,2010
                    
                    
                    8622011
                    
                    
                    1,6362012
                    
                    
                    2862013
                    
                    
                    3392014
                    
                    
                    1442015
                    
                    
                    1802016
                    
                    
                    2092017
                    
                    
                    1503,806




F-23




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


15.
Capital lease obligations:




The
Company leases certain of its equipment under capital leases. Each lease
contract generally has a term of four years with a purchase option. No specific
restrictions or guarantee provisions are included in the
arrangement.





Future
payments on capital leases for the years ending December 31 are as
follows:




(In
      thousands of U.S . dollars)
                            
                            December 31,2010
                            
                            
                            432011
                            
                            
                            432012
                            
                            
                            27Total
                            
                            
                            113Less
      amounts representing interest
                            
                            
                            (14
                            )Future
      payments on capital leases
                            
                            
                            99Less
      current portion
                            
                            
                            33Long
      term portion
                            
                            
                            66





Interest
paid in the years ended December 31, 2007, 2008 and 2009 was approximately
$16,000, $16,000 and $14,000, respectively.




16.
Earnings Per Share:




The
following is a reconciliation of the numerators and denominators of the basic
and diluted earnings per share computations:




Year ended December 31,(In
      thousands, except per share amounts)
                  
                  2007
                  
                  
                  2008
                  
                  
                  2009Numerator:Net
      income (loss)
                  
                  $
                  (37,737
                  )
                  
                  $
                  (12,084
                  )
                  
                  $
                  (11,439
                  )Denominator:Weighted
      average shares outstanding used for basic earnings (loss) per
      share
                  
                  
                  24,024,131
                  
                  
                  
                  24,081,723
                  
                  
                  
                  24,225,261Effect
      of dilutive securities:Stock-options
      and warrants
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Weighted
      average shares outstanding and dilutive securities used for diluted
      earnings (loss) per share
                  
                  
                  24,024,131
                  
                  
                  
                  24,081,723
                  
                  
                  
                  24,225,261Basic
      earnings (loss) per share
                  
                  $
                  (1.57
                  )
                  
                  $
                  (0.50
                  )
                  
                  $
                  (0.47
                  )Diluted
      earnings (loss) per share
                  
                  $
                  (1.57
                  )
                  
                  $
                  (0.50
                  )
                  
                  $
                  (0.47
                  )





For the
years ended December 31, 2007, 2008 and 2009, the effects of dilutive securities
were excluded from the calculation of earnings per share as a net loss was
reported in these periods.





Options
to purchase 2,978,000 shares of common stock at an average of €13 per share were
outstanding during 2009, but were not included in the computation of diluted EPS
because the exercise price was greater than the average market price of common
shares. The options, which expire in December 2018, were still outstanding at
the end of year 2009.





F-24




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


17.
Shareholders’ Equity:




17.1.
Preemptive subscription rights:




Shareholders
have preemptive rights to subscribe for additional shares issued by the Company
for cash on a pro rata
basis when the Company makes a share offering. Shareholders may waive such
preemptive subscription rights at an extraordinary general meeting of
shareholders under certain circumstances. Preemptive subscription rights, if not
previously waived, are transferable during the subscription period relating to a
particular offer of shares.





17.2.
Dividends:




Dividends
may be distributed from the statutory retained earnings, subject to the
requirements of French law and the Company’s by-laws. The Company has not
distributed any dividends since its inception, as the result of an accumulated
statutory deficit of approximately $138.2 million at December 31, 2009. Dividend
distributions, if any, will be made in euros. The Company has no plans to
distribute dividends in the foreseeable future.





17.3. Warrants:




On March
4, 2005, the Company issued, at a price of €0.01 per warrant, 40,000 warrants to
the scientific advisors of the Company giving them the right to subscribe to
40,000 ordinary shares at the price of €12.34 per share. These warrants are
subject to vesting for 25% at the subscription and the remainder vest ratably
over a three year period. The exercise of these warrants should occur before
January 3, 2010. As of December 31, 2009, 7,000 warrants were exercised and
2,500 were forfeited.





The
related compensation expense is computed under prescriptions ASC
505-50.





