** **

**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

** **

**For the quarterly periodended June 30, 2006**

** **

**OR**

** **

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

 

**For the transition periodfrom                          to                          **

** **

**Commission FileNo. 000-30123**

** **

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**SCIELE PHARMA, INC.**

(Exact name of registrant as specified in its charter)

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

 

**(770) 442-9707**

(Registrant’s telephone number, including area code):

 

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

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

 

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

o Yes   x No  

As of August 4, 2006, there were 35,220,495 shares of the Registrant’sCommon Stock outstanding.

 

 

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**SCIELE PHARMA, INC.FORM 10-QINDEX**
|                                                       | ** ** | ** **                                                                                                      | ** ** | **Page** |
|-------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|----------|
| PART  I.    FINANCIAL INFORMATION |       |                                                                                                            |
|                                                  |       |                                                                                                            |       |     |
| Item 1.                                          |       | Consolidated Balance  Sheets at June 30, 2006 and December 31, 2005                                             |       | 3        |
|                                                  |       |                                                                                                            |       |     |
|                                                  |       | Consolidated Statements of Operations for the three  and six months ended June 30, 2006 and June 30, 2005  |       | 4        |
|                                                  |       |                                                                                                            |       |     |
|                                                  |       | Consolidated Statements of Cash Flows for the six  months ended June 30, 2006 and  June 30, 2005                |       | 5        |
|                                                  |       |                                                                                                            |       |     |
|                                                  |       | Notes to Consolidated Financial Statements                                                                      |       | 6        |
|                                                  |       |                                                                                                            |       |     |
| Item 2.                                               |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                     |       | 14       |
|                                                  |       |                                                                                                            |       |     |
| Item 3.                                               |       | Quantitative  and Qualitative Disclosures about Market Risk                                                     |       | 20       |
|                                                  |       |                                                                                                            |       |     |
| Item 4.                                               |       | Controls and  Procedures                                                                                        |       | 21       |
|                                                  |       |                                                                                                            |       |     |
| PART  II.    OTHER INFORMATION    |       | 21                                                                                                              |
|                                                  |       |                                                                                                            |       |     |
| Item 1.                                               |       | Legal  Proceedings                                                                                              |       | 21       |
|                                                  |       |                                                                                                            |       |     |
| Item 2.                                               |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                    |       | 21       |
|                                                  |       |                                                                                                            |       |     |
| Item 4.                                               |       | Submission of  Matters to a Vote of Security Holders                                                            |       | 22       |
|                                                  |       |                                                                                                            |       |     |
| Item 5.                                               |       | Other  Information                                                                                              |       | 22       |
|                                                  |       |                                                                                                            |       |     |
| Item 6.                                          |       | Exhibits                                                                                                        |       | 22       |
|                                                  |       |                                                                                                            |       |     |
|                                                  |       | Signatures                                                                                                      |       | 23       |
|                                                  |       |                                                                                                            |       |     |
|                                                  |       | Certifications                                                                                                  |       |     |

 

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**PARTI—FINANCIAL INFORMATION**

