**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

**[MARK ONE]**

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

**Forthe quarterly period ended September 30, 2005**

**OR**

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

**Forthe transition periodfrom                       to                       **

**CommissionFile No. 000-30123**

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**FIRST HORIZON PHARMACEUTICAL CORPORATION**

(Exact name of registrantas 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’s  telephone number, including area code): |

 

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Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes  x    No  o

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

Asof October 21, 2005, there were 35,181,851****sharesof the Registrant’s Common Stock outstanding.

 

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**FIRST HORIZONPHARMACEUTICAL CORPORATIONFORM 10-QINDEX**
|                                                 | ** **                                                                                                                      | **Page** | ** ** |
|-------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------|----------|------------|
| PART I.   FINANCIAL  INFORMATION |                                                                                                                            |
| Item 1.                                    | Consolidated Balance Sheets at  September 30, 2005 and December 31, 2004                                              | 3        |       |
|                                            | Consolidated Statements of  Operations for the three and nine months ended September 30, 2005 and  September 30, 2004 | 4        |       |
|                                            | Consolidated Statements of  Cash Flows for the nine months ended September 30, 2005 and  September 30, 2004           | 5        |       |
|                                            | Notes to Consolidated  Financial Statements                                                                                     | 6        |       |
| Item  2.                                        | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                     | 15       |       |
| Item  3.                                        | Quantitative and Qualitative  Disclosures about Market Risk                                                                     | 23       |       |
| Item  4.                                        | Controls and Procedures                                                                                                         | 24       |       |
| PART II.   OTHER  INFORMATION    | 25                                                                                                                              |     |
| Item 1.                                         | Legal Proceedings                                                                                                               | 25       |       |
| Item  2.                                        | Unregistered Sales of Equity  Securities and Use of Proceeds                                                                    | 25       |       |
| Item  4.                                        | Submission of Matters to a  Vote of Security Holders                                                                            | 26       |       |
| Item 5.                                         | Other Information                                                                                                               | 26       |       |
| Item 6.                                    | Exhibits                                                                                                                        | 26       |       |
|                                            | Signatures                                                                                                                      | 27       |       |
|                                            | Certifications                                                                                                                  | 28       |       |
|                                                 |                                                                                                                                 |          |            |  |  |

 

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**PART I—FINANCIAL INFORMATION**

**ITEM 1.   FINANCIAL STATEMENTS**

**FIRST HORIZON PHARMACEUTICAL CORPORATIONCONSOLIDATED BALANCE SHEETS(in thousands, except share data)**

| ** **                                                                                                                                                            | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                            | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                            |       |                         |       |                        |       |   |   |   |   |
| Current assets:                                                                                                                                                       |       |                         |       |                        |       |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                            |       |                         | $          | 14,658                      |       |   |   | $ | 36,586 |   |   |
| Marketable  securities                                                                                                                                                |       |                         | 83,183     |                        |       |   | 160,636 |   |   |
| Accounts  receivable, net of allowance for doubtful accounts and discounts of $1,339  and $749 at September 30, 2005 and December 31, 2004, respectively    |       |                         | 32,504     |                        |       |   | 23,833 |   |   |
| Inventories                                                                                                                                                           |       |                         | 33,013     |                        |       |   | 15,824 |   |   |
| Income taxes  receivable                                                                                                                                              |       |                         | 3,497      |                        |       |   | 5,438 |   |   |
| Current deferred  tax assets                                                                                                                                          |       |                         | 3,150      |                        |       |   | 3,419 |   |   |
| Other current  assets                                                                                                                                                 |       |                         | 13,981     |                        |       |   | 7,581 |   |   |
| Total current  assets                                                                                                                                                 |       |                         | 183,986    |                        |       |   | 253,317 |   |   |
| Property and equipment,  net                                                                                                                                          |       |                         | 5,385      |                        |       |   | 5,110 |   |   |
| Intangibles, net                                                                                                                                                      |       |                         | 321,502    |                        |       |   | 229,953 |   |   |
| Other assets                                                                                                                                                          |       |                         | 4,438      |                        |       |   | 10,104 |   |   |
| Total assets                                                                                                                                                          |       |                         | $          | 515,311                     |       |   |   | $ | 498,484 |   |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                        |       |                         |       |                        |       |   |   |   |   |
| Current liabilities:                                                                                                                                                  |       |                         |       |                        |       |   |   |   |   |
| Account payable                                                                                                                                                       |       |                         | $          | 9,390                       |       |   |   | $ | 14,569 |   |   |
| Accrued expenses                                                                                                                                                      |       |                         | 16,203     |                        |       |   | 20,508 |   |   |
| Total current  liabilities                                                                                                                                            |       |                         | 25,593     |                        |       |   | 35,077 |   |   |
| Long-term liabilities:                                                                                                                                                |       |                         |       |                        |       |   |   |   |   |
| Convertible debt                                                                                                                                                      |       |                         | 150,000    |                        |       |   | 150,000 |   |   |
| Deferred tax  liabilities                                                                                                                                             |       |                         | 6,497      |                        |       |   | 4,404 |   |   |
| Other long-term  liabilities                                                                                                                                          |       |                         | 206        |                        |       |   | 594 |   |   |
| Total liabilities                                                                                                                                                     |       |                         | 182,296    |                        |       |   | 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; 36,181,414 and 36,087,044  issued at September 30, 2005 and December 31, 2004, respectively |       |                         | 36         |                        |       |   | 36 |   |   |
| Additional paid-in  capital                                                                                                                                           |       |                         | 289,703    |                        |       |   | 288,335 |   |   |
| Retained earnings                                                                                                                                                     |       |                         | 69,541     |                        |       |   | 43,315 |   |   |
| Deferred  compensation                                                                                                                                                |       |                         | (215       | )                           |       |   | — |   |   |
| Accumulated other  comprehensive loss                                                                                                                                 |       |                         | (2,860     | )                           |       |   | (87 | ) |   |
|                                                                                                                                                                  |       |                         | 356,205    |                        |       |   | 331,599 |   |   |
| Less: Treasury  stock at cost, Common stock, 1,000,000 shares at September 30, 2005 and  December 31, 2004                                                  |       |                         | (23,190    | )                           |       |   | (23,190 | ) |   |
| Total  stockholders’ equity                                                                                                                                      |       |                         | 333,015    |                        |       |   | 308,409 |   |   |
| Total liabilities and  stockholders’ equity                                                                                                                      |       |                         | $          | 515,311                     |       |   |   | $ | 498,484 |   |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**FIRST HORIZON PHARMACEUTICAL CORPORATIONCONSOLIDATED STATEMENTSOF OPERATIONS(unaudited, in thousands, except per share data)**

| ** **                                                        | ** ** | **For The Three Months  Ended September 30,** | ** ** | **For The Nine Months  Ended September 30,** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                        | ** ** | **2005**                                                               | ** ** | **2004**                                                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net revenues                                                      |       | $                                                                      | 58,718     |                                                                  | $          | 41,559 |   | $ | 149,491 |   | $ | 109,567 |   |
| Operating costs and  expenses:                                    |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Cost of revenues (excluding depreciation and  amortization)  |       | 8,768                                                                  |       | 8,895                                                                 |       | 23,290 |   | 21,295 |   |
| Selling, general and administrative expense                       |       | 26,480                                                                 |       | 16,699                                                                |       | 68,240 |   | 46,287 |   |
| Depreciation and amortization                                     |       | 6,217                                                                  |       | 4,330                                                                 |       | 16,322 |   | 12,600 |   |
| Research and development expense                                  |       | 1,399                                                                  |       | 479                                                                   |       | 2,285 |   | 1,023 |   |
| Total operating costs and expenses                                |       | 42,864                                                                 |       | 30,403                                                                |       | 110,137 |   | 81,205 |   |
| Operating income                                                  |       | 15,854                                                                 |       | 11,156                                                                |       | 39,354 |   | 28,362 |   |
| Other income  (expense):                                          |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Interest expense                                                  |       | (799                                                                   | )          | (756                                                                  | )          | (2,202 | ) | (1,720 | ) |
| Interest income                                                   |       | 673                                                                    |       | 1,219                                                                 |       | 2,351 |   | 2,500 |   |
| Other                                                             |       | —                                                                 |       | —                                                                |       | (684 | ) | (11 | ) |
| Total other income (expense)                                      |       | (126                                                                   | )          | 463                                                                   |       | (535 | ) | 769 |   |
| Income before provision for income taxes                          |       | 15,728                                                                 |       | 11,619                                                                |       | 38,819 |   | 29,131 |   |
| Provision for  income taxes                                       |       | (5,094                                                                 | )          | (4,184                                                                | )          | (12,593 | ) | (11,140 | ) |
| Net income                                                        |       | $                                                                      | 10,634     |                                                                  | $          | 7,435 |   | $ | 26,226 |   | $ | 17,991 |   |
| Other comprehensive income (loss)                                 |       | (247                                                                   | )          | 758                                                                   |       | (2,773 | ) | (741 | ) |
| Comprehensive income                                              |       | $                                                                      | 10,387     |                                                                  | $          | 8,193 |   | $ | 23,453 |   | $ | 17,250 |   |
| Net income per  common share:                                     |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Basic earnings per common share                                   |       | $                                                                      | 0.30       |                                                                  | $          | 0.21 |   | $ | 0.75 |   | $ | 0.50 |   |
| Diluted earnings per common share                                 |       | $                                                                      | 0.26       |                                                                  | $          | 0.18 |   | $ | 0.65 |   | $ | 0.45 |   |
| Weighted average  common shares outstanding:                      |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Basic                                                             |       | 35,119                                                                 |       | 35,767                                                                |       | 35,071 |   | 35,870 |   |
| Diluted                                                           |       | 42,548                                                                 |       | 43,521                                                                |       | 42,569 |   | 42,205 |   |

