**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM10-Q**

** **
| **[MARK ONE]**                              | ** ** | ** **                                                                                                   |
|--------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|
| ** **                                       | ** ** | ** **                                                                                                   |
| **ý**                                       | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
| ** **                                       | ** ** | ** **                                                                                                   |
| **For the quarterly period ended June 30, 2005** |
| ** **                                       | ** ** | ** **                                                                                                   |
| **OR**                                           |
| ** **                                       | ** ** | ** **                                                                                                   |
| **o**                                            | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition periodfrom                          to                       **

 

**Commission File No. 000-30123**

 

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**FIRSTHORIZON PHARMACEUTICAL CORPORATION**

(Exactname of registrant as specified in its charter)

 
| **Delaware**                              | ** ** | **58-2004779**                           |
|-------------------------------------------|------------|------------------------------------------|
| (State  of incorporation)                 |       | (I.R.S.  Employer Identification Number) |
| ** **                                | ** ** | ** **                               |
| **6195 Shiloh Road, Alpharetta, Georgia** | ** ** | **30005**                                |
| (Address  of principal executive offices) |       | (Zip  code)                              |

 

**(770) 442-9707**

(Registrant’stelephone number, including area code):

 

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Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ý        No o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 126-2of the Exchange Act). Yes ý        No o

 

As of July 28, 2005, therewere 35,062,865 shares of the Registrant’s Common Stock outstanding.

 

 

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**FIRST HORIZON PHARMACEUTICAL CORPORATION**

**FORM 10-Q**

**INDEX**

 
| ** **                                            | **Page**                                                                                                  |
|-------------------------------------------------------|-----------------------------------------------------------------------------------------------------------|
| PART  I.    FINANCIAL INFORMATION |                                                                                                      |
|                                                  |                                                                                                      |
| Item 1.                                          | Consolidated Balance Sheets at June  30, 2005 and December 31, 2004                                       | 3 |
|                                                  |                                                                                                      |   |
|                                                  | Consolidated Statements of  Operations for the three and six months ended June 30, 2005 and June 30, 2004 | 4 |
|                                                  |                                                                                                      |   |
|                                                  | Consolidated Statements of  Cash Flows for the six months ended June 30, 2005 and June 30, 2004           | 5 |
|                                                  |                                                                                                      |   |
|                                                  | Notes to Consolidated  Financial Statements                                                               | 6 |
|                                                  |                                                                                                      |   |
| Item 2.                                               | Management’s Discussion and  Analysis of Financial Condition and Results of Operations               | 10 |
|                                                  |                                                                                                      |   |
| Item 3.                                               | Quantitative and Qualitative  Disclosures about Market Risk                                               | 15 |
|                                                  |                                                                                                      |   |
| Item 4.                                               | Controls and Procedures                                                                                   | 15 |
|                                                  |                                                                                                      |   |
| PART II.    OTHER  INFORMATION    | 15                                                                                                        |
|                                                  |                                                                                                      |
| Item 1.                                               | Legal Proceedings                                                                                         | 15 |
|                                                  |                                                                                                      |   |
| Item 2.                                               | Unregistered Sales of Equity  Securities and Use of Proceeds                                              | 16 |
|                                                  |                                                                                                      |   |
| Item 4.                                               | Submission of Matters to a  Vote of Security Holders                                                      | 16 |
|                                                  |                                                                                                      |   |
| Item 5.                                               | Other Information                                                                                         | 16 |
|                                                  |                                                                                                      |   |
| Item 6.                                          | Exhibits                                                                                                  | 16 |
|                                                  |                                                                                                      |   |
|                                                  | Signatures                                                                                                | 17 |
|                                                  |                                                                                                      |   |
|                                                  | Certifications                                                                                            | 18 |

 

2

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**PART I—FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**FIRST HORIZON PHARMACEUTICAL CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

**(in thousands, except share data)**

 
| ** **                                                                                                                                                  | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                  | ** ** | **(unaudited)**    | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                  |       |               |       |                        |       |
| Current assets:                                                                                                                                             |       |               |       |                        |       |
| Cash and cash  equivalents                                                                                                                                  |       | $                  | 13,415     |                        | $          | 36,586 |   |
| Marketable  securities                                                                                                                                      |       | 83,950             |       | 160,636                     |       |
| Accounts  receivable, net of allowance for doubtful accounts and discounts of $842 and  $749 at June 30, 2005 and December 31, 2004, respectively      |       | 26,980             |       | 23,833                      |       |
| Inventories                                                                                                                                                 |       | 33,878             |       | 15,824                      |       |
| Income taxes  receivable                                                                                                                                    |       | 4,093              |       | 5,438                       |       |
| Current deferred  tax assets                                                                                                                                |       | 3,029              |       | 3,419                       |       |
| Other current  assets                                                                                                                                       |       | 11,675             |       | 7,581                       |       |
|                                                                                                                                                        |       |               |       |                        |       |
| Total current  assets                                                                                                                                       |       | 177,020            |       | 253,317                     |       |
|                                                                                                                                                        |       |               |       |                        |       |
| Property and  equipment, net                                                                                                                                |       | 5,369              |       | 5,110                       |       |
| Other assets:                                                                                                                                               |       |               |       |                        |       |
| Intangibles, net                                                                                                                                            |       | 319,507            |       | 229,953                     |       |
| Other                                                                                                                                                       |       | 4,508              |       | 10,104                      |       |
|                                                                                                                                                        |       |               |       |                        |       |
| Total other  assets                                                                                                                                         |       | 324,015            |       | 240,057                     |       |
|                                                                                                                                                        |       |               |       |                        |       |
| Total assets                                                                                                                                                |       | $                  | 506,404    |                        | $          | 498,484 |   |
|                                                                                                                                                        |       |               |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                              |       |               |       |                        |       |
| Current  liabilities:                                                                                                                                       |       |               |       |                        |       |
| Account payable                                                                                                                                             |       | $                  | 12,524     |                        | $          | 14,569 |   |
| Accrued expenses                                                                                                                                            |       | 17,143             |       | 20,508                      |       |
|                                                                                                                                                        |       |               |       |                        |       |
| Total current  liabilities                                                                                                                                  |       | 29,667             |       | 35,077                      |       |
|                                                                                                                                                        |       |               |       |                        |       |
| Long-term liabilities:                                                                                                                                      |       |               |       |                        |       |
| Convertible debt                                                                                                                                            |       | 150,000            |       | 150,000                     |       |
| Deferred tax  liabilities                                                                                                                                   |       | 5,648              |       | 4,404                       |       |
| Other long-term  liabilities                                                                                                                                |       | 352                |       | 594                         |       |
|                                                                                                                                                        |       |               |       |                        |       |
| Total  liabilities                                                                                                                                          |       | 185,667            |       | 190,075                     |       |
|                                                                                                                                                        |       |               |       |                        |       |
| Stockholders’  equity:                                                                                                                                 |       |               |       |                        |       |
| Preferred stock,  1,000,000 shares authorized and none outstanding                                                                                          |       | —             |       | —                      |       |
| Common stock,  $0.001 par value; 100,000,000 shares authorized; 36,061,527 and 36,087,044  issued at June 30, 2005 and December 31, 2004, respectively |       | 36                 |       | 36                          |       |
| Additional  paid-in capital                                                                                                                                 |       | 287,827            |       | 288,335                     |       |
| Retained  earnings                                                                                                                                          |       | 58,907             |       | 43,315                      |       |
| Deferred  compensation                                                                                                                                      |       | (230               | )          | —                      |       |
| Accumulated  other comprehensive loss                                                                                                                       |       | (2,613             | )          | (87                         | )          |
|                                                                                                                                                        |       |               |       |                        |       |
|                                                                                                                                                        |       | 343,927            |       | 331,599                     |       |
| Less: Treasury  stock at cost, Common stock, 1,000,000 shares at June 30, 2005 and  December 31, 2004                                                  |       | (23,190            | )          | (23,190                     | )          |
|                                                                                                                                                        |       |               |       |                        |       |
| Total  stockholders’ equity                                                                                                                            |       | 320,737            |       | 308,409                     |       |
|                                                                                                                                                        |       |               |       |                        |       |
| Total  liabilities and stockholders’ equity                                                                                                            |       | $                  | 506,404    |                        | $          | 498,484 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

3

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**FIRST HORIZON PHARMACEUTICAL CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(unaudited, in thousands, except per share data)**

 
| ** **                                                  | ** ** | **For The Three Months Ended June 30,** | ** ** | **For The Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                  | ** ** | **2005**                                     | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net revenues                                                |       | $                                            | 49,816     |                                       | $          | 35,990 |   | $ | 90,773 |   | $ | 68,008 |   |
| Operating costs  and expenses:                              |       |                                         |       |                                       |       |   |   |   |   |
| Cost of revenues  (excluding depreciation and amortization) |       | 7,353                                        |       | 6,825                                      |       | 14,522 |   | 12,400 |   |
| Selling, general  and administrative expense                |       | 24,075                                       |       | 15,737                                     |       | 41,760 |   | 29,588 |   |
| Depreciation and  amortization                              |       | 5,742                                        |       | 4,139                                      |       | 10,105 |   | 8,270 |   |
| Research and  development expense                           |       | 621                                          |       | 363                                        |       | 886 |   | 544 |   |
|                                                        |       |                                         |       |                                       |       |   |   |   |   |
| Total operating  costs and expenses                         |       | $                                            | 37,791     |                                       | $          | 27,064 |   | $ | 67,273 |   | $ | 50,802 |   |
|                                                        |       |                                         |       |                                       |       |   |   |   |   |
| Operating income                                            |       | 12,025                                       |       | 8,926                                      |       | 23,500 |   | 17,206 |   |
|                                                        |       |                                         |       |                                       |       |   |   |   |   |
| Other income  (expense):                                    |       |                                         |       |                                       |       |   |   |   |   |
| Interest expense                                            |       | (964                                         | )          | (754                                       | )          | (1,403 | ) | (964 | ) |
| Interest income                                             |       | 935                                          |       | 990                                        |       | 1,678 |   | 1,281 |   |
| Other                                                       |       | (400                                         | )          | (23                                        | )          | (684 | ) | (11 | ) |
|                                                        |       |                                         |       |                                       |       |   |   |   |   |
| Total other  income (expense)                               |       | $                                            | (429       | )                                          | $          | 213 |   | $ | (409 | ) | $ | 306 |   |
|                                                        |       |                                         |       |                                       |       |   |   |   |   |
| Income before  provision for income taxes                   |       | 11,596                                       |       | 9,139                                      |       | 23,091 |   | 17,512 |   |
| Provision for  income taxes                                 |       | (3,592                                       | )          | (3,630                                     | )          | (7,499 | ) | (6,956 | ) |
|                                                        |       |                                         |       |                                       |       |   |   |   |   |
| Net income                                                  |       | $                                            | 8,004      |                                       | $          | 5,509 |   | $ | 15,592 |   | $ | 10,556 |   |
| Other  comprehensive loss                                   |       | $                                            | 1,348      |                                       | $          | 1,482 |   | $ | 2,526 |   | $ | 1,499 |   |
|                                                        |       |                                         |       |                                       |       |   |   |   |   |
| Comprehensive  income                                       |       | $                                            | 6,656      |                                       | $          | 4,027 |   | $ | 13,066 |   | $ | 9,057 |   |
|                                                        |       |                                         |       |                                       |       |   |   |   |   |
| Net income per  common share:                               |       |                                         |       |                                       |       |   |   |   |   |
| Basic earnings  per common share                            |       | $                                            | 0.23       |                                       | $          | 0.15 |   | $ | 0.44 |   | $ | 0.29 |   |
|                                                        |       |                                         |       |                                       |       |   |   |   |   |
| Diluted earnings  per common share                          |       | $                                            | 0.20       |                                       | $          | 0.14 |   | $ | 0.39 |   | $ | 0.27 |   |
|                                                        |       |                                         |       |                                       |       |   |   |   |   |
| Weighted average  common shares outstanding:                |       |                                         |       |                                       |       |   |   |   |   |
| Basic                                                       |       | 35,029                                       |       | 36,000                                     |       | 35,047 |   | 35,872 |   |
|                                                        |       |                                         |       |                                       |       |   |   |   |   |
| Diluted                                                     |       | 42,415                                       |       | 43,825                                     |       | 42,453 |   | 41,228 |   |

