UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549  FORM 10-K (Mark one) x
Annual
  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934For the
  Fiscal Year ended March 31, 2006o
Transition
  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934  Commission File No. 0-24676CARACO PHARMACEUTICAL LABORATORIES,
LTD.(Exact name of registrant as
  specified in its charter)Michigan

38-2505723(State of Incorporation)

(I.R.S. Employer Identification
  No.)1150 Elijah McCoy Drive, Detroit, MI
48202(Address of principal executive
office)(313) 871-8400(Registrants telephone
number)Securities Registered Pursuant to Section
  12(b) of the Exchange Act:Title of
  Each Class to be so Registered


Name of Each
  ExchangeOn which Each Classis to be RegisteredCommon Stock, No Par Value

American
  Stock Exchange Securities Registered Pursuant to Section
12(g) of the Exchange Act:  None. Indicate by check mark if the registrant is a
well-known seasoned issuer, as defined in Rule 405 of the Securities
Act.   YesoNox Indicate by check mark if the registrant is
not required to file reports pursuant to Section 13 or Section 15 (d) of the
Act.    YesoNox Indicate by check mark if the registrant is a
shell company (as defined in Rule 12 b-2 of the Exchange Act).
   YesoNox 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 xNoo

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part
III of this Form 10-K or any amendments to this Form 10-K. o

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

Large Accelerated Filer   o      Accelerated Filer x        Non-Accelerated
Filer   o

The aggregate market value of the voting
common stock held by non-affiliates, based on the last sale price of the common
stock as of September 30, 2005, the last day of the Registrants most recently
completed second quarter, as reported on the American Stock Exchange, was
$82,145,710.

Indicate the number of shares outstanding of
each of the registrants classes of Common Stock, as of the latest practicable
date.

As of June 7, 2006, there were 26,421,994
shares of common stock outstanding.

Documents
Incorporated By Reference:

Portions of
registrants definitive 2006 Proxy Statement in connection with its Annual
Meeting to be held in September 2006 to be filed on or before July 31, 2006.

CARACO PHARMACEUTICAL LABORATORIES, LTD.
FORM 10-K

Forward Looking Statements

This
report, other than the historical financial and business information, may
contain forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act. Without
limitation, the words believes, plans, expects, and similar expressions
are intended to identify forward-looking statements. Those statements include
statements regarding our intent, belief, and current expectation. These
statements are not guarantees of future performance and are subject to risks
and uncertainties that cannot be predicted or quantified. Consequently, actual
results could differ materially from those expressed or implied by such forward-looking
statements. Such risks and uncertainties include, but are not limited to those
referenced in Part I, Item 1A below. These forward-looking statements represent
our judgment as of the date of this report. We disclaim, however, any intent or
obligation to update our forward-looking statements.

PART I

Item 1. Business

Introduction

Caraco
Pharmaceutical Laboratories, Ltd. (Caraco which is also referred to as the Company,
the Corporation, we, us or our) is a corporation organized under
Michigan law in 1984, engaged in the business of developing, manufacturing,
marketing and distributing generic and private-label pharmaceuticals to the
nations largest wholesalers, distributors, warehousing and non- warehousing
chain drugstores and managed care providers, throughout the U.S.

A generic pharmaceutical is the chemical and therapeutic equivalent of a
brand-name drug as to which the patent and/or market exclusivity has expired.
Generics are well accepted for substitution of brand products as they sell at
lower prices than the prices of the branded products at the equivalence in
quality and bioavailability.

The
Companys principal executive offices are located at 1150 Elijah McCoy Drive,
Detroit, Michigan 48202, and its telephone number is (313) 871-8400. The
Company files annual reports, quarterly reports, current reports, proxy
statements and other information with the Securities and Exchange Commission.
You may read and copy any of the Companys SEC filings at the SECs Public
Reference Room at 450 5thStreet, N.W., Washington, D.C., 20549. You
may call the SEC at 1-800-SEC-0330 for further information about the Public
Reference Room. Our SEC filings are also available to the public on the SECs
website at http://www.sec.gov and at our principal Internet address at
www.caraco.com. We believe that these reports are made available as soon as
reasonably practicable after we electronically file with or furnish them to the
SEC.

On
January 27, 2005, the Board of Directors of the Company resolved to change the
Companys fiscal year from December 31 to March 31 commencing in 2005. This
change was made in order to make the Companys fiscal year conform to the March
31 fiscal year of its parent company, Sun Pharmaceutical Industries Limited (Sun
Pharma). This Form 10-K covers the audited fiscal year, April 1, 2005 to March
31, 2006 (Fiscal 2006). Comparative financial information to Fiscal 2006 is
provided in this Form 10-K with respect to the twelve month period, April 1,
2004 to March 31, 2005, which is unaudited (Fiscal 2005). Additional
information is provided with respect to the transition period (January 1, 2005
through March 31, 2005) which is audited (the Transition Period). See Item 6
and Item 7 below.

Overview

Our
manufacturing facility and executive offices were constructed in 1991, pursuant
to a $9.1 million loan from the Economic Development Corporation of the City of
Detroit (the EDC). Since August 1997, capital infusions and loans have
primarily come from Sun Pharmaceutical Industries Limited, a specialty
pharmaceutical corporation organized under the laws of India (Sun Pharma).
Among other things, Sun Pharma has acted as a guarantor on loans to Caraco, has
supplied us with raw materials for certain of our products, helped us obtain
machinery and equipment to enhance our production capacities at competitive
prices and transferred certain generic products to us. Sun Pharmas investment
in and support of Caraco has resulted in, since the second quarter of 2002,
Caraco achieving the sales necessary to support its operations. As of June 7,

1

2006, Sun Pharma beneficially owns approximately 64% (75%
including its
convertible Series B Preferred Stock) of the outstanding shares of Caraco. See Current
Status and Sun Pharmaceutical Industries Limited.

Current Status

During
Fiscal 2006 we recorded net sales of $82.8 million compared to $64.1 million
Fiscal 2005. We have generated cash from operations of $8.9 million as compared
to $20.6 million during the relevant periods. Cash was used primarily to
augment working capital. We incurred a net loss of $10.4 million compared to
net loss of $2.3 million during the relevant periods. The higher loss was
primarily due to higher non-cash research and development expense (R&D) of
$35.1 million as compared to $26.8 million during the relevant period. This
non-cash R&D expense relates to nine products passing their bio-equivalency
studies during Fiscal 2006 and the related value of the preferred stock issued
to Sun Pharma Global, Inc., a wholly-owned subsidiary of Sun Pharma, (Sun
Global) pursuant to the Products Agreement as defined below, as compared to
eight products during Fiscal 2005. At March 31, 2006, we had stockholders
equity of $56.4 million as compared to stockholders equity of $31.7 million at
March 31, 2005 and a stockholders equity of $25.8 million at December 31, 2004. See Part II 
Item 7.
Managements Discussion and Analysis of Financial Condition and Results of
Operations.

Pursuant
to our products agreement with Sun Global,, we have selected, through March 31,
2005, all products out of the 25 products to be transferred to us by Sun
Global. Of these, twenty
products passed their bio-equivalency studies as of March 31, 2006, and one
since then. Sun Global has thereby earned 544,000 preferred shares for each
such product. See Sun Pharmaceutical Industries Limited and Part II  Item
7.  Future Outlook.

We
filed ten ANDAs with the FDA
during Fiscal 2006. This brings our total number of ANDAs pending approval by
the FDA to 14.

Overview of the Generic Drug Industry

We
believe that sales of generic pharmaceuticals have increased in recent years
because of a number of factors including (i) increased number of formerly
patented drugs which have become available to generic competition; (ii) changes
in governmental and third-party payor health care reimbursement policies to
encourage cost containment; (iii) increased acceptance of generic drugs by physicians,
pharmacists and consumers; (iv) modification of state and federal laws to
permit or require substitution of generic drugs by pharmacists; and (v)
enactment of ANDA procedures for obtaining FDA approval to manufacture generic
prescription drugs.

The
generic pharmaceutical business is highly competitive. Although generic
pharmaceuticals must meet the same quality standards as branded
pharmaceuticals, they could potentially be sold at prices that reflect a
discount up to 90% (in some cases even more) than the price of their branded
counterparts. The discount is relevant to the amount of competitors on any
given product.

Companies
aspiring to earn higher margins for generic drugs may have a strategy of
manufacturing niche products or hard to replicate products or could include a
litigious strategy of patent challenges and first to file. The developer of a
generic product that is the first to have its ANDA accepted for filing by the
FDA and whose filing includes a Paragraph IV Certification that the patent on
the brand-name drug is invalid, unenforceable and/or not infringed may be
eligible to receive a 180-day period of generic market exclusivity. During that
180-day period, the exclusive generic product would tend to earn higher margins
on a higher volume of sales than in a situation in which other generic
competition was also present. Recently this strategy has also seen reduced
margins as authorized generics have become more prevalent. Authorized generics
occur when the brand innovator has licensed its brand product to a generic
manufacturer or has chosen to produce another label and provide the brand drug
generically at typical generic discounts.

Products
that are difficult to develop requiring difficult-to-source raw materials or
representing smaller therapeutic niche markets, are generally marketed by fewer
companies and may also offer margins that are higher than those where barriers
to entry do not exist.

2

Caracos Products and Product Strategy

Our present
product portfolio includes 21 prescription products in 44 strengths in 99
package sizes. The products and their use for the indications are
set forth in the table below:

Generic Name

PurposeMetroprolol
  Tartrate

Hyper-TensionParomomycin
  Sulfate

AntibacterialSalsalate

DecongestantCholine
  Magnesium Trisalicylate

Arthritis/NSAIDClonazepam

Seizure,
  Panic DisordersFlurbiprofen

Arthritis/NSAIDCarbamazepine
  Chewable

Anti-convulsantCarbamazepine
  IR

Anti-convulsantOxaprozin

Rheumatoid
  DiseaseMetformin
  Hydrochloride

DiabetesTramadol
  Hydrochloride

Opiate
  Agonist/AnalgesicTramadol
  Hydrochloride with Acetominophen

Opiate
  Agonist/AnalgesicMeperidine
  Hydrochloride*

AnalgesicTiclopidine

Reduction of
  incidence of strokesTizanidine

Management
  of muscle tone associated with spasticityDigoxin

Heart
  failureMirtazapine

Anti-depressantCitalopram
  Hbr

Anti-depressantClozapine

Anti-psychoticMidrin**

Vascular
  & Migraine Headache suppressantFluvoxamine

Anti-depressant* Expected to be marketed sometime in Fiscal 2007.

**
Product marketed on behalf of Sun Pharmaceutical Industries Inc., a wholly
owned subsidiary of Sun                Pharma, in one strength and one pack size.

We have
submitted 34 ANDAs to the FDA for approval as of March 31, 2006, including 10
filed during Fiscal 2006. Of these 34 ANDAs filed, the FDA has approved 20
through March 31, 2006. Accordingly, we have 14 pending ANDAs.

Our
strategy has been to analyze the marketplace and try to determine opportunities
for products having good market potential, that are difficult to develop, that
require difficult-to-source raw materials and/or products representing smaller
therapeutic niche markets. Recently, we have started to develop products, which
have potential patent litigation, and/or first to file opportunities. We
anticipate also seeking opportunities to in-license authorized generics and
other generic pharmaceuticals.

3

Sun Pharmaceutical Industries Limited

Pursuant to
a stock purchase agreement, Sun Pharma made an initial investment
of $7.5 million for the purchase of 5.3
million common shares of Caraco in 1997.

Sun
Pharma and its affiliates had loaned us approximately $10 million since August
1997. .As of December 2003, we had repaid all of such loans. Sun Pharma also
assisted us, by acting as guarantor, in obtaining line of credit loans from
ICICI Bank Limited, The Bank of Nova Scotia and Citibank FSB in the amounts of
$5.0 million, $12.5 million and $10.0 million, respectively, all of which have
been terminated as of December 31, 2004.

In
August 1997, we entered into an agreement, whereby Sun Pharma was required to
transfer to us the technology formula for 25 generic pharmaceutical products
over a period of five years through August 2003. We exchanged 544,000 shares of
our common stock for each technology transfer of an ANDA product (when
bio-equivalency studies were successfully completed) and 181,333 shares for
each technology transfer of a DESI product. The products provided to us from
Sun Pharma were selected by mutual agreement. Under such agreement, we
conducted, at our expense, all tests including bio-equivalency studies.
Pursuant to such agreement, Sun Pharma delivered to us the technology for 13
products. This agreement has expired and as noted below, we have entered into a
new agreement, with Sun Global, an affiliate of Sun Pharma.

On
November 21, 2002, we entered into a products agreement with Sun Global. Under
the agreement, which was approved by our independent directors, Sun Global
agreed to provide us with 25 new generic drugs over a five-year period. Our
rights to the products are limited to the United States and its territories or
possessions, including Puerto Rico. Sun Global retains rights to the products
in all other territories. The products are selected by mutual agreement. Under
such agreement, we conduct, at our expense, all tests including bio-equivalency
studies. We are also obligated to market the products consistent with our
customary practices and to provide marketing personnel. In return for the
technology transfer, Sun Global receives 544,000 shares of Series B Preferred
Stock for each generic drug transferred when such drug has passed its
bio-equivalency studies. The preferred shares are non-voting, do not receive
dividends and are convertible into common shares after three years (or
immediately upon a change in control) on a one-to-one basis. The preferred
shares have a liquidation preference equal to the value attributed to them on
the dates on which they were earned. While such preferred shares are
outstanding, we cannot, without the consent of the holders of a majority of the
outstanding shares of the preferred stock, amend or repeal our articles of incorporation
or bylaws if such action would adversely affect the rights of the preferred
stock. In addition, without such consent, we cannot authorize the issuance of
any capital stock having any preference or priority superior to the preferred
stock.

The
products agreement was amended by the Independent Committee, comprised of the
three independent directors, in the first quarter of 2004 to eliminate the
provision requiring that the Independent Committee concur in the selection of
each product, and provides instead, that each product satisfy certain objective
criteria developed by management and approved by the Independent Committee.
Pursuant to such objective criteria, we have selected all the 25 products,
twenty of which passed bio-equivalency studies as of March 31, 2006, and one
since then. See Part II  Item 7. Managements Discussion and Analysis of
Financial Condition and Results of Operations  Future Outlook.

Sun
Pharma has established Research and Development Centers in Mumbai and Vadodara,
India, where the development work for products is performed.

Sun
Pharma and its subsidiaries supply us with certain raw materials and
formulations. In addition, Sun Pharma assists us in acquiring machinery and
equipment to enhance our production capacities. During Fiscal 2006, we
purchased approximately $28.1 million in raw materials and formulations from
Sun Pharma and its subsidiaries, as compared to $5.3 million during the
Transition Period and $16.7 million during calendar 2004. We acquired $0.2
million worth of machinery and equipment from Sun Pharma as compared to $0.1
million during the Transition Period and $0.6 million during calendar 2004.
Such machinery and equipment are sold to us at their cost.

Sun
Pharma also assists us by sending qualified technical professionals who work as
Caraco employees.

Sun
Pharma and its affiliates are using Caraco as a contract manufacturer and/or
distributor for two of their products pursuant to agreements entered into in December
2004 and in January 2005, of which only one is being marketed..

During
the Transition Period, SPARC Bioresearch Private Limited (SPARC), an
affiliate of Sun Pharma,

4

performed
certain analytical studies required as part of the bio-equivalency process for
two products. The Corporation incurred approximately $172,000 of costs during
the period for the studies performed by SPARC. No similar studies were
performed by SPARC during Fiscal 2006 or during the years ended December 31,
2004 and 2003.

During
the first quarter of 2004, Sun Pharma acquired 3,452,291 additional shares of
common stock and 1,679,066 stock options from two former directors and a
significant shareholder. Sun exercised these stock options during the fourth
quarter of 2004. Sun Pharmas current beneficial ownership is 64% (75% including its convertible Series B
Preferred Stock).

Marketing

We
believe the primary factors driving competition in the generic pharmaceutical
industry are price, product development, timely FDA approval, manufacturing
capabilities, product quality, customer service and reputation.

Caraco
competes effectively with respect to each of these factors; however, price is a
key competitive factor in the generic pharmaceutical business. To compete
effectively on the basis of price and remain profitable, a generic drug
manufacturer must manufacture its products in a cost-effective manner. In
addition, we must maintain an adequate level of inventories to meet customer
demands in a timely manner.

Our
products are effectively marketed among all classes of customers, including
wholesalers, buying groups, managed care organizations, chain retail
pharmacies, independent retail pharmacies, hospitals, etc. Increased
competition, the emergence of large buying groups representing independent
retail pharmacies, the continued growth of managed care organizations and
consolidation among wholesalers, has resulted in higher discounts on
pharmaceutical products. As the influence of these entities continues to grow,
the Company will continue to face pricing pressure on our portfolio of
products.

Our
marketing objective is to compete effectively, encourage long-term
relationships, and supply contracts, increase our market share on products that
have not matured, gain market share on new products that are to be launched,
and continue to expand our customer base.

Sales and Customers

Our
sales team effectively addressed the challenges in Fiscal 2006 of price
erosion, increase market share on certain products that had room for
improvement, improved the balance of sales to the trade classes we service,
increased sales with a limited number of approvals, executed our plan well and
improved on our capacity constraints, improved inventory levels and geared up
to meet the challenges inherent in the generic industry in fiscal 2007. Every
functional area has been fortified to meet the demand of our continued growth.

Certain
of our end-use customers purchase our products through designated wholesalers,
such as Amerisource-Bergen Corporation, McKesson Corporation and/or Cardinal
Health, who act as intermediary distribution channels for our products. For
example, the Veterans Administration, which has entered into the sales contract
as discussed below, has selected Mckesson as its designated wholesaler. Accordingly, shipments to three large
wholesale customers, namely McKesson Corporation (51% and 55%),
Amerisource-Bergen Corporation (9% and 11%) and Cardinal Health (17% and 12%),
accounted for approximately 77% and 78% of gross sales for Fiscal 2006 and the
Fiscal 2005, respectively. Balances due from these customers represented
approximately 72% and 75% of gross accounts receivable at March 31, 2006 and
2005, respectively. No other single customer represented more than 10% of our
gross sales during Fiscal 2006 and Fiscal 2005.

We
have entered into a sales contract on June 21, 2002 with the Veterans
Administration, an agency of the U.S. government. Our agreement with this
customer commenced on August 5, 2002 for a one-year period, with four 1-year
option periods thereafter, and is for the purchase of one product, Metformin
Hydrochloride. The first three option periods were exercised. The agreement may
be terminated by the purchaser without cause and in such case, we would only be
entitled to a percentage of the contract price reflecting the percentage of the
work performed prior to the notice of termination, plus reasonable charges that
have resulted from the termination. The agreement provides that certain
penalties would be incurred if we are unable to meet our sales commitment.

Seasonality

The
Companys business, taken as a whole, is not materially affected by seasonal
factors.

5

Research and Development

The
development of new prescription ANDA products, including formulation, stability
testing and the FDA approval process, averages from two to five years. A drug
is bioequivalent to a brand-name drug if the rate and extent of absorption of
the drug are not significantly different from those of the brand-name drug.
Although we perform our own stability testing, bioequivalence is done through
independent testing laboratories. The Companys research and development
consists principally in conducting market research and patent research on brand
name pharmaceuticals and generic pharmaceuticals in order to determine which
products we may want to develop. A majority of our research and development is
provided by Sun Global as a result of our technology transfer agreement and a
portion is being done by Caraco. Our development list consists of both near
term launches and launches that we intend to market several years in the
future.

We
incurred total R&D Expense for Fiscal 2006, Fiscal 2005 and calendar 2004
as set forth below:

Fiscal 2006

$
43.5 millionFiscal 2005
  (Unaudited)

$
33.4 millionCalendar
  2004

$
30.5 millionThe non-cash
  R&D Expense for the Fiscal 2006, Fiscal 2005 and calendar 2004 are set
  forth below:

Fiscal 2006

$
35.1 millionFiscal 2005
  (Unaudited)

$
26.8 millionCalendar
  2004

$
24.4 millionThe
non-cash technology transfer charges are for research and product development
provided by Sun Global. The charges are based on the fair value of the
preferred shares on the date the respective product formula passes the
bio-equivalency studies. The fair value of such shares is based upon an
independent valuation.

Regulation

The
research and development, manufacture and marketing of our products are subject
to extensive regulation by the FDA and by other federal, state and local
entities, which regulate, among other things, research and development
activities, testing, manufacture, labeling, storage, record keeping, advertising
and promotion of pharmaceutical products.

