**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

----

**FORM 10-Q**

**[MARK ONE]**

**x**          QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

**For the quarterly period ended September 30, 2006**

**OR**

**o**           TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

**For the transition periodfrom                          to                          **

**Commission File No. 000-30123**

----

**SCIELE PHARMA, INC.**

(Exact name ofregistrant as specified in its charter)

| **Delaware**                                              |   | **58-2004779**                           |
|-----------------------------------------------------------|--------|------------------------------------------|
| (State of  incorporation)                                 |   | (I.R.S. Employer  Identification Number) |
| ** **                                                |   | ** **                               |
| **Five  Concourse Parkway, Suite 1800, Atlanta, Georgia** |   | **30328**                                |
| (Address of  principal executive offices)                 |   | (Zip code)                               |

 

**(770)442-9707**

(Registrant’stelephone number, including area code):

----

Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x        No o

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer. See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one):
| Large accelerated filer x |   | Accelerated  filer o |   | Non-accelerated  filer o   |
|---------------------------|--------|----------------------|--------|--------------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). 

o Yes   x No  

As of October 24, 2006, there were 34,871,834 shares of the Registrant’sCommon Stock outstanding.

 

----

**SCIELE PHARMA, INC.FORM 10-QINDEX**
| PART  I.    FINANCIAL INFORMATION |                                                                                                                  |
|-------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------|
|                                                  |                                                                                                                  |   |
| Item 1.                                          | Consolidated  Balance Sheets at September 30, 2006 and December 31, 2005                                              |   |
|                                                  |                                                                                                                  |   |
|                                                  | Consolidated  Statements of Operations for the three and nine months ended September 30,  2006 and September 30, 2005 |   |
|                                                  |                                                                                                                  |   |
|                                                  | Consolidated  Statements of Cash Flows for the nine months ended September 30, 2006 and  September 30, 2005           |   |
|                                                  |                                                                                                                  |   |
|                                                  | Notes to  Consolidated Financial Statements                                                                           |   |
|                                                  |                                                                                                                  |   |
| Item 2.                                               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                           |   |
|                                                  |                                                                                                                  |   |
| Item 3.                                               | Quantitative  and Qualitative Disclosures about Market Risk                                                           |   |
|                                                  |                                                                                                                  |   |
| Item 4.                                               | Controls and  Procedures                                                                                              |   |
|                                                  |                                                                                                                  |   |
| PART  II.    OTHER INFORMATION    |                                                                                                                  |
|                                                  |                                                                                                                  |   |
| Item 1.                                               | Legal Proceedings                                                                                                     |   |
|                                                  |                                                                                                                  |   |
| Item 2.                                               | Unregistered  Sales of Equity Securities and Use of Proceeds                                                          |   |
|                                                  |                                                                                                                  |   |
| Item 4.                                               | Submission  of Matters to a Vote of Security Holders                                                                  |   |
|                                                  |                                                                                                                  |   |
| Item 5.                                               | Other Information                                                                                                     |   |
|                                                  |                                                                                                                  |   |
| Item 6.                                          | Exhibits                                                                                                              |   |
|                                                  |                                                                                                                  |   |
|                                                  | Signatures                                                                                                            |   |
|                                                  |                                                                                                                  |   |
|                                                  | Certifications                                                                                                        |   |

 

2

----

 

**PART I—FINANCIAL INFORMATION**

**ITEM 1. FINANCIAL STATEMENTS**

**SCIELE PHARMA, INC.CONSOLIDATED BALANCE SHEETS(in thousands, except share data)**
| ** **                                                                                                                                                  | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                  | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                  | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                             |       |                         |       |                        |       |
| Cash and cash  equivalents                                                                                                                                  |       | $                            | 35,634     |                        | $          | 17,043 |   |
| Marketable  securities                                                                                                                                      |       | 119,678                      |       | 82,757                      |       |
| Accounts  receivable, net of allowance of $2,889 and $2,427 at September 30, 2006 and  December 31, 2005, respectively                                 |       | 43,259                       |       | 48,353                      |       |
| Inventories                                                                                                                                                 |       | 24,776                       |       | 28,924                      |       |
| Income taxes  receivable                                                                                                                                    |       | 5,156                        |       | 547                         |       |
| Current deferred  tax assets                                                                                                                                |       | 2,441                        |       | 3,705                       |       |
| Other current  assets                                                                                                                                       |       | 22,009                       |       | 23,059                      |       |
| Total current  assets                                                                                                                                       |       | 252,953                      |       | 204,388                     |       |
| Property and equipment,  net                                                                                                                                |       | 8,179                        |       | 5,148                       |       |
| Other assets:                                                                                                                                               |       |                         |       |                        |       |
| Intangibles, net                                                                                                                                            |       | 308,848                      |       | 315,798                     |       |
| Other                                                                                                                                                       |       | 6,862                        |       | 4,371                       |       |
| Total other  assets                                                                                                                                         |       | 315,710                      |       | 320,169                     |       |
|                                                                                                                                                        |       |                         |       |                        |       |
| Total assets                                                                                                                                                |       | $                            | 576,842    |                        | $          | 529,705 |   |
|                                                                                                                                                        |       |                         |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                              | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                                        |       |                         |       |                        |       |
| Account payable                                                                                                                                             |       | $                            | 13,938     |                        | $          | 12,093 |   |
| Accrued expenses                                                                                                                                            |       | 26,595                       |       | 18,482                      |       |
| Total current  liabilities                                                                                                                                  |       | 40,533                       |       | 30,575                      |       |
| Long-term liabilities:                                                                                                                                      |       |                         |       |                        |       |
| Convertible debt                                                                                                                                            |       | 150,000                      |       | 150,000                     |       |
| Deferred tax  liabilities                                                                                                                                   |       | 11,541                       |       | 8,803                       |       |
| Other long-term  liabilities                                                                                                                                |       | 2,408                        |       | 191                         |       |
|                                                                                                                                                        |       |                         |       |                        |       |
| Total  liabilities                                                                                                                                          |       | 204,482                      |       | 189,569                     |       |
| Stockholders’ equity:                                                                                                                                  |       |                         |       |                        |       |
| Preferred stock,  1,000,000 shares authorized and none outstanding                                                                                          |       | —                       |       | —                      |       |
| Common stock,  $0.001 par value; 100,000,000 shares authorized; 35,658,484 and 35,907,376  issued at September 30, 2006 and December 31, 2005, respectively |       | 36                           |       | 36                          |       |
| Additional paid-in  capital                                                                                                                                 |       | 291,559                      |       | 292,639                     |       |
| Retained  earnings                                                                                                                                          |       | 114,124                      |       | 82,524                      |       |
| Deferred  compensation                                                                                                                                      |       | (12,117                      | )          | (7,489                      | )          |
| Accumulated  other comprehensive loss                                                                                                                       |       | (2,690                       | )          | (4,384                      | )          |
|                                                                                                                                                        |       | 390,912                      |       | 363,326                     |       |
| Less: Treasury stock at  cost, Common stock, 800,000 and 1,000,000 shares at September 30, 2006 and  December 31, 2005, respectively                   |       | (18,552                      | )          | (23,190                     | )          |
|                                                                                                                                                        |       |                         |       |                        |       |
| Total  stockholders’ equity                                                                                                                            |       | 372,360                      |       | 340,136                     |       |
|                                                                                                                                                        |       |                         |       |                        |       |
| Total liabilities and  stockholders’ equity                                                                                                            |       | $                            | 576,842    |                        | $          | 529,705 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

3

----

**SCIELEPHARMA, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(unaudited, in thousands, except per share data)**
| ** **                                                  | ** ** | **For The Three Months Ended September 30,** | ** ** | **For The Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **2006**                                                                   | ** ** | **2005**                                                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net revenues                                                |       | $                                                                          | 74,784     |                                                                      | $          | 58,718 |   | $ | 213,636 |   | $ | 149,491 |   |
| Operating costs  and expenses:                              |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Cost of revenues (excluding depreciation and  amortization) |       | 10,283                                                                     |       | 8,768                                                                     |       | 30,181 |   | 23,290 |   |
| Selling, general and administrative expense                 |       | 35,912                                                                     |       | 26,480                                                                    |       | 106,958 |   | 68,240 |   |
| Depreciation and amortization                               |       | 6,752                                                                      |       | 6,217                                                                     |       | 19,787 |   | 16,322 |   |
| Research and development expense                            |       | 4,502                                                                      |       | 1,399                                                                     |       | 11,323 |   | 2,285 |   |
|                                                        |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Total operating costs and expenses                          |       | 57,449                                                                     |       | 42,864                                                                    |       | 168,249 |   | 110,137 |   |
|                                                        |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Operating income                                            |       | 17,335                                                                     |       | 15,854                                                                    |       | 45,387 |   | 39,354 |   |
|                                                        |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Other income  (expense):                                    |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Interest expense                                            |       | (864                                                                       | )          | (799                                                                      | )          | (2,389 | ) | (2,202 | ) |
| Interest income                                             |       | 1,399                                                                      |       | 673                                                                       |       | 3,374 |   | 2,351 |   |
| Other                                                       |       | (44                                                                        | )          | —                                                                    |       | (44 | ) | (684 | ) |
|                                                        |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Total other income (expense)                                |       | 491                                                                        |       | (126                                                                      | )          | 941 |   | (535 | ) |
|                                                        |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Income before  provision for income taxes                   |       | 17,826                                                                     |       | 15,728                                                                    |       | 46,328 |   | 38,819 |   |
| Provision for  income taxes                                 |       | (5,525                                                                     | )          | (5,094                                                                    | )          | (14,728 | ) | (12,593 | ) |
|                                                        |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Net income                                                  |       | $                                                                          | 12,301     |                                                                      | $          | 10,634 |   | $ | 31,600 |   | $ | 26,226 |   |
| Other  comprehensive gain (loss)                            |       | 1,127                                                                      |       | (247                                                                      | )          | 1,694 |   | (2,773 | ) |
|                                                        |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Comprehensive  income                                       |       | $                                                                          | 13,428     |                                                                      | $          | 10,387 |   | $ | 33,294 |   | $ | 23,453 |   |
|                                                        |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Net income per  common share:                               |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Basic earnings per common share                             |       | $                                                                          | 0.35       |                                                                      | $          | 0.30 |   | $ | 0.90 |   | $ | 0.75 |   |
|                                                        |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Diluted earnings per common share                           |       | $                                                                          | 0.34       |                                                                      | $          | 0.26 |   | $ | 0.82 |   | $ | 0.65 |   |
|                                                        |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Weighted average  common shares outstanding:                |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Basic                                                       |       | 35,043                                                                     |       | 35,119                                                                    |       | 35,147 |   | 35,071 |   |
|                                                        |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Diluted                                                     |       | 36,014                                                                     |       | 42,548                                                                    |       | 39,270 |   | 42,569 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