 

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

 

4

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**FIRST HORIZON PHARMACEUTICAL CORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(unaudited, in thousands)**

 
| ** **                                                                         | ** ** | **For The Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                             |       |                                  |       |   |   |
| Net income                                                                         |       | $                                     | 15,592     |   | $ | 10,556 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                  |       |   |   |
| Depreciation and  amortization                                                     |       | 10,105                                |       | 8,270 |   |
| Marketable  securities impairment                                                  |       | 684                                   |       | — |   |
| Non-cash  interest expense                                                         |       | 170                                   |       | 107 |   |
| Non-cash  compensation expense                                                     |       | 5                                     |       | — |   |
| Deferred income  tax expense                                                       |       | 1,527                                 |       | 2,804 |   |
| Reduction in  taxes payable—stock option exercises                            |       | 476                                   |       | 2,160 |   |
| Changes in  assets and liabilities, net of acquired assets and liabilities:        |       |                                  |       |   |   |
| Accounts  receivable                                                               |       | (3,147                                | )          | (1,672 | ) |
| Inventories                                                                        |       | (18,054                               | )          | 589 |   |
| Other current  assets and other assets                                             |       | (3,668                                | )          | (2,758 | ) |
| Income taxes  receivable                                                           |       | 1,345                                 |       | (2,147 | ) |
| Accrued expenses  and other long-term liabilities                                  |       | 1,393                                 |       | (291 | ) |
| Accounts payable                                                                   |       | (6,129                                | )          | 4,543 |   |
|                                                                               |       |                                  |       |   |   |
| Net cash  provided by operating activities                                         |       | 299                                   |       | 22,161 |   |
| Cash flows from  investing activities:                                             |       |                                  |       |   |   |
| Purchase of  products                                                              |       | (94,671                               | )          | (5,138 | ) |
| Purchase of  property and equipment                                                |       | (1,163                                | )          | (305 | ) |
| Proceeds from  sale of marketable securities                                       |       | 97,271                                |       | — |   |
| Purchase of  marketable securities                                                 |       | (20,994                               | )          | (138,300 | ) |
|                                                                               |       |                                  |       |   |   |
| Net cash used in  investing activities                                             |       | (19,557                               | )          | (143,743 | ) |
| Cash flows from  financing activities:                                             |       |                                  |       |   |   |
| Capitalized  financing costs incurred                                              |       | —                                |       | (4,572 | ) |
| Repurchase of  common stock                                                        |       | (2,094                                | )          | (4,557 | ) |
| Proceeds from  long-term debt                                                      |       | —                                |       | 150,000 |   |
| Net proceeds  from issuance of common stock                                        |       | 875                                   |       | 5,486 |   |
|                                                                               |       |                                  |       |   |   |
| Net cash (used  in) provided by financing activities                               |       | (1,219                                | )          | 146,357 |   |
| Effect of  foreign exchange rates on cash                                          |       | (2,694                                | )          | (25 | ) |
| Net change in  cash and cash equivalents                                           |       | (23,171                               | )          | 24,750 |   |
| Cash and cash  equivalents, beginning of period                                    |       | 36,586                                |       | 33,722 |   |
|                                                                               |       |                                  |       |   |   |
| Cash and cash  equivalents, end of period                                          |       | $                                     | 13,415     |   | $ | 58,472 |   |
|                                                                               |       |                                  |       |   |   |
| Non-cash  financing transactions:                                                  |       |                                  |       |   |   |
| Issuance of  restricted stock                                                      |       | $                                     | 235        |   | $ | — |   |
|                                                                               |       |                                  |       |   |   |
| Supplemental  Cash Flow Information:                                               |       |                                  |       |   |   |
| Cash paid for  income taxes                                                        |       | $                                     | 3,499      |   | $ | 4,206 |   |
|                                                                               |       |                                  |       |   |   |
| Cash paid for  interest                                                            |       | $                                     | 1,520      |   | $ | 25 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

5

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**FIRST HORIZON PHARMACEUTICAL CORPORATION**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(unaudited)**

 

**1.****                                     ****Basis of Presentation**

 

The accompanying unaudited interim consolidated financial statementsreflect all adjustments (consisting solely of normal recurring adjustments)which management considers necessary for 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, 2004 (FileNo. 000-30123).

 

**2.****                                     ****New Accounting Pronouncements**

 

In May 2005, the Financial Accounting Standards Board (“FASB”) issuedStatement 154, *“Accounting Changes and Error Corrections, areplacement of APB Opinion No. 20 and FASB Statement No. 3.” *The standard requiresretrospective application to prior periods’ financial statements of a voluntarychange in accounting principle unless it is deemed impracticable. The standardstates that a change in method of depreciation, amortization or depletion forlong-lived, non-financial assets be accounted for as a change in accountingestimate that is affected by a change in accounting principle.  The standard is effective for accountingchanges and corrections of errors made occurring in fiscal years beginningafter December 15, 2005.  The adoption ofStatement of Financial Accounting Standards (“SFAS”) No. 154 is not expected tohave a material impact on the Company’s financial position or results ofoperations.

 

In December 2004, the FASB issued Statement 153,*”Exchanges of Nonmonetary Assets, an amendment of APBOpinion No.29.”* The standard is based on the principle thatexchanges of nonmonetary assets should be measured based on the fair value ofthe assets exchanged and eliminates the exception under APB Opinion No. 29for an exchange of similar productive assets and replaces it with an exceptionfor exchanges of nonmonetary assets that do not have commercial substance. Thestandard is effective for nonmonetary exchanges occurring in fiscal periods beginningafter June 15, 2005. The adoption of SFAS No. 153 is not expected tohave a material impact on the Company’s financial position or results ofoperations.

 

In December 2004, the FASB issued Statement 123 (revised 2004),*”Share-Based Payment.”* The standardeliminates the disclosure-only election under the prior SFAS 123 andrequires the recognition of compensation expense for stock options and otherforms of equity compensation based on the fair value of the instruments on thedate of grant. The standard is effective for fiscal years beginning afterJune 15, 2005. See Note 3 for the disclosures of the pro formadilutive impact on net income and earnings per share of expensing stock optionsbased on the Black-Scholes model.

 

In November 2004, the FASB issued Statement 151,*”Inventory Costs.”* The standard clarifiesthat abnormal amounts of idle facility expense, freight, handling costs, andwasted materials should be recognized as current-period charges and requiresthe allocation of fixed production overheads to inventory based on the normalcapacity of the production facilities. The standard is effective for inventorycosts incurred during fiscal years beginning after June 15, 2005. Theadoption of SFAS No. 151 is not expected to have a material impact on theCompany’s financial position or results of operations.

 

**3.****                                     ****Stock Based Compensation**

 

The Company applies APB No. 25, “*Accountingfor Stock Issued to Employees,*” and related interpretations inaccounting for all stock options issued to employees. Accordingly, the Companyrecords compensation expense for any stock option grants and restricted stockgrants with exercise prices lower than fair value, recognized ratably over thevesting period.

 

Applying the Black Scholes option-pricing models prescribed by SFASNo. 123, “*Accounting for Stock BasedCompensation,*” to calculate the compensation costs of the Company’soptions, the Company’s pro forma net income per common share would have beenreported as follows (in thousands except per share data):

 
| ** **                                                                                                                     | ** ** | **For The Three Months Ended June 30,** | ** ** | **For The Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                     | ** ** | **2005**                                     | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income as  reported                                                                                                        |       | $                                            | 8,004      |                                       | $          | 5,509 |   | $ | 15,592 |   | $ | 10,556 |   |
| Deduct:                                                                                                                        |       |                                         |       |                                       |       |   |   |   |   |
| Total  stock-based employee compensation expense determined under fair value basis  for all awards, net of related tax effects |       | (674                                         | )          | (606                                       | )          | (1,159 | ) | (1,247 | ) |
|                                                                                                                           |       |                                         |       |                                       |       |   |   |   |   |
| Pro forma                                                                                                                      |       | $                                            | 7,330      |                                       | $          | 4,903 |   | $ | 14,433 |   | $ | 9,309 |   |
|                                                                                                                           |       |                                         |       |                                       |       |   |   |   |   |
| Net income per  common share—basic:                                                                                       |       |                                         |       |                                       |       |   |   |   |   |
| As reported                                                                                                                    |       | $                                            | 0.23       |                                       | $          | 0.15 |   | $ | 0.44 |   | $ | 0.29 |   |
| Pro forma                                                                                                                      |       | $                                            | 0.21       |                                       | $          | 0.14 |   | $ | 0.41 |   | $ | 0.26 |   |
|                                                                                                                           |       |                                         |       |                                       |       |   |   |   |   |
| Net income per  common share—diluted:                                                                                     |       |                                         |       |                                       |       |   |   |   |   |
| As reported                                                                                                                    |       | $                                            | 0.20       |                                       | $          | 0.14 |   | $ | 0.39 |   | $ | 0.27 |   |
| Pro-forma                                                                                                                      |       | $                                            | 0.18       |                                       | $          | 0.12 |   | $ | 0.36 |   | $ | 0.24 |   |

 

The weighted average fair value per share of options granted during thethree months ended June 30, 2005 and 2004 is estimated at $14.96 and$13.06, respectively. The value of options is estimated on the date of thegrant using the following weighted average assumptions:

 
| ** **               | ** ** | **2005**     | ** ** | **2004**     | ** ** |
|--------------------------|------------|--------------|------------|--------------|------------|
| Risk-free  interest rate |       | 3.76         | %          | 3.22         | %          |
| Expected  dividend yield |       | —       |       | —       |       |
| Expected lives           |       | 5 years |       | 5 years |       |
| Expected  volatility     |       | 116.25       | %          | 128.36       | %          |

 

6

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The Black-Scholes option valuation model was not developed for use invaluing employee stock options. Instead, this model was developed for use inestimating the fair value of traded options, which have shorter lives and novesting restrictions, and are fully transferable, which differ significantlyfrom the Company’s stock option awards. In addition, option valuation modelsrequire the input of highly subjective assumptions including the expected stockprice volatility and expected survival rates of the options.  The Company is reviewing alternativeapproaches to valuing employee stock options.