**ITEM 1. FINANCIAL STATEMENTS**

**SCIELE PHARMA,INC.CONSOLIDATED BALANCE SHEETS(in thousands, except share data)**
| ** **                                                                                                                                                  | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                  | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                  | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                             |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                   |       | $                       | 30,843     |                        | $          | 17,043 |   |
| Marketable securities                                                                                                                                       |       | 102,177                 |       | 82,757                      |       |
| Accounts receivable, net of allowance of $2,746 and  $2,427 at June 30, 2006 and December 31, 2005, respectively                                       |       | 44,141                  |       | 48,353                      |       |
| Inventories                                                                                                                                                 |       | 26,708                  |       | 28,924                      |       |
| Income taxes receivable                                                                                                                                     |       | 7,763                   |       | 547                         |       |
| Current deferred tax assets                                                                                                                                 |       | 2,919                   |       | 3,705                       |       |
| Other current assets                                                                                                                                        |       | 23,777                  |       | 23,059                      |       |
|                                                                                                                                                        |       |                    |       |                        |       |
| Total current assets                                                                                                                                        |       | 238,328                 |       | 204,388                     |       |
|                                                                                                                                                        |       |                    |       |                        |       |
| Property and equipment, net                                                                                                                                 |       | 8,011                   |       | 5,148                       |       |
| Other assets:                                                                                                                                               |       |                    |       |                        |       |
| Intangibles, net                                                                                                                                            |       | 309,102                 |       | 315,798                     |       |
| Other                                                                                                                                                       |       | 5,301                   |       | 4,371                       |       |
|                                                                                                                                                        |       |                    |       |                        |       |
| Total other assets                                                                                                                                          |       | 314,403                 |       | 320,169                     |       |
|                                                                                                                                                        |       |                    |       |                        |       |
| Total assets                                                                                                                                                |       | $                       | 560,742    |                        | $          | 529,705 |   |
|                                                                                                                                                        |       |                    |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                              | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current  liabilities:                                                                                                                                       |       |                    |       |                        |       |
| Account payable                                                                                                                                             |       | $                       | 14,901     |                        | $          | 12,093 |   |
| Accrued expenses                                                                                                                                            |       | 18,184                  |       | 18,482                      |       |
|                                                                                                                                                        |       |                    |       |                        |       |
| Total current liabilities                                                                                                                                   |       | 33,085                  |       | 30,575                      |       |
|                                                                                                                                                        |       |                    |       |                        |       |
| Long-term  liabilities:                                                                                                                                     |       |                    |       |                        |       |
| Convertible debt                                                                                                                                            |       | 150,000                 |       | 150,000                     |       |
| Deferred tax liabilities                                                                                                                                    |       | 10,721                  |       | 8,803                       |       |
| Other long-term liabilities                                                                                                                                 |       | 2,489                   |       | 191                         |       |
|                                                                                                                                                        |       |                    |       |                        |       |
| Total liabilities                                                                                                                                           |       | 196,295                 |       | 189,569                     |       |
|                                                                                                                                                        |       |                    |       |                        |       |
| Stockholders’  equity:                                                                                                                                 |       |                    |       |                        |       |
| Preferred stock, 1,000,000 shares authorized and  none outstanding                                                                                          |       | —                  |       | —                      |       |
| Common stock, $0.001 par value; 100,000,000 shares  authorized; 36,000,781 and 35,907,376 issued at June 30, 2006 and  December 31, 2005, respectively |       | 36                      |       | 36                          |       |
| Additional paid-in capital                                                                                                                                  |       | 298,036                 |       | 292,639                     |       |
| Retained earnings                                                                                                                                           |       | 101,823                 |       | 82,524                      |       |
| Deferred compensation                                                                                                                                       |       | (13,079                 | )          | (7,489                      | )          |
| Accumulated other comprehensive loss                                                                                                                        |       | (3,817                  | )          | (4,384                      | )          |
|                                                                                                                                                        |       | 382,999                 |       | 363,326                     |       |
| Less: Treasury stock at cost, Common stock, 800,000  and 1,000,000 shares at June 30, 2006 and December 31, 2005,  respectively                        |       | (18,552                 | )          | (23,190                     | )          |
|                                                                                                                                                        |       |                    |       |                        |       |
| Total stockholders’ equity                                                                                                                             |       | 364,447                 |       | 340,136                     |       |
|                                                                                                                                                        |       |                    |       |                        |       |
| Total liabilities and stockholders’ equity                                                                                                             |       | $                       | 560,742    |                        | $          | 529,705 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

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**SCIELEPHARMA, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(unaudited, in thousands, except per share data)**