The
Federal Food, Drug and Cosmetic Act, the Public Health Services Act, the
Controlled Substances Act and other federal statutes and regulations govern or
influence our business. Noncompliance with applicable requirements can result
in fines and other judicially imposed sanctions, including product seizures,
injunction actions and criminal prosecutions. In addition, administrative
remedies can involve voluntary recall of products, and the total or partial
suspension of products as well as the refusal of the government to approve
pending applications or supplements to approved applications. The FDA also has
the authority to withdraw approval of drugs in accordance with statutory due
process procedures.

FDA
approval is required before any dosage form of any new unapproved drug,
including a generic equivalent of a previously approved drug, can be marketed.
All applications for FDA approval must contain information relating to product
formulation, stability, manufacturing processes, packaging, labeling and
quality control. To obtain FDA approval for an unapproved new drug, a
prospective manufacturer must also demonstrate compliance with the FDAs
current good manufacturing practices (cGMP) regulations as well as provide
substantial evidence of safety and efficacy of the drug product. Compliance
with cGMPs is required at all times during the manufacture and processing of
drugs. Such compliance requires considerable Corporation time and resources in
the areas of production and quality control.

Following
such inspections, the FDA may issue notices on Form 483 and Warning
Letters that could cause a company to modify certain activities identified
during the inspection. A Form 483 notice may be issued at the conclusion
of an FDA inspection and lists conditions the FDA inspectors believe may
violate cGMP or other FDA regulations. FDA guidelines specify that a Warning
Letter is issued only for violations of regulatory significance for which the
failure to adequately and promptly achieve correction may be expected to result
in an enforcement action.

The
FDA routinely performs inspection of pharmaceutical companies facilities. On
May 1, 2006 the FDA initiated an inspection of our facility for cGMP
compliance. This inspection will be completed over the next few weeks. While
there is no

6

assurance that
the FDA will not issue observations, we believe that we are cGMP compliant.

There
are generally two types of applications that would be used to obtain FDA
approval for pharmaceutical products:

New
Drug Application (NDA). Generally, the NDA procedure is required for drugs
with active ingredients and/or with a dosage form, dosage strength or delivery
system of an active ingredient not previously approved by the FDA. We have not
submitted an NDA to date.

Abbreviated
New Drug Application (ANDA). The Hatch-Waxman Act established a statutory
procedure for submission of ANDAs to the FDA covering generic equivalents of previously
approved brand-name drugs. Under the ANDA procedure, an applicant is not
required to submit complete reports of preclinical and clinical studies of
safety and efficacy, but instead is required to provide bioavailability data
illustrating that the generic drug formulation is bioequivalent to a previously
approved drug. Bioavailability measures the rate and extent of absorption of a
drugs active ingredient and its availability at the site of drug action,
typically measured through blood levels. A generic drug is bioequivalent to the
previously approved drug if the rate and extent of absorption of the generic
drug are not significantly different from that of the previously approved
brand-name drug.

The
FDA may deny an ANDA if applicable regulatory criteria are not satisfied. The
FDA may withdraw product approvals if compliance with regulatory standards is
not maintained or if new evidence demonstrating that the drug is unsafe or
lacks efficacy for its intended uses becomes known after the product reaches
the market.

As
previously disclosed, we currently manufacture several products that are
regulated as Drug Efficacy Studies Implementation, or DESI, products. These
products do not require the submission of an ANDA or an NDA to the FDA. These
products are, however, subject to cGMP compliance. Also, while products within
this DESI classification require no prior approval from the FDA before
marketing, they must comply with applicable FDA monographs, which specify,
among other things, required ingredients, dosage levels, label contents and
permitted uses. These monographs may be changed from time to time, in which
case we might be required to change the formulation, packaging or labeling of
any affected product. Changes to monographs normally have a delayed effective
date, so while we may have to incur costs to comply with any such changes,
disruption of distribution is not likely.

FDA
policy and its stringent requirements have increased the time and expense
involved in obtaining ANDA approvals and in complying with FDAs cGMP
standards. The ANDA filing and approval process takes approximately 12 to 18
months. The timing of final FDA approval of ANDA applications depends on a
variety of factors, including whether or not the maker of the applicable
branded drug is entitled to the protection of one or more statutory exclusivity
periods, during which the FDA is prohibited from approving generic products. In
certain circumstances, a regulatory exclusivity period can extend beyond the
life of a patent, and thus block ANDAs from being approved on the patent
expiration date. For example, the FDA may now extend the exclusivity of a
product by six months past the date of a patent expiration if the manufacturer
undertakes studies on the effect of their product in children (a so-called pediatric
extension). FDA approval is required before each dosage form of any new drug
can be marketed. Applications for FDA approval must contain information
relating to bio-equivalency, product formulation, raw material suppliers,
stability, manufacturing processes, packaging, labeling and quality control.
FDA procedures require full-scale manufacturing equipment to be used to produce
test batches for FDA approval. Validation of manufacturing processes by the FDA
also is required before a company can market new products. The FDA conducts
pre-approval and post-approval reviews and plant inspections to enforce these
rules. Supplemental filings are required for approval to transfer products from
one manufacturing site to another and may be under review for a year or more.
In addition, certain products may only be approved for transfer once new
bio-equivalency studies are conducted.

The
Hatch-Waxman Act provides incentives for generic pharmaceutical manufacturers
to challenge patents on branded pharmaceutical products and/or their methods of
use, as well as to develop non-infringing forms of the patented subject matter.
The Hatch-Waxman legislation places significant burdens on the challenger to
ensure that such suits are not frivolous, but also offers the opportunity for
significant financial reward if the challenge is successful.

If
there is a patent listed in the FDAs Orange Book at the time of filing an ANDA
with the FDA and the generic drug company intends to market the generic
equivalent prior to the expiration of that patent, the generic company files
with its ANDA a certification asserting that the patent is invalid,
unenforceable and/or not infringed (a so-called Paragraph IV Certification).
After receiving notice from the FDA that its application is acceptable for
filing, the generic company sends the

7

patent holder
and the holder of the New Drug Application (NDA) for the brand-name drug a
notice explaining why it believes that the patents in question are invalid,
unenforceable or not infringed. Upon receipt of the notice from the generic
company, the patent holder has 45 days during which to bring a patent
infringement suit in federal district court against the generic company. The
discovery, trial and appeals process in such suits can take several years.

If
a suit is commenced by the patent holder, the Hatch-Waxman Act provides for an
automatic stay on the FDAs ability to grant final approval of the ANDA for the
generic product. The period during which the FDA may not approve the ANDA and
the patent challenger therefore may not market the generic product is
30 months, or such shorter or longer period as may be ordered by the
court. The 30-month period may or may not, and often does not, coincide with
the timing of the resolution of the lawsuit or the expiration of a patent, but
if the patent challenge is successful or the challenged patent expires during
the 30-month period, the FDA may approve the generic drug for marketing,
assuming there are no other obstacles to approval such as exclusivities given
to the NDA holder.

Under
the Hatch-Waxman Act, the developer of a proposed generic drug which is the
first to have its ANDA accepted for filing by the FDA, and whose filing
includes a Paragraph IV Certification, may be eligible to receive a 180-day
period of generic market exclusivity. This period of market exclusivity may
provide the patent challenger with the opportunity to earn a return on the
risks taken and its legal and development costs and to build its market share
before competitors can enter the market.

The
Generic Drug Enforcement Act of 1992 establishes penalties for wrongdoing in
connection with the development or submission of an ANDA by authorizing the FDA
to permanently or temporarily bar companies or individuals from submitting or
assisting in the submission of an ANDA, and to temporarily deny approval and
suspend applications to market off-patent drugs. The FDA has authority to withdraw
approval of an ANDA under certain circumstances and to seek civil penalties.
The FDA can also significantly delay the approval of a pending ANDA under
certain circumstances and to seek civil penalties. The FDA can also
significantly delay the approval of a pending ANDA under its Fraud, Untrue
Statements of Material Facts, Bribery, and Illegal Gratuities Policy.
Manufacturers of drugs must also comply with the FDAs cGMP standards or risk
sanctions such as the suspension of manufacturing or the seizure of drug
products and the FDAs refusal to approve additional ANDAs. The Drug
Enforcement Agency (DEA) conducts inspections bi-annually.

Each
domestic drug product-manufacturing establishment must be registered with the
FDA. Establishments, like ours, handling controlled substances, must be
licensed by the DEA. We are licensed by both the FDA and DEA.

We
are also subject to regulation under other federal, state and local regulations
regarding work place safety, environmental protection and hazardous substance
controls, among others. Specifically, we are licensed by the Michigan Board of
Pharmacy as a manufacturer and wholesaler of prescription drugs and as a
distributor of controlled substances. We are also licensed by the Michigan Liquor
Control Commission to use alcohol in the manufacture of drugs.

Reimbursement
legislation, such as Medicaid, Medicare, and other programs, governs
reimbursement levels. All pharmaceutical manufacturers rebate to individual
states a percentage of their revenues arising from Medicaid-reimbursed drug
sales. Generic drug manufacturers currently rebate an applicable percentage of
calculated average manufacturer price (AMP) marketed under ANDAs. We believe
that the federal and state governments may continue to enact measures in the
future aimed at reducing the cost of drugs and devices to the public. We cannot
predict the nature of such measures or their impact on our profitability.

8

Environment

The
Company is subject to federal, state, and local laws and regulations relating
to the protection of the environment. These evolving laws and regulations may
require expenditures over a long period of time to control environmental
impacts. The Company has established procedures for the ongoing evaluation of
its operations to identify potential environmental exposures and assure
compliance with regulatory policy and procedures.

The
Company believes that its operations comply in all material respects with
applicable laws and regulations concerning the environment. While it is
impossible to accurately predict the future costs associated with environmental
compliance and potential compliance with environmental laws, any compliance is
not expected to require significant capital expenditures and has not had, and
is not presently expected to have, a material adverse effect on the Companys
earnings or competitive position.

Suppliers and Materials

The
principal components used in our business are active and inactive
pharmaceutical ingredients and packaging materials. Some of these components
are purchased from single sources, however, the majority of the components have
an alternate source of supply. Development and approval of our pharmaceuticals
are dependent upon our ability to procure components from FDA approved sources.
Because the FDA approval process requires manufacturers to specify their
proposed suppliers of components in their applications, FDA approval of a new
supplier would be required if components were no longer available from the
specified suppliers. We have been, and continue to be, actively identifying and
validating alternate suppliers for our components. Our purchases of components
are made from manufacturers in the U.S. and from abroad, including Sun Pharma.
See Sun Pharmaceutical Industries Limited. All purchases of components are
made in U.S. Dollars.

Although
to date no significant difficulty has been encountered in obtaining components
required for products and sources of supply are considered adequate, there can
be no assurance that we will continue to be able to obtain components as
required.

Competition

The
generic pharmaceutical industry is undergoing rapid and significant changes due
to increasing number of generic manufacturers, introduction of authorized
generics, technological advancement and consolidation among the customers. Many
of our competitors have greater financial, production, and research and
development resources and greater name recognition.

Competition
continues to be intense which could result in further erosion of prices and
profit margins. The number of generic manufacturers both domestic and from
overseas is increasing resulting in increased pricing pressure. The most
significant means of competition are price, innovation and development, timely
FDA approval, manufacturing capabilities, product quality, marketing, customer
service and reputation. Other principal competitive factors in the generic
pharmaceutical market are the ability to be the first company, or among the
first companies, to introduce a generic product after the related patent
expires,, methods of distribution, maintenance of inventories for timely
delivery, and breadth of product line. Approvals for new products may have a
synergistic effect on a companys entire product line since orders for new
products are frequently accompanied by, or bring about, orders for other
products available from the same source. We believe that price is the most
significant competitive factor in the generic industry, particularly as the
number of generic entrants with respect to a particular product increases. As
competition from other manufacturers intensifies, selling prices typically
decline. We compete by keeping our prices competitive, selecting appropriate
products, based on therapeutic segments, market sizes and number of competitors
manufacturing the products, by providing reliability in the timely delivery,
and in the continued quality, of our products.

Line of Credit

On November 17, 2005, the Company entered into a one-year, $10 million Credit
Agreement with JP Morgan Chase Bank, N.A. Under the Credit Agreement, the
lender may make loans and issue letters of credit to the Company for the
Companys working capital needs and general corporate purposes. Letters of
credit, if issued, expire one year from their date of issuance, but no later
than November 17, 2007. During Fiscal 2006, we utilized $1.5 million of the
available line and have repaid the

9

same.
Borrowings are secured by the Companys receivables, inventory and all proceeds
therefrom. Borrowings may be prepaid at any time by the Company. Interest is
payable based on LIBOR or an alternate base rate (determined by reference to
the prime rate or the federal funds effective rate), as selected by the
Company. The rate of interest is LIBOR plus 75 basis points or Prime rate minus
100 basis points (effective rates of 6.0% and 6.75%, respectively at March 31,
2006.) The Credit Agreement requires that certain financial covenants be met on
a quarterly basis. The Corporation is in compliance with these financial
covenants at March 31, 2006. There are no borrowings under this Credit
Agreement at March 31, 2006.

Employees

We had a
total of 272 and 205 full-time equivalent and contract employees at March 31,
2006 and 2005, respectively, engaged in research and development, quality
assurance, quality control, administration, sales and marketing, materials
management, facility management and manufacturing and packaging.. Most of our
scientific and engineering employees have had prior experience with
pharmaceutical or medical products companies, including Sun Pharma. See Sun
Pharmaceutical Industries Limited.

A union
represents substantially all of our permanent, full-time hourly employees. In
September 2004, we successfully negotiated a four-year collective bargaining
agreement with the union. This agreement sets forth the wage increases which
the union employees will receive in each of the next four years, and thereby
giving us and the union employees, we believe, a measure of certainty and
stability.

Product Liability and Insurance

We
currently maintain general and product liability insurance, with coverage
limits of $10 million per incident and in the aggregate. Our insurance policies
provide coverage on a claims made basis and are subject to annual renewal. Such
insurance may not be available in the future on acceptable terms or at all.
There can be no assurance that the coverage limits of such policies will be
adequate to cover our liabilities, should they occur. See Item 3. Legal
Proceedings.

Item 1A. Risk Factors:

Risks Related to Our
Business

The
following discussion highlights some of the risks related to our business and
others are discussed elsewhere in this report. These and other risks could
materially and adversely affect our business, financial condition, operating
results or cash flows and the market value of our common stock.

If we are unable to
successfully develop or commercialize new products, our operating results will
suffer.

Our
future results of operations depend to a significant extent upon our ability to
successfully commercialize new products in a timely manner. There are numerous
difficulties in developing and commercializing new products, including:


developing,
  testing and manufacturing products in compliance with regulatory standards in
  a timely fashion;
receiving
  the requisite regulatory approvals for such products in a timely manner;
the
  availability of raw materials at a competitive cost, including active
  pharmaceutical ingredients and other key ingredients;
development
  and commercializing a new products is time consuming, costly and subject to
  various factors, including litigation brought by our competitors, that may
  delay or prevent the development and commercialization of new products
  expected to market;Our gross profit may
fluctuate from period to period depending upon our product sales mix including
new launches, our product pricing, customer class of trade, and our costs for
active ingredients.

Some
specific issues that could result in a fluctuation could include any or all of
the following;


the amount
  of new product introductions;10


the level of
  competition and associated pricing pressure in the marketplace for certain
  products;
the
  availability of raw materials;The
profitability of our product sales is also dependent upon the prices we are
able to charge for all our products, the costs of excipients purchased from
third parties, and our ability to manufacture our products in a cost effective
manner.

An unaffiliated third party may make a claim for royalties which could
have a material adverse effect on our results of operations.

In
1993, we entered into a products agreement with an unaffiliated generic drug company (the Non-Affiliate). Under the agreement, two products were to be delivered to us in exchange for
royalties and options. Pursuant to the agreement, we received a formulation for one product (the Product) from the Non-Affiliate. However, we
have determined that the formula provided to us by the Non-Affiliate with respect to the Product is different than the formula approved by the FDA and manufactured and introduced by us. Accordingly, since April 2003, we
have discontinued to accrue royalties. The Product has been one of our top selling products. There is no assurance that the Non-Affiliate will not challenge our determination and make a claim
that royalties and/or options are owed. If successful, such a claim could have a material adverse effect on our results of operations.

If brand
pharmaceutical companies are successful in limiting the use of generics through
litigation, legislature and regulatory efforts, our sales of generic products
may suffer.

Many
brand pharmaceutical companies increasingly have used state and federal
legislative and regulatory and other litigation as means to delay generic
competition. These efforts have included:


pursuing new
  patents for existing products which may be granted just before the expiration
  of one patent, which could extend patent protection for additional years or
  otherwise delay the launch of our generic product;
submitting
  for changes in U. S. Pharmacopoeia which is an organization that publishes
  industry wide compendia of drug standards;
using the
  Citizens Petition process to request amendments to FDA standards;
attaching
  patent extension amendments to non-related federal legislation;
engage in
  state-by-state initiative to enact legislation that restricts substitution of
  certain generic drugs which could possibly impact products that we are
  developing.Third parties may
claim that we infringe their proprietary rights and may prevent us from
manufacturing and selling some of our products.

The
manufacture, use and sale of new products that are the subject of conflicting
patent rights have been the subject of substantial litigation in the
pharmaceutical industry. These lawsuits relate to the validity and infringement
of patents or proprietary rights of third parties. We may have to defend
against charges that we violated patents or proprietary rights of third
parties. Litigation may be costly and time-consuming, and could divert the
attention of our management and technical personnel. If it is found that we infringe
on the rights of others, we could lose our right to develop or manufacture
products or could be required to pay monetary damages or royalties to license
proprietary rights from third parties. As a result, an adverse determination in
a judicial or administrative proceeding could prevent us from manufacturing and
selling a product(s), which could negatively affect our financial condition and
results of operations.

Our policies
regarding returns and chargebacks by wholesalers may reduce our revenues in future
fiscal periods.

Based
on industry practice, generic product manufacturers including Caraco have
liberal return policies and make decisions whether or not to provide shelf
stock allowances (or credits) for inventories on hand on product that has
already been sold to the customer. If a new competitor enters the marketplace
and significantly lowers the price of any of its competing products, it is
possible that we would make a decision to reduce the price of our product. As a
result, we would be obligated to provide significant credits to our customers
who are then holding inventories of such products, which could reduce sales
revenue and gross margin for the period the credit is provided. Like our
competitors, we also give credits for chargebacks to wholesale customers that
have contracts with us for their sales to chain drug retail, group purchasing
organizations, or other retail customers. A chargeback represents an amount
payable in the future to a wholesaler for the

11

difference
between the invoice price paid to us by our wholesale customer for a particular
product and the negotiated contract price that the wholesalers customer pays
for that product. Although we establish reserves based on our historical
experience and our best estimates of the potential impact that these policies
may have, we cannot ensure that our reserves are adequate or that actual
product returns, allowances and chargebacks will not exceed our estimates,
which could adversely affect our financial condition, cash flows and market
price of our stock.

The loss of our key
personnel could cause our business to suffer.

The
success of our present and future operations will depend, to a significant
extent, upon the experience, abilities and continued services of key personnel.
We cannot assure you that we will be able to attract and retain key personnel.

Extensive industry
regulation has had, and will continue to have, a significant impact on our
business, especially our product development, manufacturing and distribution
capabilities.

All
pharmaceutical companies, are subject to complex, costly regulations that
continue to evolve as set forth by the federal government, principally the FDA
and to a lesser extent by the DEA and state government agencies. The Federal
Food, Drug and Cosmetic Act, the Controlled Substances Act and other federal
statutes and regulations govern the testing, manufacturing, storage, packing,
labeling, record keeping, safety, sales and marketing, promotion, and
distribution of our products.

Under
these regulations, we are subject to periodic routine inspection of our
facilities, procedures, operations and the testing of our products by the FDA,
the DEA and other authorities that regulate our business. These inspections are
designed to confirm that we are in compliance with all applicable regulations.
Following an inspection, the FDA may issue notices on Form 483 and /or
warning letters that could cause us to modify certain activities identified
during the inspection. A Form 483 notice is generally issued at the
conclusion of a FDA inspection and lists conditions the FDA inspectors believe
may violate cGMP or other FDA regulations. FDA guidelines specify that a
warning letter is issued only for violations of regulatory significance for
which the failure to promptly and adequately achieve correction may be expected
to result in an enforcement action. Possible sanctions could include among
others, FDA issuance of adverse publicity, fines, product recalls, total or
partial suspension of production and/or distribution, suspension of the FDAs
review of product applications, enforcement actions, injunctions, and civil or
criminal prosecution. These sanctions, if imposed, could materially harm our
operating results and financial condition. Under certain circumstances, the FDA
also has the authority to revoke previously granted drug approvals. Although we
have internal compliance programs in place these programs may not meet
regulatory agency standards or if compliance is deemed deficient in any
significant way, it could materially harm our business. Certain of our vendors
that sell to us are also subject to similar regulation and periodic
inspections.