The
effects of applying the fair value method provided in accordance with ASC 505
and ASC 718 are shown in Note 5.




On March
2, 2006, the Company authorized the Directors, to subscribe to 69,250 warrants
for a subscription price of €2.0 per warrant ($2.40).  Each warrant is
exercisable to purchase one Share at price of €20.07 ($23.99). These warrants
were subscribed in April 2006. As of December 31, 2009, all the warrants were
cancelled.





On June
12, 2006, the Company authorized the Directors of the Company, to subscribe to
125,000 warrants for a subscription price of €1.46 per warrant
($1.84).  Each warrant is exercisable to purchase one Share at a price
of €14.6 ($18.48). These warrants are issued for a three-year period and will
vest over one year from the date of issuance. These warrants were subscribed in
July and August 2006. As of December 31, 2009, all the warrants were
cancelled.





On May
15, 2007, the Company authorized the Directors of the Company, to subscribe to
125,000 warrants for a subscription price of €2.16 per warrant
($2.93).  Each warrant is exercisable to purchase one Share at a price
of €20.54 ($27.83). These warrants are issued for a three-year period and will
vest over one year from the date of issuance. These warrants were subscribed in
June 2007. As of December 31, 2009, 25,000 warrants were cancelled.





On June
3, 2008 the Company authorized the Directors of the Company, to subscribe to
250,000 warrants for a subscription price of €0.91 per warrant
($1.42).  Each warrant is exercisable to purchase one Share at a price
of €6.57 ($10.20). These warrants are issued for a four-year period and will
vest over one year from the date of issuance. These warrants were subscribed in
June 2008.





On June
24, 2009 the Company authorized the Directors of the Company, to subscribe to
250,000 warrants for a subscription price of €0.74 per warrant
($1.03).  Each warrant is exercisable to purchase one Share at a price
of €4.50 ($6.29). These warrants are issued for a four-year period and will vest
over one year from the date of issuance. These warrants were subscribed in July
2009.





On
exercise of warrants by beneficiaries, the Company issues new
shares.





F-25




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


17.4. Stock
options:




The
Company issued stock options under plans approved by shareholders in 1990, 1993,
1996, 2000, 2001, 2003, 2004, 2005, and 2007. The option terms provide for
exercise within a maximum 10-year term as from the date of grant. Generally,
each option vests no more than four years from the date of grant.




In
January 1997, the French parliament adopted a law that requires French companies
and beneficiaries to pay social contributions, which generally represent 45% of
the taxable salary, on the difference between the exercise price of a stock
option and the fair market value of the underlying shares on the exercise date
if the beneficiary sells the stock before a four-year period following the grant
of the option (five years for options granted before 2000). This law is
consistent with personal income tax law that requires individuals to pay income
tax on the difference between the option exercise price and the fair value of
the shares at the sale date if the shares are sold within four years of the
option grant. The law applies to all options exercised after January 1,
1997.  The Company has instituted an internal rule whereby, whilst
remaining an employee of the Company, an individual may not sell the underlying
share within four years of the option being granted.





In
December 2007, the French parliament adopted a law that requires French
companies to pay an additional social security contribution of 10% for each
option granted, based on either the fair value of the option  or 25%
of share price at date of grant. This is applicable on all options granted since
October 16, 2007.





On
exercise of stock options by beneficiaries, the Company issues new
shares.





17.5.
Free Share Awards




On May
15, 2007, the shareholders of the Company authorized the issue of new shares
which authorizes the Board of Directors to award and issue up to 200,000 shares
free of charge to officers and employees of the Company as compensation for
services rendered.  Under the terms of the awards the shares are
definitively owned by the beneficiaries two years following their allocation and
the Company issues new shares. The beneficiaries are required to retain the
shares for  two additional years.





On June
3, 2008, the shareholders of the Company authorized the issue of new shares
which authorizes the Board of Directors to award and issue up to 200,000 shares
free of charge to officers and employees of the Company as compensation for
services rendered.  Under the terms of the awards the shares are
definitively owned by the beneficiaries two years following their allocation and
the Company issues new shares. The beneficiaries are required to retain the
shares for  two additional years.