 
| ** **                                                  | ** ** | **For The Three Months Ended June 30,** | ** ** | **For The Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **2006**                                                              | ** ** | **2005**                                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net revenues                                                |       | $                                                                     | 72,399     |                                                                | $          | 49,816 |   | $ | 138,852 |   | $ | 90,773 |   |
| Operating costs and  expenses:                              |       |                                                                  |       |                                                                |       |   |   |   |   |
| Cost of revenues (excluding depreciation and  amortization) |       | 10,546                                                                |       | 7,353                                                               |       | 19,898 |   | 14,522 |   |
| Selling, general and administrative expense                 |       | 36,531                                                                |       | 24,075                                                              |       | 71,046 |   | 41,760 |   |
| Depreciation and amortization                               |       | 6,521                                                                 |       | 5,742                                                               |       | 13,035 |   | 10,105 |   |
| Research and development expense                            |       | 3,961                                                                 |       | 621                                                                 |       | 6,821 |   | 886 |   |
|                                                        |       |                                                                  |       |                                                                |       |   |   |   |   |
| Total operating costs and expenses                          |       | $                                                                     | 57,559     |                                                                | $          | 37,791 |   | $ | 110,800 |   | $ | 67,273 |   |
|                                                        |       |                                                                  |       |                                                                |       |   |   |   |   |
| Operating income                                            |       | 14,840                                                                |       | 12,025                                                              |       | 28,052 |   | 23,500 |   |
|                                                        |       |                                                                  |       |                                                                |       |   |   |   |   |
| Other income (expense):                                     |       |                                                                  |       |                                                                |       |   |   |   |   |
| Interest expense                                            |       | (760                                                                  | )          | (964                                                                | )          | (1,525 | ) | (1,403 | ) |
| Interest income                                             |       | 1,063                                                                 |       | 935                                                                 |       | 1,975 |   | 1,678 |   |
| Other                                                       |       | —                                                                |       | (400                                                                | )          | — |   | (684 | ) |
|                                                        |       |                                                                  |       |                                                                |       |   |   |   |   |
| Total other income (expense)                                |       | $                                                                     | 303        |                                                                | $          | (429 | ) | $ | 450 |   | $ | (409 | ) |
|                                                        |       |                                                                  |       |                                                                |       |   |   |   |   |
| Income before  provision for income taxes                   |       | 15,143                                                                |       | 11,596                                                              |       | 28,502 |   | 23,091 |   |
| Provision for  income taxes                                 |       | (4,971                                                                | )          | (3,592                                                              | )          | (9,203 | ) | (7,499 | ) |
|                                                        |       |                                                                  |       |                                                                |       |   |   |   |   |
| Net income                                                  |       | $                                                                     | 10,172     |                                                                | $          | 8,004 |   | $ | 19,299 |   | $ | 15,592 |   |
| Other  comprehensive gain (loss)                            |       | $                                                                     | 429        |                                                                | $          | (1,348 | ) | $ | 567 |   | $ | (2,526 | ) |
|                                                        |       |                                                                  |       |                                                                |       |   |   |   |   |
| Comprehensive  income                                       |       | $                                                                     | 10,601     |                                                                | $          | 6,656 |   | $ | 19,866 |   | $ | 13,066 |   |
|                                                        |       |                                                                  |       |                                                                |       |   |   |   |   |
| Net income per common  share:                               |       |                                                                  |       |                                                                |       |   |   |   |   |
| Basic earnings per common share                             |       | $                                                                     | 0.29       |                                                                | $          | 0.23 |   | $ | 0.55 |   | $ | 0.44 |   |
|                                                        |       |                                                                  |       |                                                                |       |   |   |   |   |
| Diluted earnings per common share                           |       | $                                                                     | 0.27       |                                                                | $          | 0.20 |   | $ | 0.49 |   | $ | 0.39 |   |
|                                                        |       |                                                                  |       |                                                                |       |   |   |   |   |
| Weighted average common  shares outstanding:                |       |                                                                  |       |                                                                |       |   |   |   |   |
| Basic                                                       |       | 35,346                                                                |       | 35,029                                                              |       | 35,201 |   | 35,047 |   |
|                                                        |       |                                                                  |       |                                                                |       |   |   |   |   |
| Diluted                                                     |       | 38,550                                                                |       | 42,415                                                              |       | 40,602 |   | 42,453 |   |

 

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

4

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**SCIELEPHARMA, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited, in thousands)**