Sales of our products
may continue to be adversely affected by the continuing consolidation of the
distribution network and the concentration of customers.

Our
principal customers are wholesale drug distributors, major retail drug store
chains and managed care. These customers comprise a significant part of the
distribution network for pharmaceutical products in the U.S. This distribution
network is continuing to undergo significant consolidation marked by mergers
and acquisitions among wholesale distributors and the growth of large retail
drug store chains and managed care companies. As a result, a small number of
large wholesale distributors and large chain drug stores and managed care
providers control a significant share of the market. We expect that
consolidation of drug wholesalers, retailers and managed care providers will increase
pricing and other competitive pressures on drug manufacturers, including
Caraco.

Even if we are able to obtain regulatory
approvals for our new pharmaceutical products, the success of those products is
dependent upon market acceptance. Levels of market acceptance for our new
products could be impacted by several factors, including:


availability
  of alternate product from our competitors;
the timing
  of our market entry;
acceptance
  of our product on government and private formularies;12


and the
  prices that we sell our products at versus our competitors prices.These factors
amongst others are beyond our control and could materially have a negative
effect on operations and the market value of our common stock.

From time to time a relatively small group of
products could represent a significant portion of our sales and if the products
sales of these product decline unexpectedly it could have a negative material
effect on our business and could cause our market value of our common stock to
decline.

Sales
of a limited number of our products often represent a significant portion of
our net revenues and net earnings. If the volume or pricing of our largest
selling products declines in the future, our business, financial position and
results of operations could be materially adversely affected, and the market
value of our common stock could decline.

Our competitors may be able to develop
products and processes competitive with or superior to our own for many
reasons, including that they may have:


proprietary
  processes or product delivery systems;
larger
  research and development and marketing staffs;
larger
  production capacity in general or for a given product;
more
  financial resources than Caraco;
more
  experience in developing new drugs;Our reporting and
payment obligations under Medicaid and other governmental programs are complex
and may change periodically based upon new guidelines provided those agencies.

Although
the regulations regarding reporting and payment obligations are complex, we
believe we are properly and accurately calculating and reporting the amounts
owed in respect of Medicaid and other governmental pricing programs. Our
calculations are subject to review and challenge by the applicable governmental
agencies, and it is possible that any such review could result in material
changes. Any governmental agencies may initiate an investigation of the Company
and could impose, based on a claim of violation of fraud and false claims laws
or otherwise, civil and/or criminal sanctions, including fines, penalties and
possible exclusion from federal health care programs (including Medicaid and
Medicare).

Sun Global could determine not to assist us
in our research and development and Sun Pharma could cease supplying support
and raw materials

Collectively
Sun Global and Sun Pharma could determine that its own research and development
takes precedent over the research and development it provides to Caraco. This
could cause a gap in our research and development timelines until Caraco could
increase its own capabilities. This gap could possibly cause future growth
concerns until resolved. Sun Pharma which supplies us raw material could face
supply issues or not be capable of supplying the raw material for certain
products we manufacture. This could cause lower sales or possibly lower margins
until we negotiate new suppliers and gain the requisite approvals to
manufacture our product with a new raw material source.

A significant portion
of our net sales are from the sales of a limited number of customers. Should we
lose a particular contract with a customer or the customer is acquired by a
non-customer, our sales and operational results could face a significant
decline.

A
significant portion of our net revenues are derived from sales to a limited
number of customers. As such, a reduction in or loss of business with one
customer, or if one customer were to experience difficulty in paying us on a
timely basis, our business, financial position and results of operations could
be materially adversely affected.

Our product liability insurance may not be
enough to mitigate risk associated with our products

13

Though
we believe we carry adequate product liability insurance it is possible that a
lawsuit or lawsuits could exceed our insurance levels and have a negative
impact on our financial results

We manufacture our product line predominately
from one FDA approved facility. There is a possibility that our production
could be negatively impacted by a closure of this facility

Should
our facility located in Detroit incur a closure of any type it would have a
negative impact on our results. We carry a limited amount of finished goods on
hand and much of our inventory is either work in progress or is in bulk
amounts. Should we experience an act of God that closes our facility, or
production is stopped or a power outage continues for an inordinate period of
time, it could have a significant negative effect on our results.

Any
of these factors and others could have a material adverse effect on our
business, financial position and results of operations and could cause the
market value of our common stock to decline.

Item 1B. Unresolved Staff Comments

None

Item 2. Properties.

The Facilities

Our
entire property, plant, equipment and intellectual property are free of any
mortgages, liens or similar restrictions. Our primary facility located in
Detroit, Michigan, which was designed and constructed to our specifications and
completed in 1994, contains our production, research and development and
corporate office. During Fiscal 2006, we added approximately 10,000 square feet
of manufacturing space, giving us a total of 80,000 square feet of usable space. The manufacturing portion of the facility has a special building and systems
design, with each processing area equipped with independent zone and air
handling units to provide temperature and humidity control to each room. These
air handling units are designed to prevent product cross contamination through
the use of pre-filter and final HEPA filter banks. All processing air quarters
are maintained in a negative pressure mode using laminar airflow design. This
system of airflow provides a measurable control of air borne particulate
entrapment in each room. Environmental segregation of individual rooms within a
particular zone is accomplished by the use of duct HEPA filter booster fan
units that facilitate the isolation and confinement of room activities. These
special dynamics provide an added dimension and flexibility in product
selection and processing techniques.

We
have leased an approximately 55,000 square foot facility located near our
primary facility for finished goods distribution, storage of inventory and
office space. The lease expires in 2009 and includes an option to renew until
2011.

We
also have leased an approximately 7,000 square foot office space for our
administrative, sales and marketing and accounting offices. The lease expires
in 2009.

We
have invested approximately $3.6 million during Fiscal 2006 as compared to $3.3
million during twelve months ending March 31,2005 to upgrade our facilities. We
have invested approximately $0.6 million during the Transition Period as
compared to $1.3 million during the corresponding period of 2004. We invested
$4.0 million in 2004 and $2.4 million in 2003

We
believe the existing facilities are suitable and adequate for our current level
of operations and anticipated growth in the near future. We also believe that
our facilities are adequately covered by insurance.

Item 3. Legal Proceedings.

As
previously disclosed, on June 9, 2005, Novo Nordisk A/S and Novo Nordisk, Inc.
(Novo Nordisk) filed a complaint in the United States District Court for the
Eastern District of Michigan alleging that the Companys filling of an ANDA
seeking approval to market its generic version of Novo Nordisks Prandin® drug
product infringed Novo Nordisks patent, which expires June 12, 2018. Novo
Nordisk seeks an order from the Court which, among other things, directs the
FDA not to approve Caracos ANDA any earlier than the claimed expiration date.
The ANDA filed by Caraco contains a Paragraph IV certification challenging the
Novo Nordisk patent. We believe that the Novo Nordisk patent is invalid and/or
will not be infringed by Caracos manufacture, use or sale of the product, and
we intend to vigorously defend this action in order to

14

capitalize on
potential 180 days of marketing exclusivity available for this product.

As
previously disclosed, on September 22, 2004, Ortho-McNeil Pharmaceutical, Inc.
(Ortho-McNeil) filed a complaint in the United States District Court for the
Eastern District of Michigan alleging that the Companys filing of an ANDA
seeking approval to market its generic version of Ortho-McNeils Ultracet® drug
product infringed Ortho-McNeils patent, which expires on September 6, 2011.
Ortho-McNeil seeks an order from the Court which, among other things, directs
the FDA not to approve Caracos ANDA any earlier than the claimed expiration
date. The ANDA filed by Caraco contained a Paragraph IV Certification
challenging the Ortho-McNeil patent. We believe that the Ortho-McNeil patent is
invalid and/or will not be infringed by Caracos manufacture, use or sale of
the product, and we intend to vigorously defend this action. Since this action,
Ortho-McNeil has entered into a license agreement with another manufacturer and
has launched its product generically while another manufacturer has launched
its approved generic at risk. On October 8, 2005, arguments were heard in the
US District Court in the Eastern District of Michigan, on our motion for
summary judgment on the issue of non-infringement. On October 19, 2005 our
motion for summary judgment was granted in our favor. On December 19, 2005, the
FDA approved the manufacture, use and sale of the product. Ortho-McNeil has
filed an appeal of the finding of non-infringement by the Eastern District of
Michigan. Additionally, the United States Patent and Trademark Office has
allowed Ortho-McNeils request for a reissue patent that, when issued,
Ortho-McNeil contends will be infringed by Caracos now-marketed product. We believe
that, like its original patent, Ortho-McNeils reissue patent will be invalid
and unenforceable.

As
previously disclosed, on February 12, 2003, C. Arnold Curry filed a complaint
in the Wayne County Circuit Court alleging breach of a written employment
agreement. Dr. Curry sought 175,000 shares of our common stock (35,000 shares
for each of the first five ANDAs approved by the FDA). We and the plaintiff
each filed a motion for summary disposition. Both parties motions were denied,
and the parties submitted the matter to binding arbitration. In connection with
the submission to arbitration, the parties agreed that Mr. Curry would receive
a minimum of 15,000 shares of common stock. On April 20, 2006, the arbitrator
entered a determination of no cause of action against Mr. Curry and in favor of
the Company.

From
time to time, we are also involved in other legal proceedings incidental to our
normal business activities, and while the outcome of any such proceedings
cannot be accurately predicted, we do not believe the ultimate resolution of
any existing matters would have a material adverse effect on our financial
position or results of operations.

Item 4. Submission of Matters to a Vote of
Security Holders.

We
did not submit any matters to a vote of security holders in the fourth quarter
of Fiscal 2006 through the solicitation of proxies or otherwise.

PART II

Item 5. Market for Registrants Common
Equity, Related Stockholder Matters and Issuers and Affiliates Purchases of Equity
Securities.

Our
common stock is listed on the American Stock Exchange under the symbol CPD.
The following table sets forth for Fiscal 2006, the Transition Period and the
year ended December 31, 2004, the high and low sales prices for each of the
applicable quarters.

Fiscal
  2006

High

LowFirst
  Quarter

$
8.97

$
7.06Second
  Quarter

$
9.29

$
8.10Third
  Quarter

$
9.81

$
7.50Fourth
  Quarter

$
13.42

$
8.762005

High

LowTransition
  Period

$
9.32

$
7.4415

2004

High

LowFirst
  Quarter

$
13.74

$
7.31Second
  Quarter

$
11.94

$
9.40Third
  Quarter

$
10.24

$
6.80Fourth
  Quarter

$
10.00

$
6.82As
of June 7, 2006 there were 93 registered holders of our Common Stock.

During
Fiscal 2006, we issued to Sun Global 4,896,000 preferred shares in exchange for
the transfer of nine products. During the Transition Period, we issued to Sun
Global 1,632,000 preferred shares in exchange for the transfer of three
products. During 2004, we issued to Sun Global 4,352,000 preferred shares in
exchange for the transfer of eight products (of which 544,000 preferred shares
were earned during 2003 for one product transfer) pursuant to our current
products agreement.

Pursuant
to various stock and option purchase agreements between Sun Pharma and three
stockholders and their affiliates, Sun Pharma acquired in January and February,
2004, 3,452,291 shares of common stock and rights to acquire options for
1,679,066 shares of common stock. The shares were acquired for $9.00 per share
and the rights to the options were acquired for $9.00 less the exercise price
of each option.

During
2004, we issued 1,679,066 shares of common stock to Sun Pharma against exercise
of stock options, which Sun Pharma had acquired from two former directors
during the first quarter of 2004.

All
shares of preferred stock and common stock specified above that were issued by
the Company were issued pursuant to exemptions from registration under Section
4(2) of the Securities Act of 1933.

Dividend Policy

We
never have declared or paid cash dividends on our common stock. We currently
intend to retain all future earnings for the operation and expansion of our
business. We do not anticipate declaring or paying cash dividends on our common
stock in the foreseeable future. Any payment of cash dividends on the common
stock will be at the discretion of the Board of Directors and will depend upon
our results of operations, earnings, capital requirements, and other factors
deemed relevant by our Board of Directors.

Item 6. Selected Financial Data

The
following selected financial data of the Company is qualified by reference to
and should be read in conjunction with the financial statements and notes
thereto and other financial information included elsewhere herein. The summary
balance sheet data as of March 31, 2006 and 2005 and summary statements of
operations data for the years ended December 31, 2003 and 2004, the three month
period ended March 31, 2005 and the year ended March 31, 2006 are derived from
and qualified by reference to the audited financial statements of the Company
which are included elsewhere herein. The summary balance sheet data as of December
31, 2004, 2003 and 2002 and the summary of the statements of operations for the
years ended December 31, 2004, 2003, 2002 and 2001 are derived from the audited
financial statements of the Company which are not included herein and have been
previously filed with the SEC.

In
January 2005, the Company changed its fiscal year from December 31st to March
31st. The results from the twelve month period March 31, 2005 were derived from
the Companys published quarterly results and are unaudited. Accordingly, this
twelve month period is not disclosed in the accompanying financial statements.
It is included in the selected financial data for comparative purposes only as
defined below.

16

Financial Data

(In thousands, except per share
data)Statements
of operations data

Year ended
March 31,2006

2005(Audited)

(Unaudited)Net sales

$
82,789

$
64,116Cost of
  goods sold


41,873


26,930Gross profit


40,916


37,185Selling,
  general and administrative expenses


8,183


5,874Research and
  development costs  affiliate  non cash


35,055


26,769Research and
  development costs  other


8,437


6,640Operating
  loss


(10,759
)

(2,097
)Other income
  / (expenses)


336


(181
)Net Loss


(10,423
)

(2,278
)Net Loss per
  shareBasic


(0.39
)

(0.09
)Diluted


(0.39
)

(0.09
)Weighted
  Average Shares Outstanding:Basic


26,392


26,348Diluted


26.392


26,348Financial Data (continued)

(In
        thousands, except per share data)Statements
        of operations data
    
    Transition
        Period
        Ended
        March 31,
    
    Year
        ended
        December 31,2005
    
    2004
    
    2003
    
    2002
    
    2001Net
        sales
    
    $
    17,337
    
    $
    60,340
    
    $
    45,498
    
    $
    22,381
    
    $
    5,922Cost
        of goods sold
    
    
    7,879
    
    
    24,441
    
    
    19,507
    
    
    12.047
    
    
    4,186Gross
        profit
    
    
    9,457
    
    
    35,899
    
    
    25,991
    
    
    10,334
    
    
    1,736Selling,
        general and administrative expenses
    
    
    1,879
    
    
    5,277
    
    
    7,363
    
    
    3,828
    
    
    2,680Research
        and development costs  affiliate  non cash
    
    
    10,200
    
    
    24,397
    
    
    3,103
    
    
    3,887
    
    
    0Research
        and development costs  other
    
    
    1,720
    
    
    6,053
    
    
    3,112
    
    
    3,348
    
    
    3,080Operating
        (loss) / income
    
    
    (4,342
    )
    
    172
    
    
    12,412
    
    
    (730
    )
    
    (4,024
    )Other
        income / (expense)
    
    
    21
    
    
    (371
    )
    
    (1,189
    )
    
    (1,526
    )
    
    (1,734
    )Net
        (Loss) / Income
    
    
    (4,322
    )
    
    (199
    )
    
    11,223
    
    
    (2,256
    )
    
    (5,757
    )Net
        (Loss) / Income per shareBasic
    
    
    (0.16
    )
    
    (0.01
    )
    
    0.46
    
    
    (0.10
    )
    
    (0.29
    )Diluted
    
    
    (0.16
    )
    
    (0.01
    )
    
    0.44
    
    
    (0.10
    )
    
    (0.29
    )Weighted
        Average Shares Outstanding:Basic
    
    
    26,348
    
    
    24,734
    
    
    24,137
    
    
    22,031
    
    
    21,173Diluted
    
    
    26,348
    
    
    24,734
    
    
    25,482
    
    
    22,031
    
    
    21,17317

Financial Data (continued)

(In thousands)As at March 31,

As at December 31,Balance
Sheet Data

2006

2005

2004

2003

2002Current
  assets

$
62,282

$
32,938

$
24,857

$
18,918

$
12,106Property,
  plant and equipment, net


14,960


12,897


12,546


9,506


7,747Total assets


77,242


45,835


37,403


28,424


19,853Current
  liabilities


20,864


14,149


11,627


20,008


13,753Long term
  debt











13,395


25,724Total
  liabilities


20,864


14,149


11,627


33,404


39,476Stockholders
  Equity (Deficit)


56,378


31,686


25,776


(4,980
)

(19,623
)Working
  Capital (Deficiency)


41,418


18,789


13,230


(1,090
)

(1,647
)Item 7. Managements Discussion and Analysis
Of Financial Condition and Results of Operations.

The
following discussion and analysis provides information that the management
believes is relevant to an understanding of our results of operations and
financial condition. The discussion should be read in conjunction with the
financial statements and notes thereto.

Critical Accounting Policies and Estimates

Our
discussion and analysis of our financial condition and results of operations
are based on our financial statements, which have been prepared in accordance
with accounting principles generally accepted in the United States. Certain of
our accounting policies are particularly important to the portrayal of our
financial position and results of operations and require managements
subjective judgments. As a result, these judgments are subject to an inherent
degree of uncertainty. In applying these policies, management makes estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates. Our
significant estimates include our provisions for price adjustments (primarily
chargebacks), valuation allowances for deferred tax assets, and valuation of
overhead components in inventory.

We
believe the following critical accounting policies affect our more significant
judgments and estimates used in the preparation of our financial statements.
There have neither been material changes to our critical accounting policies
for the periods presented nor any material quantitative revisions to our
critical accounting estimates for the periods presented.

18

Revenue Recognition

Revenue
from product sales, net of estimated provisions, is recognized when there is
persuasive evidence that an arrangement exists, shipment of the goods has
occurred, the selling price is fixed or determinable, and collectibility is
reasonably probable. Our customers consist primarily of large pharmaceutical
wholesalers who sell directly into the retail channel. Provisions for sales
discounts, and estimates for chargebacks, rebates, and product returns are
established as a reduction of product sales revenue at the time revenues are
recognized, based on historical experience and current market trends adjusted
to reflect known changes in the factors that impact these reserves. These
revenue reductions are reflected as a direct reduction to accounts receivable
through an allowance.

Chargebacks

Chargebacks
represent our most significant provision against gross accounts receivable and
related reduction to gross revenue. Chargebacks are credits given to our
wholesale customers for the price difference on our product they sell (at a
contractual price) to retail, chain stores, and managed care organizations at
prices lower than we sell to our wholesale customer. We record an estimate at
the end of the reporting period to the wholesaler of the amount to be charged
back to us, over and above those already received by us. Such estimated
amounts, in addition to certain other deductions, are deducted from our gross
sales to determine our net revenues. We have recorded provisions for
chargebacks based upon various factors, including current contract prices,
historical trends, and our future expectations. The amount of actual chargebacks
claimed could be either higher or lower than the amounts we accrued. Changes in
our estimates, if any, would be recorded in the income statement in the period
of the change. If we over or under estimate the amount that will ultimately be
charged back to us by our wholesaler customers, there could be a material
impact on our financial statements.

We
consider the following factors in the determination of the estimates of
chargebacks.

1.
We consider
  the historical data of chargebacks as a percentage of sales, as well as the
  various chargeback reports that we receive from the customers.2.
Volume of
  product sold to wholesalers and the average chargeback rates, on a quarterly
  and annualized basis are applied to current period and annual product sales
  to make a realistic accrual.3.
The sales
  trends for future estimated prices, wholesale acquisition cost (WAC), the
  contract prices with the retailers, chain stores and managed care
  organizations (end-users). Our prices with the wholesalers and end users are
  contracted prices.Shelf Stock Adjustments

Shelf
stock adjustments are credits issued to our customers to reflect decreases in
the selling prices of our product. These credits are customary in the industry
and are intended to reduce the customers inventory cost to better reflect
current market prices. The determination to grant a shelf stock adjustment to a
customer following a price decrease is at our discretion.