4

----

**SCIELEPHARMA, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited, in thousands)**
| ** **                                                                         | ** ** | **For The Nine Months** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                         | ** ** | **Ended September 30,**      | ** ** |
| ** **                                                                         | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                             |       |                                   |       |   |   |
| Net income                                                                         |       | $                                      | 31,600     |   | $ | 26,226 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                   |       |   |   |
| Depreciation and amortization                                                      |       | 19,787                                 |       | 16,322 |   |
| Loss on sale of securities                                                         |       | 43                                     |       | 684 |   |
| Loss on disposal of property and equipment                                         |       | 172                                    |       | — |   |
| Non-cash compensation expense                                                      |       | 6,466                                  |       | 20 |   |
| Non-cash interest expense                                                          |       | 282                                    |       | 252 |   |
| Deferred income tax expense                                                        |       | 3,668                                  |       | 2,435 |   |
| Reduction in taxes payable—stock option exercises                             |       | —                                 |       | 1,411 |   |
| Changes in assets and liabilities, net of acquired  assets and liabilities:        |       |                                   |       |   |   |
| Accounts receivable                                                                |       | 5,094                                  |       | (8,671 | ) |
| Inventories                                                                        |       | 4,148                                  |       | (17,189 | ) |
| Other current assets and other assets                                              |       | 1,385                                  |       | (5,986 | ) |
| Income taxes receivable                                                            |       | (4,609                                 | )          | 1,941 |   |
| Accrued expenses and other                                                         |       | 4,413                                  |       | 307 |   |
| Accounts payable                                                                   |       | 1,845                                  |       | (5,179 | ) |
| Net cash provided by operating activities                                          |       | 74,294                                 |       | 12,573 |   |
| Cash flows from  investing activities:                                             |       |                                   |       |   |   |
| Purchase of products                                                               |       | (5,600                                 | )          | (106,337 | ) |
| Purchase of property and equipment                                                 |       | (3,175                                 | )          | (1,809 | ) |
| Proceeds from sale of property and equipment                                       |       | 51                                     |       | — |   |
| Proceeds from sale of marketable securities                                        |       | 94,936                                 |       | 97,576 |   |
| Purchase of marketable securities                                                  |       | (131,086                               | )          | (20,994 | ) |
| Net cash used in investing activities                                              |       | (44,874                                | )          | (31,564 | ) |
| Cash flows from  financing activities:                                             |       |                                   |       |   |   |
| Repurchase of common stock                                                         |       | (14,804                                | )          | (2,094 | ) |
| Financing debt costs                                                               |       | (3,758                                 | )          | — |   |
| Reduction in taxes payable—stock option exercises                             |       | 2,149                                  |       | — |   |
| Net proceeds from issuance of common stock                                         |       | 4,370                                  |       | 1,816 |   |
| Net cash used in financing activities                                              |       | (12,043                                | )          | (278 | ) |
| Effect of  foreign exchange rates on cash                                          |       | 1,214                                  |       | (2,659 | ) |
| Net change in  cash and cash equivalents                                           |       | 18,591                                 |       | (21,928 | ) |
| Cash and cash  equivalents, beginning of period                                    |       | 17,043                                 |       | 36,586 |   |
| Cash and cash  equivalents, end of period                                          |       | $                                      | 35,634     |   | $ | 14,658 |   |
| Non-cash  financing transactions:                                                  |       |                                   |       |   |   |
| Issuance of restricted stock                                                       |       | $                                      | 5,879      |   | $ | 235 |   |
| Supplemental  Cash Flow Information:                                               |       |                                   |       |   |   |
| Cash paid for income taxes                                                         |       | $                                      | 13,507     |   | $ | 6,337 |   |
| Cash paid for  interest                                                            |       | $                                      | 2,689      |   | $ | 2,880 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

5

----

**SCIELE PHARMA, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS(unaudited)**

**1.****                                      NameChange**

InJune 2006, the stockholders of First Horizon Pharmaceutical Corporationapproved changing the name from First Horizon Pharmaceutical Corporation toSciele Pharma, Inc. (the “Company”). The name change became effective on June15, 2006.

**2.****                                      Basisof Presentation**

Theaccompanying unaudited interim consolidated financial statements reflect alladjustments (consisting solely of normal recurring adjustments) whichmanagement considers necessary for the fair presentation of the financialposition, results of operations and cash flows of the Company for the interimperiods. Certain footnote disclosures normally included in financial statementsprepared according to accounting principles generally accepted in the UnitedStates of America have been condensed or omitted from these interim financialstatements as permitted by the rules and regulations of the Securities andExchange Commission. Interim results are not necessarily indicative of resultsfor the full year. The interim results should be read in conjunction with thefinancial statements and notes thereto included in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2005 (File No. 000-30123).

**3.****                                      NewAccounting Pronouncements**

OnSeptember 15, 2006 the Financial Accounting Standards Board (“FASB”) issuedStatement No. 157, *Fair Value Measurements.*  The Statement provides guidance for usingfair value to measure assets and liabilities. This Statement references fair value as the price that would be receivedto sell an asset or paid to transfer a liability in an orderly transactionbetween market participants in the market in which the reporting entitytransacts. The Statement applies whenever other standards require (or permit)assets or liabilities to be measured at fair value.  The Statement does not expand the use of fairvalue in any new circumstances.  It  is effective for financial statements issuedfor fiscal years beginning after November 15, 2007, and interim periods withinthose fiscal years.  The adoption of SFASNo. 157 is not expected to have a material impact on the Company’s financialstatements.

InMarch 2006, the FASB issued Statement No. 156, *Accountingfor Servicing of Financial Assets,*which amends FAS 140, *Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities.*In a significant change to currentguidance, the Statement of Financial Accountant Standards (“SFAS”) No. 156permits an entity to choose either of the following subsequent measurementmethods for each class of separately recognized servicing assets andservicing liabilities: (1) Amortization Method or (2) Fair Value Measurement Method.SFAS No. 156 is effective as of the beginning of an entity’s first fiscalyear that begins after September 15, 2006.   The adoption of SFAS No. 156 is not expectedto have a material impact on the Company’s financial statements.

InFebruary 2006, the FASB issued Statement No. 155, *Accounting for Certain Hybrid Financial Instruments—an amendment ofFASB Statements No. 133 and 140.*This Statement permits fairvalue of remeasurement for any hybrid financial instrument that contains anembedded derivative that otherwise would require bifurcation; clarifies whichinterest-only strips and principal-only strips are not subject to therequirements of SFAS No. 133, *Accounting for DerivativeInstruments and Hedging Activities,*establishes a requirement toevaluate interests in securitized financial assets to identify interests thatare freestanding derivatives or that are hybrid financial instruments thatcontain an embedded derivative requiring bifurcation; clarifies thatconcentrations of credit risk in the form of subordination are notembedded derivatives; and amended SFAS No. 140, *Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities,*to eliminate the prohibition on a qualifyingspecial-purpose entity from holding a derivative financial instrument thatpertains to a beneficial interest other than another derivative financialinstrument. SFAS No. 155 is effective for all financial instrumentsacquired, issued, or subject to a remeasurement (new basis) event occurringafter the beginning of an entity’s first fiscal year that begins afterSeptember 15, 2006.  The adoption ofSFAS No. 155 is not expected to have a material impact on the Company’sfinancial statements.

InJuly 2006, the FASB issued FIN No. 48,*Accounting for Uncertainty in Income Taxes* (“FIN No. 48”). FINNo. 48 clarifies the accounting for income taxes by prescribing the minimumrecognition threshold a tax position is required to meet before beingrecognized in the financial statements. FIN No. 48 also provides guidance onderecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. In addition, FIN No. 48 scopesout income taxes from Financial 

6

----

AccountingStandards Board Statement No. 5, *Accountingfor Contingencies*.  FIN No. 48is effective for fiscal years beginning after December 15, 2006. TheCompany has not determined the effect, if any, the adoption of theInterpretation will have on its financial statements.

InMay 2005, the FASB issued Statement 154,*Accounting Changes and Error Corrections, a replacement of APB OpinionNo. 20 and FASB Statement No. 3. * The Statementrequires retrospective application to prior periods’ financial statements of avoluntary change in accounting principle unless it is deemed impracticable,unless the change in accounting  relates to the principle method ofdepreciation, amortization or depletion for long-lived, non-financial assets inwhich case the change is accounted for as a change in accounting estimate thatis affected by a change in accounting principle. The Statement is effective foraccounting changes and corrections of errors made occurring in fiscal yearsbeginning after December 15, 2005. The adoption of SFAS No. 154 didnot have a material impact on the Company’s financial position or results ofoperations.

InDecember 2004, the FASB issued Statement 153, *Exchanges of Nonmonetary Assets, an amendment of APB Opinion No.29.*The standard is based on the principle that exchanges of nonmonetary assetsshould be measured based on the fair value of the assets exchanged andeliminates the exception under APB Opinion No. 29 for an exchange ofsimilar productive assets and replaces it with an exception for exchanges ofnonmonetary assets that do not have commercial substance. The standard iseffective for nonmonetary exchanges occurring in fiscal periods beginning afterJune 15, 2005. The adoption of SFAS No. 153 did not have a materialimpact on the Company’s financial position or results of operations.

InDecember 2004, the FASB issued Statement 123 (revised 2004), *Share-Based Payment.* The Statementeliminates the disclosure-only election under SFAS No. 123 and requiresthe recognition of compensation expense for stock options and other forms of equitycompensation based on the fair value of the instruments on the date of grant.The standard is effective for fiscal years beginning after June 15, 2005.See Note 4 for the effect of the adoption on net income and earnings pershare.

**4.****                                      StockBased Compensation**

AtSeptember 30, 2006, the Company had two stock-based compensation plans allowingfor the issuance of stock options and restricted shares and an employee stockownership plan. Prior to December 31, 2005, the Company accounted for thoseplans under the recognition and measurement provisions of APB Opinion (“APB”)No. 25, *Accounting for Stock Issued to Employees*,and related Interpretations, as permitted by FASB No. 123 (revised 2004), *Accounting for Stock-Based Compensation*. No stock-basedemployee compensation cost related to stock options was recognized in theStatement of Operations for the three or  nine months ended September 30, 2005, as alloptions granted under those plans had an exercise price equal to the marketvalue of the underlying common stock on the date of grant. Effective January 1,2006, the Company adopted the fair value recognition provisions of FASBStatement No. 123(R) (“SFAS No. 123R”), “*Share-Based Payment*”,using the modified-prospective-transition method. Under that transition method,compensation cost recognized in the three and nine months ended September 30,2006 includes: (a) compensation cost for all share-based payments granted priorto, but not yet vested as of January 1, 2006, based on the grant date fairvalue estimated in accordance with the original provisions of SFAS No. 123, and(b) compensation cost for all share-based payments granted subsequent toJanuary 1, 2006, based on the grant-date fair value estimated in accordancewith the provisions of SFAS No. 123R. Results for prior periods have not beenrestated.

As aresult of adopting SFAS No. 123R on January 1, 2006, the Company’s incomebefore income taxes for the three and nine months ended September 30, 2006, are$2.1 million and $6.5 million lower, respectively, than if it had continued toaccount for share-based compensation under APB No. 25.  Basic earnings per share for the three andnine months ended September 30, 2006 would have been $0.39 and $1.01,respectively, if the Company had not adopted SFAS No. 123R, compared toreported basic earnings per share of $0.35 and $0.90, respectively.  Diluted earnings per share for the three and ninemonths ended September 30, 2006 would have been $0.38 and $0.93, respectively,if the Company had not adopted SFAS No. 123R, compared to reported dilutedearnings per share of $0.34 and $0.82, respectively.