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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**FIRST HORIZON PHARMACEUTICAL CORPORATIONCONSOLIDATED STATEMENTSOF CASH FLOWS(unaudited, in thousands)**

| ** **                                                                         | ** ** | **For The Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                                                              | ** ** | **2004** | ** ** |
| Cash flows from operating activities:                                              |       |                                                                  |       |   |   |   |   |   |   |
| Net income                                                                         |       |                                                                  | $          | 26,226 |   |   |   | $ | 17,991 |   |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                                                  |       |   |   |   |   |   |   |
| Depreciation and  amortization                                                     |       |                                                                  | 16,322     |   |   |   | 12,600 |   |   |
| Loss on sale of  marketable securities                                             |       |                                                                  | 684        |   |   |   | — |   |   |
| Non-cash interest  expense                                                         |       |                                                                  | 252        |   |   |   | 208 |   |   |
| Non-cash compensation  expense                                                     |       |                                                                  | 20         |   |   |   | — |   |   |
| Deferred income tax  expense                                                       |       |                                                                  | 2,435      |   |   |   | 4,000 |   |   |
| Reduction in taxes  payable—stock option exercises                            |       |                                                                  | 1,411      |   |   |   | 2,591 |   |   |
| Changes in assets and liabilities, net of acquired  assets and liabilities:        |       |                                                                  |       |   |   |   |   |   |   |
| Accounts receivable                                                                |       |                                                                  | (8,671     | ) |   |   | (762 | ) |   |
| Inventories                                                                        |       |                                                                  | (17,189    | ) |   |   | (238 | ) |   |
| Other current assets and  other assets                                             |       |                                                                  | (5,986     | ) |   |   | (3,935 | ) |   |
| Income taxes receivable                                                            |       |                                                                  | 1,941      |   |   |   | 4,839 |   |   |
| Accrued expenses and  other long-term liabilities                                  |       |                                                                  | 307        |   |   |   | 1,888 |   |   |
| Accounts payable                                                                   |       |                                                                  | (5,179     | ) |   |   | 5,240 |   |   |
| Net cash provided by  operating activities                                         |       |                                                                  | 12,573     |   |   |   | 44,422 |   |   |
| Cash flows from investing activities:                                              |       |                                                                  |       |   |   |   |   |   |   |
| Purchase of product and  licensing rights                                          |       |                                                                  | (106,337   | ) |   |   | (5,296 | ) |   |
| Purchase of property and  equipment                                                |       |                                                                  | (1,809     | ) |   |   | (644 | ) |   |
| Proceeds from sale of  marketable securities                                       |       |                                                                  | 97,576     |   |   |   | — |   |   |
| Purchase of marketable  securities                                                 |       |                                                                  | (20,994    | ) |   |   | (150,451 | ) |   |
| Net cash used in  investing activities                                             |       |                                                                  | (31,564    | ) |   |   | (156,391 | ) |   |
| Cash flows from financing activities:                                              |       |                                                                  |       |   |   |   |   |   |   |
| Capitalized financing costs  incurred                                              |       |                                                                  | —     |   |   |   | (5,015 | ) |   |
| Repurchase of common  stock                                                        |       |                                                                  | (2,094     | ) |   |   | (17,960 | ) |   |
| Proceeds from long-term  debt                                                      |       |                                                                  | —     |   |   |   | 150,000 |   |   |
| Net proceeds from  issuance of common stock                                        |       |                                                                  | 1,816      |   |   |   | 5,951 |   |   |
| Net cash (used in)  provided by financing activities                               |       |                                                                  | (278       | ) |   |   | 132,976 |   |   |
| Effect of foreign  exchange rate changes on cash                                   |       |                                                                  | (2,659     | ) |   |   | (94 | ) |   |
| Net change in cash and  cash equivalents                                           |       |                                                                  | (21,928    | ) |   |   | 20,913 |   |   |
| Cash and cash  equivalents, beginning of period                                    |       |                                                                  | 36,586     |   |   |   | 33,722 |   |   |
| Cash and cash  equivalents, end of period                                          |       |                                                                  | $          | 14,658 |   |   |   | $ | 54,635 |   |   |
| Non-cash financing transactions:                                                   |       |                                                                  |       |   |   |   |   |   |   |
| Issuance of restricted  stock                                                      |       |                                                                  | $          | 235 |   |   |   | $ | — |   |   |
| Supplemental Cash Flow Information:                                                |       |                                                                  |       |   |   |   |   |   |   |
| Cash paid for income  taxes                                                        |       |                                                                  | $          | 6,337 |   |   |   | $ | 4,230 |   |   |
| Cash paid for interest                                                             |       |                                                                  | $          | 2,880 |   |   |   | $ | 1,351 |   |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

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**FIRST HORIZON PHARMACEUTICAL CORPORATIONNOTES TO CONSOLIDATEDFINANCIAL STATEMENTS(unaudited)**

**1.   Basis of Presentation**

The accompanying unauditedinterim consolidated financial statements reflect all adjustments (consistingsolely of normal recurring adjustments) which management considers necessaryfor fair presentation of the financial position, results of operations and cashflows of the Company for the interim periods. Certain footnote disclosuresnormally included in financial statements prepared according to accountingprinciples generally accepted in the United States of America have beencondensed or omitted from these interim financial statements as permitted bythe rules and regulations of the Securities and Exchange Commission.Interim results are not necessarily indicative of results for the full year.The interim results should be read in conjunction with the financial statementsand notes thereto included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004 (File No. 000-30123).

**2.   New Accounting Pronouncements**

In July 2005, the Financial Accounting Standards Board (“FASB”) issuedan exposure draft of a proposed interpretation, *Accountingfor Uncertain Tax Positions**—**anInterpretation of FASB Statement No. 109* (“SFAS No. 109”).This interpretation would apply to all open tax positions accounted for inaccordance with SFAS No. 109, including those acquired in businesscombinations. It is a proposed asset recognition approach to apply a dualthreshold for uncertain tax positions. The interpretation would allow therecognition of a tax benefit when it is probable that it could be sustainedupon audit. The interpretation defines “probable” as it is defined in SFAS No. 5,“*Accounting for Contingencies*.” Theproposed interpretation would be effective for the first fiscal year endingafter December 15, 2005. The Company is currently reviewing the effect, ifany, the proposed guidance will have on its financial statements.

In May 2005, the FASB issued Statement 154, *“Accounting Changes and Error Corrections, a replacement of APB OpinionNo. 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, unless thechange in accounting relates to the principle method of depreciation,amortization or depletion for long-lived, non-financial assets in which casethe change is accounted for as a change in accounting estimate that is affectedby 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 of Statement of Financial AccountingStandards (“SFAS”) No. 154 is not expected to have a material impact onthe Company’s financial position or results of operations.

In December 2004, the FASB issued Statement 153,“*Exchanges of Nonmonetary Assets, anamendment of APB Opinion No.29.”* The standard is based on theprinciple that exchanges of nonmonetary assets should be measured based on thefair value of the assets exchanged and eliminates the exception under APBOpinion No. 29 for an exchange of similar productive assets and replacesit with an exception for exchanges of nonmonetary assets that do not havecommercial substance. The standard is effective for nonmonetary exchangesoccurring in fiscal periods beginning after June 15, 2005. The adoption ofSFAS No. 153 did not have a material impact on the Company’s financialposition or results of operations.

In December 2004, the FASB issued Statement 123(revised 2004), “*Share-Based Payment.”*The standard eliminates the disclosure-only election under the priorSFAS 123 and requires the recognition of compensation expense for stockoptions and other forms of equity compensation based on the fair value of 

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the instruments on thedate of grant. The standard is effective for fiscal years beginning after June 15,2005. See Note 3 for the disclosures of the pro forma dilutive impact onnet income and earnings per share of expensing stock options based on theBlack-Scholes model.

In November 2004, theFASB issued Statement 151, *“Inventory Costs.”* The standardclarifies that abnormal amounts of idle facility expense, freight, handlingcosts, and wasted materials should be recognized as current-period charges andrequires the allocation of fixed production overheads to inventory based on thenormal capacity of the production facilities. The standard is effective forinventory costs incurred during fiscal years beginning after June 15,2005. The adoption of SFAS No. 151 is not expected to have a materialimpact on the Company’s financial position or results of operations.

**3.   Stock Based Compensation**

The Company applies APB No. 25, “*Accounting for Stock Issued to Employees,*”and related interpretations in accounting for all stock options issued toemployees. Accordingly, the Company records compensation expense for any stockoption grants and restricted stock grants with exercise prices lower than fairvalue, recognized ratably over the vesting period.