Factors
considered when recording a reserve for a shelf stock adjustments include
estimated launch dates of competing products based on market intelligence,
estimated decline in market price of our product based on historical experience
and input from customers and levels of inventory held by customers at the date
of the adjustments as provided by them.

Product returns and other allowances

In
the pharmaceutical industry, customers are normally granted the right to return
product for credit if the product has not been used prior to its expiration date.
Our return policy typically allows product returns for products within a
12-month window from six months prior to the expiration date and up to six
months after the expiration date. We estimate the level of sale, which will
ultimately be returned pursuant to our return policy, and record a related
reserve at the time of sale. These amounts are deducted from our gross sales to
determine our net revenues. Our estimates take into consideration historical
returns of our products and our future expectations. We periodically review the
reserves established for returns and adjust them based on actual experience, if
necessary. The primary factors we consider in estimating our potential product
returns include shelf life of expiration date of each product and historical
levels of expired product returns. In case we become aware

19

of any returns
due to product related issues, such information from the customers, is used to
estimate an additional reserve. The amount of actual product return could be
either higher or lower than the amounts we accrued. Changes in our estimates,
if any, would be recorded in the income statement in the period of the change.
If we over or under estimate the quantity of product which will ultimately be
returned, there may be a material impact to our financial statements.

Discounts
(trade and prompt payment discounts) are accrued at the end of every reporting
period based on the gross sales made to the customers during the period and
based on their terms of trade. We review the contracts between the customer and
us as well as the historical data and percentages to estimate the discount
accrual.

Customer
rebates are estimated at every period end, based on direct or indirect
purchases. If the purchases are direct, the rebates are recognized when
products are purchased and a periodic credit is given. For indirect purchases,
the rebates are recognized based on the terms with such customer. Medicaid
Rebates are estimated based on the historical data we receive from the public
sector benefit providers, which is based on the final dispensing of our product
by a pharmacy to a benefit plan participant.

Doubtful Accounts

Doubtful
accounts are estimated based on the data available from external sources,
including information on financial condition of customers. Also, a regular
review of past due receivables is done on a quarterly basis to identify and
make provision for such receivables not expected to be recovered.

Our
gross sales for Fiscal 2006 were $200.4 million, as compared to $141.9 million
for Fiscal 2005. Chargebacks, returns, discounts and other customary customer
deductions and other sales costs constituted approximately 59% for Fiscal 2006
compared to 54% for Fiscal 2005. Net sales for Fiscal 2006 were $82.8 million,
as compared to $64.1 million for Fiscal 2005. The primary cause of increase in
the sales diluters by almost 4% between the periods is the impact of price
erosions for the products we sell and the corresponding impact of such price
erosions on chargebacks

The
following is a roll forward of the provisions for chargebacks, shelf stock
adjustments, returns and allowances and estimated doubtful account allowances
during Fiscal 2005 and Fiscal 2006.

($ in Millions)

Allowances charged to Gross
SalesBalances at
  begining of
  period

Current
  Period

Prior Period

Credits taken
  by customers

Balance at
  the end of
  periodFor Fiscal 2005Chargebacks
  & shelf stock adjustments


16,051


72,505


-0-


68,746

$
19,810Returns and
  other allowances


878


4,258


-0-


4,016


1,120Doubtful
  Accounts


500


-0-


-0-


400


100For Fiscal
  2006Chargebacks
  & shelf stock adjustments

$
19,810

$
111,525


-0-

$
119,868

$
11,467Returns and
  other allowances


1,120


7,471


-0-


7,091


1,500Doubtful
  Accounts


100


-0-


-0-


-0-


10020

Income Taxes

As
part of the process of preparing our financial statements we are required to
estimate our income taxes in each of the jurisdictions in which we operate. We
account for income taxes by the liability method. Under this method, deferred
income taxes are recognized for tax consequences in future years of differences
between the tax bases of assets and liabilities and their financial reporting
amounts at each year-end, based on enacted laws and statutory tax rates
applicable for the differences that are expected to affect taxable income.
Valuation allowances are provided if based upon the weight of available
evidence, it is more likely than not that some or all of the deferred tax
assets will not be realized. We have not recorded any federal tax provision or
benefit for the Fiscal 2006, the Transition Period or for the years ended
December 31, 2004 and 2003. We have provided a valuation allowance for the full
amount of our net deferred tax assets since realization of any future benefit
from deductible temporary differences and net operating loss carry forwards
cannot be sufficiently assured at March 31, 2006, March 31, 2005, December 31,
2004 and 2003. At March 31, 2006, we had federal net operating loss
carryforwards of approximately $58.8
million available to reduce future taxable income, which will expire between
2007 and 2017. Under the provisions of the Internal Revenue Code, certain
substantial changes in our ownership may result in a limitation on the amount
of net operating loss carry forwards which can be used in future years. We
believe that ownership changes to date will not limit future utilization of net
operating loss carryforwards.

Inventory

We
value inventories at the lower of cost or market. We determine the cost of raw
materials, work in process and finished goods using the specific identification
cost method. We analyze our inventory levels quarterly and write down inventory
that has become obsolete and inventory that has a cost basis in excess of its
expected net realizable value. Expired inventory is disposed of and the related
costs are written off. Materials acquired for R&D on products yet to be
launched are written off in the year of acquisition. The determination of
whether or not inventory costs will be realizable requires estimates by
management. A critical estimate in this determination is the estimate of the
future expected inventory requirements, whereby we compare our internal sales
forecasts to inventory on hand. Actual results may differ from those estimates
and inventory write-offs may be required. We must also make estimates about the
amount of manufacturing overhead to allocate to our finished goods and work in
process inventories. Although the manufacturing process is generally similar
for our products, we must make judgments as to the portion of costs to allocate
to purchased product, work in process and finished goods, and such allocations
can vary based upon the composition of these components and the fact that each
product produced does not necessarily require the same amount of time or effort
for the same production step. Accordingly, the assumptions we make can impact
the value of reported inventories and cost of sales.

FDA Compliance

The FDA commenced an inspection of the Companys facility on May 1, 2006. This is a
routine inspection which will continue over the next few weeks. While there is
no assurance that the FDA will not issue observations, we believe that we are
cGMP compliant.
21

Overview of Fiscal 2006

We
recorded net sales of $82.8 million during Fiscal 2006 compared to $64.1
million during Fiscal 2005. We have generated cash from operations of $8.9
million during Fiscal 2006 as compared to $20.6 million during Fiscal 2005.
This cash was generated after funding our working capital requirements of $17.5
million and $4.9 million during the relevant periods. We incurred a net loss of
$10.4 million during Fiscal 2006 compared to net loss of $2.3 million during
Fiscal 2005. The higher loss was primarily due to higher non-cash research and
development expense (R&D) of $35.1 million during Fiscal 2006 as compared to
$26.8 million during Fiscal 2005. This non-cash R&D expense relates to nine
products passing their bio-equivalency studies and related value of the
preferred stock issued to Sun Global during Fiscal 2006 as compared to eight
products during Fiscal 2005. At March 31, 2006, we had stockholders equity of
$56.4 million as compared to stockholders equity of $31.7 million at March 31,
2005.

In
January 2005, the Company changed its fiscal year end from December 31 to March
31. The following discussion of historical operating results compares Fiscal
2006 to Fiscal 2005. Results from Fiscal 2005 were derived from the Companys
published quarterly results and are unaudited. Accordingly, this twelve month
period is not disclosed in the accompanying financial statements. It is
included in this discussion for comparative purposes only. For the previous
calendar year ended December 31, 2004, the comparison is to the calendar year
ended December 31, 2003. The discussion of historical operating results also includes
and compares the three months ended March 31, 2006 to the Transition Period.
Results from the three month period ended March 31, 2006 were derived from the
Companys published quarterly results and are unaudited.

Fiscal 2006 Compared to Fiscal 2005

Year ended March 31,2006

2005(Audited)

(Unaudited)Statement
of operations data

(in thousands, except per share
data)$


$Net sales


82,789


64,116Cost of
  goods sold


41,873


26,930Gross profit


40,916


37,186Selling,
  general and administrative expense


8,183


5,874Research and
  development costs  affiliate  non cash


35,055


26,769Research and
  development costs  other


8,437


6,640Operating
  loss


(10,759
)

(2,097
)Other income
  (expense)


336


(181
)Net Loss


(10,423
)

(2,278
)Net Loss per
  shareBasic


(0.39
)

(0.08
)Diluted


(0.39
)

(0.08
)Weighted
  Average Shares Outstanding:Basic


26,392


26,348Diluted


26.392


26,34822

Net
Sales. Net sales for the relevant periods of 2006 and
2005 were $82.8 and $64.1 million, reflecting an increase of over 29%. The
increase is primarily due to the higher production, new product launches
(primarily the sales of our generic equivalent of Ultracet® and increased
marketing of our products to new and existing customers. Currently, we
manufacture and market all except one of the approved products. Sales of three
products accounted for approximately 70% and 77% of net sales for the relevant
periods of 2006 and 2005, respectively. See Note 1 to Financial Statements 
Revenue Recognition for explanation of the determination of net sales.

Gross Profit. We earned a gross profit
of
$40.9 million as compared to a gross profit of $37.2 million during the
relevant periods, reflecting an increase of 10%. The increase in gross profit
for the relevant periods is primarily due to higher sales, new product
launches, an improved balance in the mix of customers or the class of trade and
product selection being sold partially offset by price erosion during the year.

The
gross profit margin declined to 49% as compared to 58% during the relevant
periods. The decrease was primarily the result of increased competition, both
domestic and foreign, resulting in erosion of prices and profit margins.

Selling, General and Administrative
Expense.
Selling, general and administrative expense during the relevant periods were
$8.2 million and $5.9 million, representing an increase of 39%. The selling,
general and administrative expense have increased to 9.9% of net sales as
compared to 9.2% of net sales during the relevant periods.

The
increase in SG&A for Fiscal 2006 over Fiscal 2005 was due to an increase in
regulatory costs for compliance with SEC regulations, including Sarbanes-Oxley
requirements ($0.4 million), primarily additions to management and associated
compensation ($0.7 million), higher taxes on property ($0.2 million) and higher
SG&A expenses associated with higher sales volumes as well as a one time
charge ($0.3 million) associated with our decision to forego an acquisition of
real property in favor of alternate expansion opportunities.

Research
and Development Expenses. Total R&D expenses for
the relevant periods were $43.5 million for Fiscal 2006 and $33.4 million for
Fiscal 2005. Cash research and development expenses were $8.4 million for
Fiscal 2006 and $6.6 million during Fiscal 2005. We incurred non-cash research
and development expenses (technology transfer cost) of $35.1 million for the
4,896,000 shares of preferred stock for nine product transfers as compared to
$26.8 million for the 4,352,000 shares of preferred stock for eight product
transfers. The substantially higher R&D expenses, both cash and non-cash,
represent increased R&D activities.

Interest
Expense. We incurred approximately four thousand dollars
interest expense during Fiscal 2006 on a short term borrowing from JPMorgan
Chase Bank  See Note 2 to Financial Statements. Interest expense on loans from
the EDC, ICICI Bank, the Bank of Nova Scotia and Citibank was $0.2 million
during Fiscal 2005. The decrease in the amount of interest is primarily due to
paying off the entire loans due to the EDC, ICICI Bank, the Bank of Nova Scotia
and CitiBank during Fiscal 2005.

Results of Operations. We incurred a net
loss of $10.4 million and $2.3 million during the relevant periods. The lower
results of operation are primarily due to higher non-cash R&D expenses and
higher Cash R&D expenses.

Three months ended March 31, 2006 compared
with the Transition
Period


23

2006
(Unaudited)

Transition
Period
(Audited)Statement
of operations data

(in thousands, except per share
data)Net
sales

$
24,701

$
17,337Cost of
goods sold


12,011


7,879Gross
profit


12,690


9,457Selling,
general and administrative
  expenses


2,481


1,879Research
and development costs  affiliate
   non cash


14,008


10,200Research
and development costs - other


2,925


1,720Operating
loss


(6,724
)

(4,342
)Other
income (expenses)


185


21Net
Loss


(6,539
)

(4,322
)Net Loss
per shareBasic


(0.25
)

(0.16
)Diluted


(0.25
)

(0.16
)Weighted
Average Shares Outstanding:Basic


26,392


26,348Diluted


26,392


26,348Net
Sales. Net sales for the relevant periods of 2006 and
2005 were $24.7 million and $17.3 million, reflecting an increase of almost
43%. The increase is primarily due to the higher production, new product
launches and increased marketing of our products to new and existing customers.
Currently, we manufacture and market all except one of the approved products.
See Part I, Item 1. Business  Current Status above. Sales of four and three
products accounted for approximately 76% and 77% of net sales for the relevant
periods, respectively. See Note 1 to Financial Statements  Revenue
Recognition.

Gross Profit. We earned a gross profit
of
$12.7 million as compared to a gross profit of $9.5 million during the relevant
periods, reflecting an increase of 34%. The improvement was primarily due to
higher sales volumes during the three months ended March 31, 2006 compared to
the Transition Period.

The
gross profit margin declined to 51% as compared to 55% during the relevant
periods. The decrease was primarily the result of increased competition, both
domestic and foreign, resulting in erosion of prices and profit margins.

Selling, General and Administrative
Expenses.
Selling, general and administrative expenses during the relevant periods were
$2.5 million and $1.9 million, representing an increase of 32%. The selling,
general and administrative expenses have reduced to 9.4% of net sales compared
to 10.8% of net sales during the relevant periods.

The
increase in SG&A during the relevant periods has been due to an increase in
regulatory costs for compliance with SEC regulations, including Sarbanes-Oxley
requirements ($0.1 million), primarily additions to management and associated
compensation ($0.2 million), and higher SG&A expenses associated with
higher sales volumes.

Research
and Development Expenses. Total R&D expenses for
the relevant periods were $16.9 million and $11.9 million. Cash research and
development expenses were $3.0 million and $1.7 million during the relevant
periods. We incurred non-cash research and development expenses (technology
transfer cost) of $14.0 million for the 1,632,000 shares of preferred stock for
three product transfers as compared to $10.2 million for the 1,632,000 shares
of preferred stock for three product transfers. The substantially higher
R&D expenses, both cash and non-cash, represent increased R&D
activities.

Interest
Expense. Interest expense on loans from the JP Morgan
Chase Bank was approximately four thousand dollars during the relevant period of 2006. There
was no corresponding expense during the Transition Period.

24

Results
of Operations. We incurred a net loss of $6.5 million
and $4.3 million during the relevant periods. The lower results of operation
are primarily due to higher non-cash R&D expenses.

Year
Ended December 31, 2004 Compared with Year Ended December 31, 2003

Net
Sales. Net sales for 2004 and 2003 were $60.3 million
and $45.5 million, respectively, reflecting an increase of almost 33%. The
increase is due to the higher production and marketing of our products to new
and existing customers. Currently, we manufacture and market all except one of
the approved products. See Part I, Item 1. Business  Current Status above.
Sales of two products accounted for approximately 74% and 87% of net sales in
2004 and 2003, respectively.

Gross
Profit. We earned a gross profit of $35.9 million for
2004 as compared to a gross profit of $26.0 million for 2003, reflecting an
increase of 38% over 2003. The improvement was primarily due to higher sales
volumes with improved margins due to product mix in the current period as
compared to the corresponding period of 2003 and ability to absorb operational
overheads due to higher sales.

In
addition to increased sales, the gross profit margin has marginally improved to
59% in 2004 as compared to 57% for 2003. The increase was primarily the result
of:


Change in
  the product mix of sales.
Reduction in
  manufacturing costs due to increased batch sizes.
Further
  improved efficiency in the overall manufacturing process associated with
  higher utilization of plant capacity.
Utilization
  of newly installed larger and faster equipment to achieve economies of scale.Selling,
General and Administrative Expenses. Selling, general
and administrative expenses for 2004 and 2003 were $5.3 million and $7.4
million, respectively, representing a decrease of 28%. Selling, general and
administrative expenses have decreased to 9% of net sales for 2004 as compared
to 16% of net sales for 2003.

The decrease
in SG&A of approximately $2.1 million in 2004 was primarily due to one time
recording of variable compensation expense during 2003 on the extension of the
term of two former directors stock options and severance compensation to a
former CEO.

Research
and Development Expenses. Total R&D expense for
2004 of $30.5 million was substantially higher as compared to $6.2 million
during 2003. Cash research and development expenses of $6.1 million for 2004
were higher by 97% when compared with $3.1 million incurred for 2003. We
incurred non-cash research and development expenses (technology transfer cost)
of $24.4 million for the 3,808,000 shares of preferred stock for seven product
transfers during 2004 as compared to $3.1 million for the 544,000 shares of
preferred stock for one product transfer during 2003. The substantially
higher R&D expenses, both cash and non-cash, represent increased R&D
activities.

Interest
Expense. Interest expense on loans from the EDC, Sun
Pharma and its affiliates, ICICI Bank, the Bank of Nova Scotia and Citibank,
was $0.4 million and $1.2 million for 2004 and 2003, respectively. The decrease
in the amount of interest is primarily due to paying off the entire loans due
to the EDC, ICICI Bank, the Bank of Nova Scotia and CitiBank during 2004 as
well as Sun Pharma loans during 2003.

Results
of Operations. We incurred a net loss of $0.2 million
for 2004 as compared to earning a net income of $11.2 million for 2003. The
significantly lower results of operation for 2004 as compared to 2003 are
primarily due to higher non-cash R&D expenses.

Liquidity and Capital
Resources

Fiscal
2006 and Fiscal 2005

We
generated cash of $8.9 million from operations as compared to cash of $20.6
million during the relevant periods. The lower cash generation during Fiscal
2006 was primarily due to augmenting working capital. Cash generated from
operations was used to finance our capital expenditures of $3.6 million. Cash
from operations during Fiscal 2005 was used to

25

finance
capital expenditure of $3.3 million.

At
March 31, 2006, we had working capital of $41.4 million compared to a working
capital of $18.8 million at March 31, 2005. The working capital was
significantly higher due to higher receivables and inventories at the end of
March 2006 compared to that at March 31, 2005, partially offset by higher
current liabilities.

Three
Months ended March 31, 2006 to the Transition Period

We
generated cash of $4.3 million from operations as compared to cash of $4.8
million during the relevant periods. In addition to augmenting working capital,
the cash generated from operations was used to finance our capital expenditures
of $1.2 million and $0.7 million during the relevant periods.

At
March 31, 2006, we had working capital of $41.4 million compared to a working
capital of $18.8 million at March 31, 2005. The working capital was
significantly higher due to higher receivables and inventories at the end of
March 2006 compared to that at March 31, 2005, partially offset by higher
current liabilities.

Years
ended December 31, 2004 and 2003

During
2004, we generated cash of $22.0 million from operations as compared to cash of
$15.5 million during 2003. The higher cash generation during 2004 has been
primarily due to higher sales volumes, better-cost absorption, an improved
product mix, obtaining more competitive prices for raw materials and better
utilization of new equipment to improve production and productivity.

In
addition to paying down debt, the cash generated from operations for both 2004
and 2003 was used to finance our capital expenditures of $4.0 million during
2004 and $2.4 million during 2003.

During
2004, we repaid the entire balance of $4.4 million due to ICICI Bank Limited
and the $6.4 million mortgage loan due to the Economic Development Corporation
of the City of Detroit (the EDC), and repaid $12.5 million due to the Bank of
Nova Scotia. These payoffs were funded from internal cash flow and by utilizing
a $10.0 million credit line arranged with Citibank, FSB. We have also repaid
the entire borrowing of $10.0 million from Citibank during 2004. These
repayments leave us debt-free (other than normal accounts payables and
accruals) at December 31, 2004, and our entire property, plant, equipment and
intellectual property free of any mortgages, liens or restrictions. In
comparison, during 2003 we borrowed $1.6 million from the Bank of Nova Scotia
and repaid the entire Sun Pharma loans of $9.7 million and the scheduled
payments of $1.2 million to the EDC and $0.6 million to the ICICI Bank.

During
2004, we generated $3.5 million from the exercise of stock options by Sun
Pharma, our employees and one officer and director. During 2003, we generated
$0.9 million from the exercise of stock options by our employees and directors.

At
December 31, 2004, we had working capital of $13.2 million compared to a
negative working capital of $1.1 million at December 31, 2003. The negative
working capital as on December 31, 2003 was primarily due to classification of
loans as current of $8.8 million due to ICICI Bank and the Bank of Nova Scotia
and $1.1 million due to the EDC.