Priorto the adoption of SFAS No. 123R, the Company presented all tax benefits ofdeductions resulting from the exercise of stock options as operating cash flowsin the Statement of Cash Flows. SFAS No. 123R requires the cash flows resultingfrom the tax benefits related to tax deductions in excess of compensation costrecognized for those options (excess tax benefits) to be classified asfinancing cash flows. The $2.1 million excess tax benefit classified as afinancing cash inflow would have been classified as an operating cash inflow ifthe Company had not adopted SFAS No. 123R.

7

----

Theweighted average fair value per share of options granted during the nine monthsended September 30, 2006 and September 30, 2005 is estimated at $17.24 and $17.17,respectively. There were no stock options granted in the three months endedSeptember 30, 2006.  The value of optionsis estimated on the date of the grant using the following weighted averageassumptions:
|                          | ** ** | **2006** | ** ** | **2005**     | ** ** |
|--------------------------|------------|----------|------------|--------------|------------|
| Risk-free  interest rate |       | 4.70     | %          | 3.83         | %          |
| Expected  dividend yield |       | —   |       | —       |       |
| Expected lives           |       | 5 years  |       | 5 years |       |
| Expected volatility      |       | 106.70   | %          | 115.87       | %          |

 

Non-qualifiedstock options are priced at the fair market value of the Company’s stock on thedate of the grant and typically vest at the rate of 25% per year commencing onthe first anniversary date of the grant and expire on the seventh anniversarydate of the grant.  The Company recognized$0.6 million and $2.1 million of stock-based compensation expense for stockoptions in the three and nine months ended September 30, 2006respectively.   The Company did notrecognize any stock-based compensation expense for stock options in 2005.

In2005 and through September 30, 2006, the Company issued restricted shares toexecutives and employees. The following table summarizes restricted stockoutstanding at September 30, 2006 and changes during the nine months ended(shares in thousands):
|                                        | ** ** | **Number of**  | ** ** | **Weighted** | ** ** |
|----------------------------------------|------------|---------------------|------------|--------------|------------|
| ** **                             | ** ** | **Shares**          | ** ** | **Average**  | ** ** |
| ** **                             | ** ** | **Subject to** | ** ** | **Share**    | ** ** |
| ** **                             | ** ** | **Issuance**        | ** ** | **Price**    | ** ** |
| Outstanding at  December 31, 2005 |       | 543                 |       | $            | 14.45      |   |
| Granted                                |       | 461                 |       | 17.24        |       |
| Cancelled                              |       | (106                | )          | 14.97        |       |
| Exercised                              |       | (16                 | )          | 15.74        |       |
| Outstanding at  September 30, 2006     |       | 882                 |       | $            | 15.88      |   |

The restrictions on therestricted stock lapse according to one of two schedules.  Under one schedule, the restrictions willlapse when specific key performance objectives have been reached or on thefifth anniversary date of the issuance. Under the second schedule, the restrictions will lapse 25% annually overfour years.   The fair value of therestricted stock is expensed over the period during which the restrictionslapse.  For the three and nine monthsended September 30, 2006 the Company recognized $0.8 million and $2.4 million, respectively,in deferred compensation expense related to the restricted shares. The Companyrecognized less than $0.1 million for both the three and nine months endedSeptember 30, 2005.

Had compensationcosts for the Company’s options been determined using the Black-Scholes optionvaluation model prescribed by SFAS No. 123, *Accounting for Stock BasedCompensation*, for the three and nine months ended 2006 and 2005 theCompany’s pro forma net income per common share would have been reported asfollows (in thousands, except per share amounts):
| ** **                                                                                                                    | ** ** | **For The Three Months  Ended September 30,** | ** ** | **For The Nine Months  Ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                                                                    | ** ** | **2006**                                                               | ** ** | **2005**                                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income as  reported                                                                                                       |       | $                                                                      | 12,301     |                                                                  | $          | 10,634 |   | $ | 31,600 |   | $ | 26,226 |   |
| Add:                                                                                                                          |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Stock-based compensation expense included in  reported net earnings, net of related tax effects                               |       | 1,421                                                                  |       | —                                                                |       | 4,415 |   | — |   |
| Deduct:                                                                                                                       |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Total stock-based employee compensation expense  determined under fair value basis for all awards, net of related tax effects |       | (1,421                                                                 | )          | (719                                                                  | )          | (4,415 | ) | (1,878 | ) |
|                                                                                                                          |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Pro forma                                                                                                                     |       | $                                                                      | 12,301     |                                                                  | $          | 9,915 |   | $ | 31,600 |   | $ | 24,348 |   |
|                                                                                                                          |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Net income per  common share—basic:                                                                                      |       |                                                                   |       |                                                                  |       |   |   |   |   |
| As reported                                                                                                                   |       | $                                                                      | 0.35       |                                                                  | $          | 0.30 |   | $ | 0.90 |   | $ | 0.75 |   |
| Pro forma                                                                                                                     |       | $                                                                      | 0.35       |                                                                  | $          | 0.28 |   | $ | 0.90 |   | $ | 0.69 |   |
|                                                                                                                          |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Net income per  common share—diluted:                                                                                    |       |                                                                   |       |                                                                  |       |   |   |   |   |
| As reported                                                                                                                   |       | $                                                                      | 0.34       |                                                                  | $          | 0.26 |   | $ | 0.82 |   | $ | 0.65 |   |
| Pro-forma                                                                                                                     |       | $                                                                      | 0.34       |                                                                  | $          | 0.24 |   | $ | 0.82 |   | $ | 0.61 |   |

 

8

----

The Black-Scholesoption valuation model was not developed for use in valuing employee stockoptions. Instead, this model was developed for use in estimating the fair valueof traded options, which have no vesting restrictions, and are fullytransferable, which differ significantly from the Company’s stock options. Inaddition, stock option valuation models require the input of highly subjectiveassumptions including the expected stock price volatility and expected survivalrates of the stock options.

In2005, the Company began an Employee Stock Ownership Plan (“ESOP”), whichprovides benefits to substantially all employees. The annual contribution, ifany, to the ESOP is at the discretion of the Board of Directors of the Company.In February 2006, the Company distributed 200,000 shares to the ESOP.  In the three and nine months ended September30, 2006 the Company recorded $0.6 million and $2.1 million, respectively,compared to the $0.2 million and $0.6 million for the three and nine monthsended September 30, 2005 in compensation expense for the ESOP.

**5.****                                      MarketableSecurities**

The Company classifies its existing marketablesecurities as available-for-sale. All available-for-sale securities areclassified as current as the Company has the ability to use them for currentoperating and investing purposes. There was less than $0.1 million inrealized losses for the three and nine months ended September 30, 2006. AtSeptember 30, 2006, the Company had total net unrealized losses from marketablesecurities of $1.2 million.

Thecarrying amount of available-for-sale securities and their approximate fair valuesat September 30, 2006 were as follows (in thousands):
|                                                 | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|-------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------------------|------------|
| U.S. Government  and Federal agency obligations |       | $                   | 52,747     |                         | $          | —                        |       | $                          | (849       | ) | $ | 51,898 |   |
| Corporate bonds                                 |       | 68,152              |       | 2                            |       | (374                          | )          | 67,780                     |       |
| Total                                           |       | $                   | 120,899    |                         | $          | 2                             |       | $                          | (1,223     | ) | $ | 119,678 |   |

The following tablepresents the age of gross unrealized losses and fair value by investmentcategory for all securities in a loss position as of September 30, 2006 (inthousands):
|                                                 | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total**                  | ** ** |
|-------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|----------------------------|------------|
| ** **                                      | ** ** | **Estimated  Fair  Value**             | ** ** | **Estimated  Unrealized  Losses**    | ** ** | **Estimated  Fair  Value** | ** ** | **Estimated  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** | **Estimated  Unrealized  Losses** | ** ** |
| U.S. Government  and Federal agency obligations |       | $                                      | —     |                                 | $          | —                     |       | $ | 41,098 |   | $ | (849 | ) | $ | 41,098 |   | $ | (849 | ) |
| Corporate bonds                                 |       | —                                 |       | —                               |       | 19,378                     |       | (374 | ) | 19,378 |   | (374 | ) |
| Total                                           |       | $                                      | —     |                                 | $          | —                     |       | $ | 60,476 |   | $ | (1,223 | ) | $ | 60,476 |   | $ | (1,223 | ) |

The Company hasdetermined that its unrealized losses are temporary based on the minor amountof the losses compared to amortized cost and the short duration of the losses,as well as the credit worthiness of the investees. The Company expects that alllosses will be recovered, and intends to hold securities to recovery. Ifmarket, industry and/or investee conditions deteriorate, we may incurimpairments.

Theamortized cost and estimated fair value of marketable securities at September30, 2006 by contractual maturity are shown below (in thousands):

9

----

 
|                                           | ** ** | **Amortized  Cost** | ** ** | **Estimated  Fair Value** | ** ** |
|-------------------------------------------|------------|---------------------|------------|--------------------------------|------------|
| Due in one year  or less                  |       | $                   | 87,817     |                           | $          | 87,395 |   |
| Due after one  year through three years   |       | 27,113              |       | 26,453                         |       |
| Due after three  years through five years |       | 4,954               |       | 4,831                          |       |
| Due after five  years                     |       | 1,015               |       | 999                            |       |
|                                      |       | $                   | 120,899    |                           | $          | 119,678 |   |

The carrying amount ofavailable-for-sale securities and their approximate fair values atDecember 31, 2005 were as follows (in thousands):
|                                                 | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|-------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------------------|------------|
| U.S. Government  and Federal agency obligations |       | $                   | 58,227     |                         | $          | —                        |       | $                          | (1,349     | ) | $ | 56,878 |   |
| Corporate bonds                                 |       | 26,520              |       | —                       |       | (641                          | )          | 25,879                     |       |
| Total                                           |       | $                   | 84,747     |                         | $          | —                        |       | $                          | (1,990     | ) | $ | 82,757 |   |

 

**6.****                                      Inventories**

Inventoriesconsist of purchased pharmaceutical products and are stated at the lower ofcost or market. Cost is determined using the first-in, first-out method, andmarket is considered to be net realizable value. Inventories consist offinished product and bulk product awaiting processing and packaging intofinished product. Inventories, net of reserves of $0.7 million and $0.9 millionat September 30, 2006 and December 31, 2005, respectively, consisted of(in thousands):
|                   | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------|------------|------------------------------|------------|-----------------------------|------------|
| Bulk product      |       | $                            | 8,957      |                        | $          | 2,406 |   |
| Finished product  |       | 15,819                       |       | 26,518                      |       |
| Total inventories |       | $                            | 24,776     |                        | $          | 28,924 |   |

**7.****                                      IntangibleAssets**

InJanuary 2006, the Company paid Bayer Healthcare AG a milestone payment of$5.0 million for the licensing rights to Sular. In July 2006, the Company’ssales of Sular triggered the final $5.0 million milestone payment to BayerHealthcare AG.  This payment will be madein October.  These milestone paymentswill be amortized over the remaining useful life of Sular.

InSeptember 2006, the Company launched Ostiva, an oral prescription nutritionalsupplement formulation with Metafolin, calcium, Magnesium, Vitamins B6, B12 andVitamin D that gives women nutritional support to help maintain healthybones.  Under its agreement with PamLab,from which it acquired its rights to Ostiva, the Company made a payment of $0.6million for the launch of Ostiva.  PamLabis also entitled to royalties on net sales, as defined in the agreement.  The intangible asset recorded in connectionwith the acquisition is expected to be amortized over a period of eight years.