On June
24, 2009, the shareholders of the Company authorized the issue of new shares
which authorizes the Board of Directors to award and issue up to 200,000 shares
free of charge to officers and employees of the Company as compensation for
services rendered.  Under the terms of the awards the shares are
definitively owned by the beneficiaries two years following their allocation and
the Company issues new shares. The beneficiaries are required to retain the
shares for  two additional years.




In
December 2007, the French parliament adopted a law that
requires  French companies to pay an additional  social
contribution of 10%  for each share granted, based on the share price
at date of grant.





On
December 12, 2006 the Company granted 106,000 free share awards to officers and
employees. On December 13, 2008, the Company issued 98,750 new shares related to
this grant.





On
December 11, 2007 the Company granted 130,000 free share awards to officers and
employees. On December 11, 2009 the Company issued 117,250 new shares related to
this grant.





On
December 10, 2008 the Company granted 250,000 free share awards to officers and
employees.





On
February 1, 2009 the Company granted 25,000 free shares to
officers.





On
December 11, 2009 the Company granted 295,000 free share awards to officers and
employees.





F-26




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


17.6. Accumulated
other comprehensive income:




The
components of accumulated other comprehensive income are as
follows:




December 31,(In
      thousands of U.S. dollars)
                    
                    2008
                    
                    
                    2009Foreign
      currency translation
                    
                    
                    12,150
                    
                    
                    
                    14,469Total
                    
                    
                    12,150
                    
                    
                    
                    14,469




18. Income
taxes :




Income
(loss) before income taxes comprises the following:




Year ended December 31,(in
      thousands of U.S. dollars)
                  
                  2007
                  
                  
                  2008
                  
                  
                  2009France
                  
                  $
                  (37,143
                  )
                  
                  $
                  (11,584
                  )
                  
                  $
                  (11,439
                  )





A
reconciliation of income tax benefit (provision) computed at the French
statutory rate ( 33.33%) to the income tax benefit is as follows:




Year ended December 31,(in
      thousands of U.S. dollars)
                  
                  2007
                  
                  
                  2008
                  
                  
                  2009Income
      tax benefit (provision) computed at the French statutory
    rate
                  
                  
                  12,380
                  
                  
                  
                  3,861
                  
                  
                  
                  3,813Deferred
      Tax Allowance
                  
                  
                  (12,380
                  )
                  
                  
                  (3,861
                  )
                  
                  
                  (3,813
                  )Withholding
      tax
                  
                  
                  (594
                  )
                  
                  
                  (500
                  )
                  
                  
                  -Total
                  
                  
                  (594
                  )
                  
                  
                  (500
                  )
                  
                  
                  -




License
fees, milestone and royalties payments may be subject to a withholding tax
depending on the tax rules of the country in which the licensee is located. In
2007 and 2008, withholding tax relates to royalties received from GSK in
accordance with the license agreement.





Since our
subsidiary realizes no taxable income, the Company does not incur any income
taxes under United States jurisdiction.




F-27




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


Significant
components of the Company's deferred taxes consist of the
following:




December 31,(In
      thousands of U.S. dollars)
                    
                    2008
                    
                    
                    2009Deferred
      income tax assets:Net
      French taxable operating loss carry-forwards (not
utilized)
                    
                    
                    45,266
                    
                    
                    
                    48,007Other
      deferred income tax assets
                    
                    
                    3,528
                    
                    
                    
                    6,779Valuation
      allowance
                    
                    
                    (48,593
                    )
                    
                    
                    (54,447
                    )Net
      deferred income tax assets
                    
                    
                    201
                    
                    
                    
                    339Deferred
      income tax liabilities
                    
                    
                    (201
                    )
                    
                    
                    (339
                    )Deferred
      income taxes, net
                    
                    
                    -
                    
                    
                    
                    -





The
Company has provided valuation allowances covering 100% of net deferred tax
assets due to the Company's history of losses.





As of
December 31, 2009, the Company had $144,034,000 in French net operating
losses carry-forwards which have no expiration date.