The
available increased cash flow during 2004 was partly utilized to increase
inventories, up from $9.6 million in 2003 to $17.1 million. These increased
inventories served us well to satisfy increased sales requirement from $45.5
million in 2003 to $60.3 million in 2004. To meet customer demands in timely
manner, it is essential to keep sufficient inventories at all levels including
Finished goods stock. Therefore, if necessary the trend of increasing
inventories will continue in 2005 to support increased sales.

The
following tables present a summary of each of the four quarters of Fiscal 2006.
The unaudited interim financial statements include all adjustments, consisting
only of normal recurring adjustments, necessary for a fair statement of such
information when read in conjunction with our audited financial statements and
related notes. Our quarterly operating results have varied in the past, may
continue to do so and are not necessarily indicative of results for any future
period.

Fiscal 2006 
April 1, 2005 to March 31, 2006 (unaudited)

26

(In thousands, except per share
data)

Quarter 1


Quarter 2


Quarter 3


Quarter 4Net Sales


17,613


19,796


20,679


24,701Net (Loss)
  Profit


1,616


(4,820
)

(680
)

(6,539
)Earnings Per
  ShareBasic


0.06


(0.18
)

(0.03
)

(0.25
)Diluted


0.05


(0.18
)

(0.03
)

(0.25
)Contractual
Obligations and Off Balance Sheet Transactions

Contractual
Obligations

Contractual Obligations

1-3 yearsOperating Leases

$
0.5 millionThere
are no other contractual obligations requiring disclosure.

Off Balance
Sheet Transactions

None

Future Outlook

Management
is optimistic about our future outlook. We have been substantially compliant
with cGMPs since 2001, and received approvals of 18 ANDAs and tentative
approvals for 2 ANDAs. We expanded and upgraded our facilities and expanded our
customer base during the last five years including Fiscal 2006. We have
improved our market share on products that have been in our portfolio and we
have gained the appropriate marketshare to date on new product launched in
2006. Our efforts in developing new products has increased and our momentum
should permit us to grow at a reasonable level. We believe that we will
continue to achieve 25% to 30% revenue growth during Fiscal 2007 over Fiscal
2006.

Pricing
pressures, however, due to increased competition, have continued during 2004,
the Transition Period and Fiscal 2006 and are expected to continue in Fiscal
2007, which may result in lower growth rates and gross margins. Management has
and will continue to work diligently to counter the pricing pressures through
increased sales volumes, better-cost absorption of operational overheads, and
cost reductions where possible.

As
disclosed, under the products agreement dated November 21, 2002 between Sun
Global and the Company, Sun Global has agreed to transfer the technology for 25
products to the Company over a five year period in exchange for 544,000
preferred shares (which are convertible on a one-to-one basis into common
shares) per product. Since the date of the products agreement, the Company has
selected all 25 products for development and twenty of these products have passed
their respective bio-equivalency studies (one in December 2003, seven in 2004,
three during the Transition Period and nine during Fiscal 2006) and one since
then. If some or all of the four remaining products pass their bio-equivalency
studies in fiscal 2007, the fair value of the preferred shares earned by Sun
Global in exchange for such products could cause our non-cash research and
development expenses to increase to an amount which would significantly
decrease profit or create a loss.

While
the increased development of new products will increase both our cash and
non-cash R&D expense and will impact EPS, we expect that cash will be
available for among other things, to meet increased working capital
requirements, fund potential Paragraph IV Certification litigation and finance
further capital investments.

27

The
Company will continue to aggressively move forward with the development of new
products. We believe that receiving products from Sun provides us with a
partner with a proven track record; one that already has provided us with
quality products. Moreover, Sun Pharmas increased beneficial ownership in us
to approximately 64%, should, we believe, provide it with the incentive to
continue to help us succeed. Sun Pharma has previously provided us with
capital, loans, guarantees of loans, personnel, raw materials and equipment,
which have significantly helped us to date.

Managements
plans for fiscal 2007 include:


Continued
  focus and improvement on FDA compliance.
Increased
  pace of research and development activities, with a view to maximize the
  number of ANDA filings.
Continue to
  invest in equipment and facilities to expand capacity to meet requirements of
  projected short term and long term growth.
Increased
  market share for certain existing products and recently introduced new
  products and enhanced customer reach and satisfaction.
Prompt
  introduction of new approved products to the market.
Achieving
  further operational efficiencies by attaining economies of scale and cost
  reduction per unit.
Increase the
  number of products, as well as anticipated volume increases for existing
  products, which, in turn, will improve manufacturing capacity utilization.
Consider
  alternative ways of increasing cash, such as marketing ANDAs owned by Sun
  Pharma,.
Expand our
  relationships with financial institutions to fortify our credit position and
  borrowings as necessary.
Research
  alternate product development sources and product licenses such as in
  licensing authorized generics from brand innovator companies and acquisitions
  of ANDAs from competitor manufacturers both domestically and abroad.Item 7A. Quantitative and Qualitative
Disclosures About Market Risk.

The Company
has no debt or other market risk securities or transactions in foreign
exchange.

Line of Credit

On
November 17, 2005, the Company entered into a one-year, $10 million Credit
Agreement with JP Morgan Chase Bank, N.A. Under the Credit Agreement, the
lender may make loans and issue letters of credit to the Company for the
Companys working capital needs and general corporate purposes. Letters of
credit, if issued, expire one year from their date of issuance, but no later than
November 17, 2007. As of March 31, 2006, we utilized $1.5 million of the
available line and have repaid the same. Borrowings are secured by the
Companys receivables, inventory and all proceeds therefrom. Borrowings may be
prepaid at any time by the Company. Interest is payable based on LIBOR or an
alternate base rate (determined by reference to the prime rate or the federal
funds effective rate), as selected by the Company. The rate of interest is
LIBOR plus 75 basis points or Prime rate minus 100 basis points. The Credit Agreement requires that certain financial covenants be met on a quarterly basis. The Company is in
compliance with these financial convenants at March 31, 2006.

Item 8. Financial Statements and
Supplementary Data

INDEX TO FINANCIAL STATEMENTS

Page1.
Report of Independent Registered Public Accounting Firm on Internal
  Control Over Financial Reporting

F-1 & F-22.
Report of Independent Registered Public Accounting Firm

F-3 & F-428

3.
Financial Statements:Balance Sheets as of March 31, 2006 and 2005

F-5 & F-6Statements of Operations for the year ended March 31, 2006, the
  Transition Period and for the years ended December 31, 2004 and 2003

F-7Statements of Stockholders Equity (Deficit) for the year ended March
  31, 2006, the Transition Period and for the years ended December 31, 2004 and
  2003

F-8Statements of Cash Flows for the year ended March 31, 2006, the
  Transition Period and for the years ended March 31, 2006, December 31, 2004
  and 2003

F-9Notes to Financial Statements

F-10 to F-34Item 9. Changes in and Disagreements With
Accountants on Accounting and Financial Disclosure.

None.

Item 9A. Controls and Procedures.

a. The term
disclosure controls and procedures is defined in Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934 (the Exchange Act). These
rules refer to the controls and other procedures of a company that are designed
to ensure that information required to be disclosed by a company in the reports
that it files under the Exchange Act is recorded, processed, summarized and
reported within required time periods. Our Chief Executive Officer and our
Chief Financial Officer have evaluated the effectiveness of our disclosure
controls and procedures as of the end of the period covered by this report (the
Evaluation Date), and have concluded that, as of the Evaluation Date, our disclosure
controls and procedures are effective in providing them with material
information relating to the Company known to others within the Company which is
required to be included in our periodic reports filed under the Exchange Act.

b. There
has been no change in the Companys internal control over financial reporting
that occurred during the Transition Period that materially affected, or is
reasonably likely to materially affect, the Companys internal control over
financial reporting.

Managements Report on Internal Control Over
Financial Reporting

Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rule
13a-15(f). Under the supervision and with the participation of management,
including our Chief Executive Officer and Chief Financial Officer, we conducted
an evaluation of the effectiveness of our internal control over financial
reporting based on the framework in Internal Control  Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).

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 risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
wit the policies or procedures may deteriorate.

Based
on our evaluation, management concluded that our internal control over
financial reporting was effective as of March 31, 2006. Our managements
assessment of the effectiveness of our internal control over financing
reporting as of March 31, 2006 has been audited by Rehmann Robson, an
independent registered public accounting firm, as stated in its Report of
Independent Registered Public Accounting Firm on Internal Control Over
Financial Report which appears on pages F-3 and F-4 below.

Item 9B. Other Information.

None.

29

PART III

Item 10. Directors
and Executive Officers of the Registrant.

The
information with respect to directors and executive officers of the
Corporation, the Corporations Code of Ethics, and compliance with Section
16(a) of the Exchange Act included under the sections Nominees For Directors
Terms Expiring in 2008, Incumbent Directors Terms Expiring in 2006,
Incumbent Directors Terms Expiring in 2007, Committees and Meetings of
Directors, Nomination of Directors, Executive Officers, Code of Business
Conduct and Ethics, and Section 16(a) Beneficial Ownership Reporting
Compliance in our 2005 Proxy Statement to be filed with the Securities and
Exchange Commission on or before July 31, 2006, is incorporated herein by reference.

Item 11. Executive
Compensation.

The
information regarding executive compensation included under the section
Compensation of Executive Officers and Compensation of Directors in our
2005 Proxy Statement to be filed with the Securities and Exchange Commission on
or before July 31, 2006, is incorporated herein by reference.

Item 12. Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.

The
information with respect to the security ownership of certain beneficial owners
and management and with respect to equity compensation plans included under the
sections Security Ownership of Certain Beneficial Owners, Security Ownership
of Management and Directors and Equity Compensation Plan Information in our
2005 Proxy Statement to be filed with the Securities and Exchange Commission on
or before July 31, 2006, is incorporated herein by reference. In addition, the
information contained under the Equity Compensation Plan Information subheading
under Item 5 of this report is incorporated herein by reference.

Item 13. Certain
Relationships and Related Transactions.

The
information with respect to certain relationships and related transactions
included under the section Transactions of Directors, Executive Officers and
Certain Beneficial Owners of
Caraco in our 2005 Proxy Statement to be filed with the Securities and
Exchange Commission on or before July 31, 2006, is incorporated herein by
reference.

Item 14. Principal
Accountant Fees and Services.

The
information under the caption Relationship with Independent Auditors  Audit
and Non-Audit Fees in our 2005 Proxy Statement to be filed with the Securities
and Exchange Commission on or before July 31, 2006, is incorporated herein by
reference.

Part
IV

Item 15. Exhibits Financial Statement
Schedules.

(a)
1          
  Financial StatementsPage1.
Report of Independent Registered Public Accounting Firm on Internal
  Control Over Financial Reporting
F-1 & F-22.
Report of Independent Registered Public Accounting Firm
F-3 & F-430

3.
Financial Statements:Balance Sheets as of March 31, 2006 and 2005
F-5 & F-6Statements of Operations for the year ended March 31, 2006, the Transition
  Period and for the years ended December 31, 2004 and 2003
F-7Statements of Stockholders Equity (Deficit) for the year ended March
  31, 2006, the Transition Period and for the years ended December 31, 2004 and
  2003
F-8Statements of Cash Flows for the year ended March 31, 2006, the
  Transition Period and for the years ended March 31, 2006, December 31, 2004
  and 2003
F-9Notes to Financial Statements
F-10 to F-342
Financial Statement SchedulesNone3
ExhibitsThe
  exhibits filed in response to Item 601 of Regulation S-K are listed in the
  Exhibit Index, which is incorporated herein by reference.(b)
ExhibitsThe
  exhibits filed in response to Item 601 of Regulation S-K are listed in the
  Exhibit Index, which is incorporated herein by reference.(c)
Other SchedulesNoneSIGNATURES

Pursuant to
the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized on the 12th day of June, 2006.

CARACO PHARMACEUTICAL LABORATORIES, LTD.

/s/ Daniel H. MovensDaniel H. MovensChief Executive Officer31

POWER OF ATTORNEY

KNOW ALL
MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Daniel H. Movens and / or Jitendra N. Doshi, this 12th
day of June, 2006, his true and lawful attorney(s)-in-fact and agent(s), with
full power of substitution and resubstitution, for him and in his name, place
and stead, in any and all capacities, to sign any or all amendments to this
report and to file the same, with all exhibits and schedules thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorney(s)-in-fact and agent(s) full power and authority to
do and perform each and every act and thing requisite and necessary to be done,
as fully to all intents and purposes as he might or could do in person, hereby
ratifying and confirming all that said attorney(s)-in-fact and agent(s), or
their substitutes(s), may lawfully do or cause to be done by virtue hereof.

Pursuant to
the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons in the capacities and on the date
indicated above.

/s/ Dilip S. Shanghvi

Chairman of the BoardDilip S. Shanghvi/s/ Daniel H. Movens

Director, Chief Executive OfficerDaniel H. Movens/s/ Jitendra N. Doshi

Director and CFO and COO (and Principal Accounting Officer)Jitendra N. DoshiDirectorJohn D. Crissman/s/ Sailesh T. Desai

DirectorSailesh T. Desai/s/ Timothy Manney

DirectorTimothy ManneyDirectorMadhava Reddy/s/ Georges Ugeux

DirectorGeorges Ugeux/s/ Sudhir V. Valia

DirectorSudhir V. Valia32

CARACO
  PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)FINANCIAL
STATEMENTS

AND

REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

FOR THE YEAR ENDED
MARCH 31, 2006, 
THE THREE MONTHS ENDED MARCH 31, 2005 AND
THE YEARS ENDED DECEMBER 31, 2004 AND 2003

CARACO
PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical Industries Limited)

INDEX
  TO FINANCIAL STATEMENTSReport of Independent Registered Public Accounting Firm on
  Internal Control Over Financial Reporting

F-1 - 2Report of Independent
  Registered Public Accounting Firm

F-3 - 4Financial Statements as of March
  31, 2006 and 2005, and for the Year Ended March 31, 2006, the Three Months
  Ended March 31, 2005 and the Years Ended December 31, 2004 and 2003Balance Sheets

F-5 - 6Statements
  of Operations

F-7Statements
  of Stockholders Equity (Deficit)

F-8Statements
  of Cash Flows

F-9Notes
  to Financial Statements

F-10 - 35*
* * * *

REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Stockholders and Board of Directors
Caraco Pharmaceutical Laboratories, Ltd.
Detroit, Michigan

We have audited managements assessment, included in
the accompanying Managements Annual Report on Internal Control Over Financial
Reporting that Caraco Pharmaceutical Laboratories, Ltd. (a Michigan
corporation) (a subsidiary of Sun Pharmaceutical Industries Limited) (the
Corporation) maintained effective internal control over financial reporting
as of March 31, 2006, based on criteria established in Internal Control -Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(the COSO criteria). The Corporations management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on managements assessment and an
opinion on the effectiveness of the Corporations internal control over
financial reporting 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 effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control
over financial reporting, evaluating managements assessment, testing and
evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.

A corporations internal control over financial
reporting is a process designed by, or under the supervision of, the
corporations principal executive and principal financial officers, or persons
performing similar functions, and effected by the corporations board of
directors, management, and other personnel 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 corporations internal control over financial
reporting includes those policies and procedures that (1) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the corporation; (2)
provide reasonable assurance that transactions are recorded as

F-1

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 (3) 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.

In our opinion, managements assessment that the
Corporation maintained effective internal control over financial reporting as
of March 31, 2006, is fairly stated, in all material respects, based on the
COSO criteria. Also in our opinion, the Corporation maintained, in all material
respects, effective internal control over financial reporting as of March 31,
2006, based on the COSO criteria.

We have also audited, in accordance with the standards
of the Public Company Accounting Oversight
Board (United States), the financial statements as of and for the
year ended March 31, 2006 of the Corporation and our report dated May 7, 2006
expressed an unqualified opinion on those financial statements.

/s/ Rehmann Robson

Troy, Michigan
May 7, 2006

F-2

REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Stockholders and Board of Directors
Caraco Pharmaceutical Laboratories, Ltd.
Detroit, Michigan

We have audited the accompanying balance sheets of Caraco Pharmaceutical
Laboratories, Ltd. (a
Michigan corporation) (a subsidiary of Sun Pharmaceutical Industries Limited) (the
Corporation) as of March 31, 2006 and 2005 and the related statements of
operations, stockholders equity (deficit) and cash flows for the year ended
March 31, 2006, the three months ended March 31, 2005 and for each of the two
years in the period ended December 31, 2004. These financial statements
are the responsibility of the Corporations management. Our responsibility is
to express an opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to
above present fairly, in all material respects, the financial position of
Caraco Pharmaceutical Laboratories, Ltd. as of March 31, 2006 and 2005,
and the results of its operations and its cash flows for the year ended March
31, 2006, the three months ended March 31, 2005, and for each of the two years
in the period ended December 31, 2004 in conformity with accounting principles
generally accepted in the United States of America.

F-3

We have also audited, in accordance with the standards
of the Public Company Accounting Oversight
Board (United States), the effectiveness of the Corporations
internal control over financial reporting as of March 31, 2006, based on the
criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated May 7, 2006
expressed an unqualified opinion on managements assessment of the
effectiveness of the Corporations internal control over financial reporting
and an unqualified opinion on the effectiveness of the Corporations internal
control over financial reporting.

/s/ Rehmann Robson


Troy, Michigan
May 7, 2006

F-4

CARACO
PHARMACEUTICAL LABORATORIES, LTD.
(a subsidiary of Sun Pharmaceutical Industries Limited)

BALANCE
  SHEETSASSETS


March 312006

2005Current assetsCash and cash
equivalents

$
11,924,245

$
6,627,425Accounts
receivable, net


20,859,099


6,736,778Inventories


26,965,690


18,467,693Prepaid
expenses and deposits


2,532,561


1,105,618Total current assets


62,281,595


32,937,514Property, plant and equipmentLand


197,305


197,305Buildings and
improvements


10,790,703


9,605,888Equipment


12,040,688


9,701,979Furniture and
fixtures


681,705


589,329Total


23,710,401


20,094,501Less
accumulated depreciation


8,749,997


7,197,422Net property, plant and equipment


14,960,404


12,897,079Total assets

$
77,241,999

$
45,834,593The accompanying
notes are an integral part of these financial statements.

F-5

LIABILITIES AND STOCKHOLDERSEQUITY

March 312006

2005Current liabilitiesAccounts
payable, trade

$
3,696,265

$
2,577,668Accounts
payable, Sun Pharma


14,678,085


9,639,890Accrued
expenses


2,489,398


1,931,442Total liabilities (all current)


20,863,748


14,149,000Commitments
  and contingencies
  (Notes 9, 11 and 12)Stockholders equity (Note 7)Series B convertible preferred
stock, no par value; issued and
  outstanding 10,880,000 shares (March 31, 2006) 5,984,000 shares (March 31,
  2005)


72,755,770


37,700,410Common stock, no par value;
authorized 30,000,000 shares, issued and
  outstanding 26,421,994 shares (March 31, 2006) 26,360,294 shares (March 31,
  2005)


44,988,597


44,927,987Additional paid-in capital


2,718,735


2,718,735Accumulated deficit


(64,084,851
)

(53,661,539
)Total stockholders equity


56,378,251


31,685,593Total liabilities and stockholders equity

$
77,241,999

$
45,834,593F-6

CARACO
PHARMACEUTICAL LABORATORIES, LTD.
(a subsidiary of Sun Pharmaceutical Industries Limited)

STATEMENTS
  OF OPERATIONSThree
  Months Ended
  March 31, 2005

Year Ended
  December 31Year Ended
  March 31, 20062004

2003Net sales

$
82,788,918

$
17,336,500

$
60,340,309

$
45,498,400Cost of goods sold (Notes 1 and
4)


41,872,834


7,879,425


24,441,569


19,507,406Gross
  profit


40,916,084


9,457,075


35,898,740


25,990,994Selling, general and
administrative expenses


8,182,718


1,879,480


5,276,755


7,363,341Research and development costs
- affiliate (Note 7)


35,055,360


10,200,000


24,397,040


3,103,370Research and development costs
- other


8,437,338


1,719,865


6,053,334


3,112,294Operating
  (loss) income


(10,759,332
)

(4,342,270
)

171,611


12,411,989Other
  income (expense)Interest
income


233,385


16,385


40,316


9,102Interest
expense


(3,740
)




(407,330
)

(1,233,531
)(Loss) gain on
sale of equipment








(10,636
)

25,531Other
income


106,375


4,172


6,671


9,627Other
  income (expense) - net


336,020


20,557


(370,979
)

(1,189,271
)Net
  (loss) income

$
(10,423,312
)
$
(4,321,713
)
$
(199,368
)
$
11,222,718Net
  (loss) income per shareBasic

$
(0.39
)
$
(0.16
)
$
(0.01
)
$
0.46Diluted

$
(0.39
)
$
(0.16
)
$
(0.01
)
$
0.44The accompanying
notes are an integral part of these financial statements.