Intangibleassets which are not deemed to have an indefinite life are amortized on astraight-line basis over their respective useful lives.

Thefollowing table reflects the components of intangible assets as of September30, 2006 (in thousands):
| ** **                      | ** ** | **Gross Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Amount** | ** ** | **Expected Life** | ** ** |
|---------------------------------|------------|-----------------------|------------|-------------------------------|------------|---------------------|------------|------------------------|------------|
| Licensing rights                |       | $                     | 366,640    |                          | $          | (74,672             | )          | $                      | 291,968    |   | 10 to 20 years |   |
| Trade names                     |       | 11,578                |       | (2,872                        | )          | 8,706               |       | 15 to 20 years         |       |
| Contracts                       |       | 8,300                 |       | (7,705                        | )          | 595                 |       | 5 years                |       |
| Supply/Distribution  agreements |       | 10,350                |       | (4,727                        | )          | 5,623               |       | 1 to 10 years          |       |
| Other  intangibles              |       | 2,590                 |       | (634                          | )          | 1,956               |       | 20 years               |       |
| Total                           |       | $                     | 399,458    |                          | $          | (90,610             | )          | $                      | 308,848    |   |   |   |

 

10

----

The following tablereflects the components of intangible assets as of December 31, 2005 (inthousands):
| ** **                      | ** ** | **Gross Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Amount** | ** ** | **Expected Life** | ** ** |
|---------------------------------|------------|-----------------------|------------|-------------------------------|------------|---------------------|------------|------------------------|------------|
| Licensing rights                |       | $                     | 356,040    |                          | $          | (59,642             | )          | $                      | 296,398    |   | 10 to 20 years |   |
| Trade names                     |       | 11,060                |       | (2,293                        | )          | 8,767               |       | 15 to 20 years         |       |
| Contracts                       |       | 8,300                 |       | (6,492                        | )          | 1,808               |       | 5 years                |       |
| Supply/Distribution  agreements |       | 10,350                |       | (3,951                        | )          | 6,399               |       | 1 to 10 years          |       |
| Other  intangibles              |       | 3,108                 |       | (682                          | )          | 2,426               |       | 20 years               |       |
| Total                           |       | $                     | 388,858    |                          | $          | (73,060             | )          | $                      | 315,798    |   |   |   |

Forthe three and nine months ended September 30, 2006, amortization expenserelated to the intangible assets was $5.9 million and $17.5 million,respectively. Amortization is calculated on a straight-line basis over the estimateduseful life of the intangible asset, and the Company estimates the annualamortization expense for each of the five succeeding fiscal years to be asfollows (in thousands):
| Fiscal year ended December 31: | ** ** | **Amount** | ** ** |
|----------------------------------------------------|------------|------------|------------|
| 2006                                               |       | $          | 22,553     |   |
| 2007                                               |       | 21,958     |       |
| 2008                                               |       | 21,958     |       |
| 2009                                               |       | 21,958     |       |
| 2010                                               |       | 21,958     |       |
|                                                    |            |            |            |  |

 

**8.****                                      OtherLong-Term Assets**

Otherassets at September 30, 2006 and December 31, 2005 consisted of thefollowing (in thousands):
|                               | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Capitalized  finance costs    |       | $                            | 6,806      |                        | $          | 4,312 |   |
| Deposits                      |       | 56                           |       | 59                          |       |
| Total long-term other  assets |       | $                            | 6,862      |                        | $          | 4,371 |   |

 

**9.****                                      AccruedExpenses**

Accruedexpenses at September 30, 2006 and December 31, 2005 consisted of thefollowing (in thousands):
|                                     | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Employee  compensation and benefits |       | $                            | 3,453      |                        | $          | 4,111 |   |
| Product returns                     |       | 1,482                        |       | 1,090                       |       |
| Product rebates                     |       | 2,870                        |       | 2,441                       |       |
| Sales deductions                    |       | 5,700                        |       | 2,802                       |       |
| Accrued  royalties                  |       | 6,389                        |       | 5,082                       |       |
| Product purchases                   |       | 5,000                        |       | —                      |       |
| Other                               |       | 1,701                        |       | 2,956                       |       |
|                                |       | $                            | 26,595     |                        | $          | 18,482 |   |

 

11

----

**10.****                               Long-termDebt**

InMarch 2004, the Company issued a total of $150.0 million of its 1.75%senior subordinated contingent convertible notes due in 2024 (the “2004 Notes”)in transactions that were exempt from registration in reliance uponRule 144A and other available exemptions under the Securities Act. In May2006 and pursuant to a registered exchange offer, the Company exchanged eachoutstanding 2004 Note with new notes (the “New Notes”) that, among otherthings, require the Company to redeem the $150.0 million 2004 Notes with cashinstead of common stock. As an incentive to the 2004 Note holders to exchangethe 2004 Notes for New Notes, the Company paid each exchanging holder anexchange fee equal to 0.75% of the face value of each New Note exchanged.  The Company paid an aggregate exchange fee of$1,125,000. The New Notes are due March 8, 2024 and accrued interest ispayable semi-annually in arrears on March 8 and September 8 of eachyear, which commenced on September 8, 2004. In addition to the interest onthe New Notes, after March 8, 2007, the Company will also pay contingentinterest during specified six-month periods if the average trading price of theNew Notes per $1,000 principal amount for the five day trading period ending onthe third trading day immediately preceding the first day of the applicablesix-month period equals $1,200 or more. During any period when contingentinterest is payable, it will be payable at a rate equal to 0.5% per annum. Asthis contingent interest feature is based on the underlying trading price ofthe New Notes, the contingent interest qualifies as an embedded derivative. Asof September 30, 2006, management determined that the fair value of thiscontingent interest embedded derivative was not material. The net proceeds fromthis issuance, after deducting offering expenses, were approximately $145.4million. Financing costs of $4.6 million were incurred with the originalissuance and $1,125,000 with the exchange, which are being amortized on astraight-line basis over the life of the notes, and are included in otherassets in the consolidated balance sheet.

Uponconversion, the Company will deliver, for each New Note, consideration (the “conversionvalue”) having a value equal to the product of the conversion rate (initially,approximately 45.1467, subject to adjustment) multiplied by the average of theclosing price of our common stock on the Nasdaq National Market on each of thefive consecutive trading days beginning on the third trading day following theconversion date of New Notes (the “applicable stock price”). This considerationvalue will be paid in cash (the “required cash amount”) in an amount equal tothe lesser of (a) the aggregate principal amount of New Notes on theconversion date or (b) the conversion value, and the remainder will bepaid in shares of our common stock. The number of shares to be delivered willequal (a)(i) the conversion value minus (ii) the required cash amount,divided by (b) the applicable stock price. Holders may convert theNew Notes only under the following circumstances: (1) during any calendarquarter, if the closing sales price of the Company’s common stock exceeds 120%of the conversion price for at least 20 trading days in the 30 consecutivetrading days ending on the last trading day of the preceding calendar quarter;(2) if the New Notes have been called for redemption; (3) during thefive trading day period immediately following any nine consecutive trading dayperiod in which the trading price of the New Notes per $1,000 principal amountfor each day of that period was less than 95% of the product of the closingprice of the Company’s common stock and the number of shares of common stockissuable upon conversion of $1,000 principal amount of the New Notes; or(4) the occurrence of specified corporate transactions.

Aholder that surrenders New Notes for conversion in connection with certainfundamental changes that occur prior to March 13, 2007 may beentitled to an increase in the conversion rate. However, in lieu of increasingthe conversion rate applicable to those New Notes, the Company may incertain circumstances elect to change its conversion obligation so that, inlieu of delivering cash, and, if applicable, shares of our common stock inrespect of such conversion obligation, the Company will deliver shares of theacquiring company’s common stock. In addition to the events which wouldconstitute a change of control (as defined in the indenture relating to the NewNotes), a fundamental change will also include the occurrence of anytransaction or event or any series of transactions or events in connectionwith which all or substantially all of our common stock is exchanged for,converted into, acquired for or constitutes solely the right to receive stock,other securities, other property, assets or cash, unless either:

(a)          the persons that “beneficially owned,” the shares of our voting stockimmediately prior to such transaction, “beneficially own,” shares of the survivingor continuing corporation’s voting stock representing at least a majority ofthe total voting power of all outstanding classes of voting stock of suchcorporation or

(b)         both of the following conditions aresatisfied:

(i)                                     at least 90% of the consideration (other thancash payments for fractional shares or pursuant to statutory appraisal rights)in such transaction consists of common stock, ordinary shares or AmericanDepository Shares, and any associated rights, traded on a U.S. nationalsecurities exchange or quoted on the Nasdaq National Market (or that will be sotraded or quoted when issued or exchanged in connection with such transaction)and

(ii)                                  as a result of such transaction, theconsideration due upon conversion of New Notes shall be payable solely inshares of such securities, and any associated rights and cash for fractionalshares.

12

----

The Company has the option to redeem the New Notes beginningMarch 13, 2007 at a price equal to 100% of their aggregate principalamount, plus accrued and unpaid interest, including contingent interest, ifany.

Theholders of the New Notes have the option to require the Company to repurchasethe New Notes on March 8 of 2009, 2014 and 2019, and upon a change incontrol, at a price equal to 100% of their aggregate principal amount, plusaccrued and unpaid interest, including contingent interest, if any.

TheCompany had no debt other than the aforementioned notes outstanding at September30, 2006 or December 31, 2005.

**11.****                               CreditAgreement**

On September 18,2006, the Company and certain of its subsidiaries entered into a secured creditagreement (the “Credit Agreement”) with UBS Securities LLC and LaSalle BankNational Association as lead arrangers, UBS AG, Stamford Branch, as issuingbank, administrative agent and collateral agent, Regents Bank, Fifth Third Bankand Bank of America, N.A. as co-documentation agents and UBS Loan Finance LLC,as swingline lender. The Credit Agreement provides the Company and its Caymansubsidiary, Sciele Pharma Cayman Ltd., with a five-year revolving creditfacility of up to $100 million, with an option to expand the facility creditline by up to an additional $75 million. 

Amountsoutstanding under the new credit facility generally bear interest at thelenders’ corporate base rate or the LIBOR, plus a specified margin of between1.75% and 2.5% depending on the Company’s ratio of indebtedness to earnings.The Credit Agreement contains customary negative covenants and financialcovenants with which the Company is in full compliance. 

The Company’s obligationsunder the Credit Agreement are secured by a pledge of substantially all of theassets of the Company and are guaranteed by substantially all of the Company’ssubsidiaries that are not borrowers. 

The Companyterminated its existing credit agreement with LaSalle Bank NationalAssociation, dated February 11, 2003, as subsequently amended.  

**12.****                               ShareBuyback Program**

TheCompany adopted a share repurchase program effective August 3, 2005, thatauthorizes the repurchase of up to $20.0 million of its outstanding shares ofcommon stock over the next twelve months with no periodic sub-limits on theamount of repurchases. This plan expired on August 2, 2006. 