Applyingthe Black-Scholes option-pricing models prescribed by SFAS No. 123, “*Accounting for Stock Based Compensation,*”to calculate the compensation costs of the Company’s options, the Company’s proforma net income per common share would have been reported as follows (inthousands except per share data):

| ** **                                                                                                                    | ** ** | **For The Three Months Ended  September 30,** | ** ** | **For The Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                                                                    | ** ** | **2005**                                                               | ** ** | **2004**                                                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income as  reported                                                                                                       |       |                                                                   | $          | 10, 634                                                               |       |   |   | $ | 7,435 |   |   |   | $ | 26,226 |   |   |   | $ | 17,991 |   |   |
| Deduct:                                                                                                                       |       |                                                                   |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total stock-based employee compensation expense  determined under fair value basis for all awards, net of related tax effects |       |                                                                   | (719       | )                                                                     |       |   | (661 | ) |   |   | (1,878 | ) |   |   | (1,908 | ) |   |
| Pro forma                                                                                                                     |       |                                                                   | $          | 9,915                                                                 |       |   |   | $ | 6,774 |   |   |   | $ | 24,348 |   |   |   | $ | 16,083 |   |   |
| Net income per  common share—basic:                                                                                      |       |                                                                   |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| As reported                                                                                                                   |       |                                                                   | $          | 0.30                                                                  |       |   |   | $ | 0.21 |   |   |   | $ | 0.75 |   |   |   | $ | 0.50 |   |   |
| Pro forma                                                                                                                     |       |                                                                   | $          | 0.28                                                                  |       |   |   | $ | 0.19 |   |   |   | $ | 0.69 |   |   |   | $ | 0.45 |   |   |
| Net income per  common share—diluted:                                                                                    |       |                                                                   |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| As reported                                                                                                                   |       |                                                                   | $          | 0.26                                                                  |       |   |   | $ | 0.18 |   |   |   | $ | 0.65 |   |   |   | $ | 0.45 |   |   |
| Pro-forma                                                                                                                     |       |                                                                   | $          | 0.24                                                                  |       |   |   | $ | 0.17 |   |   |   | $ | 0.61 |   |   |   | $ | 0.40 |   |   |

 

Theweighted average fair value per share of options granted during the threemonths ended September 30, 2005 and 2004 is estimated at $15.09 and$14.72, respectively. The value of options is estimated on the date of thegrant using the following weighted average assumptions:

| ** **               | ** ** | **2005**     | ** ** | **2004**     | ** ** |
|--------------------------|------------|--------------|------------|--------------|------------|
| Risk-free  interest rate |       | 3.83         | %          | 3.38         | %          |
| Expected dividend  yield |       | —       |       | —       |       |
| Expected lives           |       | 5 years |       | 5 years |       |
| Expected volatility      |       | 115.87       | %          | 123.79       | %          |

 

The Black-Scholes option valuation model was notdeveloped for use in valuing employee stock options. Instead, this model wasdeveloped for use in estimating the fair value of traded options, which 

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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 isreviewing alternative approaches to valuing employee stock options.

On May 31, 2005, theCompany granted 12,500 shares of restricted common stock to certain members ofits Board of Directors. The shares vest equally over a 4 year period. Totalcompensation of $235,000 will be recognized ratably over the 4 year vestingperiod. As of September 30, 2005, deferred compensation related to therestricted stock totaled $215,000.

**4.   Marketable Securities**

The Company classifies its existing marketablesecurities as available-for-sale. All available-for-sale securities areclassified as current as the Company has the ability to use them for currentoperating and investing purposes. There were $0.0 million and $0.7 millionin realized losses in the three and nine months ended September 30, 2005,respectively. At September 30, 2005, the Company had total net unrealizedlosses from marketable securities of $2.0 million.

Thecarrying amount of available-for-sale securities and their approximate fairvalues at September 30, 2005 were as follows (in thousands):

| ** **                                            | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** **               | **Fair  Value** | ** **                     |
|-------------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|--------------------------|-----------------|--------------------------------|
| U.S. Government  and Federal agency obligations  |       |                | $          | 58,428                       |       |                          |                     | $               |     — |   |   |   | $ | (1,308 | ) |   | $ | 57,120 |   |
| Corporate bonds                                       |       |                | 26,712     |                         |       |                          |    — |            |                           |   | (649 | ) |   | 26,063 |   |
| Total                                                 |       |                | $          | 85,140                       |       |                          |                     | $               |     — |   |   |   | $ | (1,957 | ) |   | $ | 83,183 |   |

 

Thefollowing table presents the age of gross unrealized losses and fair value byinvestment category for all securities in a loss position as of September 30,2005 (in thousands):

| ** **                                      | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total**       | ** ** |
|-------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------------|------------|
| ** **                                      | ** ** | **Fair  Value**                        | ** ** | **Gross  Unrealized  Losses**        | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized  Losses** | ** ** |
| U.S. Government  and Federal agency obligations |       | $                                      | 9,872      |                                 |       | $               | (127       | ) |   | $ | 47,282 |   |   | $ | (1,181 | ) |   | $ | 57,154 |   |   | $ | (1,308 | ) |   |
| Corporate bonds                                 |       | 3,587                                  |       |                                 | (42        | )               |       | 22,442 |   |   | (607 | ) |   | 26,029 |   |   | (649 | ) |   |
| Total                                           |       | $                                      | 13,459     |                                 |       | $               | (169       | ) |   | $ | 69,724 |   |   | $ | (1,788 | ) |   | $ | 83,183 |   |   | $ | (1,957 | ) |   |

 

The Company has determined that its unrealized lossesare temporary based on the minor amount of the losses compared to amortizedcost, as well as the credit worthiness of the investees. The Company expectsthat all losses will be recovered, and intends to hold securities to recovery.If market, industry and/or investee conditions deteriorate, the Company mayincur future impairments.

8

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Theamortized cost and fair value of marketable securities at September 30,2005 by contractual maturity are shown below (in thousands):

| ** **                                | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
|-------------------------------------------|------------|----------|------------|---------------------|------------|
| Due in one year  or less                  |       | $        | 13,628     |                |       | $ | 13,459 |   |   |
| Due after one  year through three years   |       | 56,125   |       |                | 54,700     |   |   |
| Due after three  years through five years |       | 10,557   |       |                | 10,304     |   |   |
| Due after five  years                     |       | 4,830    |       |                | 4,720      |   |   |
|                                      |       | $        | 85,140     |                |       | $ | 83,183 |   |   |

 

Thecarrying amount of available-for-sale securities and their approximate fairvalues at December 31, 2004 were as follows (in thousands):

| ** **                                            | ** ** | **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**

Inventoriesconsist of purchased pharmaceutical products and are stated at the lower ofcost or market. Cost is determined using the first-in, first-out method, andmarket is considered to be net realizable value. Inventories consist of finishedproduct and bulk product awaiting processing and packaging into finishedproduct. Inventories, net of reserves of $0.8 million at September 30,2005 and December 31, 2004, consisted of (in thousands):

| ** **        | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------|------------|------------------------------|------------|-----------------------------|------------|
| Bulk product      |       |                         | $          | 7,369                       |       |   |   | $ | 6,882 |   |   |
| Finished product  |       |                         | 25,644     |                        |       |   | 8,942 |   |   |
| Total inventories |       |                         | $          | 33,013                      |       |   |   | $ | 15,824 |   |   |

 

**6.   Intangible Assets**

In May 2005, the US Food and Drug Administrationgranted approval for Triglide, a fenofibrate formulation. The Company obtainedexclusive US marketing rights in May 2004 to Triglide, a novel fenofibrateformulation that employs one of SkyePharma’s proprietary solubilizationtechnologies. Under its Agreement with SkyePharma, the Company made a paymentof $15 million to SkyePharma as a result of the approval during the quarterended June 30, 2005. SkyePharma is also entitled to royalties on netsales, as defined. The intangible asset recorded in connection with theacquisition of Triglide is being amortized over a period of fifteen years.

On March 28, 2005, the Company acquired theworldwide rights to Fortamet and Altoprev from Andrx Corporation. As of September 30,2005, the Company has paid Andrx $85.0 million. Andrx is also entitled toroyalties on net sales of these products.

With the assistance of valuation experts, the Companyallocated the purchase price to the fair value of the various intangible assetsacquired from Andrx Corporation, which are not deemed to have an indefinitelife. Intangible assets are amortized on a straight-line basis over theirrespective useful lives. The 

9

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intangible assets recordedin connection with the acquisition of Fortamet and Altoprev will be amortizedover a period of fifteen years.