The
increase in available net operating losses carry-forwards in 2009 is due to a
tax loss of $3,338,000.  The French government provides tax credits to
companies for spending on innovative research and development. Income tax
benefits correspond to these French research tax credits, which are credited
against income taxes payable in each of the four years after being incurred or,
if not so utilized, are recoverable in cash. As of December 31, 2009, Flamel had
total research tax credits receivable of $11,884,000. In December 2008, the
Company obtained an advance from OSEO, a governmental agency supporting
innovation, secured against the Research tax credits generated in fiscal years
2005, 2006 and 2007 (see Note 12.1)  Generally, if these credits are
not applied against future income taxes, they will be received as cash payments
in the fourth year after the credit is earned: At the beginning of 2009, the
French government introduced a temporary measure consisting in early
reimbursement of the research credit tax  for fiscal year 2008. The
company received reimbursement of the research tax credit for fiscal 2008 in May
2009. The measure was renewed by the French government for the fiscal year 2009
and the Company expects to apply for early reimbursement in the first half of
2010.





The
scheduled payments are shown in the following table




(In
      thousands of U.S . dollars)
                    
                    December 31,2010
                    
                    
                    9,400Total
      current portion
                    
                    
                    9,4002011
                    
                    
                    2,484Total
      long term portion
                    
                    
                    2,484Total
                    
                    
                    11,884





19. Employee
Retirement plans:




In
accordance with French law, post-retirement benefits for most of the Company’s
employees are sponsored by the relevant government agencies in France. The
Company’s liability with respect to these plans is generally limited to specific
monthly payroll deductions. Consequently, there is no additional liability in
connection with these plans. Expenses recognized for these plans were $1,713,000
in 2009, $1,690,000 in 2008 and $1,609,000 in 2007.





French
law requires the Company to provide for the payment of a lump sum retirement
indemnity to French employees based upon years of service and compensation at
retirement. Benefits do not vest prior to retirement. The Company’s benefit
obligation was $2,208,000, $1,649,000, $1,450,000 as of December 31, 2009,
2008 and 2007, respectively. The increase in the balance is the result of
increases to the obligation for service and interest cost, adjusted by the
actuarial valuation and the overall impact of the translation of this
euro-denominated obligation to U.S. dollars. Any actuarial gains or losses
are recognized in the period when they occur.





F-28




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


In 2008,
the French Government reinforced legislation regarding an employer’s ability to
make employees retire.  As such the retirement indemnity has been
calculated on the assumption of voluntary retirement and  the impact on the
benefit obligation was recognized as an actuarial loss.





The
benefit obligation is calculated as the present value of estimated future
benefits to be paid, using the following assumptions:




2007
                          
                          2008
                          
                          2009Average
      increase of salaries
                          
                          3%
                          
                          3%
                          
                          3%Discounted
      interest rate
                          
                          5.5%
                          
                          5.5%
                          
                          5.0%Turn
      over
                          
                          average
      of the last 4 years
                          
                          actuarial
      standard and average of the last 5 years
                          
                          actuarial
      standard and average of the last 5 yearsAge
      of retirement
                          
                          65
      years
                          
                          60
      to 65 years
                            actuarial
      standard based on age and professional status
                          
                          60
      to 65 years
                            actuarial
      standard based on age and professional
status





Changes
in the funded status of the benefit plans were as follows:




December 31,In
      thousands of U.S . dollars
                    
                    2008
                    
                    
                    2009Benefit
      obligations at beginning of year
                    
                    
                    1,450
                    
                    
                    
                    1,649Service
      cost
                    
                    
                    131
                    
                    
                    
                    137Interest
      cost
                    
                    
                    80
                    
                    
                    
                    90Plan
      amendments
                    
                    
                    -
                    
                    
                    
                    136Benefits
      paids
                    
                    
                    (143
                    )
                    
                    
                    -Actuarial
      loss (gain)
                    
                    
                    226
                    
                    
                    
                    122Exchange
      rate changes
                    
                    
                    (95
                    )
                    
                    
                    74Benefit
      obligations at end of year
                    
                    
                    1,649
                    
                    
                    
                    2,208




December 31,Change
      in plan assets
                    
                    2008
                    
                    
                    2009Fair
      value of plan assets at beginning of year
                    
                    
                    -
                    
                    
                    
                    -Employer
      contributions
                    
                    
                    143
                    
                    
                    
                    -Benefits
      paid
                    
                    
                    (143
                    )
                    
                    
                    -Fair
      value of plan assets at end of year
                    
                    
                    -
                    
                    
                    
                    -




The
Company does not have a funded benefit plan and the lump sum retirement
indemnity is accrued on the balance sheet as a liability.