 
| ** **                                                                                   | ** ** | **For The Six Months** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                   | ** ** | **Ended June 30,**          | ** ** |
| ** **                                                                                   | ** ** | **2006**                              | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                                       |       |                                  |       |   |   |
| Net income                                                                                   |       | $                                     | 19,299     |   | $ | 15,592 |   |
| Adjustments to  reconcile net income to net cash (used in) provided by operating activities: |       |                                  |       |   |   |
| Depreciation and amortization                                                                |       | 13,035                                |       | 10,105 |   |
| Marketable securities impairment                                                             |       | —                                |       | 684 |   |
| Non-cash compensation expense                                                                |       | 4,415                                 |       | 5 |   |
| Non-cash interest expense                                                                    |       | 168                                   |       | 170 |   |
| Deferred income tax expense                                                                  |       | 2,646                                 |       | 1,527 |   |
| Reduction in taxes payable—stock option exercises                                       |       | —                                |       | 476 |   |
| Changes in  assets and liabilities, net of acquired assets and liabilities:                  |       |                                  |       |   |   |
| Accounts receivable                                                                          |       | 4,212                                 |       | (3,147 | ) |
| Inventories                                                                                  |       | 2,216                                 |       | (18,054 | ) |
| Other current assets and other assets                                                        |       | (691                                  | )          | (3,668 | ) |
| Income taxes receivable                                                                      |       | (7,216                                | )          | 1,345 |   |
| Accrued expenses and other                                                                   |       | 1,083                                 |       | 1,393 |   |
| Accounts payable                                                                             |       | 2,808                                 |       | (6,129 | ) |
| Net cash provided by operating activities                                                    |       | 41,975                                |       | 299 |   |
| Cash flows from  investing activities:                                                       |       |                                  |       |   |   |
| Purchase of products                                                                         |       | (5,000                                | )          | (94,671 | ) |
| Purchase of property and equipment                                                           |       | (1,886                                | )          | (1,163 | ) |
| Proceeds from sale of marketable securities                                                  |       | 42,223                                |       | 97,271 |   |
| Purchase of marketable securities                                                            |       | (61,539                               | )          | (20,994 | ) |
| Net cash used in investing activities                                                        |       | (26,202                               | )          | (19,557 | ) |
| Cash flows from  financing activities:                                                       |       |                                  |       |   |   |
| Repurchase of  common stock                                                                  |       | (6,932                                | )          | (2,094 | ) |
| Financing debt costs                                                                         |       | (1,775                                | )          | — |   |
| Reduction in taxes payable—stock option exercises                                       |       | 2,149                                 |       | — |   |
| Net proceeds from issuance of common stock                                                   |       | 4,064                                 |       | 875 |   |
| Net cash used in financing activities                                                        |       | (2,494                                | )          | (1,219 | ) |
| Effect of foreign exchange rates on cash                                                     |       | 521                                   |       | (2,694 | ) |
| Net change in cash and cash equivalents                                                      |       | 13,800                                |       | (23,171 | ) |
| Cash and cash equivalents, beginning of period                                               |       | 17,043                                |       | 36,586 |   |
| Cash and cash equivalents, end of period                                                     |       | $                                     | 30,843     |   | $ | 13,415 |   |
| Non-cash  financing transactions:                                                            |       |                                  |       |   |   |
| Issuance of restricted stock                                                                 |       | $                                     | 4,924      |   | $ | 235 |   |
| Supplemental  Cash Flow Information:                                                         |       |                                  |       |   |   |
| Cash paid for income taxes                                                                   |       | $                                     | 11,449     |   | $ | 3,499 |   |
| Cash paid for  interest                                                                      |       | $                                     | 1,325      |   | $ | 1,520 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

5

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**SCIELEPHARMA, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(unaudited)**

**1.             Name Change**

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

**2.             Basis of Presentation**

Theaccompanying unaudited interim consolidated financial statements reflect alladjustments (consisting solely of normal recurring adjustments) which managementconsiders necessary for the fair presentation of the financial position,results of operations and cash flows of the Company for the interim periods.Certain footnote disclosures normally included in financial statements preparedaccording to accounting principles generally accepted in the United States ofAmerica have been condensed or omitted from these interim financial statementsas permitted by the rules and regulations of the Securities and ExchangeCommission. Interim results are not necessarily indicative of results for thefull year. The interim results should be read in conjunction with the financialstatements and notes thereto included in the Company’s Annual Report onForm 10-K for the year ended December 31, 2005 (File No. 000-30123).

**3.             New Accounting Pronouncements**

InMarch 2006, the Financial Accounting Standards Board (“FASB”) issuedStatement 156, *Accounting for Servicing of FinancialAssets,*which amends FAS 140, *Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities.*Ina significant change to current guidance, the Statement of Financial AccountantStandards (“SFAS”) No. 156 permits an entity to choose either of thefollowing subsequent measurement methods for each class of separatelyrecognized servicing assets and servicing liabilities:  (1) Amortization Method or (2) FairValue Measurement Method. SFAS No. 156 is effective as of the beginning ofan entity’s first fiscal year that begins after September 15, 2006.   The adoption of SFAS No. 156 is not expectedto have a material impact on the Company’s financial statements.

InFebruary 2006, the FASB issued Statement No. 155, *Accounting for Certain Hybrid Financial Instruments—an amendment ofFASB Statements No. 133 and 140.*This Statement permits fairvalue of remeasurement for any hybrid financial instrument that contains anembedded derivative that otherwise would require bifurcation; clarifies whichinterest-only strips and principal-only strips are not subject to therequirements of SFAS No. 133, *Accounting for DerivativeInstruments and Hedging Activities;*establishes a requirement toevaluate interests in securitized financial assets to identify interests thatare freestanding derivatives or that are hybrid financial instruments that containan embedded derivative requiring bifurcation; clarifies that concentrations ofcredit risk in the form of subordination are not embedded derivatives; andamended SFAS No. 140, *Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities,*toeliminate the prohibition on a qualifying special-purpose entity from holding aderivative financial instrument that pertains to a beneficial interest otherthan another derivative financial instrument. SFAS No. 155 is effectivefor all financial instruments acquired, issued, or subject to a remeasurement(new basis) event occurring after the beginning of an entity’s first fiscalyear that begins after September 15, 2006. The adoption of SFAS No. 155 is not expected to have a material impacton the Company’s financial statements.