Thefollowing table reflects the components of all of the Company’s intangibleassets as of September 30, 2005 (in thousands):

| ** **                      | ** ** | **Gross Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Amount** | ** ** | **Expected Life** | ** ** |
|---------------------------------|------------|-----------------------|------------|-------------------------------|------------|---------------------|------------|------------------------|------------|
| Licensing rights                |       |                  | $          | 356,027                       |       |                |       | $                      | (54,794    | ) |   |   | $ | 301,233 |   |   | 10 to 20 years |   |
| Trade names                     |       |                  | 11,060     |                          |       |                | (2,293     | )                      |       |   | 8,767 |   |   | 15 to 20 years |   |
| Contracts                       |       |                  | 8,300      |                          |       |                | (6,077     | )                      |       |   | 2,223 |   |   | 5 years |   |
| Supply/Distribution  agreements |       |                  | 11,490     |                          |       |                | (4,729     | )                      |       |   | 6,761 |   |   | 10 years |   |
| Other intangibles               |       |                  | 3,108      |                          |       |                | (590       | )                      |       |   | 2,518 |   |   | 20 years |   |
| Total                           |       |                  | $          | 389,985                       |       |                |       | $                      | (68,483    | ) |   |   | $ | 321,502 |   |   |   |   |

 

Thefollowing table reflects the components of intangible assets as of December 31,2004 (in thousands):

| ** **                      | ** ** | **Gross Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Amount** | ** ** | **Expected Life** | ** ** |
|---------------------------------|------------|-----------------------|------------|-------------------------------|------------|---------------------|------------|------------------------|------------|
| Licensing rights                |       |                  | $          | 249,715                       |       |                |       | $                      | (42,540    | ) |   |   | $ | 207,175 |   |   | 10 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 |   |   | 10 years |   |
| Other intangibles               |       |                  | 3,082      |                          |       |                | (527       | )                      |       |   | 2,555 |   |   | 20 years |   |
| Total                           |       |                  | $          | 283,647                       |       |                |       | $                      | (53,694    | ) |   |   | $ | 229,953 |   |   |   |   |

 

Forthe three and nine months ended September 30, 2005, amortization expenserelated to the intangible assets was $5.6 million and $14.8 million,respectively. Amortization is calculated on a straight-line basis over theestimated useful life of the intangible asset, and the Company estimates theannual amortization expense for each of the five succeeding fiscal years to beas follows (in thousands):

| **Fiscal year ended December 31:** | ** ** | ** ** | ** ** | **Amount** | ** ** |
|--------------------------------------------------------|------------|------------|------------|------------|------------|
| 2005                                                   |       | $          | 20,827     |       |
| 2006                                                   |       | $          | 22,601     |       |
| 2007                                                   |       | $          | 22,498     |       |
| 2008                                                   |       | $          | 21,192     |       |
| 2009                                                   |       | $          | 20,941     |       |

 

**7.   Other Assets**

Otherassets at September 30, 2005 and December 31, 2004 consisted of thefollowing (in thousands):

| ** **                            | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Capitalized  finance costs            |       |                         | $          | 4,374                       |       |   |   | $ | 4,619 |   |   |
| Advance payment  for product licenses |       |                         | —     |                        |       |   | 5,426 |   |   |
| Deposits                              |       |                         | 64         |                        |       |   | 59 |   |   |
| Total other assets                    |       |                         | $          | 4,438                       |       |   |   | $ | 10,104 |   |   |

 

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**8.   Accrued Expenses**

Accruedexpenses at September 30, 2005 and December 31, 2004 consisted of thefollowing (in thousands):

| ** **                          | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Employee  compensation and benefits |       |                         | $          | 3,863                       |       |   |   | $ | 1,951 |   |   |
| Product returns                     |       |                         | 1,426      |                        |       |   | 1,563 |   |   |
| Product rebates                     |       |                         | 2,340      |                        |       |   | 2,031 |   |   |
| Sales deductions                    |       |                         | 3,145      |                        |       |   | 2,549 |   |   |
| Accrued royalties                   |       |                         | 3,887      |                        |       |   | 1,202 |   |   |
| Product license  fee                |       |                         | —     |                        |       |   | 5,000 |   |   |
| Other                               |       |                         | 1,542      |                        |       |   | 6,212 |   |   |
|                                |       |                         | $          | 16,203                      |       |   |   | $ | 20,508 |   |   |

 

**9.**   Long-term Debt

In March 2004, the Company issued a total of$150.0 million of its 1.75% senior subordinated contingent convertiblenotes due in 2024 in transactions that were exempt from registration inreliance upon Rule 144A and other available exemptions under theSecurities Act. The notes are due March 8, 2024 and accrued interest ispayable semi-annually in arrears on March 8 and September 8 of eachyear. In addition to the interest on the notes, after March 8, 2007, theCompany will also pay contingent interest during specified six-month periods ifthe average trading price of the notes per $1,000 principal amount for the fiveday trading period ending on the third trading day immediately preceding thefirst day of the applicable six-month period equals $1,200 or more. During anyperiod when contingent interest is payable, it will be payable at a rate equalto 0.5% per annum. As this contingent interest feature is based on theunderlying trading price of the notes, the contingent interest qualifies as anembedded derivative. As of September 30, 2005, management determined thatthe fair value of this contingent interest embedded derivative was notmaterial. The net proceeds from this issuance, after deducting offeringexpenses, were approximately $145.4 million. Financing costs of $4.6 millionwere incurred with the issuance which are being amortized on a straight linebasis over the life of the notes and are included in other assets in theconsolidated balance sheet.

Holders of the notes may initially convert the notesinto shares of the Company’s common stock at a conversion rate of 45.1467shares per $1,000 principal amount of the notes, which is equivalent to aconversion price of $22.15 per share, subject to anti-dilution adjustments,before the close of business on March 8, 2024. Holders may convert thenotes only under the following circumstances: (1) during any calendarquarter commencing after June 30, 2004, if the closing sales price of theCompany’s 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 the Company’s common stock and the numberof shares of common stock issuable upon conversion of $1,000 principal amountof the notes; or (4) the occurrence of specified corporate transactions.

The Company has the option to redeem the notesbeginning March 13, 2007 at a price equal to 100% of their aggregateprincipal amount, plus accrued and unpaid interest, including contingentinterest, if any.

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The holders of the notes have the option to requirethe Company to repurchase the notes on March 8 of 2009, 2014 and 2019, andupon a change in control, at a price equal to 100% of their aggregate principalamount, plus accrued and unpaid interest, including contingent interest, ifany.

In connection with the issuance of the notes, on March 30,2004 the Company filed a registration statement on Form S-3 with theSecurities and Exchange Commission to register for resale of 6.8 millionshares of the Company’s common stock issuable, subject to anti-dilutionadjustments, upon conversion of the notes. The registration statement becameeffective during the second quarter of 2004.

The Company had no debtother than the aforementioned notes outstanding at September 30, 2005 or December 31,2004.

**10.**   Credit Agreement

On February 11, 2003,the Company entered into a $20.0 million senior secured revolving creditfacility with various lenders and LaSalle Bank National Association, asadministrative agent. Borrowings may be used for working capital requirementsand general corporate purposes. Borrowings are secured by substantially all ofthe Company’s assets. Borrowings bear interest at the Company’s option at thebase rate in effect from time to time plus an applicable margin or theEurodollar rate, plus an applicable margin. The applicable margin will varydependent upon the Company’s leverage ratio in effect from time to time. Therevolving facility matures on August 11, 2006. The revolving loan containsvarious covenants, including covenants relative to maintaining financial ratiosand earnings levels, limitations on acquisitions, dispositions, mergers andcapital expenditures, limitations on incurring additional indebtedness and aprohibition on payment of dividends and certain issuances of capital stock. Inthe three and nine months ended September 30, 2005, the Company utilizedthe senior secured revolving credit facility, however as of September 30,2005 the Company had repaid all borrowings on this senior secured revolvingcredit facility.

**11.**   Share BuybackProgram

In July 2002, the Company announced a sharerepurchase program. This program authorized the repurchase of up to$8 million in common stock until July 2003. Through July 2003,the Company repurchased 823,400 shares of its common stock at an aggregate costof approximately $2.1 million. In August 2003, the Company’s Board ofDirectors authorized the repurchase of up to an additional $7.9 million ofcommon stock, for a total authorization of $10.0 million, and extended therepurchase program to August 2004. In September 2003, the Companyrepurchased 162,225 shares of common stock at an aggregate cost ofapproximately $1.0 million. Through December 2003, the Company hadrepurchased a total of 985,625 shares of common stock at an aggregate cost ofapproximately $3.1 million. During the six months ended June 2004,the Company repurchased a total of 260,000 shares of common stock at anaggregate cost of approximately $4.6 million. All of these shares wereretired.

In July 2004, the Company’s Board of Directorsauthorized a $20.0 million share repurchase program. The new program,which authorizes the repurchase of up to $5 million of common stock perquarter, became effective in August 2004, terminating and replacing the$10.0 million share repurchase program authorized by the Company’s Boardof Directors in fiscal 2002. This share repurchase program expired in August 2005.

In the third quarter of 2004, as part of thethen-effective share repurchase program, the Company’s Board of Directors increasedthe per quarter repurchase cap and authorized the Company to repurchase a totalof 731,580 shares of common stock, inclusive of the 500,000 shares of commonstock repurchased from one of Dr. Kapoor’s family partnerships, at anaggregate cost of approximately $13.4 million. These shares have beenretired. In the fourth quarter of 2004, as part of the plan that becameeffective in August 2004, the Company repurchased 65,427 shares of commonstock. These shares have been retired.

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In December 2004, the Company, with Board ofDirectors approval, purchased 1 million shares of common stock at anaggregate cost of approximately $23.2 million which was at a fair marketvalue equal to the December 10, 2004 closing price of the Company’s commonstock as reported by Nasdaq from certain executives and board members and asignificant shareholder of the Company. The Company acquired those shares inpart, to establish a pool of authorized shares that will be available forcontribution to the Company’s Employee Stock Ownership Plan over time as theCompany in its discretion deems appropriate.

The Company adopted a new share repurchase programeffective August 3, 2005, that authorizes the repurchase of up to $20.0million of its outstanding shares of common stock over the next twelve monthswith no periodic sub-limits on the amount of repurchases. This plan replacesall prior share repurchase plans and will expire on August 2, 2006.TheCompany has repurchased no shares under this program.

In the first quarter of2005, the Company repurchased 127,169 shares of common stock at an average costof $16.44 per share, or $2.1 million. These shares have been retired. TheCompany did not repurchase any shares in the second or third quarters of 2005.