 

On May 31, 2005, the Company issued 12,500 sharesof restricted common stock to certain members of its Board of Directors. Theshares vest equally over a 4 year period. Total compensation of $235,000 willbe recognized ratably over the 4 year vesting period. As of June 30, 2005,deferred compensation related to the restricted stock totaled $230,000.

 

 

**4.****                                     ****Marketable Securities**

 

The Company classifies its existing marketable securities asavailable-for-sale. All available-for-sale securities are classified as currentas the Company has the ability to use them for current operating and investingpurposes. There were $0.4 million and $0.7 million in realized losses inthe three and six months ended June 30, 2005, respectively. At June 30,2005, the Company had total net unrealized losses from marketable securities of$1.5 million.

 

The carrying amount of available-for-sale securities and theirapproximate fair values at June 30, 2005 were as follows (in thousands):

 
| ** **                                      | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
|-------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|-----------------|------------|
| U.S. Government  and Federal agency obligations |       | $                   | 58,601     |                         | $          | —                        |       | $               | (966       | ) | $ | 57,635 |   |
| Corporate bonds                                 |       | 26,846              |       | —                       |       | (531                          | )          | 26,315          |       |
|                                            |       |                |       |                         |       |                          |       |            |       |
| Total                                           |       | $                   | 85,447     |                         | $          | —                        |       | $               | (1,497     | ) | $ | 83,950 |   |

 

The following table presents the age of gross unrealized losses and fairvalue by investment category for all securities in a loss position as of June30, 2005 (in thousands):

 
| ** **                                      | ** ** | **Less than 12 Months** | ** ** | **12 Months or More**  | ** ** | **Total**       | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|------------------------|------------|-----------------|------------|
| ** **                                      | ** ** | **Fair  Value**         | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** |
| U.S. Government  and Federal agency obligations |       | $                       | 6,806      |                   | $          | (66             | )          | $ | 50,829 |   | $ | (900 | ) | $ | 57,635 |   | $ | (966 | ) |
| Corporate bonds                                 |       | 3,318                   |       | (41                    | )          | 22,997          |       | (490 | ) | 26,315 |   | (531 | ) |
|                                            |       |                    |       |                   |       |            |       |   |   |   |   |   |   |
| Total                                           |       | $                       | 10,124     |                   | $          | (107            | )          | $ | 73,826 |   | $ | (1,390 | ) | $ | 83,950 |   | $ | (1,497 | ) |

 

The Company has determined that its unrealized losses are temporarybased on the minor amount of the losses compared to amortized cost, as well asthe credit worthiness of the investees. The Company expects that all losseswill be recovered, and intends to hold securities to recovery. If market,industry and/or investee conditions deteriorate, the Company may incur futureimpairments.

 

The amortized cost and estimated fair value of marketable securities atJune 30, 2005 by contractual maturity are shown below (in thousands):

 
| ** **                                | ** ** | **Cost** | ** ** | **Estimated  Fair Value** | ** ** |
|-------------------------------------------|------------|----------|------------|--------------------------------|------------|
| Due in one year  or less                  |       | $        | 6,367      |                           | $          | 6,294 |   |
| Due after one  year through three years   |       | 59,080   |       | 58,014                         |       |
| Due after three  years through five years |       | 13,949   |       | 13,707                         |       |
| Due after five  years                     |       | 6,051    |       | 5,935                          |       |
|                                      |       |     |       |                           |       |
|                                      |       | $        | 85,447     |                           | $          | 83,950 |   |

 

The carrying amount of available-for-sale securities and theirapproximate fair values at December 31, 2004 were as follows (inthousands):

 
| ** **                                      | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
|-------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|-----------------|------------|
| U.S. Government  and Federal agency obligations |       | $                   | 93,964     |                         | $          | 14                            |       | $               | (1,082     | ) | $ | 92,896 |   |
| Corporate bonds                                 |       | 68,443              |       | —                       |       | (703                          | )          | 67,740          |       |
|                                            |       |                |       |                         |       |                          |       |            |       |
| Total                                           |       | $                   | 162,407    |                         | $          | 14                            |       | $               | (1,785     | ) | $ | 160,636 |   |

 

**5.****                                     ****Inventories**

 

Inventories consist of purchased pharmaceutical products and are statedat the lower of cost or market. Cost is determined using the first-in,first-out method, and market is considered to be net realizable value.Inventories consist of finished product and bulk product awaiting processingand packaging into finished product. Inventories, net of reserves of $0.9million at June 30, 2005 and December 31, 2004, consisted of (in thousands):

 
| ** **         | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------|------------|--------------------|------------|-----------------------------|------------|
| Bulk product       |       | $                  | 9,710      |                        | $          | 6,882 |   |
| Finished product   |       | 24,168             |       | 8,942                       |       |
|               |       |               |       |                        |       |
| Total  inventories |       | $                  | 33,878     |                        | $          | 15,824 |   |

 

**6.****                                     ****Intangible Assets**

 

In May 2005, the US Food and Drug Administration granted approval for Triglide, a fenofibrate formulation.  The Company obtained exclusive US 

 

7

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marketing rights in May 2004 to Triglide, anovel fenofibrate formulation that employs one of SkyePharma’s proprietarysolubilization technologies. Under its Agreement with SkyePharma, the Company madea payment of $15 million to SkyePharma as a result of the approval during thequarter ended June 30, 2005.   SkyePharmais also entitled to royalties on net sales, as defined.  The intangible asset recorded in connectionwith the acquisition of Triglide is expected to be amortized over a period offifteen years.

 

On March 28, 2005, the Company acquired the worldwide rights to Fortametand Altoprev from Andrx Corporation.  Asof June 30, 2005, the Company has paid Andrx Corporation $73.3 million,and may pay up to an additional $11.7 million upon Andrx Corporation meetingcertain defined manufacturing levels and delivering certain quantities ofAltoprev. Andrx Corporation is also entitled to royalties on net sales of theseproducts.

 

With the assistance of valuation experts, the Company allocated thepurchase price to the fair value of the various intangible assets acquired fromAndrx Corporation, which are not deemed to have an indefinite life. Intangibleassets are amortized on a straight line basis over their respective usefullives. The intangible assets recorded in connection with the acquisition ofFortamet and Altoprev are anticipated to be amortized over a period of fifteenyears.

 

The following table reflects the components of all of the Company's intangibleassets as of June 30, 2005 (in thousands):

 
| ** **                      | ** ** | **Gross Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Amount** | ** ** | **Expected Life**        | ** ** |
|---------------------------------|------------|-----------------------|------------|-------------------------------|------------|---------------------|------------|-------------------------------|------------|
| Licensing rights                |       | $                     | 348,444    |                          | $          | (49,945             | )          | $                             | 298,499    |   | 15 to 20 years |   |
| Trade names                     |       | 11,060                |       | (2,016                        | )          | 9,044               |       | 15 to 20 years |       |
| Contracts                       |       | 8,300                 |       | (5,662                        | )          | 2,638               |       | 5 years                       |       |
| Supply/Distribution  agreements |       | 11,490                |       | (4,573                        | )          | 6,917               |       | 1 to 10 years  |       |
| Other  intangibles              |       | 3,108                 |       | (699                          | )          | 2,409               |       | 20 years                      |       |
|                            |       |                  |       |                          |       |                |       |                          |       |
| Total                           |       | $                     | 382,402    |                          | $          | (62,895             | )          | $                             | 319,507    |   |   |   |

 

The following table reflects the components of intangible assets as ofDecember 31, 2004 (in thousands):

 
| ** **                      | ** ** | **Gross Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Amount** | ** ** | **Expected Life** | ** ** |
|---------------------------------|------------|-----------------------|------------|-------------------------------|------------|---------------------|------------|------------------------|------------|
| Licensing rights                |       | $                     | 249,715    |                          | $          | (42,540             | )          | $                      | 207,175    |   | 15 to 20 years |   |
| Trade names                     |       | 11,060                |       | (1,739                        | )          | 9,321               |       | 20 years               |       |
| Contracts                       |       | 8,300                 |       | (4,832                        | )          | 3,468               |       | 5 years                |       |
| Supply/Distribution  agreements |       | 11,490                |       | (4,056                        | )          | 7,434               |       | 1 to 10 years          |       |
| Other  intangibles              |       | 3,082                 |       | (527                          | )          | 2,555               |       | 20 years               |       |
|                            |       |                  |       |                          |       |                |       |                   |       |
| Total                           |       | $                     | 283,647    |                          | $          | (53,694             | )          | $                      | 229,953    |   |   |   |

 

For the three and six months ended June 30, 2005, amortizationexpense related to the intangible assets was $5.2 million and $9.2million, respectively. Amortization is calculated on a straight-line basis overthe estimated useful life of the intangible asset, and the Company estimatesthe annual amortization expense for each of the five succeeding fiscal years tobe as follows (in thousands):

 
| **Fiscal  year ended December 31:** | ** ** | **Amount** | ** ** |
|-------------------------------------|------------|------------|------------|
| 2005                                |       | $          | 20,575     |   |
| 2006                                |       | $          | 22,349     |   |
| 2007                                |       | $          | 22,246     |   |
| 2008                                |       | $          | 20,940     |   |
| 2009                                |       | $          | 20,689     |   |

 

**7.****                                     ****Other Assets**

 