F-7

CARACO PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)STATEMENTS OF STOCKHOLDERS EQUITY
  (DEFICIT)Preferred Stock

Common Stock

AdditionalPaid-in

PreferredStockAccumulatedShares

Amount

Shares

Amount

Capital

Dividends

Deficit

TotalBalances at January 1,
2003




$



23,762,532

$
40,457,028

$
282,858

$
(350,380
)
$
(60,012,796
)
$
(19,623,290
)Payment of preferred stock
dividends

















350,380


(350,380
)

Issuance of common stock to
directors in lieu of cash compensation








31,000


112,310











112,310Common stock options
exercised








784,296


872,973


2,435,877








3,308,850Net income




















11,222,718


11,222,718Balances at December 31,
2003








24,577,828


41,442,311


2,718,735





(49,140,458
)

(4,979,412
)Issuance of preferred stock to
affiliate in exchange for product
  technology transfers


4,352,000


27,500,410

















27,500,410Common stock options
exercised








1,756,866


3,453,946











3,453,946Net loss




















(199,368
)

(199,368
)Balances at December 31,
2004


4,352,000


27,500,410


26,334,694


44,896,257


2,718,735





(49,339,826
)

25,775,576Issuance of preferred stock to
affiliate in exchange for product
  technology transfers


1,632,000


10,200,000

















10,200,000Common stock options
exercised








25,600


31,730











31,730Net loss




















(4,321,713
)

(4,321,713
)Balances at March 31,
2005


5,984,000


37,700,410


26,360,294


44,927,987


2,718,735





(53,661,539
)

31,685,593Issuance of preferred stock to
affiliate in exchange for product
  technology transfers


4,896,000


35,055,360

















35,055,360Common stock options
exercised








61,700


60,610











60,610Net loss




















(10,423,312
)

(10,423,312
)Balances at March 31,
2006


10,880,000

$
72,755,770


26,421,994

$
44,988,597

$
2,718,735




$
(64,084,851
)
$
56,378,251The accompanying notes are an integral part
of these financial statements.

F-8

CARACO PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)STATEMENTS OF CASH FLOWSThreeMonths Ended

Year Ended December 31Year EndedMarch 31, 2006

March 31, 2005

2004

2003Cash flows from operating
activitiesNet (loss)
income

$
(10,423,312
)
$
(4,321,713
)
$
(199,368
)
$
11,222,718Adjustments to
reconcile net (loss) income to net cash provided by operating activitiesDepreciation


1,552,578


306,626


932,419


683,339Capital stock
issued or to be issued to affiliate in exchange for
  product formula


35,055,360


10,200,000


24,397,040


3,103,370Common shares
issued in lieu of compensation











112,310Loss (gain) on
sale of property, plant and equipment








10,636


(25,531
)Variable
compensation expense for stock options extended to director
  and officer











2,435,877Changes in
operating assets and liabilities which provided (used) cashAccounts
receivable


(14,122,321
)

(2,133,911
)

(64,393
)

945,662Inventories


(8,497,997
)

(1,333,882
)

(7,523,001
)

(3,994,848
)Prepaid
expenses and deposits


(1,426,943
)

(441,807
)

(140,430
)

(90,716
)Accounts
payable


6,156,792


2,300,793


4,690,789


1,243,139Accrued
expenses


557,954


220,793


(64,548
)

(126,829
)Net cash provided by
operating activities


8,852,111


4,796,899


22,039,144


15,508,491Cash flows from investing
activitiesPurchases of
property, plant and equipment


(3,615,901
)

(657,673
)

(3,982,413
)

(2,493,173
)Proceeds from
sale of property, plant and equipment











76,200Net cash used
in investing activities


(3,615,901
)

(657,673
)

(3,982,413
)

(2,416,973
)Cash flows from financing
activitiesProceeds from
loans payable to financial institutions


1,500,000





10,000,000


1,600,000Repayments of
loans payable to financial institutions


(1,500,000
)




(26,875,000
)

(625,000
)Payment of
preferred stock dividends











(350,380
)Net repayments
of subordinated stockholder notes











(9,700,000
)Repayments of
EDC loan








(6,385,490
)

(1,217,057
)Proceeds from
issuance of common stock


60,610


31,730


3,453,946


872,973Net cash provided by (used
in) financing activities


60,610


31,730


(19,806,544
)

(9,419,464
)Net increase (decrease) in
cash and cash equivalents


5,296,820


4,170,956


(1,749,813
)

3,672,054Cash and cash equivalents,
beginning of year


6,627,425


2,456,469


4,206,282


534,228Cash and cash equivalents,
end of year

$
11,924,245

$
6,627,425

$
2,456,469

$
4,206,282The accompanying notes are an integral part
of these financial statements.

F-9

CARACO
PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical Industries Limited)

NOTES
  TO FINANCIAL STATEMENTS1.
ORGANIZATION AND SUMMARY OF
  SIGNIFICANT ACCOUNTING POLICIESOrganization and Nature of BusinessCaraco Pharmaceutical Laboratories, Ltd. (Caraco
  or the Corporation), based in Detroit, Michigan, develops, manufactures and
  markets generic, prescription and over-the-counter pharmaceuticals in the
  United States. The process of developing a line of proprietary drugs requires
  approvals by the Food and Drug Administration (FDA) of Abbreviated New Drug
  Applications (ANDA). The Corporations present product portfolio consists of
  a number of products in various strengths and package sizes. The Corporations
  drugs relate to a variety of therapeutic segments including the central
  nervous system, cardiology, pain management and diabetes.The Corporations manufacturing facility and
  executive offices were constructed in 1991, pursuant to a $9.1 million loan
  from the Economic Development Corporation of the City of Detroit (the EDC).
  Since August 1997, capital infusions and loans have primarily come from Sun
  Pharmaceutical Industries Limited, a specialty pharmaceutical corporation
  organized under the laws of India (Sun Pharma). Among other things, Sun
  Pharma has acted as a guarantor on loans to Caraco, has supplied the
  Corporation with raw materials for certain products, assisted in obtaining
  machinery and equipment to enhance production capacities at competitive
  prices, and has transferred certain generic products. As of June 3, 2006, Sun
  Pharma beneficially owns approximately 64% (75% including its convertible
  Series B Preferred stock) of the outstanding common shares of Caraco.Sun Pharmaceutical Industries LimitedPursuant to a stock purchase agreement, a Mumbai,
  India based specialty pharmaceutical manufacturing company, Sun
  Pharmaceutical Industries Limited (Sun Pharma) made an initial investment
  of $7.5 million for the purchase of 5.3 million common shares of Caraco in
  1997.Sun Pharma and its affiliates have loaned the
  Corporation approximately $10 million since August 1997. As of December 31,
  2003, all such loans had been repaid. Sun Pharma has also assisted the
  Corporation, by acting as guarantor, in a obtaining line of credit loans from
  ICICI Bank Limited, The Bank of Nova Scotia and Citibank FSB in the amounts
  of $5.0 million, $12.5 million and $10.0 million, respectively, all of which
  have been repaid and terminated as of December 31, 2004.F-10

CARACO
PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical Industries Limited)

NOTES
  TO FINANCIAL STATEMENTSIn August 1997, Caraco entered into an agreement,
  whereby Sun Pharma was required to transfer the technology formula for 25
  generic pharmaceutical products over a five-year period through August 2003
  in exchange for 544,000 shares of Caraco common stock for each technology
  transfer of an ANDA product (when bio-equivalency studies were successfully
  completed) and 181,333 shares for each technology transfer of a DESI (Drug Efficacy
  Study Implementation) product. The products provided to the Corporation from
  Sun Pharma were selected by mutual agreement. Under such agreement, Caraco
  conducted, at its own expense, all tests including bio-equivalency studies.
  Pursuant to such agreement through 2002, Sun Pharma delivered the technology
  formula for 13 products. This agreement expired on November 21, 2002, and the
  Corporation entered into a new technology transfer agreement with Sun Global,
  Inc. (Sun Global), an affiliate of Sun Pharma.Under the agreement, which was approved by the
  Corporations independent directors, Sun Global agreed to provide the
  formulations for 25 new generic drugs over a five-year period. Caracos
  rights to the products are limited to the United States and its territories
  or possessions, including Puerto Rico. Sun Global retains rights to the
  products in all other territories. The products are selected by mutual
  agreement. Under this agreement, Caraco conducts at its own expense all
  tests, including bio-equivalency studies. The Corporation also markets the
  products consistent with its customary practices and provides marketing
  personnel. In return for the technology transfer, Sun Global receives 544,000
  shares of Series B Preferred Stock for each generic drug transferred when
  such drug has passed its bio-equivalency studies.The products agreement was amended by the
  Independent Committee, comprised of the three independent directors, in the
  first quarter of 2004 to eliminate the provision requiring that the
  Independent Committee concur in the selection of each product, and provides
  instead that each product satisfy certain objective criteria developed by
  management and approved by the Independent Committee. Pursuant to such
  objective criteria, all 25 of the products under this agreement have been
  selected, 20 of which passed bio-equivalency studies through March 31, 2006.Sun Pharma has established Research and Development
  Centers in Mumbai and Vadodara in India, where the development work for
  products is performed.Sun Pharma and its subsidiaries supply the
  Corporation with certain raw materials (Note 4) and formulations, assist in
  acquiring machinery and equipment to enhance production capacities, and
  provide qualified technical professionals who work as Caraco employees.F-11

CARACO
PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical Industries Limited)

NOTES
  TO FINANCIAL STATEMENTSAlso, four of the nine directors of Caraco are, or
  were, affiliated with Sun Pharma. Further, Sun Pharma and its affiliates may
  use Caraco as a contract manufacturer and/or distributor of their products.
  In December 2004, Caraco entered into an agreement for two such products.During the three month period ended March 31, 2005
  SPARC Bioresearch Private Limited (SPARC), an affiliate of Sun Pharma,
  performed certain analytical studies required as part of the bio-equivalency
  process for two products. The Corporation incurred approximately $172,000 of
  costs during this period for the studies performed by SPARC. No similar
  studies were performed by SPARC during the years ended March 31, 2006,
  December 31, 2004 or 2003.While management has a basis to reasonably believe
  that Sun Pharmas substantial investment in Caraco provides Sun Pharma with
  sufficient economic incentive to continue to assist Caraco in developing its
  business, and Sun Pharma has expressed its intent to continue to support
  Caracos operations in the near term, as it has done in the past, there can
  be no assurance that such support will, in fact, continue.During the first quarter of 2004, Sun Pharma
  acquired 3,452,291 additional shares of common stock and 1,679,066 stock
  options from two former directors and a significant shareholder. Sun Pharma
  exercised these stock options during the fourth quarter of 2004, thereby
  increasing its beneficial ownership to 64%.In addition to its substantial relationship with and
  dependence on Sun Pharma as described above, the Corporation is subject to
  certain risks associated with companies in the generic pharmaceutical
  industry. Profitable operations are dependent on the Corporations ability to
  market its products at reasonable profit margins. In addition to maintaining
  profitable operations, the ongoing success of the Corporation will depend, in
  part, on its continuing ability to attract and retain key employees, obtain
  timely approvals of its ANDAs, and develop new products (see Operations,
  below).OperationsThe Corporation recorded net sales of $82.8 million
  during for the year ended March 31, 2006 (Fiscal 2006) and generated cash
  from operations of $8.9 million during Fiscal 2006. This cash was generated
  after funding working capital requirements of $17.5 million. The Corporation
  incurred a net loss of $10.4 million during Fiscal 2006. The loss was
  primarily due to non-cash research and development expense (R&D) of $35.1
  million recorded during Fiscal 2006. This non-cash R&D expense relates to
  nineF-12

CARACO
PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical Industries Limited)

NOTES
  TO FINANCIAL STATEMENTSproducts passing their bio-equivalency studies and
  the related value of the preferred stock issued to Sun Global during this
  period. At March 31, 2006, the Corporation had stockholders equity of $56.4
  million.Managements plans for fiscal 2007 include:
Continued focus on FDA compliance.
Increased pace of research and development
  activities, with a view to maximize ANDA filings.
Continuing to invest in equipment and facilities to
  expand capacity to meet requirements of projected growth in the near term.
Increased market share for certain existing products
  and recently introduced new products and enhanced customer reach and
  satisfaction.
Prompt introduction of newly approved products to
  the market.

Achieving further operational efficiencies by
  attaining economies of scale and cost reduction per unit.
Increase the number of products, as well as
  anticipated volume increases for existing products that, in turn, will
  improve manufacturing capacity utilization.

Expanding relationships with financial institutions
  to fortify the Corporations credit position and borrowings as necessary.
Considering alternative ways of increasing cash,
  such as through marketing ANDAs owned by Sun Pharma
Research alternative product development sources and
  product licenses such as in licensing authorized generics from brand
  innovator companies and acquisitions of ANDAs from competitor manufacturers
  both domestic and abroad.Use of EstimatesThe preparation of financial statements in
  conformity with generally accepted accounting principles requires management
  to make estimates and assumptions that affect the reported amounts of assets
  and liabilities and disclosure of contingent assets and liabilities at the
  dates of the financial statements and the reported amounts of revenues and
  expenses during the reporting periods. Actual results could differ from those
  estimates. Significant estimates include, but are not limited to, provisions
  for estimatedF-13

CARACO
PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical Industries Limited)

NOTES
  TO FINANCIAL STATEMENTScustomer returns, discounts, rebates and other price
  adjustments, including customer chargebacks (see Revenue Recognition,
  below), valuation allowances for deferred tax assets, and valuation of
  overhead components in inventory.Cash and Cash EquivalentsCash and cash equivalents consist of demand deposits
  in banks, cash on hand and all highly liquid investments purchased with an
  original maturity of three months or less. The Corporation invests its excess
  cash primarily in deposits with major banks and in other high quality
  short-term liquid money market investments. During the normal course of
  business, the Corporation may maintain cash on deposit in excess of federally
  insured limits with financial institutions. The Corporation maintains a
  policy of making investments only with institutions with at least an
  investment grade credit rating.Revenue RecognitionRevenue from product sales, net of estimated
  provisions, is recognized when there is persuasive evidence that an
  arrangement exists, shipment of the goods has occurred, the selling price is
  fixed or determinable, and collectibility is reasonably probable. The
  Corporations customers consist primarily of large pharmaceutical wholesalers
  who sell directly into the retail channel. Provisions for sales discounts,
  and estimates for chargebacks, rebates, and product returns are established
  as a reduction of product sales revenue at the time revenues are recognized,
  based on historical experience and current market trends adjusted to reflect
  known changes in the factors that impact these reserves. These revenue
  reductions are reflected as a direct reduction to accounts receivable through
  an allowance.Allowances for Sales AdjustmentsChargebacksChargebacks represent the Corporations most
  significant provision against gross accounts receivable and related reduction
  to gross revenue. Chargebacks are credits given to wholesale customers for
  the price difference on the products they sell (at a contractual price) to
  retail, chain stores, and managed care organizations at prices lower than the
  Corporation sells to the wholesale customer. The Corporation records an
  estimate at the end of the reporting period to the wholesaler of the amount
  to be charged back to them, over and above those already received by the
  Corporation. Such estimated amounts, in addition to certain other deductions,
  are deducted from the Corporations gross sales toF-14

CARACO
PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical Industries Limited)

NOTES
  TO FINANCIAL STATEMENTSdetermine their net revenues. The Corporation
  records provisions for chargebacks based upon various factors, including
  current contract prices, historical trends, and their future expectations. The
  amount of actual chargebacks claimed could be either higher or lower than the
  amounts accrued. Changes in these estimates, if any, are recorded in the
  income statement in the period of the change. If the Corporation has over or
  under estimated the amount that will ultimately be charged back to them by
  their wholesale customers, there could be a material impact on the
  Corporations financial statements.The Corporation considers
  the following factors in the determination of the estimates of chargebacks:1.
Historical data of
  chargebacks as a percentage of sales, as well as the various chargeback
  reports that are received from the wholesale customers.2.
Volume of product sold to
  wholesalers and the average chargeback rates, on a quarterly and annualized
  basis are applied to current period and annual product sales.3.
The sales trends for
  future estimated prices, wholesale acquisition cost (WAC), the contract
  prices with the retailers, chain stores and managed care organizations (end-users).
  The Corporations prices with the wholesalers and end users are contracted
  prices.Approximately 88% and 94% of the total allowance for
  trade receivables at March 31, 2006 and 2005, respectively has been
  established to provide for estimated chargebacks (see Note 3).Shelf Stock AdjustmentsShelf stock adjustments
  are credits issued to customers to reflect decreases in the selling prices of
  products. These credits are customary in the industry and are intended to
  reduce the customers inventory cost to better reflect current market prices.
  The determination to grant a shelf stock adjustment to a customer following a
  price decrease is at the Corporations discretion.Factors considered when recording a reserve for
  shelf stock adjustments include estimated launch dates of competing products
  based on market intelligence, estimated decline in market price of products
  based on historical experience and input from customers, and levels of
  inventory held by customers at the date of the pricing adjustments.F-15

CARACO
PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical Industries Limited)

NOTES
  TO FINANCIAL STATEMENTSProduct Returns and Other AllowancesIn the pharmaceutical industry, customers are
  normally granted the right to return product for credit if the product has
  not been used prior to its expiration date. The Corporations return policy
  typically allows product returns for products within a 12-month window from
  six months prior to the expiration date and up to six months after the
  expiration date. The Corporation estimates the level of sales, which will
  ultimately be returned pursuant to its return policy, and records a related
  reserve at the time of sale. These amounts are deducted from its gross sales
  to determine net revenues. These estimates take into consideration historical
  returns of our products and the Corporations future expectations. The Corporation
  periodically reviews the reserves established for returns and adjusts them
  based on actual experience, as necessary. The primary factors considered in estimating its potential product
  returns include shelf life of expiration date of each product and historical
  levels of expired product returns. If the Corporation becomes aware of any
  returns due to product related issues, this information is used to estimate
  an additional reserve. The amount of actual product return could be
  either higher or lower than the amounts reserved. Changes in these estimates,
  if any, would be recorded in the income statement in the period of the
  change. If the Corporation over or under estimates the quantity of product
  that will ultimately be returned, there may be a material impact to its
  financial statements.Discounts (trade and prompt payment discounts) are
  reserved for at the end of every reporting period based on the gross sales
  made to the customers during the period and based on their terms of trade.
  The Corporation reviews its contracts with its customers in addition to
  historical data and percentages to estimate the reserve for estimated
  discounts.Customer rebates are estimated at the end of every
  reporting period, based on direct or indirect purchases. If the purchases are
  direct, the rebates are recognized when products are purchased and a periodic
  credit is given. For indirect purchases, the rebates are recognized based on
  the terms with such customer. Medicaid Rebates are estimated based on the
  historical data the Corporation receives from the public sector benefit
  providers, which is based on the final dispensing of our products by a
  pharmacy to a benefit plan participant.F-16

CARACO
PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical Industries Limited)

NOTES
  TO FINANCIAL STATEMENTSDoubtful AccountsDoubtful accounts are estimated based on the data
  available from external sources, including information obtained related to
  the financial condition of customers. Delinquent accounts are reviewed by
  management on a quarterly basis, to identify and record allowances, as
  considered necessary, for accounts receivable not expected to be recoverable.Accounts ReceivableThe Corporation sells its products using customary
  trade terms; the resulting accounts receivable are unsecured. Accounts
  receivable are stated at the amount management expects to collect from
  outstanding balances. The Corporation provides for probable uncollectible
  amounts through a charge to earnings and a credit to a valuation allowance
  based on managements assessment of the current status of individual
  accounts. Balances that are still outstanding after the Corporation has
  attempted reasonable collection efforts are written off through a charge to
  the valuation allowance and a credit to trade accounts receivable.InventoriesInventories, which consist principally of raw
  materials, goods in transit and finished goods, as well as work-in-process,
  are stated at the lower of cost, determined using the specific identification
  method, or market. The Corporation analyzes its inventory levels quarterly
  and writes down any inventory that has become obsolete and inventory that has
  a cost basis in excess of its expected net realizable value. Expired
  inventory is disposed of and the related costs are written off. Materials
  acquired for research and development on products yet to be launched are
  written off in the year of acquisition. The determination of whether or not
  inventory costs will be realizable requires estimates by management. A
  critical estimate in this determination is the estimate of the future
  expected inventory requirements, whereby the Corporation compares its
  internal sales forecasts to inventory on hand. Actual results may differ from
  those estimates and inventory write-offs may be required. The Corporation
  must also make estimates about the amount of manufacturing overhead to
  allocate to its finished goods and work in process inventories. Although the
  manufacturing process is generally similar for its products, the Corporation
  must make judgments as to the portion of costs to allocate to purchased
  product, work in process and finished goods, and such allocations can vary
  based upon the composition of these components and the fact that each product
  produced does not necessarily require the same amount of time or effort for
  the same productionF-17