**12.**   Earnings Per Share

Belowis the calculation of basic and diluted net income per share (in thousandsexcept per share data):

| ** **                                                         | ** ** | **For The Three Months Ended  September 30,**                             | ** ** | **For The Nine Months Ended  September 30,**                        | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **       2005        ** | ** ** | **       2004       ** | ** ** | **       2005        ** | ** ** | **       2004       ** | ** ** |
| Net income                                                         |       |                                                                                               | $          | 10,634                                                                                       |       |   |   | $ | 7,435 |   |   |   | 26,226 |   |   |   | $ | 17,991 |   |   |
| Add: Interest  expense on contingent convertible notes, net of tax |       |                                                                                               | 485        |                                                                                         |       |   | 444 |   |   |   | 1,455 |   |   |   | 997 |   |   |
| Adjusted net income                                                |       |                                                                                               | $          | 11,119                                                                                       |       |   |   | $ | 7,879 |   |   |   | $ | 27,681 |   |   |   | $ | 18,988 |   |   |
| Weighted average  common shares outstanding—basic             |       |                                                                                               | 35,119     |                                                                                         |       |   | 35,767 |   |   |   | 35,071 |   |   |   | 35,870 |   |   |
| Diluted effect of  stock options and convertible debt         |       |                                                                                               | 7,429      |                                                                                         |       |   | 7,754 |   |   |   | 7,498 |   |   |   | 6,335 |   |   |
| Weighted average common shares  outstanding—diluted           |       |                                                                                               | 42,548     |                                                                                         |       |   | 43,521 |   |   |   | 42,569 |   |   |   | 42,205 |   |   |
| Basic earnings per common share:                                   |       |                                                                                               | $          | 0.30                                                                                         |       |   |   | $ | 0.21 |   |   |   | $ | 0.75 |   |   |   | $ | 0.50 |   |   |
| Diluted earnings  per common share:                                |       |                                                                                               | $          | 0.26                                                                                         |       |   |   | $ | 0.18 |   |   |   | $ | 0.65 |   |   |   | $ | 0.45 |   |   |

 

For the three months endedSeptember 30, 2005, there were 629,423 potential common shares outstandingand 12,500 shares of unvested restricted stock that were excluded from thediluted net income per share calculation because their effect would have beenanti-dilutive. For the nine months ended September 30, 2005, there were543,244 potential common shares outstanding and 12,500 shares of unvestedrestricted stock that were excluded from the diluted net income per sharecalculation because their effect would have been anti-dilutive.

**13.**   Segment Reporting

The Company is engaged solely in the business ofmarketing, developing and selling prescription pharmaceutical products.Accordingly, the Company’s business is classified in a single reportablesegment, the sale and marketing of prescription products. Prescription productsinclude a variety of branded 

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pharmaceuticals for thetreatment of cardiovascular, obstetrical and gynecological, pediatric andgastroenterological conditions and disorders.

Thefollowing presents revenues for prescription products by area of treatment:

| ** **          | ** ** | **For The Quarter Ended  September 30,**         | ** ** | **For The Nine Months Ended  September 30,** | ** ** |
|---------------------|------------|----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **          | ** ** | **     2005     ** | ** ** | **     2004     **  | ** ** | **       2005       ** | ** ** | **       2004       ** | ** ** |
| Cardiovascular      |       |                                                                 | $          | 43,849                                                                |       |   |   | $ | 23,239 |   |   |   | $ | 98,072 |   |   |   | $ | 58,234 |   |   |
| Women’s Health |       |                                                                 | 10,061     |                                                                  |       |   | 6,748 |   |   |   | 32,783 |   |   |   | 14,550 |   |   |
| Non Promoted        |       |                                                                 | 4,808      |                                                                  |       |   | 11,572 |   |   |   | 18,636 |   |   |   | 36,783 |   |   |
| Net revenues        |       |                                                                 | $          | 58,718                                                                |       |   |   | $ | 41,559 |   |   |   | $ | 149,491 |   |   |   | $ | 109,567 |   |   |

 

**14.**   Commitments andContingencies

The Company, along with certain former and currentofficers and directors, were named defendants in a consolidated securitieslawsuit initiated on August 22, 2002 in the United States District Courtfor the Northern District of Georgia. Plaintiffs in the class action litigationalleged in general terms that the Company violated Sections 11 and 12(a)(2) ofthe Securities Act of 1933 and that the Company violated Sections 10(b) and20(a) of the Securities Exchange Act of 1934 and Rule 10b-5promulgated thereunder. In an amended complaint, Plaintiffs claimed that theCompany issued a series of materially false and misleading statements to themarket in connection with the Company’s public offering on April 24, 2002and thereafter relating to alleged “channel stuffing” activities. The amendedcomplaint also alleged controlling person liability on behalf of certain of ourofficers under Section 15 of the Securities Act of 1933 and Section 20of the Securities Exchange Act of 1934. Plaintiffs sought an unspecified amountof compensatory damages in an amount to be proven at trial.

On September 29, 2004, the U.S. District Courtfor the Northern District of Georgia dismissed, without prejudice, the classaction lawsuit. Although the class action lawsuit was dismissed, the courtgranted the plaintiffs the opportunity to amend their class action lawsuitprovided that the plaintiffs pay all of the defendants’ fees and costsassociated with filing the motions to dismiss the class action lawsuit. Plaintiffsdid not file a second amended complaint as permitted, but instead filed amotion asking the District Court to reconsider its September 29, 2004order and lift the condition that they must pay defendants’ fees and costsbefore further amendment. On June 22, 2005, the District Court deniedplaintiffs’ motion and gave them another opportunity to amend if they paydefendants’ fees and costs. Once again, plaintiffs chose not to file a secondamended complaint. Instead, plaintiffs filed an appeal to the United StatesCourt of Appeals for the Eleventh Circuit. This appeal currently is pending.

As previously reported, the Company was recentlyinvolved in three litigated matters with Breckenridge Pharmaceutical, Inc.and Scientific Laboratories, Inc. All three matters have been settled onterms mutually agreeable to all parties, and all lawsuits have been dismissed.

The Company is also involved with other variousroutine legal proceedings incident to the ordinary course of business. None ofthese proceedings are expected to have a material adverse effect on theconsolidated financial statements.

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

The following should beread with the consolidated financial statements and related footnotes andManagement’s Discussion and Analysis of Results of Operations and FinancialCondition included in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2004 (File No. 000-30123). Theresults discussed below are not necessarily indicative of the results to beexpected in any future periods. The following discussion containsforward-looking statements that are subject to risks and uncertainties, whichcould cause actual results to differ from the statements made.

**Overview**

We area specialty pharmaceutical company that markets, develops and sells brand nameprescription products. Our current operating plan focuses on maximizing thesales of our existing product portfolio, accelerating growth by launching lineextensions to our current products and acquiring or licensing approved productsor late stage development products. We plan to focus on products that fitwithin our existing Cardiology and Women’s Health categories and that willallow us to leverage our sales force infrastructure. During the quarter ended September 30,2005, we promoted the following products:

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

 

We sell our productsprimarily to pharmaceutical wholesalers (who in turn distribute to pharmacies),chain drug stores, other retail merchandisers and, on a limited basis, directlyto pharmacies. We recognize revenue when our products are delivered to thecustomer, the customer takes ownership and assumes the risk of loss. Our salesforce targets high-prescribing primary care physicians and select specialtyphysicians. These physicians write prescriptions for our products in order totreat their patients. Our sales force seeks to develop relationships with thesephysicians and respond to the pharmaceutical needs of their patients. Weevaluate the effectiveness of our sales and marketing efforts by monitoringprescription trends of our promoted products.

**Results of Operations**

*Net Revenue.**  *Net revenues for the three monthsended September 30, 2005 increased $17.1 million or 41.1% to $58.7million, as compared to $41.6 million for the three months ended September 30,2004. Net revenues for the nine months ended September 30, 2005 increased$39.9 million or 36.4% to $149.5 million, as compared to$109.6 million for the nine months ended September 30, 2004. Net revenues increased for the three andnine month period as a result of the successful execution of our sales andmarketing strategy, an increase in sales force, price increases on certainpromoted products and increased sales from the expansion of our product line toinclude Fortamet, Altoprev and OptiNate in the second quarter of 2005 andTriglide in the third quarter of 2005.

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**Product Overview**

| ** **      | ** ** | **Change in total dispensed   prescriptions for the three   months ended September 30, 2005  compared to the three months   ended September 30, 2004(a)** | ** ** | **Change in new dispensed   prescriptions for the three   months ended September 30, 2005  compared to the three months   ended September 30, 2004(a)** | ** ** |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Sular           |       |                                                                                                                                                                                                                                                          | 16.3       | %                                                                                                                                                                                                                                                           |       |   | 18.0 | % |   |
| Fortamet        |       |                                                                                                                                                                                                                                                          | 392.5      | %                                                                                                                                                                                                                                                           |       |   | 162.8 | % |   |
| Altoprev        |       |                                                                                                                                                                                                                                                          | (25.8      | )%                                                                                                                                                                                                                                                          |       |   | (48.5 | )% |   |
| Triglide(b)     |       |                                                                                                                                                                                                                                                          | N/A        |                                                                                                                                                                                                                                                        |       |   | N/A |   |   |
| Nitrolingual(c) |       |                                                                                                                                                                                                                                                          | (13.6      | )%                                                                                                                                                                                                                                                          |       |   | (18.7 | )% |   |
| Prenate Elite   |       |                                                                                                                                                                                                                                                          | 70.7       | %                                                                                                                                                                                                                                                           |       |   | 11.8 | % |   |
| OptiNate(d)     |       |                                                                                                                                                                                                                                                          | N/A        |                                                                                                                                                                                                                                                        |       |   | N/A |   |   |
| Ponstel         |       |                                                                                                                                                                                                                                                          | 18.7       | %                                                                                                                                                                                                                                                           |       |   | 22.7 | % |   |

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

*(b)**         *Triglidewas launched in July 2005, as a result comparative data is not availablefor the third quarter of 2004.