Other assets at June 30, 2005 and December 31, 2004 consisted ofthe following (in thousands):

 
| ** **                            | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------|------------|--------------------|------------|-----------------------------|------------|
| Capitalized  finance costs            |       | $                  | 4,449      |                        | $          | 4,619 |   |
| Advance payment  for product licenses |       | —             |       | 5,426                       |       |
| Deposits                              |       | 59                 |       | 59                          |       |
|                                  |       |               |       |                        |       |
| Total other  assets                   |       | $                  | 4,508      |                        | $          | 10,104 |   |

 

**8.****                                     ****Accrued Expenses**

 

Accrued expenses at June 30, 2005 and December 31, 2004 consistedof the following (in thousands):

 
| ** **                          | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Employee  compensation and benefits |       | $                       | 2,742      |                        | $          | 1,951 |   |
| Product returns                     |       | 1,167                   |       | 1,563                       |       |
| Product rebates                     |       | 2,076                   |       | 2,031                       |       |
| Sales deductions                    |       | 2,552                   |       | 2,549                       |       |
| Accrued  royalties                  |       | 4,448                   |       | 1,202                       |       |
| Product license  fee                |       | —                  |       | 5,000                       |       |
| Other                               |       | 4,158                   |       | 6,212                       |       |
|                                |       |                    |       |                        |       |
|                                |       | $                       | 17,143     |                        | $          | 20,508 |   |

 

8

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**9.****                                     ****Long-term Debt**

 

In March 2004, the Company issued a total of $150.0 million ofits 1.75% senior subordinated contingent convertible notes due in 2024 intransactions that were exempt from registration in reliance upon Rule 144Aand other available exemptions under the Securities Act. The notes are dueMarch 8, 2024 and accrued interest is payable semi-annually in arrears onMarch 8 and September 8 of each year. In addition to the interest onthe notes, after March 8, 2007, the Company will also pay contingentinterest during specified six-month periods if the average trading price of thenotes per $1,000 principal amount for the five day trading period ending on thethird 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 notes, the contingent interest qualifies as an embedded derivative. As ofJune 30, 2005, management determined that the fair value of this contingentinterest embedded derivative was not material. The net proceeds from thisissuance, after deducting offering expenses, were approximately$145.4 million. Financing costs of $4.6 million were incurred withthe issuance which are being amortized on a straight line basis over the lifeof the notes and are included in other assets in the consolidated balancesheet.

 

Holders of the notes may initially convert the notes into shares of theCompany’s common stock at a conversion rate of 45.1467 shares per $1,000principal amount of the notes, which is equivalent to a conversion price of$22.15 per share, subject to anti-dilution adjustments, before the close ofbusiness on March 8, 2024. Holders may convert the notes only under thefollowing circumstances: (1) during any calendar quarter commencing afterJune 30, 2004, if the closing sales price of the Company’s common stockexceeds 120% of the conversion price for at least 20 trading days in the 30consecutive trading days ending on the last trading day of the precedingcalendar quarter; (2) if the notes have been called for redemption;(3) during the five trading day period immediately following any nineconsecutive trading day period in which the trading price of the notes per$1,000 principal amount for each day of that period was less than 95% of theproduct of the closing price of the Company’s common stock and the number ofshares of common stock issuable upon conversion of $1,000 principal amount ofthe notes; or (4) the occurrence of specified corporate transactions.

 

The Company has the option to redeem the notes beginning March 13,2007 at a price equal to 100% of their aggregate principal amount, plus accruedand unpaid interest, including contingent interest, if any.

 

The holders of the notes have the option to require the Company to repurchasethe notes on March 8 of 2009, 2014 and 2019, and upon a change in control,at a price equal to 100% of their aggregate principal amount, plus accrued andunpaid interest, including contingent interest, if any.

 

In connection with the issuance of the notes, on March 30, 2004 theCompany filed a registration statement on Form S-3 with the Securities andExchange Commission to register for resale of 6.8 million shares of theCompany’s common stock issuable, subject to anti-dilution adjustments, uponconversion of the notes. The registration statement became effective during thesecond quarter of 2004.

 

The Company had no debt other than the aforementioned notes outstandingat June 30, 2005 or December 31, 2004.

 

**10.****                              ****Credit Agreement**

 

On February 11, 2003, the Company entered into a $20.0 millionsenior secured revolving credit facility with various lenders and LaSalle BankNational Association, as administrative agent. Borrowings may be used forworking capital requirements and general corporate purposes. Borrowings aresecured by substantially all of the Company’s assets. Borrowings bear interestat the Company’s option at the base rate in effect from time to time plus anapplicable margin or the Eurodollar rate, plus an applicable margin. Theapplicable margin will vary dependent upon the Company’s leverage ratio ineffect from time to time. The revolving facility matures on August 11,2006. The revolving loan contains various covenants, including covenantsrelative to maintaining financial ratios and earnings levels, limitations onacquisitions, dispositions, mergers and capital expenditures, limitations onincurring additional indebtedness and a prohibition on payment of dividends andcertain issuances of capital stock. In April 2005, the Company borrowed$20.0 million on the facility.  Asof June 30, 2005 it has repaid the $20.0 million and there was no outstandingbalance on the Credit Agreement; however, on July 7, 2005, the Company borrowed$5.0 million on the facility which amount is outstanding as of the date of thisReport.

 

**11.****                              ****Share Buyback Program**

 

In July 2002, the Company announced a share repurchase program.This program authorized the repurchase of up to $8 million in common stockuntil July 2003. Through July 2003, the Company repurchased 823,400shares of its common stock at an aggregate cost of approximately$2.1 million. In August 2003, the Company’s Board of Directorsauthorized the repurchase of up to an additional $7.9 million of commonstock, for a total authorization of $10.0 million, and extended the repurchaseprogram to August 2004. In September 2003, the Company repurchased162,225 shares of common stock at an aggregate cost of approximately$1.0 million. Through December 2003, the Company had repurchased atotal of 985,625 shares of common stock at an aggregate cost of approximately$3.1 million. During the six months ended June 2004, the Companyrepurchased a total of 260,000 shares of common stock at an aggregate cost ofapproximately $4.6 million. All of these shares were retired.

 

In July 2004, the Company’s Board of Directors authorized a$20.0 million share repurchase program. The new program, which authorizesthe repurchase of up to $5 million of common stock per quarter, becameeffective in August 2004, terminating and replacing the $10.0 millionshare repurchase program authorized by the Company’s Board of Directors infiscal 2002. The share repurchase program will expire in August 2005.

 

In the third quarter of 2004, as part of the new share repurchaseprogram, the Company’s Board of Directors increased the per quarter repurchasecap and authorized the Company to repurchase a total of 731,580 shares ofcommon stock, inclusive of the 500,000 shares of common stock repurchased fromone of Dr. Kapoor’s family partnerships, at an aggregate cost ofapproximately $13.4 million. These shares have been retired. In the fourthquarter of 2004, as part of the plan that became effective in August 2004,the Company repurchased 65,427 shares of common stock. These shares have beenretired.

 

In December 2004, the Company, with Board of Directors approval,purchased 1 million shares of common stock at an aggregate cost ofapproximately $23.2 million which was at a fair market value equal to theDecember 10, 2004 closing price of the Company’s common stock as reportedby Nasdaq from certain executives and board members and a significantshareholder of the Company. The Company acquired those shares in part, toestablish a pool of authorized shares that will be available for contributionto the Company’s Employee Stock Ownership Plan over time as the Company in itsdiscretion deems appropriate.

 

In the first quarter of 2005,the Company repurchased 127,169 shares of common stock at an average cost of$16.44 per share, or $2.1 million. These shares have been retired.  The Company did not repurchase any shares inthe second quarter of 2005.

 

The Company adopted a newshare repurchase program effective August 3, 2005, that authorizes therepurchase of up to $20.0 million of its outstanding shares of common stockover the next twelve months with no periodic sub-limits on the amount ofrepurchases.  This plan replaces allprior share repurchase plans and will expire on August 2, 2006.

 

**12.****                              ****Earnings Per Share**

 

Below is the calculation of basic and diluted net income per share (inthousands except per share data):

 

9

----

 
| ** **                                                         | ** ** | **For The Three Months Ended June 30,** | ** ** | **For The Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                                     | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income                                                         |       | $                                            | 8,004      |                                       | $          | 5,509 |   | 15,592 |   | $ | 10,556 |   |
| Add: Interest  expense on contingent convertible notes, net of tax |       | 485                                          |       | 439                                        |       | 970 |   | 545 |   |
|                                                               |       |                                         |       |                                       |       |   |   |   |   |
| Adjusted net  income                                               |       | $                                            | 8,489      |                                       | $          | 5,948 |   | $ | 16,562 |   | $ | 11,101 |   |
|                                                               |       |                                         |       |                                       |       |   |   |   |   |
| Weighted average  common shares outstanding—basic             |       | 35,029                                       |       | 36,000                                     |       | 35,047 |   | 35,872 |   |
| Diluted effect  of stock options and convertible debt              |       | 7,386                                        |       | 7,825                                      |       | 7,406 |   | 5,356 |   |
|                                                               |       |                                         |       |                                       |       |   |   |   |   |
| Weighted average  common shares outstanding—diluted           |       | 42,415                                       |       | 43,825                                     |       | 42,453 |   | 41,228 |   |
|                                                               |       |                                         |       |                                       |       |   |   |   |   |
| Basic earnings  per common share:                                  |       | $                                            | 0.23       |                                       | $          | 0.15 |   | $ | 0.44 |   | $ | 0.29 |   |
|                                                               |       |                                         |       |                                       |       |   |   |   |   |
| Diluted earnings  per common share:                                |       | $                                            | 0.20       |                                       | $          | 0.14 |   | $ | 0.39 |   | $ | 0.27 |   |

 

                For the threemonths ended June 30, 2005, there were 773,206 potential common sharesoutstanding and 12,500 shares of unvested restricted stock that were excludedfrom the diluted net income per share calculation because their effect wouldhave been anti-dilutive.  For the sixmonths ended June 30, 2005, there were 583,115 potential common sharesoutstanding and 12,500 shares of unvested restricted stock that were excludedfrom the diluted net income per share calculation because their effect wouldhave been anti-dilutive.

 

**13.****                              ****Segment Reporting**

 

The Company is engaged solely in the business of marketing, developingand selling prescription pharmaceutical products. Accordingly, the Company’sbusiness is classified in a single reportable segment, the sale and marketingof prescription products. Prescription products include a variety of brandedpharmaceuticals for the treatment of cardiovascular, obstetrical andgynecological, pediatric and gastroenterological conditions and disorders.