CARACO
  PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES
  TO FINANCIAL STATEMENTSstep. Accordingly, the assumptions made can impact
  the value of reported inventories and cost of sales.Net (Loss) Income
  Per ShareNet (loss) income per share is computed using the
  weighted average number of common shares outstanding during each period and
  considers a dual presentation and reconciliation of basic and diluted per
  share amounts. Diluted reflects the potential dilution of all common stock
  equivalents.At March 31, 2006 and 2005 and at December 31, 2004
  options to purchase 341,400, 357,000 and 381,600 shares respectively,
  10,880,000, 5,984,000 and 4,352,000 shares of convertible preferred stock,
  respectively and 45,000 shares of common stock granted to the Corporations
  Chief Executive Officer during 2006 (Note 7) were excluded from the
  computation of earnings per share because they would have an antidilutive
  effect on net loss per share.The following table sets forth the computation of
  basic and diluted (loss) income per common share:Year Ended
March 31

Three
Months
Ended March 31

Year Ended
December 312006

2005

2004

2003Numerator:Net (loss)
  income available for common stockholders

$
(10,423,312
)
$
(4,321,713
)
$
(199,368
)
$
11,222,718Denominator:Weighted average
  shares outstanding, basic


26,392,054


26,348,347


24,734,282


24,137,108Incremental
  shares from assumed conversion of common stock options











1,344,851Weighted average
  shares outstanding, diluted


26,392,054


26,348,347


24,734,282


25,481,959Net (loss)
  income per common shareBasic

$
(0.39
)
$
(0.16
)
$
(0.01
)
$
.46Diluted

$
(0.39
)
$
(0.16
)
$
(0.01
)
$
.44F-18

CARACO
  PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES
  TO FINANCIAL STATEMENTSProperty, Plant
  and Equipment and DepreciationProperty, plant and equipment is carried at cost
  less accumulated depreciation. Land is carried at cost. Depreciation is
  computed using the straight-line method over the estimated useful lives of
  the related assets, which range from 3 to 40 years. Major improvements and
  renewals are capitalized while ordinary maintenance and repairs are expensed.
  Management annually reviews these assets for impairment and reasonably
  believes the carrying value of these assets will be recovered through cash
  flows from operations.Federal Income
  TaxesDeferred income tax assets and liabilities are
  determined based on the difference between the financial statement and
  federal income tax basis of assets and liabilities as measured by the
  estimated tax rates that will be in effect when these differences reverse.
  The principal difference between assets and liabilities for financial
  statement and federal income tax return purposes is attributable to accounts
  receivable allowances and the anticipated utilization of tax net operating
  losses.Research and
  Development CostsSeries B convertible preferred stock (Note 7) is
  issued on an ongoing basis to Sun Pharma and its affiliates under the
  Products Agreement between the Corporation and Sun Global in exchange for the
  formulations of technology products delivered by Sun Global to the
  Corporation. The resulting amount of research and development expense is
  charged to operations and is determined based on the fair value of the
  preferred shares on the date the respective product formula passes its
  bio-equivalency studies. The fair value of such shares is based upon an
  independent valuation.Research and development costs settled in cash are
  charged to expense as incurred.Common Stock
  Issued to DirectorsCommon stock was issued from time to time in lieu of
  cash for directors fees, and was recorded as compensation expense at the fair
  values of such shares on the dates they were earned. Subsequent to December
  31, 2003, directors fees are paid in cash. Also, since December 31, 2003,
  independent directors are granted stock options upon completion of their
  anniversary of serving on the board of directors.F-19

CARACO
  PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES
  TO FINANCIAL STATEMENTSFair Values of
  Financial InstrumentsThe carrying values of cash equivalents, accounts
  receivable, and accounts payable approximate their fair values due to the
  short-term maturities of these financial instruments.Recent Accounting
  PronouncementsIn July 2005, the Financial
  Accounting Standards Board(FASB) published an Exposure Draft of
  a proposed Interpretation, Accounting for Uncertain Tax Positions. The
  Exposure Draft seeks to reduce the significant diversity in practice
  associated with recognition and measurement in the accounting for income
  taxes. It would apply to all tax positions accounted for in accordance with Statement of Financial Accounting Standards
  (SFAS) 109, Accounting for Income Taxes. The Exposure Draft requires that
  a tax position meet a probable recognition threshold for the benefit of the
  uncertain tax position to be recognized in the financial statements. This
  threshold is to be met assuming that the tax authorities will examine the
  uncertain tax position. The Exposure Draft contains guidance with respect to
  the measurement of the benefit that is recognized for an uncertain tax
  position, when that benefit should be derecognized, and other matters. This
  proposed Interpretation would clarify the accounting for uncertain tax
  positions in accordance with SFAS 109. This Interpretation, once approved, is
  expected to be effective as of the end of the fiscal year ending after
  December 15, 2005. The Corporation does not expect that the exposure draft
  will have a significant impact on its operating results.In May 2005, the FASB issued SFAS 154, Accounting
  Changes and Error Corrections, which replaces APB Opinion No. 20,
  Accounting Changes, and supersedes FASB Statement No. 3, Reporting
  Accounting Changes in Interim Financial Statementsan amendment of APB
  Opinion No. 28. SFAS 154 requires retrospective application to prior
  periods financial statements of changes in accounting principle, unless it
  is impracticable to determine either the period-specific effects or the
  cumulative effect of the change. When it is impracticable to determine the
  period-specific effects of an accounting change on one or more individual
  prior periods presented, SFAS 154 requires that the new accounting principle
  be applied to the balances of assets and liabilities as of the beginning of
  the earliest period for which retrospective application is practicable and
  that a corresponding adjustment be made to the opening balance of retained
  earnings for that period rather than being reported in an income statement.
  When it is impracticable to determine the cumulative effect of applying a
  change in accounting principle to all prior periods, SFAS 154 requires that
  the new accounting principle be applied as if it wereF-20

CARACO
  PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES
  TO FINANCIAL STATEMENTSadopted prospectively from the earliest date
  practicable. SFAS 154 shall be effective for accounting changes and
  corrections of errors made in fiscal years beginning after December 15,
  2005. The Corporation does not expect that the provisions of the SFAS 154
  will have a significant impact on its operating results.The FASB has proposed amending SFAS 128, Earnings
  per Share, to make it consistent with International Accounting Standard 33,
  Earnings per Share, and make earning per share, or EPS, computations
  comparable on a global basis. Under the proposed amendment, the year-to-date
  EPS computation would be performed independently from the quarterly
  computations. Additionally, for all contracts that may be settled in either
  cash or shares of stock, companies must assume that settlement will occur by
  the issuance of shares for purposes of computing diluted EPS, even if they intend
  to settle by paying cash or have a history of cash-only settlements,
  regardless of who controls the means of settlement. Lastly, under the
  proposed amendment, shares that will be issued upon conversion of a mandatory
  convertible security must be included in the weighted-average number of
  shares outstanding used in computing basic EPS from the date that conversion
  becomes mandatory, using the if-converted method, regardless of whether the
  result is anti-dilutive. The proposed amended standard was expected to be
  issued during the first quarter of 2005. However, the FASB has not yet
  finalized the revised effective date of the proposed amendment or its
  transition provisions. Retrospective application in all periods presented
  would be required and could require the restatement of previously reported
  EPS. The Corporation does not expect that the provisions of the amended SFAS
  128 will have a significant impact on its operating results.In December 2004, the FASB issued SFAS 123R (revised
  2004), Share-Based Payment, (SFAS 123R). SFAS 123R addresses the accounting
  for share-based payments to employees, including grants of employee stock
  options. Under the new standard, Caraco will no longer be able to account for
  share-based compensation transactions using the intrinsic method in
  accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees.
  Instead, Caraco will be required to account for such transactions using a
  fair-value method and recognize the expense in the statement of operations.
  On April 14, 2005, the Securities and Exchange Commission announced the
  adoption of a new rule that amends the compliance dates for SFAS 123 (R). The
  new rule allows companies to implement SFAS 123 (R) at the beginning of their
  next fiscal year, instead of their next reporting period beginning after June
  15, 2005. The Corporation plans to adopt the new statement beginning in the
  first quarter of fiscal 2007. The Corporation expects that the adoption of
  SFAS 123R will not have a significant impact on its results of operations,
  nor does it expect that the adoption of SFAS 123R will impact its overall
  financial position.F-21

CARACO
  PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES
  TO FINANCIAL STATEMENTSHowever, the calculation of compensation cost for
  share-based payment transactions after the effective date of SFAS 123R may be
  different from the calculation of compensation cost under SFAS 123, but such
  differences have not yet been quantified.In December 2004, the FASB issued SFAS 153 Exchanges
  of Nonmonetary Assets, and Amendment of APB Opinion No. 29. The guidance in
  APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the
  principle that exchanges of nonmonetary assets should be measured based on
  the fair value of the assets exchanged. The guidance in APB Opinion No. 29,
  however, included certain exceptions to the principle. SFAS 153 amends APB
  Opinion No. 29 to eliminate the exception for nonmonetary exchanges of
  similar productive assets and replaces it with a general exception for
  exchanges of nonmonetary assets that do not have commercial substance. A
  nonmonetary exchange has commercial substance if the future cash flows of the
  entity are expected to change significantly as a result of the exchange. SFAS
  153 is effective for nonmonetary asset exchanges in fiscal periods beginning
  after June 15, 2005. The Corporation does not believe that the adoption of
  SFAS 153 will have a material impact on its results of operations or financial
  position.2.
SUPPLEMENTAL
  CASH FLOWS INFORMATIONNon-Cash
  Financing ActivitiesAs described in Notes 1 and 7, pursuant to the
  technology transfer agreement with an affiliate of the Corporations parent,
  Caraco, on an ongoing basis, finances the acquisition of research and
  development costs in exchange for the issuance of preferred stock to its
  parent. Preferred stock earned or issued to affiliates had fair values of
  $35,055,360 for the year ended March 31, 2006, $10,200,000 for the three
  month period ended March 31, 2005, and $24,397,040 and $3,103,370 for the
  years ended December 31, 2004 and 2003, respectively.Other Cash Flows
  InformationCash paid for interest was approximately $4,000,
  $407,000 and $1,783,000 for the years ended March 31, 2006, December 31, 2004
  and 2003, respectively. No cash was paid for interest for the three month
  period ended March 31, 2005.F-22

CARACO
  PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES
  TO FINANCIAL STATEMENTS3.
ACCOUNTS
  RECEIVABLE, NET OF ALLOWANCES FOR SALES ADJUSTMENTS AND DOUBTFUL ACCOUNTS
  (NOTE 1)Accounts receivable and related allowances are
  summarized as follows:March 312006

2005Accounts receivable - gross

$
33,926,099

$
27,766,778Allowances:Chargebacks


11,467,000


19,810,000Sales returns
  and allowances


1,500,000


1,120,000Doubtful
  accounts


100,000


100,000Total allowances


13,067,000


21,148,000Accounts receivable, net of allowances

$
20,859,099

$
6,736,778A summary of the activity in accounts receivable
  allowances is as follows:TotalAllowancesBalance at December 31, 2002

$
9,305,000Additions charged to net sales


56,515,000Deductions allowed to customers


(49,777,000
)Balance at December 31, 2003


16,043,000Additions charged to net sales


67,670,000Deductions allowed to customers


(65,578,000
)Balance at December 31, 2004


18,135,000Additions charged to net sales


21,712,000Deductions allowed to customers


(18,817,000
)Balance at March 31, 2005


21,130,000Additions charged to net sales


118,996,000Deductions allowed to customers


(126,959,000
)Balance at March 31, 2006

$
13,067,000F-23

CARACO
  PHARMACEUTICAL LABORATORIES, LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES
  TO FINANCIAL STATEMENTS4.
INVENTORIESInventories consist of the following amounts:March 312006

2005Raw materials

$
9,735,502

$
5,504,006Goods in transit


5,974,600


3,700,651Work in process


3,283,911


2,607,903Finished goods


7,971,677


6,655,133Total inventories

$
26,965,690

$
18,467,693The principal components used in the Corporations
  business are active and inactive pharmaceutical ingredients and certain
  packaging materials. Some of these components are purchased from single
  sources, however, the majority of the components have an alternate source of
  supply. Because the FDA approval process requires manufacturers to specify
  their proposed supplier of components in their applications, FDA approval of
  a new supplier would be required if components were no longer available from
  the specified suppliers.During the year ended March 31, 2006, the three
  months ended March 31, 2005, and during the years ended December 31,
  2004 and 2003, the Corporation purchased inventory components of
  approximately $28.1 million, $5.3 million, $16.7 million and $10.3 million,
  respectively, from Sun Pharma.5.
DEBTEDC LoanDuring 2004, the Corporation repaid the entire
  amount due to the EDC under the Development and Loan Agreement dated August
  10, 1990.Loans Payable to
  Financial InstitutionsDuring 2004, the Corporation obtained a $10,000,000
  line-of-credit with Citibank, N.A., that incurred interest at the London
  Interbank Offered Rate (LIBOR) plus 125 basis points. Borrowings on the
  line-of-credit were available to Caraco only when secured by an irrevocable
  standby letter-of-credit from Sun Pharma. Such a letter was provided byF-24

CARACO PHARMACEUTICAL LABORATORIES,
  LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES TO FINANCIAL STATEMENTSSun Pharma during 2004. The letter had expired as of
  December 31, 2004, and was terminated on March 15, 2005.On November 17, 2005, the
  Corporation entered into a one-year, $10 million Credit Agreement with JP
  Morgan Chase Bank, N.A. Under the Credit Agreement, the lender may make loans
  and issue letters of credit to the Corporation for the Corporations working capital
  needs and general corporate purposes. Letters of credit, if issued, expire
  one year from their date of issuance, but no later than November 17, 2007.
  Borrowings are secured by the Corporations receivables and inventory.
  Interest is payable based on a LIBOR Rate or an alternate base rate
  (determined by reference to the prime rate or the federal funds effective
  rate), as selected by the Corporation. The rate of interest is LIBOR plus 75
  basis points or the banks prime rate minus 100 basis points (effective rates
  of 6.0% and 6.75%, respectively at March 31, 2006.) The Credit
  Agreement requires that certain financial covenants be met on a quarterly
  basis. The Corporation is in compliance with these financial covenants at
  March 31, 2006. There are no borrowings
  under this Credit Agreement at March 31, 2006.6.
INCOME
  TAXESThe Corporations deferred income taxes result
  principally from its net operating loss carryforwards. At March 31, 2006 a
  net deferred income tax asset of approximately $20.1 million (computed using
  a 34% tax rate) relating to these temporary differences exists. Based on the
  Corporations prior operating results and operating characteristics,
  utilization of this deferred tax asset to offset future taxable income is not
  reasonably assured. Accordingly, Caraco has recorded a valuation allowance to
  fully offset the net deferred tax asset, resulting in no net deferred tax
  asset or liability in the accompanying balance sheets. The valuation
  allowance increased by approximately $3.7 million for the year ended March
  31, 2006, $2.0 million for the three month period ended March 31, 2005, $0.4
  million in 2004, and decreased by approximately $4.1 million in 2003.At March 31, 2006, net operating loss carryforwards
  of approximately $58.8 million, which expire between 2007 and 2017, are
  available to offset future federal taxable income, if any. Sun Pharma has,
  over time, increased its ownership of the Corporations capital stock. Under
  rules established by the Internal Revenue Code, this change in ownership may
  adversely affect how the Corporation is able to utilize these net operating
  loss carryforwards in future years.F-25

CARACO PHARMACEUTICAL LABORATORIES,
  LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES TO FINANCIAL STATEMENTS7.
STOCKHOLDERS
  EQUITY (DEFICIT)Common StockDuring 2003, the Corporations shareholders approved
  the authorization of an additional 20,000,000 shares of common stock. The
  Corporation has not yet filed an amendment to its articles of incorporation
  to effect this change.The Corporation granted 45,000 shares of common
  stock on May 2, 2005 to its Chief Executive Officer, which vest at a rate of
  15,000 shares on each anniversary date until they are fully vested on May 2,
  2008. The Corporation has recorded compensation expense of approximately
  $109,000 related to the portion of the stock grant that vested during fiscal
  2006.Preferred StockAccrued dividends of $0.4 million on Series A
  preferred shares were paid during 2003, and the holder, then a Corporation
  director, converted all Series A outstanding shares into an equivalent number
  of common shares. Accordingly, at March 31, 2006 and 2005, no Series A shares
  remain designated.In November 2002, in connection with the new
  technology transfer agreement established with Sun Global (Note 1), the
  Corporation designated the Series B Convertible Preferred Stock. The Series B
  preferred shares are non-redeemable and have no par value. In addition, the
  Series B Convertible Preferred Stock has no voting or dividend rights or
  liquidation preference other than priority liquidation based on their values
  on the dates they were earned, and can be converted after three years from
  the issuance date (or immediately upon a change in control) into one share of
  common stock, subject to a conversion adjustment (Note 1). While such
  preferred shares are outstanding, Caraco cannot, without the consent of the
  holders of a majority of the outstanding shares of the preferred stock, amend
  or repeal its articles of incorporation or bylaws if such action would
  adversely affect the rights of the preferred stock. In addition, without such
  consent, capital stock having any preference or priority superior to the
  preferred stock may not be issued. As of March 31, 2006, the Corporation has
  issued 10,880,000 shares of the Series B Convertible Preferred stock to Sun
  Pharma in exchange for twenty product transfers. Such shares have been
  cumulatively valued at $72,755,770 million as of March 31, 2006.F-26

CARACO PHARMACEUTICAL LABORATORIES,
  LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES TO FINANCIAL STATEMENTS8.
COMMON
  STOCK OPTIONSCommon Stock
  Option PlansAs of March 31, 2006, the Corporation maintains one
  stock option plan, the 1999 Equity Participation Plan (the 1999 Plan) (all
  options under the 1993 plan were exercised during 2003, under which the
  Corporation may grant options to employees and non-employee-directors for the
  purchase of up to 3,000,000 shares of common stock.) The exercise price of
  options granted may not be less than the fair value of the common stock on
  the date of grant. Options granted under this plan generally vest in annual
  installments, from the date of grant, over a five-year period, and expire
  within six years from the date of the grant. Activity with respect to these
  options is summarized as follows:Year Ended
March 31,

Three Months Ended
March 31

Year Ended December 31,2006

2005

2004

2003Shares

Weighted
Average
Exercise
Price

Shares

Weighted
Average
Exercise
Price

Shares

Weighted
Average
Exercise
Price

Shares

Weighted
Average
Exercise
PriceOutstanding,
beginning of year


160,500


1.68


181,600


1.41


277,000

$
1.00


687,138

$
1.04Granted


46,000


8.39


4,500


9.60


9,000


9.60





Exercised


(61,700
)

0.98


(25,600
)

1.24


(80,400
)

1.08


(410,138
)

0.97Terminated


(3,400
)

9.30








(24,000
)

0.80





Outstanding, end of
year


141,400

$
3.93


160,500

$
1.67


181,600

$
1.41


277,000

$
1.00Options exercisable, end of
year


71,720

$
1.32


79,418

$
1.50


49,800

$
1.02


102,500

$
1.07Options
at March 31, 2006:

Options Outstanding

Options ExercisableRange of
Exercise Prices

Shares

Remaining
Contractual
Life *

Exercise
Price *

Shares

Exercise
Price *$0.68 to $1.00


60,400


1.2

$
0.78


48,320

$
0.78$1.01 to $2.00


25,000


1.7


1.25


20,000


1.25$7.01 to $8.00


1,500


5.0


7.90


300


7.90$8.01 to $9.00


47,500


5.2


8.41


300


8.76$9.01 to $10.00


7,000


3.8


9.55


2,800


9.55Total


141,400


2.8

$
3.93


71,720

$
1.32*Weighted average

F-27

CARACO PHARMACEUTICAL LABORATORIES,
  LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES TO FINANCIAL STATEMENTSOther Common
  Stock Option AgreementsThe Corporation has issued other stock options
  outside of the 1999 Plan. These stock options have been issued with various
  vesting schedules and expire at various dates through October 2006. Activity
  with respect to these options is summarized as follows:Year Ended
March 31