*(c)**          *Webelieve that IMS data does not capture prescriptions of Nitrolingual from someof the non-retail channels and prescription trends in the non-retail channelwhich may have a significant impact on the reported change.

*(d)**         *OptiNate was launched in March 2005,as a result comparative data is not available for the third quarter of 2004.

Net revenues from our Cardiologyproducts (namely Sular, Fortamet, Altoprev, Triglide and Nitrolingual)were $43.8 million and $98.1 million for the three and nine months ended September 30,2005 respectively, compared to $23.2 million and $58.2 million for the threeand nine months ended September 30, 2004, respectively. The increase was primarily a result of theaddition of our new products, Altoprev and Fortamet, commencing in April 2005,and Triglide, commencing in July 2005, price increases of our promoted productsand total prescription growth of Sular.

Netrevenues from our promoted Women’s Health products (namely Prenate Elite,OptiNate and Ponstel), were $10.1 million and $32.8 million for thethree and nine months ended September 30, 2005 respectively, compared to$6.7 million and $14.6 million forthe three and nine months ended September 30, 2004 respectively. Theincrease was due primarily to total prescriptions for Prenate Elite, priceincreases and the successful launch of OptiNate in March 2005. Sales ofPrenate Elite’s predecessor, Prenate GT, were lower in the three and ninemonths ended September 30, 2004 as we prepared for the launch of PrenateElite.

In March 2004, we announced the launch of PrenateElite, the next generation of the Prenate line of prenatal vitamins. We beganpromoting and selling Prenate Elite in April 2004. Prenate Elite hascaptured a market share of 13.7% of new prescriptions and 14.4% of totalprescriptions of prenatal vitamins in September 2005. (Source: IMS Health’sNational Prescription Audit PlusTM data.) Additionally, the launch of OptiNatein March 2005 has captured 8.1% of new prescriptions of prenatal vitaminsand 7.6% of total prescription in September 2005. (Source: IMS Health’sNational Prescription Audit PlusTM data.)

*Costof Revenues.**  *Costof revenues for the three and nine months ended September 30, 2005 were$8.8 million and $23.3 million compared to $8.9 million and $21.3 millionfor the three and nine months ended September 30, 2004. The increase incost of revenues for the nine months ended Spetember 30, 2005 is related to thechange in product mix and the increase in units sold as compared to the ninemonths ending September 30, 2004. While revenues increased for the threemonths ended September 30, 2005 

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compared to the three monthsended September 30, 2004, costs of sales remained flat which is dueprimarily to the change in product mix.

*GrossMargin.**  *Grossmargins for the three and nine months ended September 30, 2005 were 85.1%and 84.4%, respectively, compared to 78.6% and 80.6% for the three and ninemonths ended September 30, 2004, respectively. This increase in grossmargin is the result of a change in product mix from the prior year primarilyas the result of the current year acquisitions and the successful launch ofTriglide and OptiNate. Also contributing to the increased gross margins wereprice increases implemented during the year.

*Selling,General and Administrative Expenses.**  *Selling,general and administrative expenses increased $9.8 million, or 58.7%, to$26.5 million for the three months ended September 30, 2005, comparedto $16.7 million for the three months ended September 30, 2004.Selling, general and administrative expenses increased $21.9 million, or47.3%, to $68.2 million for thenine months ended September 30, 2005, compared to $46.3 million forthe nine months ended September 30, 2004. This increase is primarilyrelated to the increase in sales force and their associated costs for thelaunch of our new products and an increase in royalty and commission expensesrelated to the increased net revenues.

*Depreciationand Amortization Expense.**  *Depreciation and amortizationexpense increased $1.9 million, or 44.2%, to $6.2 million for thequarter ended September 30, 2005 compared to $4.3 million for thethree months ended September 30, 2004. Depreciation and amortizationexpense increased $3.7 million, or 29.4%, to $16.3 million for the nine months ended September 30, 2005 compared to$12.6 million for the nine months ended September 30, 2004. Thisincrease is primarily related to the increase in amortizable intangible assetsas a result of the purchase of Fortamet and Altoprev and the launch ofTriglide.

*Researchand Development Expense.**  *Research and development expense increased $0.9 million and$1.3 million to $1.4 million and $2.3 million for the three and nine monthsended September 30, 2005, respectively, compared to $0.5 million and $1.0 million for the three and ninemonths ended September 30, 2004. This increase is primarily related to potentialSular line extensions.

*InterestExpense.**  *Interestexpense was $0.8 million and $2.2 million for the three andnine months ended September 30, 2005 compared to $0.8 million and$1.7 million for the three and ninemonths ended September 30, 2004. The increase is due to borrowings underthe Company’s line of credit during the second and third quarters of 2005, andthe interest on the $150.0 million contingent convertible notes for the nine monthsended September 30, 2005.

*InterestIncome.**  *Interestincome was $0.7 million and $2.4 million for the three and nine monthsended September 30, 2005, compared to $1.2 million and $2.5 millionfor the three and nine months ended September 30, 2004. The decrease ininterest income for the three and nine months ended September 30, 2005 isprimarily due to a decrease in the average cash and marketable securitiesbalance resulting from the acquisitions of Fortamet, Altoprev and Triglide.

*Provision for Income Taxes.**  *Income taxes were provided for at arate of 32.4% and 32.4% for the three and nine months ended September 30,2005, respectively, compared to 36.0% and 38.2% for the three and nine monthsended September 30, 2004. This decrease in the effective rate is due tothe change in the mix of tax jurisdictions, both domestic and international, asa result of our implementation of international operations where our income wasearned, as well as a change in the ratio of non-deductible expenses to pre-taxincome.

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**Liquidity and Capital Resources**

Our liquidity requirements arise from debt service,working capital 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 cashequivalents were $14.7 million on September 30, 2005. Net cash provided byoperating activities for the nine months ended September 30, 2005 was$12.6 million. This source of cash was the result of net income of $26.2million, non-cash depreciation and amortization of $16.3 million, a decrease inincome tax receivable of $1.9 million, an increase in accrued expenses andother long-term liabilities of $0.3 million, non-cash tax expenses of $3.8million, $0.7 million for realized losses on marketable securities and non-cashinterest expense of $0.3 million. Partially offsetting the source of cash fromoperations was an increase in inventories of $17.2 million, a decrease inaccounts payable of $5.2 million, an increase in accounts receivable of $8.7million and an increase in other current assets and other assets of $6.0million,

Our cash and cash equivalents were $54.6 millionat September 30, 2004. Net cash provided by operating activities for thenine months ended September 30, 2004 was $44.4 million. Thisproviding of cash was the result of the net income of $18.0 million,non-cash depreciation and amortization expense of $12.6 million, accruedexpenses and other long-term liabilities and accounts payable of $7.1 million,non-cash tax expenses of $6.6 million, decrease in income tax receivableof $4.8 million and non-cash interest expense of $0.2 million. Partiallyoffsetting the provision of cash from operations were increases in accountsreceivable of $0.8 million, increases in inventory of $0.2 million, andincreases in other current assets and other assets of $3.9 million.

We maintain supply agreements with third partysuppliers for most of our products. Some of these supply agreements containminimum purchase requirements. For most of these supply agreements, we believethat our inventory requirements and related purchases of inventory will exceedthe minimum purchase requirements in 2005. In those cases in which we do not believeour purchases will exceed the minimum purchase requirements, we are seeking tonegotiate waivers or modifications of the minimum purchase requirements.

Net cash used in investing activities for the ninemonths ended September 30, 2005 was $31.6 million. The primary usesof this cash were for the purchases of product licenses of $106.3 million,the purchase of marketable securities of $21.0 million, and the purchases ofproperty and equipment of $1.8 million. Partially offsetting these uses ofcash were the net sales of marketable securities of $76.6 million. This liquidation of marketablesecurities was directly related to the acquisition of product licenses forFortamet and Altoprev, the first milestone payment of $15.0 millionpurchase price for Triglide and the $5.0 million additional purchase pricemilestone for Sular, as well as the $21.0 million in maturing investments thatwere reinvested upon maturity.

Net cash used in investing activities for the ninemonths ended September 30, 2004 was $156.4 million. The primary usesof this cash were for the purchases of marketable securities of$150.5 million and the purchases of product licenses of $5.3 million,and purchases of equipment of $0.6 million. During the second quarter of 2004,the Company announced an agreement with SkyePharma PLC, granting the Companythe exclusive license to market and distribute Triglide in the United States.

Net cash used in financingactivities was $0.3 million for the nine months ended September 30,2005 resulting from our repurchase of our common stock for $2.1 million. Partiallyoffsetting this net cash used was $1.8 million for the issuances of commonstock primarily related to option exercises.

Net cash provided by financing activities was$133.0 million for the nine months ended September 30, 2004. Theprimary providers of cash were the issuance of $150.0 million inconvertible debt in March 2004, as well as proceeds of $6.0 millionfrom the issuance of common stock. Partially offsetting this net cash 

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provided by financingactivities was $5.0 million in capitalized financing costs and$18.0 million in stock repurchases.