 

The following presents revenues for prescription products by area oftreatment:

 
| ** **          | ** ** | **For The Quarter Ended June 30,** | ** ** | **For The Six Months Ended June 30,** | ** ** |
|---------------------|------------|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **          | ** ** | **2005**                                | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cardiovascular      |       | $                                       | 34,754     |                                       | $          | 20,451 |   | $ | 54,225 |   | $ | 34,996 |   |
| Women’s Health |       | 10,098                                  |       | 4,519                                      |       | 22,723 |   | 7,802 |   |
| Non Promoted        |       | 4,964                                   |       | 11,020                                     |       | 13,825 |   | 25,210 |   |
|                |       |                                    |       |                                       |       |   |   |   |   |
| Net revenues        |       | $                                       | 49,816     |                                       | $          | 35,990 |   | $ | 90,773 |   | $ | 68,008 |   |

 

**14.****                              ****Commitments and Contingencies**

 

TheCompany, certain former and current officers and directors are defendants in aconsolidated securities lawsuit initiated 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 and 12(a)(a)of the Securities Act of 1933 and that we violated Sections 10(b) and 20(a) ofthe Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Inan amended complaint, Plaintiffs claimed that the Company issued a series ofmaterially false and misleading statements to the market in connection with ourpublic offering on April 24, 2002 and thereafter relating to alleged “channelstuffing” activities. The amended complaint also alleged controlling personliability on behalf of certain of our officers under Section 15 of theSecurities Act of 1933 and Section 20 of the Securities Exchange Act of 1934.Plaintiffs sought an unspecified amount of compensatory damages to be proven attrial.

 

OnSeptember 29, 2004, the U.S. District Court for the Northern District ofGeorgia dismissed, without prejudice, the class action lawsuit. Although theclass action lawsuit was dismissed, the court granted the plaintiffs the rightto refile their class action lawsuit provided that the plaintiffs pay all ofthe defendants’ fees and costs associated with filing the motions to dismissthe class action lawsuit.

 

Plaintiffs’ did not file asecond amended complaint as permitted. We have submitted a proposed order to the Court to dismiss the case withprejudice and enter a final judgment in favor of all defendants.

 

If thePlaintiffs choose to appeal any final judgment to the 11th Circuit Court ofAppeals, they will have 30 days to file a Notice of Appeal once the judgment isentered, if at all, by the U.S. District Court for the Northern District ofGeorgia.

 

On April15, 2004, we filed a patent infringement action against BreckenridgePharmaceutical, Inc. in the U.S. District Court for the Northern District ofIllinois, on the grounds that their product, Duotan PD, infringes the patentsfor our products, Tanafed DP and Tanafed DMX. In response, on April 21, 2004,Breckenridge filed for declaratory judgment in the U.S. District Court for theSouthern District of Florida seeking to invalidate the Tanafed patents. On July20, 2004, our action was transferred to the U.S. District Court for theSouthern District of Florida.

 

We intendto prosecute our infringement action and defend Breckenridge’s motion fordeclaratory judgment unless resolved otherwise. While we believe thatBreckenridge’s product, Duotan, infringes the patent for Tanafed, we cannotassure you that we will prevail. If we lose our infringement action andBreckenridge is successful in invalidating the Tanafed patent we could losemarket share for Tanafed or we may have to decrease the price of Tanafed tokeep its sales competitive, resulting in a loss of earnings and profits fromTanafed sales.

 

The Companyis also involved with other various routine legal proceedings incident to theordinary course of business. None of these proceedings are expected to have amaterial adverse effect on the consolidated financial statements.

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

The following should be read with the consolidated financial statementsand related footnotes and Management’s Discussion and Analysis of Results ofOperations and Financial Condition included in the Company’s Annual Report onForm 10-K for the year ended December 31, 2004 (FileNo. 000-30123). The results discussed below are not necessarily indicativeof the results to be expected in any future periods. The following discussioncontains forward-looking statements that are subject to risks anduncertainties, which could cause actual results to differ from the statementsmade.

 

**Overview**

 

We are a specialty pharmaceutical company that markets, develops andsells brand name prescription products. Our current operating plan focuses onmaximizing the sales of our existing product portfolio, accelerating growth bylaunching line extensions to our current products and acquiring or licensingapproved products or late stage development products. We plan to focus onproducts that fit within our existing Cardiology and Women’s Health categories andthat will allow us to leverage our sales force infrastructure. During thequarter ended June 30, 2005, we promoted the following products:

 

| **Cardiology**                             | ** ** | **Women’s Health**                     |
|--------------------------------------------|------------|---------------------------------------------|
| •    Sular        |       | •    Prenate Elite |
|                                       |       |                                        |
| •    Fortamet     |       | •    OptiNate      |
|                                       |       |                                        |
| •    Altoprev     |       | •    Ponstel       |
|                                       |       |                                        |
| •    Nitrolingual |       |                                        |

 

10

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We sell our products primarily to pharmaceutical wholesalers (who inturn distribute to pharmacies), chain drug stores, other retail merchandisersand, on a limited basis, directly to pharmacies. We recognize revenue when ourproducts are delivered to the customer, the customer takes ownership andassumes the risk of loss. Our sales force targets high-prescribing primary carephysicians and select specialty physicians. These physicians writeprescriptions for our products in order to treat their patients. Our salesforce seeks to develop relationships with these physicians and respond to thepharmaceutical needs of their patients. We evaluate the effectiveness of oursales and marketing efforts by monitoring prescription trends of our promotedproducts.

 

**Results ofOperations**

 

*Net Revenue.*    Net revenues for the three months endedJune 30, 2005 increased $13.8 million or 38.3% to $49.8 million, ascompared to $36.0 million for the quarter ended June 30, 2004. Netrevenues for the six months ended June 30, 2005 increased$22.8 million or 33.5% to $90.8 million, as compared to $68.0 millionfor the six months ended June 30, 2004. Net revenues increased for thethree and six month period as a result of the successful execution of our salesand marketing strategy, an increase in sales force, and increased sales fromthe expansion of our product line to include Fortamet, Altoprev and OptiNate.

 

**ProductOverview**

** **
| ** **       | ** ** | **Change in total dispensed prescriptions  for the three months ended June 30, 2005  compared to the three months ended June 30, 2004(a)** | ** ** | **Change in new dispensed prescriptions  for the three months ended June 30, 2005  compared to the three months ended June 30, 2004(a)** | ** ** |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Sular            |       | 19.0                                                                                                                                                      | %          | 17.0                                                                                                                                               | %          |
| Fortamet (b)     |       | N/A                                                                                                                                                       |       | N/A                                                                                                                                                |       |
| Altoprev         |       | (13.0                                                                                                                                                     | )%         | (22.1                                                                                                                                              | )%         |
| Nitrolingual(c)  |       | 1.7                                                                                                                                                       | %          | 1.7                                                                                                                                                | %          |
| Prenate Elite(d) |       | N/A                                                                                                                                                       |       | N/A                                                                                                                                                |       |
| OptiNate(e)      |       | N/A                                                                                                                                                       |       | N/A                                                                                                                                                |       |
| Ponstel          |       | 14.7                                                                                                                                                      | %          | 20.6                                                                                                                                               | %          |

 

----

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

 

*(b)**                              *Fortamet waslaunched in May 2004, as a result comparative data is not available for thesecond quarter of 2004.

 

*(c)**                               *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.

 

*(d)**                              *Prenate Elite was launched in April 2004,as a result comparative data is not available for the second quarter of 2004.

 

*(e)**                               *OptiNate was launched in March 2005, as aresult comparative data is not available for the second quarter of 2004.

 

Net revenues from ourCardiology products (namely Sular, Fortamet, Altoprev and Nitrolingual) were$34.8 million and $54.2 million for the three and six months ended June 30,2005, compared to $16.3 million and $27.0 million for the three and six monthsended June 30, 2004, respectively.  Theincrease was primarily a result of the addition of our new products, Altoprevand Fortamet, commencing in April 2005 and total prescription growth of Sularand Nitrolingual.

 

Net revenues from our promoted Women’s Health products (namely PrenateElite, OptiNate and Ponstel), were $10.1 million and $22.7 million for thethree and six months ended June 30, 2005 compared to $4.5 million and $7.8million for the three and six months ended June 30, 2004. The increase was dueprimarily to total prescriptions for Prenate Elite and the successful launch ofOptiNate in March 2005.   Sales ofPrenate Elite’s predecessor, Prenate GT, were lower in the three and six monthsended June 30, 2004 as we prepared for the launch of Prenate Elite.

 

In March 2004, we announced the launch of Prenate Elite, the nextgeneration of the Prenate line of prenatal vitamins. We began promoting andselling Prenate Elite in April 2004. Prenate Elite has captured a marketshare of 14.7% of new prescriptions and 14.2% of total prescriptions ofprenatal vitamins in June 2005. (Source: IMS Health’s National Prescription Audit PlusTM data.)  Additionally, the launch of OptiNate in March2005 has captured 5.6% of new prescriptions of prenatal vitamins and 8.8% oftotal prescription in June 2005.  (Source: IMS Health’s National Prescription Audit PlusTM data.)

 

*Cost of Revenues.*    Cost of revenues forthe three and six months ended June 30, 2005 were $7.4 million and $14.5million compared to $6.8 million and $12.4 million for the three and six monthsended June 30, 2004. The increase in cost of revenues is related to the changein product mix and the increase in net revenues for the three and six monthsended June 30, 2005 as compared to the equivalent periods ending June 30, 2004.

 

*Gross Margin.*    Gross margins for the three and six months endedJune 30, 2005 were 85.2% and 84.0%, respectively, compared to 81.0% and 81.8%for the three and six months ended June 30, 2004, respectively.  This increase in gross margin is the resultof a change in product mix from the prior year primarily as the result of thecurrent year acquisitions.

 

*Selling, General and Administrative Expenses.*    Selling, general andadministrative expenses increased $8.4 million, or 53.5%, to $24.1 millionfor the three months ended June 30, 2005, compared to $15.7 million forthe three months ended June 30, 2004. Selling, general and administrativeexpenses increased $12.2 million, or 41.2%, to $41.8 million for thesix months ended June 30, 2005, compared to $29.6 million for the sixmonths ended June 30, 2004.  Thisincrease is primarily related to the increase in sales force for the launch ofour new products and an increase in royalty and commission expenses related tothe increased net revenues.

 

*Depreciation and Amortization Expense.*    Depreciation andamortization expense increased $1.6 million, or 39.0%, to$5.7 million for the quarter ended June 30, 2005

 

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comparedto $4.1 million for the quarter ended June 30, 2004. Depreciation andamortization expense increased $1.8 million, or 21.7%, to $10.1 million for thesix months ended June 30, 2005 compared to $8.3 million for the six monthsended June 30, 2004.  This increaseis primarily related to the increase in amortizable intangible assets as aresult of the purchase of Fortamet and Altoprev.