On August 3, 2006,the Company adopted a new share repurchase program authorizing the repurchaseof up to $30.0 million of outstanding common stock.  This plan replaces all prior share repurchaseplans and will expire on August 2, 2007. As of September 30, 2006, $22.1 million is available for repurchasesunder the program.  
| ** **                              | ** ** | ** **         | ** ** | ** **         | ** ** | ** **                        | ** ** | ** ** | ** ** | **Approximate Dollar**        | ** ** |
|-----------------------------------------|------------|--------------------|------------|--------------------|------------|-----------------------------------|------------|------------|------------|------------------------------------|------------|
| ** **                              | ** ** | **Total**          | ** ** | ** **         | ** ** | **Total Number of**     | ** ** | ** ** | ** ** | **Value of Shares**      | ** ** |
| ** **                              | ** ** | **Number of** | ** ** | **Average**        | ** ** | **Shares Purchased as** | ** ** | ** ** | ** ** | **that May Yet Be** | ** ** |
| ** **                              | ** ** | **Shares**         | ** ** | **Price**          | ** ** | **Part of Publicly**    | ** ** | ** ** | ** ** | **Purchased Under**           | ** ** |
| **Fiscal Period**                  | ** ** | **Purchased**      | ** ** | **Per Share** | ** ** | **Announced Plans**          | ** ** | **Plan**   | ** ** | **the Plans**                 | ** ** |
|                                    |       |               |       |               |       |                              |       |       |       |                               |       |
| January 1  through March 31, 2006       |       | —             |       | $                  | —     |                              | —     |       | 1          |                               | $          | 15,563,420 |   |
| April 1 through  June 30, 2006          |       | 334,100            |       | $                  | 20.71      |                              | 334,100    |       | 1          |                               | $          | 8,631,399 |   |
| July 1 through  July 31, 2006           |       | —             |       | $                  | —     |                              | —     |       | 1          |                               | $          | 8,631,399 |   |
| August 1 through  August 31, 2006       |       | 409,973            |       | $                  | 19.19      |                              | 409,973    |       | 2          |                               | $          | 22,118,963 |   |
| September 1  through September 30, 2006 |       | —             |       | $                  | —     |                              | —     |       | 2          |                               | $          | 22,118,963 |   |
| Total                                   |       | 744,073            |       | $                  | 19.87      |                              | 744,073    |       |       |                               |       |   |

 

*Plan 1refers to the Share Repurchase Plan effective August 3, 2005 through August 2,2006.  Plan 2 refers to the ShareRepurchase Plan effective August 3, 2006 through August 2, 2007.*

13

----

**13.****                               EarningsPer Share**

Belowis the calculation of basic and diluted net income per share (in thousandsexcept per share data):
| ** **                                                                 | ** ** | **For The Three Months  Ended September 30,** | ** ** | **For The Nine Months  Ended September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2006**                                                               | ** ** | **2005**                                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income                                                                 |       | $                                                                      | 12,301     |                                                                  | $          | 10,634 |   | $ | 31,600 |   | $ | 26,226 |   |
| Add: Interest  expense on the old contingent convertible notes, net of tax |       | —                                                                 |       | 485                                                                   |       | 653 |   | 1,455 |   |
|                                                                       |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Adjusted net  income                                                       |       | $                                                                      | 12,301     |                                                                  | $          | 11,119 |   | $ | 32,253 |   | $ | 27,681 |   |
|                                                                       |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Weighted average  common shares outstanding—basic                     |       | 35,043                                                                 |       | 35,119                                                                |       | 35,147 |   | 35,071 |   |
| Diluted effect  of stock options restricted shares and convertible debt    |       | 971                                                                    |       | 7,429                                                                 |       | 4,123 |   | 7,498 |   |
|                                                                       |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Weighted average  common shares outstanding—diluted                   |       | 36,014                                                                 |       | 42,548                                                                |       | 39,270 |   | 42,569 |   |
|                                                                       |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Basic earnings  per common share:                                          |       | $                                                                      | 0.35       |                                                                  | $          | 0.30 |   | $ | 0.90 |   | $ | 0.75 |   |
|                                                                       |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Diluted earnings per  common share:                                        |       | $                                                                      | 0.34       |                                                                  | $          | 0.26 |   | $ | 0.82 |   | $ | 0.65 |   |

For the three monthsended September 30, 2006, there were 819,429 potential common sharesoutstanding and 53,500 shares of unvested restricted stock that were excludedfrom the diluted net income per share calculation because their effect wouldhave been anti-dilutive.  For the ninemonths ended September 30, 2006, there were 800,681 potential common sharesoutstanding and 37,000 shares of unvested restricted stock that were excludedfrom the diluted net income per share calculation because their effect wouldhave been anti-dilutive.

**14.****                               SegmentReporting**

TheCompany is engaged solely in the business of developing, marketing and sellingprescription pharmaceutical products. Accordingly, the Company’s business isclassified in a single reportable segment, the development, sale and marketingof prescription pharmaceutical products. Prescription products include avariety of branded pharmaceuticals for the treatment of cardiovascular andmetabolic diseases, and women’s health conditions.

Thefollowing presents revenues for prescription products by area of treatment:
|                          | ** ** | **For The Three Months  Ended September 30,** | ** ** | **For The Nine Months  Ended September 30,** | ** ** |
|--------------------------|------------|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                                               | ** ** | **2005**                                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
| Cardiovascular/Metabolic |       | $                                                                      | 59,594     |                                                                  | $          | 43,849 |   | $ | 164,640 |   | $ | 98,072 |   |
| Women’s Health      |       | 12,743                                                                 |       | 10,061                                                                |       | 37,882 |   | 32,783 |   |
| Non promoted             |       | 2,447                                                                  |       | 4,808                                                                 |       | 11,114 |   | 18,636 |   |
|                     |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Net revenues             |       | $                                                                      | 74,784     |                                                                  | $          | 58,718 |   | $ | 213,636 |   | $ | 149,491 |   |

 

**15.****                               Commitmentsand Contingencies**

The Company,certain former and current officers and directors are defendants in aconsolidated securities lawsuit filed on August 22, 2002 in the UnitedStates District Court for the Northern District of Georgia. Plaintiffs in theclass action alleged in general terms that we violated Sections 11 and12(a)(a) of the Securities Act of 1933 and that we violated Sections10(b) and 20(a) of the Securities Exchange Act of 1934 andRule 10b-5 promulgated thereunder. In an amended complaint, Plaintiffsclaim that we issued a series of materially false and misleadingstatements to the market in connection with our public offering onApril 24, 2002 and thereafter relating to alleged “channel stuffing”activities. The amended complaint also alleged controlling person liability onbehalf of certain of our officers under Section 15 of the Securities Actof 1933 and Section 20 of the Securities Exchange Act of 1934. Plaintiffsseek an unspecified amount of compensatory damages.

14

----

OnSeptember 29, 2004, the U.S. District Court for the Northern District ofGeorgia dismissed, without prejudice, the class action lawsuit. Althoughthe lawsuit was dismissed, the court granted the plaintiffs the right to refileprovided that the plaintiffs pay all of the defendant’s fees and costsassociated with filing the motion to dismiss the lawsuit. Plaintiffs did notfile a second amended complaint as permitted, but instead filed a motion askingthe District Court to reconsider its September 29, 2004 order and lift thecondition that they must pay defendants’ fees and costs before furtheramendment. On June 22, 2005, the District Court denied plaintiffs’ motionand gave them another opportunity to amend if they pay defendants’ fees andcosts. Once again, plaintiffs chose not to file a second amended complaint.Instead, plaintiffs filed an appeal to the United States Court of Appeals forthe Eleventh Circuit.  The court hassince ruled that Plaintiffs may recast and refile their complaint.  The Company shall continue to vigorouslydefend this action.

On September 18,2006, the Eleventh Circuit Court of Appeals affirmed the District Court’sdetermination that the Amended Complaint was a “shotgun pleading” which did notsatisfy the pleading requirements under the federal rules.  The Court ofAppeals, however, disagreed with the remedy ordered by the DistrictCourt.  Instead of dismissing the Amended Complaint with a right tofurther amend if Plaintiffs paid Defendants’ fees and costs, the Court ofAppeals held that the District Court should have ordered Plaintiffsto replead under Federal Rule of Civil Procedure 12(e).  The Court ofAppeals also held that Plaintiffs’ claims under the Securities Act of1933 must meet the heightened pleading standards of Federal Rule ofCivil Procedure 9(b) because those claims sound in fraud.  Accordingly,the Court of Appeals vacated the District Court’s orders and remanded withinstructions to order a repleading. No accrual is recorded in the Company’sfinancial statements related to this case as the Company believes that its riskof loss is remote.

The Company isalso involved with other various legal proceedings incident to the course ofbusiness. None of these proceedings are expected to have a material adverseeffect on the consolidated financial statements.

**ITEM 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

Thefollowing should be read with the consolidated financial statements and relatedfootnotes and Management’s Discussion and Analysis of Results of Operations andFinancial Condition included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005 (File No. 000-30123), asamended. The results discussed below are not necessarily indicative of theresults to be expected in any future periods. The following discussion containsforward-looking statements that are subject to risks and uncertainties, whichcould cause actual results to differ from the statements made.

**Overview**

ScielePharma, Inc., or the Company, is a specialty pharmaceutical company thatmarkets, develops and sells brand name prescription products. Our key productsfocus on two therapeutic categories, Cardiolo-Metabolic and Women’s Health. Ourkey marketed products include:

 

| Cardiovascular/Metabolic | ** ** | **Women’s Health** |
|--------------------------|------------|------------------------------|
| Altoprev                 |       | OptiNate                     |
| Fortamet                 |       | Ponstel                      |
| Nitrolingual             |       | Prenate Elite                |
| Sular                    |       | Ostiva                       |
| Triglide                 |       |                         |

                                                                

 

Ourcurrent operating plan focuses first on maximizing the sales of our existingproduct portfolio. We also plan to accelerate growth by launching lineextensions to our current products and by acquiring or licensing approvedproducts or late stage development products and other businesses. We plan tofocus on products that complement our Cardiology and Women’s Health categoriesthat will allow us to leverage our existing sales force infrastructure.

Wecurrently market and sell 15 products, nine of which are actively promoted andwhich accounted for approximately 95.9% and 94.5% our total sales for the threeand nine months ended September 30, 2006, respectively. We promote our products

15

----

through ournationwide sales marketing force of approximately 525sales representatives, targetinghigh-prescribing primary care physicians, endocrinologists, cardiologists,obstetricians and gynecologists.

**Resultsof Operations**

*Net Revenue.*    Net revenues for thethree months ended September 30, 2006 increased $16.1 million or 27.3%to $74.8 million, as compared to $58.7 million for the three monthsended September 30, 2005. Net revenues for the nine months ended September 30,2006 increased $64.1 million or 42.9% to $213.6 million, as compared to $149.5million for the nine months ended September 30, 2005. Net revenues fromour promoted products increased by $18.4 million and $71.7 million for thethree and nine months ended September 30, 2006, respectively, as a result ofgrowth from increased promotion, as well as continued success in the executionof our marketing strategy.  The increasein revenue of our promoted products was partially offset by a reduction ofnon-promoted product revenues of $2.4 million and $7.5 million for the threeand nine months ended September 30, 2006, respectively.  This reduction is primarily from our Tanafedand Robinul lines as we ceased promotion of these products as a result ofgeneric entries into the market in the first quarter of 2005. 