As of September 30, 2005, there were no amountsoutstanding under our $20 million senior credit facility.

We believe that our current balance of cash and cashequivalents, cash from operations, and the available balance of our creditfacility, will be adequate to fund our current working capital requirements forat least the next 12 months. However, in the event that we make acquisitionsin the future, 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 senior secured revolving credit facility with various lendersand LaSalle Bank National Association, as administrative agent. Subject to thesatisfaction of certain borrowing base requirements, we may from time-to-timeborrow monies under the revolving facility for working capital requirements andgeneral corporate purposes. Borrowings are secured by substantially all of ourassets. Borrowings bear interest at our option at the base rate in effect fromtime to time plus an applicable margin or the Eurodollar rate, plus anapplicable margin. The applicable margin will vary dependent upon our leverageratio in effect from time-to-time. As of September 30, 2005, we had noborrowings outstanding under this facility. During the second and thirdquarters of 2005, the Company borrowed various amounts on the facility, whichhave been repaid in full. The revolving facility, as amended, matures on August 11,2006. Fees payable under the revolving facility include a one-time commitmentfee of 0.685% of the stated amount of the facility, an unused commitment feebased on funds committed but not borrowed under the revolving facility at rateswhich vary dependent upon our leverage ratio in effect from time-to-time andletter of credit fees equal to 0.25% per annum of the face amount of letters ofcredit issued and outstanding under the revolving facility. The revolvingfacility may be prepaid from time-to-time or terminated at our discretionwithout penalty.

The credit facilitycontains various restrictive covenants, including covenants relative tomaintaining financial ratios and earnings levels, limitations on acquisitions,dispositions, mergers and capital expenditures, limitations on incurringadditional indebtedness and a prohibition on payment of dividends and certainissuances of our capital stock.

**Critical Accounting Policies**

We view ourcritical accounting policies to be those policies which are very important tothe portrayal of our financial condition and results of operations, and requiremanagement’s most difficult, complex or subjective judgments. The circumstancesthat make these judgments difficult or complex relate to the need formanagement to make estimates about the effect of matters that are inherentlyuncertain. We believe our critical accounting policies are as follows:

·       *Allowance for doubtful accounts.  *We are required toestimate the level of accounts receivable recorded on our balance sheet whichultimately will not be paid. Among other things, this assessment requiresanalysis of the financial strength of our customers, which can be highlysubjective, particularly in the recent difficult general economic environment.Our policy is to estimate bad debt expense based on prior experiencesupplemented by a periodic customer specific review when needed. If we over orunder estimate the level of accounts receivable that will not be paid, theremay be a material impact to our financial statements.

·       *Sales deductions.  *We provide volume rebates,contractual price reductions with drug wholesalers and insurance companies, andcertain other sales related deductions on a regular basis. The exact level ofthese deductions is not always immediately known and thus we must record anestimate at the time of sale. Our estimates are based on historical experiencewith similar programs, and since 

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we have a relatively smallcustomer 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 thelevel of sales deductions, there may be a material impact to our financialstatements.

·       *Product returns.  *In the pharmaceutical industry, customersare normally granted the right to return a product for a refund if the producthas not been used six-months prior to its expiration date, which is typicallytwo to three years from the date of manufacture, and for a set periodsubsequent to the expiration date. Our return policy allows product returns forproducts within an eighteen-month window from six months prior to theexpiration date and up to twelve months after the expiration date. Our returnpolicy conforms to industry standard practices. We believe that we havesufficient data to estimate future returns at the time of sale. Management isrequired to estimate the level of sales which will ultimately be returnedpursuant to our return policy, and record a related reserve at the time of sale.These amounts are deducted from our gross sales to determine our net revenues.Our estimates take into consideration historical returns of a given product,product specific information provided by our customers and information obtainedregarding the levels of inventory being held by our customers, as well asoverall purchasing patterns by our customers. Management periodically reviewsthe 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 the acquisition 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 financial statements.

·       *Intangible assets*.   When we acquire the rights tomanufacture and sell a product, we record the aggregate purchase price, alongwith the value of the product related liabilities that we assume, as intangibleassets. We use the assistance of valuation experts to help us allocate thepurchase price to the fair value of the various intangible assets that we haveacquired. Then, we must estimate the economic useful life of each of theseintangible assets in order to amortize their cost as an expense in ourstatement of operations over the estimated economic useful life of the relatedasset. The factors that drive the actual economic useful life of apharmaceutical product are inherently uncertain, and include patent protection,physician loyalty and prescribing patterns, competition by products prescribedfor similar indications, future introductions of competing products not yet FDAapproved, the impact of promotional efforts and many other issues. We use allof these factors in initially estimating the economic useful lives of ourproducts, and we also continuously monitor these factors for indications ofappropriate revisions. In assessing the recoverability of its intangibleassets, we must make assumptions regarding estimated future cash flows andother factors. If the estimated undiscounted future cash flows do not exceedthe carrying value of the intangible assets, we must determine the fair valueof the intangible assets. If the fair value of the intangible assets is lessthan its carrying value, an impairment loss will be recognized in an amountequal to the difference. We review intangible assets for impairment at leastannually and whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. Such events orcircumstances may include but are not limited to, lack of promotionalsensitivity, the introduction of competitive products and changes in governmentregulations. If we determine that an intangible asset is impaired, a non-cashimpairment charge would be recognized. If we should incur an impairment loss,there may be a material impact to our financial statements.

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On March 6, 2002, we acquired certain U.S. rightsrelating to Sular for an aggregate purchase price of $184.3 million. Withthe assistance of valuation experts, we allocated the purchase price to thefair value of the various intangible assets which we acquired as part of thetransaction. In addition, we assigned useful lives to acquired intangibleassets which are not deemed to have an indefinite life. Intangible assets areamortized on a straight line basis over their respective useful lives. Theintangible assets recorded in connection with the acquisition of Sular arebeing amortized over periods ranging from five to twenty years with a weightedaverage amortization period of nineteen years. In light of our experience in2002 in promoting Sular, we carefully evaluated the useful lives assigned tothe intangible assets acquired in the Sular acquisition and whether or not anyimpairment of any such assets was indicated. Our best estimate is that theuseful lives assigned to the Sular intangible assets remain appropriate. Ourestimate of such useful lives is subject to significant risks anduncertainties. Among these risks and uncertainties is our ability to developone or more new versions of the product, obtain approval from the FDA to marketand sell such newly developed product and procure patent protection for thatproduct before the expiration of the last to expire of the existing patentsrelated to Sular in 2008. SFAS No. 144 “Accounting for the Impairment orDisposal of Long-Lived Assets” states that an impairment loss shall berecognized only if the carrying amount of a long-lived asset is not recoverableand exceeds its fair value. As of September 30, 2005, the undiscounted futurecash flows of Sular as estimated by us over the remaining useful life of theproduct 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.

·       *Income Taxes*.   Income taxes are providedfor under the liability method. This approach requires the recognition ofdeferred tax assets and liabilities for the expected future tax consequences ofdifferences between the tax basis of assets or liabilities and their carryingamounts in the consolidated financial statements. A valuation allowance isprovided for deferred tax assets if it is more likely than not that these itemswill either expire before we are able to realize their benefit or if futuredeductibility is uncertain.

Developing the provision for income taxes requiressignificant judgment and expertise in international, federal and state incometax laws, regulations and strategies, including the determination of deferredtax assets and liabilities and, if necessary, any valuation allowances that maybe required for deferred tax assets. Our judgments and tax strategies aresubject to audit by various taxing authorities. While we believe we haveprovided adequately for our income tax liabilities in our consolidatedfinancial statements, adverse determinations by these taxing authorities couldhave a material adverse effect on our consolidated financial condition andresults of operations.

·       *Inventory obsolescence.*   Our products have shelf livesranging from 18 to 48 months. We must estimate the amount of inventoryrecorded on our balance sheet that will not be sold prior to expiration. Thisestimate requires analysis of forecasted demand for our products, ourpromotional focus, amounts of our products currently held by our customers and theimpact on our products of competing products. If we over or under estimate theamount of inventory that will not be sold prior to expiration, there may be amaterial impact to our financial statements.