The
future expected benefits to be paid over the next five years and for the five
years thereafter is as follows:




Future expected payment of benefits:
                                    Year Ending:In thousands of U.S . dollars12/31/2010
                                    
                                    
                                    5412/31/2011
                                    
                                    
                                    8412/31/2012
                                    
                                    
                                    32112/31/2013
                                    
                                    
                                    5612/31/2014
                                    
                                    
                                    532Next 5 Years
                                    
                                    
                                    586





F-29




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


In the
United States, the Company sponsors a defined contribution retirement plan for
its employees located in the United States.  The contribution is the
lesser of 25% of an employee’s wages or $49,000 in 2009. The Company made
contributions of approximately $68,000 in 2009, $82,000 in 2008 and $79,000 in
2007.





20.
Fair value of financial instruments:




At
December 31, 2008 and 2009, the carrying values of financial instruments such as
cash and cash equivalents, trade receivables and payables, other receivables and
accrued liabilities and the current portion of long-term debt approximated their
market values, based on the short-term maturities of these
instruments.





As noted
in Note 7, the company calculates fair value for its marketable securities based
on quoted market prices for identical assets and liabilities which represents
Level 1 of SFAS 157 (ASC 820-10) fair value hierarchy.


At
December 31, 2008 and 2009, the fair value of long-term debt with carrying value
of $2,953,000 and $3,806,000 was estimated to be $2,892,000 and $3,726,000,
respectively. Fair
value was determined based on expected future cash flows, discounted at market
interest rates.




21.
Commitments and Contingencies:




21.1.
Capital leases




The
Company currently has commitments regarding capital leases as described in Note
15.





21.2.
Operating leases




The
Company leases its facilities and certain equipment under non cancelable
operating leases, which expire through 2015. Future minimum lease payments under
operating leases due for the fiscal years ending December 31, 2009 are as
follows:





(In
      thousands of U.S. dollars)
                      
                      December 31,2010
                      
                      
                      1,2972011
                      
                      
                      1,0762012
                      
                      
                      9402013
                      
                      
                      4272014
                      
                      
                      201Thereafter
                      
                      
                      178TOTAL
                      
                      
                      4,119





Rental
expense for the years ended December 31, 2007, 2008 and 2009 was approximately,
$1,388,000, $1,381,000 and $1,418,000 respectively.





21.3.
Litigation




While the
Company may be engaged in various claims and legal proceedings in the ordinary
course of business, the Company is not involved (whether as a defendant or
otherwise) in and has  no knowledge of any threat of, any litigation,
arbitration or administrative or other proceeding which would have a material
adverse effect on on the results of its operations, cash flows, or financial
position as of December 31, 2009, and for the year then ended.





On
November 9, 2007 a putative class action was filed in the United States District
Court for the Southern District of New York against the Company and certain of
its current and former officers entitled Billhofer v. Flamel Technologies, et
al.  The complaint purports to allege claims arising under the
Securities Exchange Act of 1934 based on certain public statements by the
Company concerning, among other things, a clinical trial involving Coreg CR and
seeks the award of damages in an unspecified amount.  By Order dated
February 11, 2008, the Court appointed a lead plaintiff and lead counsel in the
action.  On March 27, 2008, the lead plaintiff filed an amended
complaint which continued to name as defendants the Company and two previously
named officers and asserted the same claims based on the same events as alleged
in the initial complaint.  On May 12, 2008, the Company filed a motion
to dismissthe action, which the
Court denied by Order dated October 1, 2009.  The action
is  now in the discovery phase pursuant to a schedule approved by
the Court in a Case Management Order, signed December 9, 2009. 
The Company intends to vigorously defend itself in the action.  Neither of
the two individual defendants named in the amended complaint have been served in
the action.