Three Months Ended
March 31

Year Ended December 312006

2005

2004

2003Shares

Weighted
Average
Exercise
Price

Shares

Weighted
Average
Exercise
Price

Shares

Weighted
Average
Exercise
Price

Shares

Weighted
Average
Exercise
PriceOutstanding, beginning of
period


200,000

$
3.50


200,000

$
3.50


1,876,666

$
2.01


2,250,824

$
2.00Exercised














(1,676,666
)

2.01


(374,158
)

1.16Outstanding, end of
period


200,000

$
3.50


200,000

$
3.50


200,000

$
3.50


1,876,666

$
2.01Options exercisable, end of
period


200,000

$
3.50


200,000

$
3.50


200,000

$
3.50


1,876,666

$
2.01Options
at March 31, 2006:

Options Outstanding and ExercisableRange of
Exercise Prices

Shares

Remaining
Contractual
Life

Exercise
Price$3.01 to $4.00


200,000



$
3.50The Corporation follows only the disclosure aspects
  of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting
  for Stock-Based Compensation. Management believes that the fair value and
  pro-forma disclosures, required by SFAS No. 123, are not material to the
  financial statements. The Corporation continues to apply Accounting Principles
  Board (APB) Opinion No. 25 in accounting for its plan and, accordingly, no
  compensation cost has generally been recognized in the financial statements
  for its outstanding stock options. Options to purchase 46,000, 4,500 and
  9,000 shares of common stock were granted for the year ended March 31, 2006,
  the three month period ended March 31, 2005 and the year ended December
  31, 2004, respectively, to the independent directors of the Corporation. No
  options were granted during 2003.In December 2001, the Board of Directors extended
  the exercise date to December 31, 2005 with respect to options for 224,158
  shares of Caraco common stock previously granted to a then independent
  director. Variable compensation expense of $2.1 millionF-28

CARACO PHARMACEUTICAL LABORATORIES,
  LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES TO FINANCIAL STATEMENTSand $0.3 million triggered by the
  extension was recorded during 2003 and 2002 in recognition of this
  modification.On October 2, 2003, the Corporation entered into a
  severance agreement with its former Chief Executive Officer. The agreement
  allowed vesting of options for the purchase of 40,000 common shares held by
  the former officer to be accelerated. The modification resulted in the
  options being treated as variable rather than fixed in accordance with
  Financial Accounting Standards Board Interpretation 44 (FIN 44). As a result
  variable compensation expense of $0.3 million was charged to operations
  during 2003 for the difference between the fair value of the underlying
  common stock and the exercise price of the respective options.The options modified for the independent director
  and for the former officer were exercised during 2003 resulting in an
  increase to additional paid in capital of $2.4 million during 2003.The Corporation granted options to purchase 40,000
  shares of common stock on May 2, 2005 to its Chief Executive Officer, which
  vest at a rate of 15,000 shares on each anniversary date until they are fully
  vested on May 2, 2008.Strategic
  Alliance Stock Options AgreementPursuant to an agreement between the Corporation and
  an unaffiliated large generic pharmaceutical Corporation, dated October 1,
  1993, the Corporation was to receive the formulations, technology,
  manufacturing processes and know-how, and other relevant information, and to
  pay for the bio-equivalency studies required for the preparation of ANDAs for
  two products. Pursuant to the agreement, the Corporation was required to pay
  (i) a Sign-Up Option to purchase 100,000 shares of Common Stock at $3.50 per
  share; and (ii) a Product Option to purchase shares to an exercise price of $3.50
  per share. These options may be exercised and payment for shares may be made
  only out of royalties and any interest earned on the royalties while held by
  the Corporation. No options have yet been exercised (Note 12).9.
LEASES
  (INCLUDING RELATED PARTY)The Corporation entered into two non-cancelable
  operating leases during 2000 with Sun Pharma to lease production machinery.
  The leases each required quarterly rental payments of $4,245 and expired
  during 2005.F-29

CARACO PHARMACEUTICAL LABORATORIES,
  LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES TO FINANCIAL STATEMENTSThe Corporation entered into a non-cancelable
  operating lease with an unrelated party during 2002 to lease additional
  warehouse space. This lease was subsequently modified during 2003 in lieu of
  a new non-cancelable operating lease for additional space at this warehouse. The new lease requires
  monthly payments that increase from $15,458 to $16,892 over the term of the
  lease that expires in 2007 with an option to renew for an additional year.Net rental expense on these operating leases was
  $224,569 for the year ended March 31, 2006, $64,896 for the three months
  ended March 31, 2005 and $181,129 and $176,065 for the years ended December
  31, 2004 and 2003, respectively.The Corporation entered into a non-cancelable
  operating lease with an unrelated party on March 13, 2006 to obtain additional
  space for its administrative staff. The lease commences in May 2006 and
  requires monthly payments that increase from $8,481 to $9,066 over the term
  of the lease that expires in 2009.The following is a schedule of annual future minimum
  lease payments required under the operating leases with remaining
  non-cancelable lease terms in excess of one year as of March 31, 2006:Year

Amount2007

293,0462008

104,9922009

63,171The Corporation also paid approximately $0.2 million
  for the year ended March 31, 2006, $0.1 million for the three month period
  ended March 31, 2005, respectively, and $0.6 million and $0.5 million to Sun
  Pharma during the years ended December 31, 2004 and 2003, respectively, for
  the purchase of various parts and machinery needed for operations.10.
RETIREMENT
  PLANThe Corporation maintains a deferred compensation
  plan qualified under Section 401(k) of the Internal Revenue Code. Under this
  plan, eligible employees are permitted to contribute up to the maximum
  allowable amount determined by the Internal Revenue Code. The Corporation may
  make discretionary matching and profit sharingF-30

CARACO PHARMACEUTICAL LABORATORIES,
  LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES TO FINANCIAL STATEMENTScontributions under the provisions of the Plan. The
  Corporation made no discretionary contributions during the year ended March
  31, 2006, the three months ended March 31, 2005, or for the years ended
  December 31, 2004 or 2003.11.
CONCENTRATIONS
  AND COMMITMENTSMajor CustomersShipments to three wholesalers accounted for
  approximately 77% of gross revenue for the year ended March 31, 2006, 60% of
  gross revenue for the three months ended March 31, 2005 and 79% and 80% of
  gross revenue for the years ended December 31, 2004 and 2003, respectively.
  Balances due from these customers represented approximately 72% and 77% of
  gross accounts receivable at March 31, 2006 and 2005, respectively.The loss of these customers could have a materially
  adverse effect on short-term operating results.Major ProductsShipments of three products accounted for
  approximately 80% of gross revenue for the year ended March 31, 2006, 74%
  of gross revenue for the three months ended March 31, 2005 and 80% of
  gross revenue for the year ended December 31, 2004, respectively. Shipments
  of two products accounted from approximately 87% of gross revenue for the
  year ended December 31, 2003.Approximately 84% of raw material purchases for the
  year ended March 31, 2006 and for the three months ended March 31, 2005 were
  made from Sun Pharma. Approximately 75% and 73% of Caracos raw material
  purchases for the years ended December 31, 2004 and 2003, respectively, were
  made from Sun Pharma.Product Sales
  CommitmentCertain of the Corporations customers purchase its
  products through designated wholesalers, who act as an intermediary
  distribution channel for the Corporations products. One such customer, the
  Veterans Administration, an agency of the United States Government, entered
  into a sales contract with the Corporation effective August 5, 2002 to
  purchase approximately $13,000,000 of product per year over a one year base
  contract period that ended June 30, 2003. The contract has four one-year
  option periods,F-31

CARACO PHARMACEUTICAL LABORATORIES,
  LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES TO FINANCIAL STATEMENTSthe first three of which were exercised. The
  agreement may be terminated by the purchaser without cause and in such case,
  Caraco would only be entitled to a percentage of the contract price, plus
  reasonable charges that have resulted from the termination. The agreement
  further provides for certain penalty provisions if the Corporation is unable
  to meet its sales commitment.Labor ContractThe majority of the Corporations hourly work force
  is covered by a collective bargaining agreement that expires in September
  2008.12.
OTHER
  MATTERSEmployment
  ContractsThe Corporation has employment agreements with four
  of its executive officers that provide for fixed annual salaries and at least
  a six-month continuance including insurance benefits and immediate vesting of
  stock options upon termination without cause.LitigationAs previously disclosed, on June 9, 2005, Novo
  Nordisk A/S and Novo Nordisk, Inc. (Novo Nordisk) filed a complaint in the
  United States District Court for the Eastern District of Michigan alleging
  that the Corporations filling of an ANDA seeking approval to market its
  generic version of Novo Nordisks Prandin® drug product infringed Novo
  Nordisks patent, which expires June 12, 2018. Novo Nordisk seeks an order
  from the Court which, among other things, directs the FDA not to approve
  Caracos ANDA any earlier than the claimed expiration date. The ANDA filed by
  Caraco contains a Paragraph IV certification challenging the Novo Nordisk patent.
  The corporation believes that the Novo Nordisk patent is invalid and/or will
  not be infringed by Caracos manufacture, use or sale of the product, and the
  corporation intends to vigorously defend this action in order to capitalize
  on the potential 180 days of marketing exclusivity available for this
  product.As previously disclosed, on September 22, 2004,
  Ortho-McNeil Pharmaceutical, Inc. (Ortho-McNeil) filed a complaint in the
  United States District Court for the Eastern District of Michigan alleging
  that the Corporations filing of an ANDA seeking approval to market its
  generic version of Ortho-McNeils Ultracet® drug product infringed Ortho-F-32

CARACO PHARMACEUTICAL LABORATORIES,
  LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES TO FINANCIAL STATEMENTSMcNeils patent, which expires on September 6, 2011.
  Ortho-McNeil seeks an order from the Court which, among other things, directs
  the FDA not to approve Caracos ANDA any earlier than the claimed expiration
  date. The ANDA filed by Caraco contained a Paragraph IV Certification
  challenging the Ortho-McNeil patent. The corporation believes that the
  Ortho-McNeil patent is invalid and/or will not be infringed by Caracos
  manufacture, use or sale of the product, and the corporation intends to
  vigorously defend this action. Since this action, Ortho-McNeil has entered
  into a license agreement with another manufacturer and has launched its
  product generically while another manufacturer has launched its approved
  generic at risk. On October 8, 2005, arguments were heard in the US District
  Court in the Eastern District of Michigan, on the Corporations motion for
  summary judgment on the issue of non-infringement. On October 19, 2005 the
  motion for summary judgment was granted in the Corporations favor. On
  December 19, 2005, the FDA approved the manufacture, use and sale of the
  product.Ortho-McNeil
  has filed an appeal of the finding of non-infringement by the Eastern
  District of Michigan. Additionally, the United States Patent and Trademark
  Office has allowed Ortho-McNeils request for a reissue patent that, if
  issued, Ortho-McNeil could contend that is product will be infringed by
  Caracos now-marketed product. The corporation believe that, like its
  original patent, Ortho-McNeils reissue patent will be invalid and
  unenforceable.As previously disclosed, on February 12, 2003, C.
  Arnold Curry filed a complaint in the Wayne County Circuit Court alleging
  breach of a written employment agreement. Dr. Curry sought 175,000 shares of
  the Corporations common stock (35,000 shares for each of the first five
  ANDAs approved by the FDA). The corporation and the plaintiff each filed a motion
  for summary disposition. Both parties motions were denied, and the parties
  submitted the matter to binding arbitration. In connection with the
  submission to arbitration, the parties agreed that Mr. Curry would receive a
  minimum of 15,000 shares of common stock. On April 20, 2006, the arbitrator
  entered a determination of no cause of action against Mr. Curry and in favor
  of the Corporation, thus capping the Corporations liability to Mr. Curry at
  15,000 shares. The Corporation has recorded an expense of approximately
  $116,000 related to the 15,000 shares earned by Mr. Curry.The Corporation is involved in certain legal
  proceedings from time to time incidental to normal business activities. While
  the outcome of any such proceedings cannot be accurately predicted, the
  Corporation does not believe the ultimate resolution of any existing matters
  would have a material adverse effect on its financial position or results of
  operations.F-33

CARACO PHARMACEUTICAL LABORATORIES,
  LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES TO FINANCIAL STATEMENTSProduct Liability
  and InsuranceThe Corporation currently maintains general and
  product liability insurance, with coverage limits of $10 million per incident
  and in the aggregate. The Corporation also maintains special product
  liability insurance coverage for one of its products with coverage limits of
  $1 million per incident and in the aggregate. The Corporations insurance
  policies provide coverage on a claim made basis and are subject to annual
  renewal. Such insurance may not be available in the future on acceptable
  terms or at all. There can be no assurance that the coverage limits of such
  policies will be adequate to cover the Corporations liabilities, should they
  occur.Royalty AccrualPursuant to the Strategic Alliance Stock Options
  Agreement (Note 8), Caraco received the formulation for one product,
  Metoprolol Tartrate, in March 1995. However, Caraco has determined that the
  formula provided to it with respect to Metoprolol Tartrate is different than
  the formula submitted in an ANDA to the FDA in 1995, approved by the FDA in
  1996 and manufactured and introduced by Caraco since 1997. The Corporation
  has accrued royalties of approximately $1 million, which is included with
  accrued expenses in the accompanying balance sheets at March 31, 2006 and
  2005, and since April 2003, has discontinued to accrue royalties related to
  this agreement.Subsequent
  Transactions With and Relating to Sun PharmaOn June 1, 2006 Sun Global earned 544,000 shares of
  Series B preferred stock pursuant to the products transfer agreement for one
  product transfer (Note 1).13.
SEGMENT INFORMATIONThe Corporation does not manufacture, produce or
  sell branded products or controlled-release products. The Corporation is
  primarily in the business of manufacturing, developing, selling and
  distributing various therapeutic classes of solid oral dosage of generic pharmaceuticals.
  There are no separate management teams or individuals assigned to a product
  or products or therapeutic classes of products, no separate allocation of
  funds or resources to distinct products or products or therapeutic classes or
  products, and the performance of any individual product or products or
  therapeutic classes of products is not separately assessed. The Corporation
  revenues are solely based on the receipt of customers orders.F-34

CARACO PHARMACEUTICAL LABORATORIES,
  LTD.(a subsidiary of Sun Pharmaceutical
  Industries Limited)NOTES TO FINANCIAL STATEMENTSSFAS No. 131, Disclosures About Segments of an
  Enterprise and Related Information establishes standards for reporting of
  financial information about operating segments in annual financial
  statements. The Corporation considers its business to be a single segment
  entity, as its revenues are solely attributable to its generic drug product
  line.For informational purposes, the Corporations sales,
  grouped by therapeutic categories, for the years ended March 31, 2006 and
  December 31, 2004 and the three months ended March 31, 2005 are as follows:Year Ended
March 31

Three Months
Ended
March 31

Year Ended
December 31Therapeutic
Category

2006

2005

2004Antianxiety Drug

$
2,890,213

$
631,670

$
2,119,276Antibiotic


652,055


132,624


549,261Anticonvulsant


232,669


45,578


204,003Antidepressant


8,010,744


507,480


957,558Antidiabetic


32,110,625


7,362,962


30,842,081Antihypertensive
  Drug/Beta Blocker


16,788,820


4,178,650


14,257,386Antipsychotic


2,167,911


484,780


1,293,620Cardiac


1,239,431


514,139


1,344,603Decongestants


116,257


316,524


358,059Hormonal
  Replacement Therapy





295,172


Nonsteroidal
  Antiinflammatory Agent


2,101,804


544,983


1,719,487Opiate
  Agonist/Analgesic


14,082,000


1,887,640


5,121,809Platelet
  Aggregation Inhibitor


147,856


24,571


80,730Skeletal Muscle
Relaxant


1,150,073


201,673


1,492,437Vascular and
  Migraine Headache Suppressant


1,098,460


208,054


Net
  Sales

$
82,788,918

$
17,336,500

$
60,340,309Similar data for the year ended December 31, 2003
  has not been presented as it is considered by the Corporation to be
  impracticable to do so.* * * * *

F-35

EXHIBIT INDEX

3.01

Registrants
  Amended and Restated Articles of Incorporation, as amended. (1)3.02

Certificate
  of Amendment to the Articles of Incorporation filed February 13, 1997. (2)3.03

Certificate
  of Amendment to the Articles of Incorporation filed February 10, 2000. (3)3.04

Certificate
  of Determination of Rights, Privileges and Preferences Series B Preferred
  Stock. (4)3.05

Registrants
  Amended and Restated Bylaws. (5)10.01

Agreement,
  dated as of October 1, 1993, among Registrant and Non-Affiliate (6)10.02

Employment
  Agreement, dated October 22, 1993, of Robert Kurkiewicz. (6)10.03

Stock
  Purchase Agreement by and between Caraco Pharmaceutical Laboratories, Ltd.
  and Sun Pharmaceutical Industries, Ltd. dated as of April 23, 1997. (7)10.04

Products
  Agreement by and between Caraco Pharmaceutical Laboratories, Ltd. and Sun
  Pharmaceutical Industries, Ltd. dated as of April 23, 1997. (7)10.05

Registration
  Rights Agreement dated as April 1997. (7)10.06

Amendment to
  Employment Agreement of Robert Kurkiewicz dated as of April 1, 1997. (8)10.07

1999 Equity
  Participation Plan. (9)10.08

Renewal to
  Employment Agreement of Robert Kurkiewicz dated as of January 1, 1999. (3)10.09

Third
  Amendment to Employment Agreement of Robert Kurkiewicz dated August 30, 2002.
  (3)10.10

Employment
  Agreement of Jitendra N. Doshi. (3)10.11

Agreement
  between Caraco and Sun Pharma Global, Inc. dated November 21, 2002. (4)10.12

Sales
  contract with government vendor. (4)10.13

Employment
  Agreement of Mr. Singh (5)10.14

Employment
  Agreement of Mr. Movens (10)10.15

Confidentiality
  and Non-Competition Agreement of Dan Movens (10)10.16

Summary of
  Fiscal 2006 Executive Officer Salaries (11)10.17

Credit
  Agreement with JPMorgan Chase Bank, N.A. (12)10.18

Security
  Agreement with JPMorgan Chase Bank, N.A. (12)10.19

Form of
  Grant of Employee Stock Option (+)21

Subsidiaries
  of the Registrant (+)23.01

Consent of
  Registered Independent Public Accountants (+)

24.1

Power of
  Attorney (included on signature page) (+)31.1

Certificate
  of Chief Executive Officer (+)31.2

Certificate
  of Chief Financial Officer(+)32.1

Certification
  of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.
  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002. (+)+ Filed herewith(1)
Incorporated
  by reference from Exhibits to Registrants Form 10-KSB filed on or about
  March 30, 1995 as Commission File no. 0-24676.(2)
Incorporated
  by reference from Exhibits to Registrants Form 10-KSB filed on or about
  March 31, 1997, as Commission File No. 0-24676.(3)
Incorporated
  by reference from Exhibits to Pre-Effective Amendment No. 1 to Form SB-2
  filed on September 4, 2002 as Commission File No. 333-91968.(4)
Incorporated
  by reference from Exhibits to Registrants Form 10-KSB filed on or about
  March 31, 2003, Commission File No. 0-24676.(5)
Incorporated
  by reference from Exhibit to Registrants Form 10-K filed on or about March
  15, 2005, Commission File No. 0-24676.(6)
Incorporated
  by reference from Exhibits to Registrants Registration Statement on Form
  SB-2, as amended, filed on November 5, 1993 as Commission File No.
  33-71398C.(7)
Incorporated
  by reference from Exhibits to Registrants Form 10-QSB filed on November 14,
  1997 as Commission File No. 0-24676.(8)
Incorporated
  by reference from Exhibits to Registrants Form 10-KSB filed on or about
  March 31, 1998, as Commission File No. 0-24676.(9)
Incorporated
  by reference from Appendix A to Registrants Proxy Statement dated April 28,
  1999 as Commission File No. 0-24676.(10)
Incorporated
  by reference from Exhibits to Registrants Form 10-K/A filed on or about May
  2, 2005, Commission File No. 0-24676.(11)
Incorporated
  by reference from Exhibits to Registrants Form 8-K filed on or about August
  25, 2005. Commission File No. 0-24676(12)
Incorporated
  by reference from Exhibits to Registrants Form 10-Q filed on or about
  January 26, 2006. Commission File No. 0-24676