 

| Product Overview | ** ** | ** **                                                                                                                                                                                                                                  | ** ** | ** **                                                                                                                                                                                                                                | ** ** |
|------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **       | ** ** | ** **                                                                                                                                                                                                                                  | ** ** | ** **                                                                                                                                                                                                                                | ** ** |
| ** **       | ** ** | **Change in total dispensed prescriptions  for the three months ended  September 30, 2006  compared to the three months ended  September 30, 2005(a)** | ** ** | **Change in new dispensed prescriptions  for the three months ended  September 30, 2006  compared to the three months ended  September 30, 2005(a)** | ** ** |
| Sular            |       |                                                                                                                                                                                                                                        | 20.3       | %                                                                                                                                                                                                                                         |       |   | 24.8 | % |   |
| Fortamet         |       |                                                                                                                                                                                                                                        | (1.7       | )%                                                                                                                                                                                                                                        |       |   | 3.8 | % |   |
| Altoprev         |       |                                                                                                                                                                                                                                        | (28.1      | )%                                                                                                                                                                                                                                        |       |   | (27.4 | )% |   |
| Triglide         |       |                                                                                                                                                                                                                                        | 1241.0     | %                                                                                                                                                                                                                                         |       |   | 523.5 | % |   |
| Nitrolingual(b)  |       |                                                                                                                                                                                                                                        | (3.6       | )%                                                                                                                                                                                                                                        |       |   | (0.1 | )% |   |
| Prenate Elite    |       |                                                                                                                                                                                                                                        | (22.5      | )%                                                                                                                                                                                                                                        |       |   | (20.0 | )% |   |
| OptiNate         |       |                                                                                                                                                                                                                                        | 50.0       | %                                                                                                                                                                                                                                         |       |   | 13.5 | % |   |
| Ostiva(c)        |       |                                                                                                                                                                                                                                        | N/A        |                                                                                                                                                                                                                                      |       |   | N/A |   |   |
| Ponstel          |       |                                                                                                                                                                                                                                        | (13.4      | )%                                                                                                                                                                                                                                        |       |   | (13.8 | )% |   |

 

----

*(a)**                              *Source: IMS Health’s National PrescriptionAudit PlusTM data.

*(b)**                              *We believe that IMS data does not captureprescriptions of Nitrolingual from some of the non-retail channels andprescription trends in the non-retail channel which may have a significantimpact on the reported change.

*(c)*                                Ostiva was launched in September 2006.

Net revenues from our Cardiolovascular and Metabolic products (namelySular, Fortamet, Triglide, Altoprev and Nitrolingual) were $59.6 million and $164.6million for the three and nine months ended September 30, 2006, compared to $43.8million and $98.1 million for the three and nine months ended September 30,2005, respectively.  The increase wasprimarily due to the launch of Altoprev and Fortamet in April 2005, thecontinued growth of Sular, the launch of Triglide in July 2005, as well asprice increases implemented during 2005 and 2006.

Net revenues from our promoted Women’s Health products (namely PrenateElite, OptiNate, Ostiva and Ponstel), were $12.7 million and $37.9 million forthe three and nine months ended September 30, 2006 compared to $10.1 millionand $32.8 million for the three and nine months ended September 30, 2005.This increase is primarily related to the successful launch of our women’shealth sales force in the first quarter of 2006, continued growth of our marketshare for OptiNate and price increases.

Net revenues for our non-promoted products were $2.4 million and $11.1million for the three and nine months ended September 30, 2006 compared to $4.8million and $18.6 million for the three and nine months ended September 30,2005.   This reduction is primarily fromour Tanafed and Robinul Lines as we ceased promotion of these products as aresult of generic entries into the market in the first quarter of 2005.

16

----

*Cost of Revenues.*    Cost of revenues forthe three and nine months ended September 30, 2006 were $10.3 million and $30.2million compared to $8.8 million and $23.3 million for the three and ninemonths ended September 30, 2005. The increase in cost of revenues is related tothe change in product mix and the increase in sales for the three and ninemonths ended September 30, 2006 as compared to the equivalent periods ending September30, 2005.

*Gross Margin.*    Gross margin for the three and nine months endedSeptember 30, 2006 were 86.2% and 85.8%, respectively, compared to 85.1% and 84.4%for the three and nine months ended September 30, 2005, respectively.  This increase in gross margin for the threeand nine months ended September 30, 2006 is the result of a change in productmix and price increases.

*Selling, General and Administrative Expenses.*    Selling, general andadministrative expenses increased $9.4 million, or 35.6%, to $35.9 millionfor the three months ended September 30, 2006, compared to $26.5 million forthe three months ended September 30, 2005. Selling, general and administrativeexpenses increased $38.7 million, or 56.7%, to $107.0 million for thenine months ended September 30, 2006, compared to $68.2 million for the ninemonths ended September 30, 2005. This increase in selling, general and administrative expenses is dueprimarily to the addition of 74 sales representatives and an increase inroyalty and commission expenses related to higher revenues.  Additionally, we recognized $1.8 million and$5.5 million in stock-based compensation expense for the three and nine monthsended September 30, 2006, respectively.  There was $0.2 and $0.6 in stock compensationexpenses for the three and nine months ended September 30, 2005.

*Depreciation and Amortization Expense.*    Depreciation andamortization expense increased $0.6 million, or 9.7%, to $6.8 millionfor the quarter ended September 30, 2006 compared to $6.2 million for thequarter ended September 30, 2005. Depreciation and amortization expenseincreased $3.4 million, or 20.9%, to $19.7 million for the nine months ended September30, 2006 compared to $16.3 million for the nine months ended September 30,2005.  This increase is primarily relatedto the increase in amortizable intangible assets as a result of the purchase ofFortamet and Altoprev, the launch of Triglide and two $5.0 million milestonepayments to Bayer in January and July 2006.

*Research and Development Expense.*    Research anddevelopment expense increased $3.1 million to $4.5 million for the threemonths ended September 30, 2006 compared to $1.4 million for the three monthsended September 30, 2005. Research and development expense increased $9.0million to $11.3 million for the nine months ended September 30, 2006 comparedto $2.3 million for the same period in 2005. These increases were primarily related to greater activity in thedevelopment program for lifecycle management initiatives for our products,which includes the new Sular formulation and glycopyrrolate for chronicmoderate to severe drooling in pediatric patients, and management’s increasedemphasis on development. Additionally, we recognized $0.3 million and$1.0 million in stock-based compensation expense for the three and ninemonths ended September 30, 2006, respectively. There were no compensationexpenses for the same periods of 2005. 

*Interest Expense.*    Interest expense was $0.9 millionand $2.4 million for the three and nine months ended September 30,2006 compared to $0.8 million and $2.2 million for the three and nine monthsended September 30, 2005.  The increaseis due to the entry into the new secured debt agreement in September of 2006.  The new agreement is discussed in note 11 ofthe notes to consolidated financial statements. The interest expense is primarily from the $150.0 million contingentconvertible notes discussed in note 10 to our financial statements containedelsewhere in this Report on Form 10-Q.

*Interest Income.*    Interest income was $1.4 millionand $3.4 million for the three and nine months ended September 30, 2006,compared to $0.7 million and $2.4 million for the three and nine months ended September30, 2005. The increase in interest income for the nine months ended September30, 2006 is primarily due to a higher average cash and marketable securitiesbalance as a result of cash generation from sales and higher returns on currentinvestments.

*Provision for Income Taxes.*    Income taxes wereprovided for at a rate of 31.0% and 31.8% for the three and nine months ended September30, 2006, respectively, compared to 32.4% and 32.4% for the three and ninemonths ended September 30, 2005. This decrease in the effective rate is dueprimarily to the change in the mix of tax jurisdictions, both domestic andinternational, where our income was earned.

**Liquidityand Capital Resources**

Our cash and cash equivalents were $35.6 million on September 30, 2006compared to $17.0 million at December 31, 2005. Net cash provided byoperating activities for the nine months ended September 30, 2006 was $74.3million. This source of cash was primarily the result of net income of $31.6million, resulting primarily from the sales of our promoted products, adecrease in accounts receivable of $5.1 million, as a result of an overallreduction in our days sales outstanding, an increase in accounts payable of$1.8 million, primarily related to increased business volume, a decrease ininventory of $4.1 million, primarily related to improved 

17

----

inventorymanagement, an increase of $1.4 million for other current assets and otherassets and an increase of $4.4 million in accrued expenses and other long-termliabilities, primarily related to the $5.0 million milestone payment forSular which was paid in October 2006 and partially offset by decreases ingeneral accruals.   Additional cash includes adjustment fornon-cash expense items of depreciation and amortization of $19.8 million, stockbased compensation expenses of $6.5 million, interest expense of $0.3 million, deferredincome tax expenses of $3.7 million, recognized losses on the disposal ofproperty and equipment of $0.2 million and less than $0.1 million for theloss on sale of securities. Partially offsetting these non-cash items was an increasein income tax receivable of $4.6 million related primarily to estimated taxpayments made during the year.

Our cash and cash equivalents were $14.7 million on September 30, 2005.Net cash provided by operating activities for the nine months ended September30, 2005 was $12.6 million. This source of cash was primarily the result of netincome of $26.2 million, resulting primarily from the sales of our promotedproducts,  non-cash expenses includingdepreciation and amortization of $16.3 million, a decrease in income tax receivableof $1.9 million, an increase in accrued expenses and other long-termliabilities of $0.3 million,  non-cashtax expense of $3.8 million, $0.7 million for realized losses on marketablesecurities and non-cash interest expense of $0.3 million.  Partially offsetting the source of cash fromoperations was an increase in inventories of $17.2 million, a decrease in accountspayable of $5.2 million, an increase in accounts receivable of $8.7 million andan increase in other current assets and other assets of $6.0 million.

 Net cash used in investingactivities for the nine months ended September 30, 2006 was $44.9 million.The principal uses of this cash were for the purchase of marketable securitiesof $131.1 million, of which $94.9 million were reinvestment from maturingsecurities, $3.2 million for the purchase of property and equipment, primarilyfor new office furniture and computer systems for the new home office,$5.0 million for a milestone payment to Bayer Healthcare AG in January 2006,and a $0.6 million payment for the launch of Ostiva in September 2006.Partially offsetting these uses was $0.1 million for proceeds from thesale of property and equipment.

Net cash used ininvesting activities for the nine months ended September 30, 2005 was $31.6 million.The principal uses of this cash were for the purchases of product licenses of $106.3 million,and the purchases of property and equipment of $1.8 million. Offsettingthese uses of cash were the net sales of marketable securities of $98.3 million. This liquidation of marketablesecurities was directly related to the acquisition of product licenses forFortamet and Altoprev, the first milestone payment of the $15.0 millionpurchase price for Triglide and the $5.0 million additional purchase pricemilestone for Sular, as well as $21.0 million in maturing investments that werereinvested upon maturity.

 

Net cash used in financing activities was $12.0 million for the ninemonths ended September 30, 2006 primarily resulting from the repurchase of ourcommon stock for $14.8 million and $3.8 million for debt financing costs,consisting of the exchange of the contingent convertible debt, discussed infootnote 10 of our financial statements, of $1.8 million and the secured debtagreement, discussed in footnote 11 of our financial statements, of $1.9million. Partially offsetting this net cash used was $4.4 million for theissuances of common stock related to executive and employee stock options and $2.1million for a non-cash reduction in taxes payable relating to stock options.

Netcash used in financing activities was $0.3 million for the ninemonths ended September 30, 2005 resulting from our repurchase of our commonstock for $2.1 million. Offsetting this net cash used was $1.8 millionfor the issuances of common stock related to option exercises.