F-30




FLAMEL
TECHNOLOGIES S.A
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


On August
27, 2007, a New York court denied Flamel U.S. jurisdiction in a lawsuit filed
against Gérard Soula by the Company.   This decision has not had
and is not expected to have a materially adverse effect upon the
Company.




22.
Industry and geographic information:




The
Company operates in one segment, the development and commercialization of
controlled-release therapeutic products based on its proprietary polymer based
technology.





Revenues
from GSK represented 68% of total revenues in 2008 and 60% in 2009.





Operations
outside of France consist principally of the operations of the U.S. subsidiary,
which had no sales to third parties in 2007, 2008 or 2009.





Revenues
by geographic location of customers are as follows:




(in
      thousands of U.S. dollars)
                      
                      As of December 31,2007
                      
                      
                      2008
                      
                      
                      2009RevenuesUnited
      Kingdom & Ireland
                      
                      
                      20,064
                      
                      
                      
                      21,336
                      
                      
                      
                      24,792USA
                      
                      
                      15,278
                      
                      
                      
                      9,219
                      
                      
                      
                      4,021France
                      
                      
                      1,234
                      
                      
                      
                      1,472
                      
                      
                      
                      2,691Europe
                      
                      
                      78
                      
                      
                      
                      6,592
                      
                      
                      
                      10,614Total
      Revenues
                      
                      
                      36,654
                      
                      
                      
                      38,619
                      
                      
                      
                      42,118





The
following is a summary of long-lived assets by geographic location:





(in
      thousands of U.S. dollars)
                      
                      As of December 31,2008
                      
                      
                      2009Long-lived
      assets:USA
                      
                      $
                      20
                      
                      
                      $
                      38France
                      
                      $
                      32,652
                      
                      
                      $
                      27,417Total
      long-lived assets
                      
                      $
                      32,672
                      
                      
                      $
                      27,455




F-31




SIGNATURES




The
Registrant hereby certifies that it meets all of the requirements for filing on
Form 20-F and that it has duly caused and authorized the undersigned to sign
this annual report on its behalf.




FLAMEL
      TECHNOLOGIES S.A.(Registrant)/s/
      Stephen H. WillardStephen
      H. WillardChief
      Executive
Officer




Date: May
7, 2010










EXHIBIT INDEX





ExhibitNumber
              
              Description1.1
              
              Revised
      Statutsor bylaws
      of the Company (Filed herewith)2.1
              
              Deposit
      Agreement among Flamel, The Bank of New York, as Depositary, and holders
      from time to time of American Depositary Shares issued thereunder
      (including as an exhibit the form of American Depositary Receipt)
      (1)8.1
              
              List
      of Subsidiaries (Filed herewith)11.1
              
              Code
      of Ethics for CEO (Directeur Général), Delegated Managing Directors
      (Directeurs Generaux Delegues) and Senior Financial
      Officers  (2)12.1
              
              Certification
      of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the
      Securities Exchange Act, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002 (Filed herewith)12.2
              
              Certification
      of the Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of
      the Securities Exchange Act, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002 (Filed herewith)13.1
              
              Certification
      of the Chief Executive Officer pursuant to USC Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Furnished
      herewith)13.2
              
              Certification
      of the Principal Financial Officer pursuant to USC Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
      (Furnished herewith)23.1
                23.2
              
              Consent
      of PricewaterhouseCoopers Audit (Filed herewith)
                Consent
      of Ernst & Young Audit (Filed
herewith)





(1)
Incorporated by reference to Post-Effective Amendment No. 1 to the Company’s
registration statement on Form F-6 filed July 26, 2001, as amended
(No. 333-12790).


(2)
Incorporated by reference to the Company’s Annual Report on Form 20-F for the
year ended December 31, 2003, filed on April 26, 2004.





The
registrant undertakes to provide to each shareholder requesting the same a copy
of each exhibit referred to herein upon payment of a reasonable fee limited to
the registrant’s reasonable expenses in furnishing such exhibit.