 

*Research and Development Expense.*    Research anddevelopment expense increased $0.2 million and $0.4 million to $0.6million and $0.9 million for the three and six months ended June 30, 2005,respectively, compared to $0.4 million and $0.5 million for the three andsix months ended June 30, 2004.  Thisincrease is primarily related to the Sular line extensions.

 

*Interest Expense.*    Interest expense was $0.9 millionand $1.7 million for the three and six months ended June 30, 2005compared to $0.8 million and $1.0 million for the three and six monthsended June 30, 2004.  The increaseis due to borrowings under the Company’s line of credit during the secondquarter of 2005, and the interest on the $150.0 million contingent convertiblenotes for the six months ended June 30, 2005.

 

The increase for the six months ended June 30, 2005 is also due to ourissuance of a total of $150.0 million of our 1.75% senior subordinatedcontingent convertible notes in March 2004. The notes are dueMarch 8, 2024 and accrued interest is payable semi-annually in arrears onMarch 8 and September 8 of each year. In addition to the interest onthe notes, after March 8, 2007, we will also pay contingent interestduring specified six-month periods if the average trading price of the notesper $1,000 principal amount for the five day trading period ending on the thirdtrading day immediately preceding the first day of the applicable six-monthperiod equals $1,200 or more. During any period when contingent interest ispayable, it will be payable at a rate equal to 0.5% per annum. The net proceedsfrom this issuance, after deducting offering expenses, were approximately$145.4 million.  The holders of the convertible notes mayconvert the notes into shares of our common stock at a conversion rate of45.1467 shares per $1,000 principal amount of the notes, which is equivalent toa conversion price of $22.15 per share, subject to anti-dilution adjustments,before the close of business on March 8, 2024. Holders may convert theirconvertible notes only under the following circumstances: (1) during anycalendar quarter commencing after June 30, 2004, if the closing salesprice of our common stock exceeds 120% of the conversion price for at least 20trading days in the 30 consecutive trading days ending on the last trading dayof the preceding calendar quarter; (2) if the notes have been called forredemption; (3) during the five trading day period immediately followingany nine consecutive trading day period in which the trading price of the notesper $1,000 principal amount for each day of that period was less than 95% ofthe product of the closing price of our common stock and the number of sharesof common stock issuable upon conversion of $1,000 principal amount of thenotes; or (4) the occurrence of specified corporate transactions.

 

We have the option to redeem the notes beginning March 13, 2007 ata price equal to 100% of their aggregate principal amount, plus accrued andunpaid interest, including contingent interest, if any.

 

The holders of the notes have the option to require us to repurchase thenotes on March 8 of 2009, 2014 and 2019, and upon a change in control, ata price equal to 100% of their aggregate principal amount, plus accrued andunpaid interest, including contingent interest, if any.

 

*Interest Income.*    Interest income was $0.9 millionand $1.7 million for the three and six months ended June 30, 2005, compared to$1.0 million and $1.3 million for the three and six months ended June 30,2004. The increase in interest income for the six months ended June 30, 2005 isprimarily due to a higher average cash and marketable securities balance as aresult of the proceeds from the issuance of the contingent convertible seniorsubordinated notes in March 2004.

 

*Provision for Income Taxes.*    Income taxes were providedfor at a rate of 31.0% and 32.5% for the three and six months ended June 30,2005, respectively, compared to 39.7% for the three and six months ended June30, 2004. This decrease in the effective rate is due to the change in the mixof tax jurisdictions, both domestic and international, as a result of ourimplementation of international operations where our income was earned, as wellas a change in the ratio of non-deductible expenses to pre-tax income.

 

**Liquidityand Capital Resources**

 

Our liquidity requirements arise primarily from debt service, workingcapital requirements, product development activities and funding ofacquisitions. We have met these cash requirements through cash from operations,borrowings for product acquisitions and the issuance of common stock.

 

Our cash and cash equivalents were $13.4 million on June 30, 2005.Net cash provided by operating activities for the six months ended June 30,2005 was $0.3 million. This source of cash was primarily the result of netincome of $15.6 million, non-cash expenses including depreciation andamortization of $10.1 million, marketable securities impairment of $0.7 million,taxes payable of $0.5 million and interest of $0.2 million, deferred income taxexpense of $1.5 million, a decrease in income tax receivable of $1.3 million,and an increase in accrued expenses and other long-term liabilities of $1.4million. Partially offsetting the source of cash from operations was anincrease in inventories of $18.1 million and an increase in other currentassets and other assets of $3.7 million, an increase in accounts receivable of$3.1 million and a decrease in accounts payable of $6.1 million.

 

Our cash and cash equivalents were $58.5 million at June 30,2004. Net cash provided by operating activities for the six months endedJune 30, 2004 was $22.2 million. This providing of cash was primarilythe result of the net income of $10.6 million, non-cash depreciation andamortization expense of $8.3 million, non-cash tax expenses of $5.0 million,non-cash interest expense of $0.1 million, decrease in inventory of $0.6million, and an increase in accounts payable of $4.5 million. Partiallyoffsetting provisions of cash were increases in accounts receivable of$1.7 million, income tax receivable of $2.1 million and other currentassets and other assets of $2.8 million.

 

We maintain supply agreements with third party suppliers for most of ourproducts. Some of these supply agreements contain minimum purchaserequirements. For most of these supply agreements, we believe that ourinventory requirements and related purchases of inventory will exceed theminimum purchase requirements in 2005. In those cases in which we do notbelieve our purchases will exceed the minimum purchase requirements, we areseeking to negotiate waivers or modifications of the minimum purchaserequirements.

 

Net cash used in investing activities for the six months ended June 30,2005 was $19.6 million. The primary uses of this cash was for thepurchases of product licenses of $94.7 million, marketable securities of $21.0 millionand the purchases of property and equipment of $1.2 million. Partiallyoffsetting these uses of cash were the sales of marketable securities of $97.3 million.This liquidation of marketable securities was directly related to the$78.3 million acquisition of product licenses for Fortamet and Altoprev,the first milestone payment of $15.0 million purchase price payment forTriglide and the $5.0 million additional purchase price milestone for Sular, aswell as $21.0 million in maturing investments that were reinvested uponmaturity.

 

Net cash used in investing activities for the six months endedJune 30, 2004 was $143.7 million. The primary uses of this cash werefor the purchases of marketable securities of $138.3 million and thepurchases of product licenses of $5.1 million, and purchases of equipmentof $0.3 million. During the second quarter of 2004, the Company announced anagreement with SkyePharma PLC, granting the Company the exclusive license tomarket and distribute Triglide in the United States.

 

Net cash used in financing activities was $1.2 million for the sixmonths ended June 30, 2005 primarily resulting from our repurchase of ourcommon stock for $2.1 million. Partially offsetting this net cash used was$0.9 million for the issuances of common stock related to optionexercises.

 

Net cash provided by financing activities was $146.4 million forthe six months ended June 30, 2004. The primary providers of cash were theissuance of $150.0 million in convertible debt in March 2004, as wellas proceeds of $5.5 million from the issuance of common stock. Partiallyoffsetting this net cash provided by financing activities was $4.6 millionin capitalized financing costs and $4.6 million in stock repurchases.

 

As of June 30, 2005, there were no amounts outstanding under our$20 million senior credit facility; however, on July 7, 2005, weborrowed $5.0 million under this facility.

 

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 in 

 

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thefuture, we may be required to raise additional funds through additionalborrowings or the issuance of debt or equity securities.

 

On February 11, 2003, we entered into a $20 million seniorsecured revolving credit facility with various lenders and LaSalle BankNational Association, as administrative agent. Subject to the satisfaction ofcertain borrowing base requirements, we may from time-to-time borrow moniesunder the revolving facility for working capital requirements and generalcorporate purposes. Borrowings are secured by substantially all of our assets.Borrowings bear interest at our option at the base rate in effect from time totime plus an applicable margin or the Eurodollar rate, plus an applicablemargin. The applicable margin will vary dependent upon our leverage ratio ineffect from time-to-time. As of June 30, 2005, we had no borrowings outstandingunder this facility. In April 2005, the Company borrowed $20.0 million onthe facility, which the company repaid; however, on July 7, 2005, the Companyborrowed $5 million under the facility.  Therevolving facility, as amended, matures on August 11, 2006. Fees payableunder the revolving facility include a one-time commitment fee of 0.685% of thestated amount of the facility, an unused commitment fee based on fundscommitted but not borrowed under the revolving facility at rates which varydependent upon our leverage ratio in effect from time-to-time and letter ofcredit fees equal to 0.25% per annum of the face amount of letters of credit issuedand outstanding under the revolving facility. The revolving facility may beprepaid from time-to-time or terminated at our discretion without penalty.

 

The credit facility contains various restrictive covenants, includingcovenants relative to maintaining financial ratios and earnings levels,limitations on acquisitions, dispositions, mergers and capital expenditures,limitations on incurring additional indebtedness and a prohibition on paymentof dividends and certain issuances of our capital stock.

 

**CriticalAccounting Policies**

 

We view our critical accounting policies to be those policies which arevery important 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 doubtfulaccounts.*    Weare required to estimate the level of accounts receivable recorded on ourbalance sheet which will ultimately not be paid. Among other things, thisassessment requires analysis of the financial strength of our customers, which canbe highly subjective, particularly in the recent difficult general economicenvironment. Our policy is to estimate bad debt expense based on priorexperience supplemented by a periodic customer specific review when needed. Ifwe over or under estimate the level of accounts receivable that will not bepaid, there may be a material impact to our financial statements.

 

*•**                                         **Sales deductions.*    We provide volumerebates, contractual price reductions with drug wholesalers and insurancecompanies, and certain other sales related deductions on a regular basis. Theexact level of these deductions is not always immediately known and thus wemust record an estimate at the time of sale. Our estimates are based onhistorical experience with similar programs, and since we have a relativelysmall customer base, customer specific historical experience is often useful indetermining the estimated level of deductions expected to be refunded to ourcustomers when sales incentives are offered. If we over or under estimate the levelof sales deductions, there may be a material impact to our financialstatements.