 

We believe that our current balance of cash and cash equivalents, cashfrom operations, and the available balance of our credit facility, will beadequate to fund our current working capital requirements for at least the next12 months. However, in the event that we make significant acquisitions inthe future, we may be required to raise additional funds through additionalborrowings or the issuance of debt or equity securities.

On September 18, 2006, the Company and certain of its subsidiaries enteredinto a secured credit agreement (the “Credit Agreement”) with UBS SecuritiesLLC and LaSalle Bank National Association as lead arrangers, UBS AG, StamfordBranch, as issuing bank, administrative agent and collateral agent, RegentsBank, Fifth Third Bank and Bank of America, N.A. as co-documentation agents andUBS Loan Finance LLC, as swingline lender. The Credit Agreement provides theCompany and its Cayman subsidiary, Sciele Pharma Cayman Ltd., with a five-yearrevolving credit facility of up to $100 million, with an option to expand thefacility credit line by up to an additional $75 million. 

18

----

Amountsoutstanding under the new credit facility generally bear interest at thelenders’ corporate base rate or the LIBOR, plus a specified margin of between1.75% and 2.5% depending on the Company’s ratio of indebtedness to earnings.The Credit Agreement contains customary negative covenants and financialcovenants. 

The Company’s obligationsunder the Credit Agreement are secured by a pledge of substantially all of theassets of the Company and are guaranteed by substantially all of the Company’s subsidiariesthat are not borrowers. 

The Company terminatedits existing credit agreement with LaSalle Bank National Association, datedFebruary 11, 2003, as subsequently amended.  

**CriticalAccounting Policies**

Weview our critical accounting policies to be those policies which are veryimportant to the portrayal of our financial condition and results ofoperations, and require management’s most difficult, complex or subjectivejudgments. The circumstances that make these judgments difficult or complexrelate to the need for management to make estimates about the effect of mattersthat are inherently uncertain. We believe our critical accounting policies areas follows:

·        *Allowance for doubtful accounts.* We are required to estimate the level of accountsreceivable recorded on our balance sheet which will ultimately not be paid.Among other things, this assessment requires analysis of the financial strengthof our customers, which can be highly subjective. Our policy is to estimate baddebt expense based on prior experience supplemented by a periodic customerspecific review when needed. If we over or under estimate the level of accountsreceivable that will not be paid, there may be a material impact to ourfinancial statements.

·        *Sales deductions.* We provide volume rebates, contractual pricereductions with drug wholesalers and insurance companies, and certain othersales related deductions on a regular basis. The exact level of thesedeductions is not always immediately known and thus we must record an estimateat the time of sale. Our estimates are based on historical experience withsimilar programs, and since we have a relatively small customer base, customerspecific historical experience is often useful in determining the estimatedlevel of deductions expected to be refunded to our customers when salesincentives are offered. If we over or under estimate the level of salesdeductions, there may be a material impact to our financial statements.

·        *Product returns.* In the pharmaceutical industry, customers arenormally granted the right to return product for a refund if the product hasnot been used prior to its expiration date. Our return policy allows productreturns within an eighteen-month window from six months prior to the expirationdate and up to twelve months after the expiration date. Our return policyconforms to industry standard practices. We believe that we have sufficientdata to estimate future returns at the time of sale. Management is required toestimate the level of sales which will ultimately be returned pursuant to ourreturn policy, and record a related reserve at the time of sale. These amountsare deducted from our gross sales to determine our net revenues. Our estimatestake into consideration historical returns of a given product, product specificinformation provided by our customers and information obtained regarding thelevels of inventory being held by our customers, as well as overall purchasingpatterns by our customers. Management periodically reviews the reserves establishedfor returns and adjusts them based on actual experience. If we over or underestimate the level of sales which will ultimately be returned, theremay be a material impact to our financial statements.

·        *Liabilities assumed with the acquisition of product rights.* In connection with the acquisition of productrights, we assume certain liabilities for returns of product shipped by theseller prior to the acquisition date. At the acquisition date, we estimate theamount of the assumed liabilities based on actual sales return data from theseller and include that amount in the allocation of the total purchase price.We review the estimated liability on an annual basis. If we over or underestimate liabilities assumed, there may be a material impact to ourfinancial statements.

·        *Intangible assets*. When we acquire the rights to manufacture and sell a product, we recordthe aggregate purchase price, along with the value of the product relatedliabilities that we assume, as intangible assets. We use the assistance ofvaluation experts to help us allocate the purchase price to the fair value ofthe various intangible assets that we have acquired. Then, we must estimate theeconomic useful life of each of these intangible assets in order to amortizetheir cost as an expense in our statement of operations over the estimatedeconomic useful life of the related asset. The factors that drive the actualeconomic useful life of a 

19

----

pharmaceutical product are inherently uncertain, andinclude patent and other intellectual property protection, physician loyaltyand prescribing patterns, competition by products prescribed for similarindications, future introductions of competing products not yet FDA approved,the impact of promotional efforts and many other factors. We use all of thesefactors in initially estimating the economic useful lives of our products, andwe also continuously monitor these factors for indications of appropriaterevisions.

In assessing therecoverability of its intangible assets, we must make assumptions regardingestimated future cash flows and other factors. If the estimated undiscountedfuture cash flows do not exceed the carrying value of the intangible assets, wemust determine the fair value of the intangible assets. If the fair value of theintangible assets is less than its carrying value, an impairment loss will berecognized in an amount equal to the difference. We review intangible assetsfor impairment at least annually and whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. Such events or changes in circumstances may include but arenot limited to, lack of promotional sensitivity, the introduction ofcompetitive products and changes in government regulations. If we determine thatan intangible asset is impaired, a non-cash impairment charge will berecognized. If we should incur an impairment loss, there may be a materialimpact to the financial statements.

·        *Income Taxes*. Income taxes are provided for under the liability method. This approachrequires the recognition of deferred tax assets and liabilities for theexpected future tax consequences of differences between the tax basis of assetsor liabilities and their carrying amounts in the consolidated financialstatements. A valuation allowance is provided for deferred tax assets if it ismore likely than not that these items will either expire before we are able torealize their benefit or if future deductibility is uncertain.

Developing the provisionfor income taxes requires significant judgment and expertise in international,federal and state income tax laws, regulations and strategies, including thedetermination of deferred tax assets and liabilities and, if necessary, anyvaluation allowances that may be required for deferred tax assets. Ourjudgments and tax strategies are subject to audit by various taxingauthorities. While we believe we have provided adequately for our income taxliabilities in our consolidated financial statements, adverse determinations bythese taxing authorities could have a material adverse effect on ourconsolidated financial condition and results of operations.

·        *Inventory obsolescence.* Our products have shelf lives ranging from 24to 48 months. We must estimate the amount of inventory recorded on ourbalance sheet that will not be sold prior to expiration. This estimate requiresanalysis of forecasted demand for our products, our promotional focus, amountsof our products currently held by our customers and the impact on our productsof competing products. If we over or under estimate the amount of inventorythat will not be sold prior to expiration, there may be a material impactto our financial statements.

**ForwardLooking Statements**

ThisQuarterly Report contains forward-looking statements within the meaning of thePrivate Securities Litigation Reform Act of 1995. These statements involvea number of risks and uncertainties. Although our forward-looking statementsreflect the good faith judgment of our management, these statements can only bebased on facts and factors currently known by us. Consequently, forward-lookingstatements are inherently subject to risks and uncertainties, and actualresults and outcomes may differ materially from results and outcomesdiscussed in the forward-looking statements. Risks to our business include,without limitation:

·      We may not attain expected revenuesand earnings;

·      If we are unsuccessful in obtaining thirdparty payor contracts for our products, we may experience reductions insales levels and may fail to reach anticipated sales levels;

·      If demand for our products exceeds ourinitial expectations or the ability of our suppliers to provide demand-meetingquantities of product and samples, our future ability to sell these productscould be adversely impacted;

·      The potential growth rate for our promotedproducts may be limited by slower growth for the class of drugs towhich our promoted products belong and unfavorable clinical studies about suchclass of drugs;

·      We may encounter problems in themanufacture or supply of our products, for which we depend entirely on thirdparties;

20

----

·      Strong competition exists in the sale ofour promoted products, which could adversely affect expected growth of ourpromoted products’ sales or increase our costs to sell our promoted products;

·      We may not be able to protect ourcompetitive position for our promoted products from patent infringers;

·      Altoprev has experienced manufacturingissues. If the issues recur and cannot be resolved, our ability to acquire theproduct for sale and sampling will be adversely affected;

·      We may incur unexpected costs inintegrating new products into our operations;

·      We may be unable to develop or marketline extensions for our products including Prenate, Sular, Triglide, Altoprevand Fortamet, or, even if developed, obtain patent protection for our lineextensions; further, introductions by us of line extensions of our existingproducts may require that we make unexpected changes in our estimates forfuture product returns and reserves for obsolete inventory; if these risksoccur, our operating results would be adversely affected;

·      If we have difficulties acquiring newproducts or rights to market new products from third parties, our financialresults could be adversely impacted;

·      Our licensor/supplier can terminate ourrights to commercialize Nitrolingual and the 60 dose size of this product hasnot yet met our expectation;

·      We depend on a small senior managementgroup, the departure of any member of which would likely adversely affect ourbusiness;

·      An adverse interpretation or ruling by oneof the taxing jurisdictions in which we operate could adversely impact ouroperating results;

·      A small number of customers accounts for alarge portion of our sales and the loss of one of them, or changes in theirpurchasing patterns, could result in substantially reduced sales, substantiallyand adversely impacting our financial results;

·      Ifthird-party payors do not adequately reimburse patients for our products,doctors may not prescribe them;

·      Ourbusiness is subject to increasing government price controls and otherhealthcare cost containment measures;

·      Side effects or marketing or manufacturingproblems with our products could result in product liability claims which couldbe costly to defend and could result in the withdrawal or recall of productsfrom the market;

·      We rely on operational data obtained fromIMS, an industry accepted data source. IMS data may not accurately reflectactual prescriptions (for instance, we believe IMS data does not capture allproduct prescriptions from some non-retail channels);

·      An adverse judgment in the securitiesclass action litigation in which we and certain current and formerdirectors and executive officers are defendants could have a material adverseeffect on our results of operations and liquidity;

·      If we fail to obtain, or encounterdifficulties in obtaining, regulatory approval for new products or new uses ofexisting products, or if our development agreements are terminated, we willhave expended significant resources for no return;

·      Our business and products are highlyregulated; the regulatory status of some of our products makes these productssubject to increased competition and other risks; and we run the risk that we,or third parties on whom we rely, could violate the governing regulations;

·                  Wemay be found noncompliant with applicable federal, state or internationallaws, rules or regulations;

·                  Ifgeneric competitors that compete with any of our products are introduced ourrevenues may be adversely affected; and

21

----

·                  Someunforeseen difficulties may occur.

Theserisk factors are not exhaustive. We may not have correctly identified andappropriately assessed all factors affecting our business and the publiclyavailable and other information with respect to these matters may not becomplete and correct. Additional risks and uncertainties not presently known tous or that we currently believe to be immaterial also may adversely impactus. Should any risks and uncertainties develop into actual events, thesedevelopments could have material adverse effects on our business, financialcondition, and results of operations. For these reasons, we caution you not toplace undue reliance on our forward-looking statements.

**ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

TheCompany is exposed to certain market risks that arise in the ordinary course ofbusiness. A discussion of the Company’s primary market risk exposure ispresented below.

**ForeignCurrency Exchange Risk**

Ourpurchases of Sular, Triglide and Nitrolingual are made in Euros. Although wedid not enter into any forward contracts in the third quarter of 2006, wemay eliminate risks from foreign currency fluctuations after the time ofshipment of product by entering into forward contracts for these purchases ofinventory at the time of product shipments. The Company’s earnings and cashflows could be adversely affected in the future by the relationship of the U.S.dollar with foreign currencies.

**MarketRisk on Investments**

The fairvalue of our investment portfolio would be negatively affected by an increasein interest rates. Since the majority of the Company’s investments are fixedrate interest-bearing securities and therefore subject to the risk of loss inmarket value from an increase in rates or a change in the underlying risk ofthe issuers of the notes, the Company’s future earnings and cash flows could beaffected adversely if the Company were to sell the securities prior to theirmaturity date. There were no significant realized losses from the sale ofinvestments for the three and nine months ended September 30, 2006. At September30, 2006, the Company had total net unrealized losses from marketablesecurities of $1.2 million.

**MarketRisk on Variable Rate Debt**

Inconnection with borrowings incurred under the senior secured revolving creditfacility arranged by UBS Securities LLC, we could experience market risk withrespect to changes in the general level of the interest rates and its effectupon our interest expense. Borrowings under this facility bear interest atvariable rates. Because such rates are variable, an increase in interest rateswill result in additional interest expense and a reduction in interest rateswill result in reduced interest expense. Accordingly, our present exposure tointerest rate fluctuations is primarily dependent on rate changes thatmay occur while borrowings under the senior secured credit facility areoutstanding. On September 30, 2006 there was no debt outstanding under thisfacility.

**MarketRisk on Fixed Rate Debt**

TheCompany’s long-term fixed interest rate senior subordinated contingentconvertible notes are also subject to market risk. Fixed rate debt outstandingat September 30, 2006 was $150.0 million with an interest rate of 1.75%.All other things being equal, the fair market value of the Company’s fixed ratedebt will increase as rates decline and will decrease as rates rise. The fixedrate notes outstanding totaling $150.0 million at September 30, 2006 had afair value of $151.3 million based on quoted market rates.

**ITEM 4. CONTROLS AND PROCEDURES**

**Evaluationof Disclosure Controls and Procedures**

Wemaintain a set of disclosure controls and procedures that are designed toensure that information required to be disclosed in the reports that we fileunder the Securities Exchange Act of 1934, as amended (“Exchange Act”), isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms. We carried out an evaluation under thesupervision and with the participation of management, including our Presidentand Chief Executive Officer and our Chief Financial Officer, of theeffectiveness of the design and operation of Sciele Pharma’s disclosurecontrols and procedures pursuant to Rule 

22

----

13a-15(e) of theExchange Act as of the end of the period covered by this report. Our Presidentand Chief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures provide reasonable assurance as of the endof the period for which the report is being filed that (i) informationrequired to be disclosed in our reports under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms and (ii) such information is accumulated andcommunicated to our management, including our President and Chief ExecutiveOfficer and our Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure.

**Changesin Internal Control over Financial Reporting**

Therehave been no changes in Sciele Pharma’s primary internal controls overfinancial reporting during the third fiscal quarter of 2006, that havematerially affected, or is reasonably likely to materially affect, ScielePharma’s internal controls over financial reporting.

**PART II—OTHER INFORMATION**

**ITEM 1: LEGAL PROCEEDINGS**

The Company,certain former and current officers and directors are defendants in aconsolidated securities lawsuit filed on August 22, 2002 in the UnitedStates District Court for the Northern District of Georgia. Plaintiffs in theclass action alleged in general terms that we violated Sections 11 and12(a)(a) of the Securities Act of 1933 and that we violated Sections10(b) and 20(a) of the Securities Exchange Act of 1934 andRule 10b-5 promulgated thereunder. In an amended complaint, Plaintiffsclaim that we issued a series of materially false and misleadingstatements to the market in connection with our public offering onApril 24, 2002 and thereafter relating to alleged “channel stuffing”activities. The amended compliant also alleged controlling person liability onbehalf of certain of our officers under Section 15 of the Securities Actof 1933 and Section 20 of the Securities Exchange Act of 1934. Plaintiffsseek an unspecified amount of compensatory damages.

OnSeptember 29, 2004, the U.S. District Court for the Northern District ofGeorgia dismissed, without prejudice, the class action lawsuit. Althoughthe lawsuit was dismissed, the court granted the plaintiffs the right to refileprovided that the plaintiffs pay all of the defendant’s fees and costsassociated with filing the motion to dismiss the lawsuit. Plaintiffs did notfile a second amended complaint as permitted, but instead filed a motion askingthe District Court to reconsider its September 29, 2004 order and lift thecondition that they must pay defendants’ fees and costs before furtheramendment. On June 22, 2005, the District Court denied plaintiffs’ motionand gave them another opportunity to amend if they pay defendants’ fees andcosts. Once again, plaintiffs chose not to file a second amended complaint.Instead, plaintiffs filed an appeal to the United States Court of Appeals forthe Eleventh Circuit.  The court hassince ruled that Plaintiffs may recast and refile their complaint.  The Company shall continue to vigorouslydefend this action.

On September 18,2006, the Eleventh Circuit Court of Appeals affirmed the District Court’sdetermination that the Amended Complaint was a “shotgun pleading” which did notsatisfy the pleading requirements under the federal rules.  The Court ofAppeals, however, disagreed with the remedy ordered by the DistrictCourt.  Instead of dismissing the Amended Complaint with a right tofurther amend if Plaintiffs paid Defendants’ fees and costs, the Court ofAppeals held that the District Court should have ordered Plaintiffsto replead under Federal Rule of Civil Procedure 12(e).  The Court ofAppeals also held that Plaintiffs’ claims under the Securities Act of1933 must meet the heightened pleading standards of Federal Rule ofCivil Procedure 9(b) because those claims sound in fraud.  Accordingly,the Court of Appeals vacated the District Court’s orders and remanded withinstructions to order a repleading. No accrual is recorded in the Company’sfinancial statements related to this case as the Company believes that its riskof loss is remote.

The Company isalso involved with other various legal proceedings incident to the course ofbusiness. None of these proceedings are expected to have a material adverseeffect on the consolidated financial statements.

**ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES ANDUSE OF PROCEEDS**

TheCompany adopted a share repurchase program effective August 3, 2005, thatauthorizes the repurchase of up to $20.0 million of its outstanding shares ofcommon stock over the next twelve months with no periodic sub-limits on theamount of repurchases. This plan expired on August 2, 2006. 

23

----

OnAugust 3, 2006, the Company adopted a new share repurchase program authorizing therepurchase of up to $30.0 million of outstanding common stock.  This plan replaces all prior share repurchaseplans and will expire on August 2, 2007. As of September 30, 2006, $22.1 million is available for repurchasesunder the provision.  
| ** **                              | ** ** | ** **         | ** ** | ** **         | ** ** | ** **                        | ** ** | ** ** | ** ** | **Approximate Dollar**        | ** ** |
|-----------------------------------------|------------|--------------------|------------|--------------------|------------|-----------------------------------|------------|------------|------------|------------------------------------|------------|
| ** **                              | ** ** | **Total**          | ** ** | ** **         | ** ** | **Total Number of**     | ** ** | ** ** | ** ** | **Value of Shares**      | ** ** |
| ** **                              | ** ** | **Number of** | ** ** | **Average**        | ** ** | **Shares Purchased as** | ** ** | ** ** | ** ** | **that May Yet Be** | ** ** |
| ** **                              | ** ** | **Shares**         | ** ** | **Price**          | ** ** | **Part of Publicly**    | ** ** | ** ** | ** ** | **Purchased Under**           | ** ** |
| **Fiscal Period**                  | ** ** | **Purchased**      | ** ** | **Per Share** | ** ** | **Announced Plans**          | ** ** | **Plan**   | ** ** | **the Plans**                 | ** ** |
|                                    |       |               |       |               |       |                              |       |       |       |                               |       |
| January 1  through March 31, 2006       |       | —             |       | $                  | —     |                              | —     |       | 1          |                               | $          | 15,563,420 |   |
| April 1 through  June 30, 2006          |       | 334,100            |       | $                  | 20.71      |                              | 334,100    |       | 1          |                               | $          | 8,631,399 |   |
| July 1 through  July 31, 2006           |       | —             |       | $                  | —     |                              | —     |       | 1          |                               | $          | 8,631,399 |   |
| August 1 through  August 31, 2006       |       | 409,973            |       | $                  | 19.19      |                              | 409,973    |       | 2          |                               | $          | 22,118,963 |   |
| September 1  through September 30, 2006 |       | —             |       | $                  | —     |                              | —     |       | 2          |                               | $          | 22,118,963 |   |
| Total                                   |       | 744,073            |       | $                  | 19.87      |                              | 744,073    |       |       |                               |       |   |

 

*Plan 1refers to the Share Repurchase Plan effective August 3, 2005 through August 2,2006.  Plan 2 refers to the ShareRepurchase Plan effective August 3, 2006 through August 2, 2007.*

**ITEM 4:SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS**

None.

**ITEM 5:OTHER INFORMATION**

None.

**ITEM 6:EXHIBITS**
| 10.1+ | Distribution Services Agreement of July 19, 2006  between the Company and Amerisource Bergen Drug Corporation.                                                                                                          |
|-------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2  | Credit Ageement dated September 18, 2006 between the  Company and certain of its subsidiaries as borrowers, UBS Securities LLC and  LaSalle Bank National Association as lead arrangers and the lenders named  therein. |
| 10.3  | Security Agreement dated September 18, 2006 between  the Company and certain of its subsidiaries as grantees and the grantors  named therein.                                                                           |
| 31.1  | Certifications of Chief Executive Officer and  President pursuant to Securities Exchange Act Rules 13a-14 and 15d-14,  as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                  |
| 31.2  | Certifications of Chief Financial Officer, Secretary  and Treasurer pursuant to Securities Exchange Act Rules 13a-14 and  15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.      |
| 32.1  | Certification of Chief Executive Officer and  President pursuant to 18 U.S.C. Section 1350, as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002.                                       |
| 32.2  | Certification of Chief Financial Officer, Secretary  and Treasurer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                            |

 

----

+  Confidential treatment requested

24

----

 

**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                        | **SCIELE  PHARMA, INC.** |
|------------------------|--------------------------|
| ** **             | (Registrant)             |
| ** **             | ** **               | ** ** |
| ** **             | ** **               | ** ** |
| Date: October 27, 2006 | By:                      | /s/ PATRICK P. FOURTEAU |
|                   |                     | Patrick P. Fourteau |
|                   | * *                 | *Chief Executive Officer and President* |
|                   | * *                 | *(principal executive officer)* |
|                   | * *                 | * * |
| Date: October 27, 2006 | By:                      | /s/ DARRELL BORNE |
|                   |                     | Darrell Borne |
|                   | * *                 | *Executive Vice President and Chief Financial* |
|                   | * *                 | *Officer, Secretary and Treasurer* |
|                   | * *                 | *(principal accounting and financial officer)* |

 

25

----