**Forward Looking Statements**

This reportcontains forward-looking statements (in addition to historical facts) that aresubject to risks and uncertainties that could cause actual results tomaterially differ from those described. Although we believe that theexpectations expressed in these forward-looking statements are reasonable, wecannot 

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promisethat our expectations 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:

·       Wemay not attain expected revenues and earnings;

·       The60 mg Altoprev product is currently experiencing manufacturing issues. If the issuescannot be resolved, our ability to acquire the product for sale and samplingwill be adversely affected;

·       Ifwe are unsuccessful in obtaining third party payor contracts for our products,we may experience reductions in sales levels and may fail to reach anticipatedsales levels;

·       Ifdemand for our products exceeds our initial expectations or the ability of oursuppliers to provide demand-meeting quantities of product and samples, ourfuture ability to sell these products could be adversely impacted;

·       Thepotential growth rate for our promoted products may be limited by slower growthfor the class of drugs to which our promoted products belong and unfavorableclinical studies 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 products;

·       Wemay not be able to protect our competitive position for our promoted productsfrom patent infringers;

·       Salesof our Tanafed and Robinul products have been adversely affected by theintroduction of knock-off and generic products, respectively;

·       Anissued FDA notice may cause us to incur increased expenses and adversely affectour ability to continue to market and sell our Tanafed products;

·       Wemay incur unexpected costs in integrating new products into our operations;

·       Wemay be unable to develop or market line extensions for our products includingSular, Triglide and Fortamet, or, even if developed, obtain patent protectionfor our line extensions. Further, introductions by us of line extensions of ourexisting products may require that we make unexpected changes in our estimatesfor future product returns and reserves for obsolete inventory. If these risksoccur, our operating results would be adversely affected;

·       Ourlicensor/supplier can terminate our rights to commercialize Nitrolingual andthe 60 dose size of this product has not yet met our expectation;

·       Anadverse ruling by one of the taxing jurisdictions in which we operate couldadversely impact our operating results;

·       Asmall number of customers account for a large portion of our sales and the lossof one of them, or changes in their purchasing patterns, could result insubstantially reduced sales substantially and adversely impacting our financialresults;

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

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·       Werely on operational data obtained from IMS, an industry accepted data source. IMSdata may not accurately reflect actual prescriptions (for instance, we believeIMS data does not capture all product prescriptions from some non-retailchannels);

·       Anadverse judgment in the securities class action litigation in which we andcertain current and former directors and executive officers are defendantscould have a material adverse effect on our results of operations andliquidity;

·       Ifwe fail to obtain, or encounter difficulties in obtaining, regulatory approvalfor new products or new uses of existing products, or if our developmentagreements are terminated, we will have expended significant resources for noreturn;

·       Ourbusiness and products are highly regulated. The regulatory status of some ofour products makes these products subject to increased competition and otherrisks, and we run the risk that we, or third parties on whom we rely, couldviolate the governing regulations;

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

·       Someunforeseen difficulties may occur.

This list is intended to identify some of theprincipal factors that could cause actual results to differ materially fromthose described in the forward-looking statements included herein. Thesefactors are not intended to represent a complete list of all risks anduncertainties inherent in our business, and should be read in conjunction withthe more detailed cautionary statements and risk factors included in our otherfilings with the Securities and Exchange Commission.

The Company’s productnames are trademarks, in some cases registered, of the Company.

**ITEM 3.**                QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed tocertain market risks that arise in the ordinary course of business. Adiscussion of the Company’s primary market risk exposure is presented below.

**Foreign Currency Exchange Risk**

Our purchases ofNitrolingual from Pohl-Boskamp, our purchases of Triglide under our agreementwith SkyePharma and our purchase of Sular from Bayer are made in Euros.Although we did not enter into any forward contracts in the third quarter of2005, we may eliminate risks from foreign currency fluctuations after the timeof shipment of product by entering into forward contracts for these purchasesof inventory at the time of product shipments. The Company’s earnings and cashflows could be adversely affected in the future by the relationship of the U.S.dollar with foreign currencies.

**Market Risk on Investments**

The fair value of ourinvestment portfolio would be negatively affected by an increase in interestrates. Since the majority of the Company’s investments are fixed rateinterest-bearing securities and therefore subject to the market risk of loss inmarket value from an increase in rates or a change in the underlying risk ofthe issuers of the notes, the Company’s future earnings and cash flows could beaffected adversely if the Company were to sell the securities prior to theirmaturity date. There were realized losses from the sale of investments for thethree and nine months ended September 30, 2005 of $0.0 million and$0.7 million, respectively. At September 30, 2005, the Company had totalnet unrealized losses from marketable securities of $2.0 million.

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**Market Risk on Variable Rate Debt**

In connection withborrowings incurred under the credit facility with LaSalle Bank, we couldexperience market risk with respect to changes in the general level of theinterest rates and its effect upon our interest expense. Borrowings under thisfacility bear interest at variable rates. Because such rates are variable, anincrease in interest rates will result in additional interest expense and areduction in interest rates will result in reduced interest expense.Accordingly, our present exposure to interest rate fluctuations is dependent onrate changes that may occur while borrowings under the senior secured creditfacility are outstanding. In April 2005, the Company borrowed$20 million on the facility, but repaid the $20 million loan and on September 30,2005 there was no debt outstanding under this facility.

**Market Risk on Fixed Rate Debt**

The Company’s long-termfixed interest rate senior subordinated contingent convertible notes are alsosubject to market risk. Fixed rate debt outstanding at September 30, 2005was $150 million with an interest rate of 1.75%. All other things beingequal, the fair market value of the Company’s fixed rate debt will increase asrates decline and will decrease as rates rise. The fixed rate notes outstandingtotaling $150.0 million at September 30, 2005 had a fair value of$151.7 million based on quoted market rates.

**ITEM 4.**                CONTROLSAND PROCEDURES

**Evaluationof Disclosure Controls and Procedures**

We maintain a set ofdisclosure controls and procedures that are designed to ensure that informationrequired to be disclosed in the reports that we file under the SecuritiesExchange Act of 1934, as amended (“Exchange Act”), is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms. We carried out an evaluation under the supervision and with theparticipation of management, including our Chief Executive Officer and Presidentand our Chief Financial Officer, of the effectiveness of the design andoperation of First Horizon’s disclosure controls and procedures pursuant to Rule 13a-15(e) ofthe Exchange Act as of the end of the period covered by this report. Our ChiefExecutive Officer and President and Chief Financial Officer concluded that ourdisclosure controls and procedures are effective to ensure that as of theend of the period 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 rules andforms and (ii) such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and President and our ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure.

**Changesin Internal Control over Financial Reporting**

There has been no change in First Horizon’s primaryinternal controls over financial reporting during the third fiscal quarter of2005, that has materially affected, or is reasonably likely to materiallyaffect First Horizon’s internal controls over financial reporting.

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**PART II—OTHER INFORMATION**

**ITEM 1:**               LEGALPROCEEDINGS

We, along with certain former and current officers anddirectors, were named defendants in a consolidated securities lawsuit initiatedon August 22, 2002 in the United States District Court for the NorthernDistrict of Georgia. Plaintiffs in the class action litigation alleged ingeneral terms that we violated Sections 11 and 12(a)(2) of the SecuritiesAct of 1933 and that we violated Sections 10(b) and 20(a) of theSecurities Exchange Act of 1934 and Rule 10b-5 promulgatedthereunder. In an amended complaint, Plaintiffs claimed that we issued a seriesof materially false and misleading statements to the market in connection withour public 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 of1934. Plaintiffs sought an unspecified amount of compensatory damages in anamount to be proven at trial.

On September 29, 2004, the U.S. District Courtfor the Northern District of Georgia dismissed, without prejudice, the classaction lawsuit. Although the class action lawsuit was dismissed, the courtgranted the plaintiffs the opportunity to amend their class action lawsuitprovided that the plaintiffs pay all of the defendants’ fees and costsassociated with filing the motions to dismiss the class action lawsuit. Plaintiffsdid not file a second amended complaint as permitted, but instead filed amotion asking the District Court to reconsider its September 29, 2004order and lift the condition that they must pay defendants’ fees and costsbefore further amendment. On June 22, 2005, the District Court deniedplaintiffs’ motion and gave them another opportunity to amend if they paydefendants’ fees and costs. Once again, plaintiffs chose not to file a secondamended complaint. Instead, plaintiffs filed an appeal to the United StatesCourt of Appeals for the Eleventh Circuit. This appeal currently is pending.

As previously reported, the Company was recentlyinvolved in three litigated matters with Breckenridge Pharmaceutical, Inc. andScientific Laboratories, Inc. All three matters have been settled on termsmutually agreeable to all parites, and all lawsuits have been dismissed.

The Company is alsoinvolved with other various routine legal proceedings incident to the ordinarycourse of business. None of these proceedings are expected to have a materialadverse effect on the consolidated financial statements.

**ITEM 2:**               UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS

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 September 30, 2005,deferred compensation related to the restricted stock totaled $215,000.

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Thefollowing table presents the total number of shares repurchased during thefirst 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 |   |   |
| July 1, 2005  through August 2, 2005       |       | N/A        |       |     | —     |                                         |       |                                         | —     |                                                                                                           |       |                                                                                                                         | —     |   |   |   | -0- |   |   |
| August 3, 2005  through September 30, 2005           |       |       | (2)        |     | —     |                                         |       |                                         | —     |                                                                                                           |       |                                                                                                                         | —     |   |   |   | 20,000,000 |   |   |
| 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. Thisshare repurchase program expired on August 2, 2005. 

*(2)*   In July 2005, the Board of Directors authorized a new $20million repurchase program, effective August 3, 2005, having no per-periodsublimits on repurchases.

**ITEM 4:**               SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

**ITEM 5:**               OTHERINFORMATION

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**

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

|                              | ** ** | **First Horizon  Pharmaceutical Corporation**                                                    |
|------------------------------|------------|--------------------------------------------------------------------------------------------------|
|                         |       | (Registrant)                                                                                     |
| Date: October 28,  2005 |       |                                                                                             |
|                         | By:        | /s/ PATRICK P.  FOURTEAU                                                                         |
|                         |       | Patrick P. Fourteau                                                                              |
| * *                     | * *   | *Chief Executive Officer and President  (principal executive officer)*                           |
| Date: October 28,  2005 |       |                                                                                             |
|                         | By:        | /s/ DARRELL  BORNE                                                                               |
|                         |       | Darrell Borne                                                                                    |
|                         | * *   | *Chief Financial Officer, Secretary and Treasurer  (principal accounting and financial officer)* |

 

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