 

*•**                                         **Product returns.*    In the pharmaceuticalindustry, customers are normally granted the right to return a product for arefund if the product has not been used six-months prior to its expirationdate, which is typically two to three years from the date of manufacture, andfor a set period subsequent to the expiration date. Our return policy allowsproduct returns for products within an eighteen-month window from six monthsprior to the expiration date and up to twelve months after the expiration date.Our return policy conforms to industry standard practices. We believe that wehave sufficient data to estimate future returns at the time of sale. Managementis required to estimate the level of sales which will ultimately be returnedpursuant to our return policy, and record a related reserve at the time ofsale. These amounts are deducted from our gross sales to determine our netrevenues. Our estimates take into consideration historical returns of a givenproduct, product specific information provided by our customers and informationobtained regarding the levels of inventory being held by our customers, as wellas overall purchasing patterns by our customers. Management periodicallyreviews the reserves established for returns and adjusts them based on actualexperience. If we over or under estimate the level of sales which willultimately be returned, there may be a material impact to our financialstatements.

 

*•**                                         **Liabilities assumed with theacquisition of product rights.*    Inconnection with the acquisition of product rights, we assume certainliabilities for returns of product shipped by the seller prior to theacquisition date. At the acquisition date, we estimate the amount of theassumed liabilities based on actual sales return data from the seller andinclude that amount in the allocation of the total purchase price. We reviewthe estimated liability on an annual basis. If we over or under estimateliabilities assumed, there may be a material impact to our financialstatements.

 

*•**                                          Intangibleassets*.    When we acquire the rights to manufactureand sell a product, we record the aggregate purchase price, along with thevalue of the product related liabilities that we assume, as intangible assets.We use the assistance of valuation experts to help us allocate the purchaseprice to the fair value of the various intangible assets that we have acquired.Then, we must estimate the economic useful life of each of these intangibleassets in order to amortize their cost as an expense in our statement ofoperations over the estimated economic useful life of the related asset. Thefactors that drive the actual economic useful life of a pharmaceutical productare inherently uncertain, and include patent protection, physician loyalty andprescribing patterns, competition by products prescribed for similarindications, future introductions of competing products not yet FDA approved,the impact of promotional efforts and many other issues. 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 the recoverability of its intangible assets, we must makeassumptions regarding estimated future cash flows and other factors. If theestimated undiscounted future cash flows do not exceed the carrying value ofthe intangible assets, we must determine the fair value of the intangibleassets. If the fair value of the intangible assets is less than its carryingvalue, an impairment loss will be recognized in an amount equal to thedifference. We review intangible assets for impairment at least annually andwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Such events or circumstances may includebut are not 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 would berecognized. If we should incur an impairment loss, there may be a materialimpact to our financial statements.

 

On March 6, 2002, weacquired certain U.S. rights relating to Sular for an aggregate purchase priceof $184.3 million. With the assistance of valuation experts, we allocatedthe purchase price to the fair value of the various intangible assets which weacquired as part of the transaction. In addition, we assigned useful lives toacquired intangible assets which are not deemed to have an indefinite life.Intangible assets are amortized on a straight line basis over their respectiveuseful lives. The intangible assets recorded in connection with the acquisitionof Sular are being amortized over periods ranging from five to twenty yearswith a weighted average amortization period of nineteen years. In light of ourexperience in 2002 in promoting Sular, we carefully evaluated the useful livesassigned to the intangible assets acquired in the Sular acquisition and whetheror not any impairment of any such assets was indicated. Our best estimate isthat the useful lives assigned to the Sular intangible assets remainappropriate. Our estimate of such useful lives is subject to significant risksand uncertainties. Among these risks and uncertainties is our ability todevelop one or more new versions of the product, obtain approval from the FDAto market and sell such newly developed product 

 

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and procure patent protectionfor that product before the expiration of the last to expire of the existingpatents related to Sular in 2008. SFAS No. 144 “Accounting for theImpairment or Disposal of Long-Lived Assets” states that an impairment loss shallbe recognized only if the carrying amount of a long-lived asset is notrecoverable and exceeds its fair value. As of June 30, 2005, the undiscountedfuture cash flows of Sular as estimated by us over the remaining useful life ofthe product exceed the carrying amount of the Sular asset and therefore thecarrying amount is estimated to be recoverable. However, the amount recorded asintangible assets on First Horizon’s balance sheet for the Sular assets may bemore or less than the fair value of such assets. Determining the fair value ofthe Sular intangible asset is inherently uncertain, and may be dependent insignificant part on the success of our revised plans to promote Sular.

 

On March 28, 2005, weacquired the worldwide rights of Fortamet and Altoprev. With the assistance ofvaluation experts, we allocated the purchase price to the fair value of thevarious intangible assets which we acquired as part of the transaction. Inaddition, we assigned useful lives to acquired intangible assets which are notdeemed to have an indefinite life. Intangible assets are amortized on astraight line basis over their respective useful lives. The intangible assetsrecorded in connection with the acquisition of Fortamet and Altoprev are beingamortized over a period of fifteen years.

 

In May 2005, the US Food andDrug Administration granted approval for Triglide.  The Company obtained exclusive US marketingrights to Triglide in May 2004.  Intangibleassets are amortized on a straight line basis over their respective usefullives.  The intangible assets recorded inconnection with the acquisition of Triglide are being amortized over a periodof fifteen years.

 

*•**                                         **Income Taxes*.    Income taxes areprovided for under the liability method. This approach requires the recognitionof deferred tax assets and liabilities for the expected future tax consequencesof differences between the tax basis of assets or liabilities and theircarrying amounts in the consolidated financial statements. A valuationallowance is provided for deferred tax assets if it is more likely than notthat these items will either expire before we are able to realize their benefitor if future deductibility is uncertain.

 

Developing the provision forincome 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.

 

*•**                                         **Inventoryobsolescence.    *Our products have shelf lives ranging from 24 to 48 months. We mustestimate the amount of inventory recorded on our balance sheet that will not besold prior to expiration. This estimate requires analysis of forecasted demandfor our products, our promotional focus, amounts of our products currently heldby our customers and the impact on our products of competing products. If weover or under estimate the amount of inventory that will not be sold prior toexpiration, there may be a material impact to our financial statements.

 

**ForwardLooking Statements**

 

Management’s Discussion and Analysis of Financial Condition and Resultsof Operations as well as information contained elsewhere in this reportcontains forward-looking statements that are subject to risks and uncertaintiesthat could cause actual results to materially differ from those described.These forward looking statements are identified by their use of terms andphrases such as “anticipate”, “believe”, “could”, “estimate”, “expect”, “intend”,“plan”, “predict”, “will” and other similar terms and phrases, includingreferences to assumptions. Although we believe that the expectations expressedin these forward-looking statements are reasonable, we cannot promise that ourexpectations will turn out to be correct. Our actual results could bematerially different from and worse than our expectations. With respect to suchforward-looking statements, we seek the protections afforded by the PrivateSecurities Litigation Reform Act of 1995. These risks include, withoutlimitation:

 

**•****                                         **We may notattain expected revenues and earnings;

 

**•****                                         **The 60 mgAltoprev product is currently experiencing manufacturing issues.  If the issues cannot be resolved, our abilityto acquire the product for sale and sampling will be adversely affected;

 

**•****                                         **If we areunsuccessful in obtaining third party payor contracts for Altoprev, Fortametand Triglide, we may experience reductions in sales levels and may fail toreach anticipated sales levels;

 

**•****                                         **If demand forTriglide, Fortamet and/or Altoprev exceeds our initial expectations or theability of our suppliers to provide demand-meeting quantities of product andsamples, our future ability to sell these products could be adversely impacted;

 

**•****                                         **The potentialgrowth rate for our promoted products may be limited by slower growth for theclass of drugs to which our promoted products belong and unfavorable clinicalstudies about such class of drugs;

 

**•****                                         **Strongcompetition exists in the sale of our promoted products, which could adverselyaffect expected growth of our promoted products’ sales or increase our costs tosell our promoted pruducts;

 

**•****                                         **We may not beable to protect our competitive position for our promoted products from patentinfringers;

 

**•****                                         **Sales of ourTanafed and Robinul products have been adversely affected by the introductionof knock-off and generic products, respectively;

 

**•****                                         **An issued FDAnotice may cause us to incur increased expenses and adversely affect ourability to continue to market and sell our Tanafed products;

 

**•****                                         **We may incurunexpected costs in integrating new products into our operations;

 

**•****                                         **We may beunable to develop or market line extensions for our products, or, even ifdeveloped, obtain patent protection for our line extensions.  Further, introductions by us of lineextensions of our existing products may require that we make unexpected changesin our estimates for future product returns and reserves for obsoleteinventory.  If these risks occur, ouroperating results would be adversely affected;

 

**•****                                         **Our supplier canterminate our rights to commercialize Nitrolingual and the 60 dose size of thisproduct has not yet met our expectation;

 

**•****                                         **A small number ofcustomers account for a large portion of our sales and the loss of one of them,or changes in their purchasing patterns, could result in substantially reducedsales substantially and adversely impacting ourfinancial results;

 

**•****                                         **If third-partypayors do not adequately reimburse patients for our products, doctors may notprescribe them;

 

**•****                                         **We rely onoperational data obtained from IMS, an industry accepted data source.  IMS data may not accurately reflect actualprescriptions (for instance, we believe IMS data does not capture all productprescriptions from some non-retail channels) or trade levels of inventory;

 

**•****                                         **An adversejudgment in the securities class action litigation in which we and certaindirectors and executive officers are defendants could have a material adverseeffect on our results of operations and liquidity;

 

**•****                                         **An adversejudgment in our infringement action with Breckenridge Pharmaceutical, Inc. withrespect to our Tanafed products could result in the invalidation of our Tanafedpatents, cause us to lose market share for Tanafed products and result in aloss of earnings and profits from Tanafed sales;

 

**•****                                         **If we fail toobtain, or encounter difficulties in obtaining, regulatory approval for newproducts or new uses of existing products, or if our development agreements areterminated, we will have expended significant resources for no return;

 

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**•****                                         **Our business andproducts are highly regulated.  Theregulatory status of some of our products makes these products subject toincreased competition and other risks, and we run the risk that we, or thirdparties on whom we rely, could violate the governing regulations;

 

**•****                                         **If genericcompetitors that compete with any of our products are introduced our revenuesmay be adversely affected; and

 

**•****                                         **Some unforeseendifficulties may occur.

 

This list is intended toidentify some of the principal factors that could cause actual results todiffer materially from those described in the forward-looking statements includedherein. These factors are not intended to represent a complete list of allrisks and uncertainties inherent in our business, and should be read inconjunction with the more detailed cautionary statements and risk factorsincluded in our other filings with the Securities and Exchange Commission.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK**

 

The Company is exposed to certain market risks that arise in theordinary course of business. A discussion of the Company’s primary market riskexposure is presented below.

 

**ForeignCurrency Exchange Risk**

 

Our purchases of Nitrolingual from Pohl-Boskamp, our purchases ofTriglide under our agreement with SkyePharma and our purchases of Sular fromBayer are made in Euros. Although we did not enter into any forward contractsin the second quarter of 2005, we may eliminate risks from foreign currencyfluctuations after the time of shipment of product by entering into forwardcontracts for these purchases of inventory at the time of product shipments.While the effect of foreign currency translations on export sales or importpurchases has not been material to our results of operations to date, currencytranslations could be adversely affected in the future by the relationship ofthe U.S. dollar with foreign currencies.

 

**Market Riskon Investments**

 

The fair value of our investment portfolio would be negatively affectedby an increase in interest rates. Since the majority of the Company’sinvestments are fixed rate interest-bearing securities and therefore subject tothe market risk of loss in market value from an increase in rates or a changein the underlying risk of the issuers of the notes, the Company’s futureearnings and cash flows could be affected adversely if the Company were to sellthe securities prior to their maturity date. There were realized losses fromthe sale of investments for the three and six months ended June 30, 2005 of $0.4 millionand $0.7 million, respectively. At June 30, 2005, the Company had total netunrealized losses from marketable securities of $1.5 million.

 

**Market Riskon Variable Rate Debt**

 

In connection with borrowings incurred under the credit facility withLaSalle Bank, we could experience market risk with respect to changes in thegeneral level of the interest rates and its effect upon our interest expense.Borrowings under this facility bear interest at variable rates. Because suchrates are variable, an increase in interest rates will result in additionalinterest expense and a reduction in interest rates will result in reducedinterest expense. Accordingly, our present exposure to interest ratefluctuations is primarily dependent on rate changes that may occur whileborrowings under the senior secured credit facility are outstanding. In April2005, the Company borrowed $20.0 million on the facility, but repaid the$20.0 million loan and on June 30, 2005 there was no debt outstanding underthis facility; however, on July 7, 2005, the Company borrowed $5 million underthe facility.

 

**Market Riskon Fixed Rate Debt**

 

The Company’s long-term fixed interest rate senior subordinatedcontingent convertible notes are also subject to market risk. Fixed rate debtoutstanding at June 30, 2005 was $150 million with an interest rate of1.75%. All other things being equal, the fair market value of the Company’sfixed rate debt will increase as rates decline and will decrease as rates rise.The fixed rate notes outstanding totaling $150.0 million at June 30,2005 had a fair value of $148.8 million based on quoted market rates.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controls and Procedures**

 

We maintain a set of disclosure controls and procedures that aredesigned to ensure that information required to be disclosed in the reportsthat we file under the Securities Exchange Act of 1934, as amended (“ExchangeAct”), is recorded, processed, summarized and reported within the time periodsspecified in 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 First Horizon’s disclosurecontrols and procedures pursuant to Rule 13a-15(e) of the Exchange Act asof the end of the period covered by this report. Our President and ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures provide reasonable assurance as of the end of theperiod for which the report is being filed that (i) information requiredto be disclosed in our reports under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms and (ii) such information is accumulated and communicated to ourmanagement, including our President and Chief Executive Officer and our ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure.

 

**Changes inInternal Control over Financial Reporting**

 

There has been no change in First Horizon’s primary internal controlsover financial reporting during the second fiscal quarter of 2005, that hasmaterially affected, or is reasonably likely to materially affect First Horizon’sinternal controls over financial reporting.

 

**PART II—OTHER INFORMATION**

 

**ITEM 1:LEGAL PROCEEDINGS**

 

TheCompany, certain former and current officers and directors are defendants in aconsolidated securities lawsuit initiated 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 and 12(a)(a)of the Securities Act of 1933 and that we violated Sections 10(b) and 20(a) of theSecurities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. In an amendedcomplaint, Plaintiffs claimed that the Company issued a series of materiallyfalse and misleading statements to the market in connection with our publicoffering on April 24, 2002 and thereafter relating to alleged “channelstuffing” activities. The amended complaint also alleged controlling personliability on behalf of certain of our officers under Section 15 of theSecurities Act of 1933 and Section 20 of the Securities Exchange Act of 1934.Plaintiffs sought an unspecified amount of compensatory damages to be proven attrial.

 

OnSeptember 29, 2004, the U.S. District Court for the Northern District ofGeorgia dismissed, without prejudice, the class action lawsuit. Although theclass action lawsuit was dismissed, the court granted the plaintiffs the rightto refile their class action lawsuit provided that the plaintiffs pay all ofthe defendants’ fees and costs associated with filing the motions to dismissthe class action lawsuit.

 

Plaintiffs’ did not file asecond amended complaint as permitted.  Wehave submitted a proposed order to the Court to dismiss the case with prejudiceand enter a final judgment in favor of all defendants.

 

If thePlaintiffs choose to appeal any final judgment to the 11th Circuit Court ofAppeals, they will have 30 days to file a Notice of Appeal once the judgment isentered, if at all, by the U.S. District Court for the Northern District ofGeorgia.

 

On April15, 2004, we filed a patent infringement action against BreckenridgePharmaceutical, Inc. in the U.S. District Court for the Northern District ofIllinois, on the grounds that their product, Duotan PD, infringes the patentsfor our products, Tanafed DP and Tanafed DMX. In response, on April 21, 2004,Breckenridge filed for declaratory judgment in the U.S. District Court for theSouthern District of Florida seeking to invalidate the Tanafed patents. On July20, 2004, our action was transferred to the U.S. District Court for theSouthern District of Florida.

 

We intendto prosecute our infringement action and defend Breckenridge’s motion fordeclaratory judgment unless resolved otherwise. While we believe thatBreckenridge’s product, Duotan, infringes the patent for Tanafed, we cannotassure you that we will prevail. If we lose our infringement action andBreckenridge is successful in invalidating the Tanafed patent we could losemarket share for Tanafed or we may have to decrease the price of Tanafed tokeep its sales competitive, resulting in a loss of earnings and profits fromTanafed sales.

 

The Companyis also involved with other various routine legal proceedings incident to theordinary course of business. None of these proceedings are expected to have amaterial adverse effect on the consolidated financial statements.

 

 

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**ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OFPROCEEDS**

 

On May 31, 2005, the Company issued 12,500 shares of restricted commonstock to certain members of its Board of Directors.  The shares vest equally over a 4 yearperiod.  Total compensation of $235,000will be recognized ratably over the 4 year vesting period.  As of June 30, 2005, deferred compensationrelated to the restricted stock totaled $230,000.

 

The following table presents the total number of shares repurchasedduring the first half of fiscal 2005 and the average price paid per share:

 
| **Fiscal  Period**                                   | ** ** | **Plan** | ** ** | **Total  Number of  Shares  Purchased** | ** ** | **Average  Price Paid  Per Share** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announced Plans** | ** ** | **Approximate Dollar  Value of Shares that  May Yet Be  Purchased  Under the Plans** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------------------------------------------|------------|------------------------------------|------------|-----------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| January 1, 2005  through February 28, 2005 |       | N/A      |       | —                                       |       | —                             |       | —                                                                      |       | $                                                                                    | 5,323,000  |   |
| March 1, 2005  through March 31, 2005      |       | (1       | )          | 127,169                                      |       | $                                  | 16.44      |                                                                        | 127,169    |                                                                                 | 3,233,000  |   |
| April 1, 2005  through June 30, 2005                 |       | N/A      |       | —                                       |       | —                             |       | —                                                                      |       | 3,233,000                                                                            |       |
|                                                 |       |     |       |                                         |       |                               |       |                                                                        |       |                                                                                 |       |
| Total Fiscal  2005 To Date                           |       |     |       | 127,169                                      |       |                               |       | 127,169                                                                     |       |                                                                                 |       |
|                                                      |            |          |            |                                              |            |                                    |            |                                                                             |            |                                                                                      |            |  |  |

 

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*(1)*                               In July 2004, the Company’s Board ofDirectors authorized a $20.0 million share repurchase program. The newprogram, which authorized the repurchase of up to $5 million of commonstock per quarter, became effective on August 3, 2004 and terminated andreplaced the $10.0 million share buyback program then in effect. The sharerepurchase program will expire on August 2, 2005.  In July 2005, the Board of Directors authorizeda new $20 million repurchase program, effective August 3, 2005, having noper-period sublimits on repurchases.

 

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

 

TheCompany held its 2005 annual meeting of stockholders on May 31, 2005.  The following summarizes the two proposalssubmitted for a vote of the stockholders at the meeting:

 

Proposal 1:  To elect two Class C Directors to the CompanyBoard of Directors for a three-year term.

 
| ** **                  | ** ** | **Pierre  Lapalme** | ** ** | **William  J. Robinson** | ** ** | **Patrick  J. Zenner** | ** ** |
|-----------------------------|------------|---------------------|------------|--------------------------|------------|------------------------|------------|
| Votes  “For”      |       | 38,902,923          |       | 32,807,723               |       | 23,105,750             |       |
| Votes  “Withheld” |       | 350,765             |       | 1,445,965                |       | 11,147,938             |       |

 

Mr. Lapalme, Mr. Robinson and Mr. Zenner willserve until the 2008 annual meeting of the stockholders.  In addition, the terms of the following directorscontinued after the meeting:  Dr. John N.Kapoor, Mr. Jerry N. Ellis, Mr. Patrick P. Fourteau and Mr. Jon S. Saxe.

 

Proposal 2:  To ratify the appointment of independentregistered accounting firm, BDO Seidman, LLP.

 
| Votes  “For”     | 33,849,181 |   |
|----------------------------|------------|--------|
| Votes  “Against” | 389,687    |   |
| Abstain                    | 14,820     |   |

 

Each of the twoproposals were approved by the stockholders of the Company at the annualmeeting.

 

**ITEM 5:OTHER INFORMATION**

 

None.

 

**ITEM 6: EXHIBITS**

 
| 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.                      |

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
| ** **           |     | **FIRST  HORIZON PHARMACEUTICAL CORPORATION**       |
|----------------------|----------|-----------------------------------------------------|
|                 |     | (Registrant)                                        |   |
|                 |     |                                                |
|                 |     |                                                |
| Date: August 2, 2005 |     |                                                |
|                 | By:      | /s/ Patrick P. Fourteau                             |
|                 |     | Patrick P. Fourteau                                 |
| * *             |     | *Chief  Executive Officer and President*            |
| * *             | * * | *(principal  executive officer)*                    |
|                 |     |                                                |
| Date: August 2, 2005 |     |                                                |
|                 | By:      | /s/ Darrell Borne                                   |
|                 |     | Darrell Borne                                       |
| * *             |     | *Chief  Financial Officer, Secretary and Treasurer* |
| * *             | * * | *(principal  accounting and financial officer)*     |

 

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