InJuly 2006, the FASB issued FIN No. 48,*Accounting for Uncertainty in Income Taxes* (“FIN No. 48”). FINNo. 48 clarifies the accounting for income taxes by prescribing the minimumrecognition threshold a tax position is required to meet before beingrecognized in the financial statements. FIN 48 also provides guidance onderecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. In addition, FIN 48 scopes outincome taxes from Financial Accounting Standards Board Statement No. 5, *Accounting for Contingencies*.  The Interpretation is effective for fiscalyears beginning after December 15, 2006. The Company has not determinedthe effect, if any, the adoption of the Interpretation will have on itsfinancial statements.

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

InDecember 2004, the FASB issued Statement 153, *Exchanges of Nonmonetary Assets, an amendment of APB Opinion No.29.*The standard is based on the principle that exchanges of nonmonetary assetsshould be measured based on the fair value of 

6

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the assetsexchanged and eliminates the exception under APB Opinion No. 29 for anexchange of similar productive assets and replaces it with an exception forexchanges of nonmonetary assets that do not have commercial substance. Thestandard is effective for nonmonetary exchanges occurring in fiscal periodsbeginning after June 15, 2005. The adoption of SFAS No. 153 did nothave a material impact on the Company’s financial position or results ofoperations.

InDecember 2004, the FASB issued Statement 123 (revised 2004), *Share-Based Payment.* The Statementeliminates the disclosure-only election under SFAS 123 and requires therecognition of compensation expense for stock options and other forms of equitycompensation based on the fair value of the instruments on the date of grant.The standard is effective for fiscal years beginning after June 15, 2005.See Note 4 for the effect of the adoption on net income and earnings pershare.

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

AtJune 30, 2006, the Company had two stock-based compensation plans allowing forthe issuance of stock options and restricted shares and an employee stockownership plan. Prior to December 31, 2005, the Company accounted for thoseplans under the recognition and measurement provisions of APB Opinion (“APB”)No. 25, *Accounting for Stock Issued to Employees*,and related Interpretations, as permitted by FASB Statement No. 123 (revised2004) (“SFAS 123”), *Accounting for Stock-BasedCompensation*. No stock-based employee compensation cost related tostock options was recognized in the Statement of Operations for the six monthsended June 30, 2005, as all options granted under those plans had an exerciseprice equal to the market value of the underlying common stock on the date ofgrant. Effective January 1, 2006, the Company adopted the fair valuerecognition provisions of FASB Statement No. 123(R) (“SFAS 123R”), “*Share-Based Payment*”, using themodified-prospective-transition method. Under that transition method,compensation cost recognized in the six months ended June 30, 2006 includes:(a) compensation cost for all share-based payments granted prior to, but notyet vested as of January 1, 2006, based on the grant date fair value estimatedin accordance with the original provisions of SFAS No. 123, and (b)compensation cost for all share-based payments granted subsequent to January 1,2006, based on the grant-date fair value estimated in accordance with theprovisions of SFAS No. 123R. Results for prior periods have not been restated.

As aresult of adopting SFAS No. 123R on January 1, 2006, the Company’s incomebefore income taxes for the three and six months ended June 30, 2006, are $2.4million and $4.4 million lower, respectively than if it had continued toaccount for share-based compensation under APB No. 25.  Basic earnings per share for the three and sixmonths ended June 30, 2006 would have been $0.33 and $0.63, respectively, ifthe Company had not adopted SFAS No. 123R, compared to reported basic earningsper share of $0.29 and $0.55, respectively. Diluted earnings per share for the three and six months ended June 30,2006 would have been $0.31 and $0.57, respectively, if the Company had notadopted SFAS No. 123R, compared to reported diluted earnings per share of $0.27and $0.49, respectively.

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

Theweighted average fair value per share of options granted during the three andsix months ended June 30, 2006 and June 30, 2005 is estimated at $22.20 and $16.93and $14.96 and $18.30, respectively. The value of options is estimated on thedate of the grant using the following weighted average assumptions:
| ** **               | ** ** | **2006**     | ** ** | **2005**     | ** ** |
|--------------------------|------------|--------------|------------|--------------|------------|
| Risk-free  interest rate |       | 5.08         | %          | 3.76         | %          |
| Expected  dividend yield |       | —       |       | —       |       |
| Expected lives           |       | 5 years |       | 5 years |       |
| Expected volatility      |       | 105.59       | %          | 116.25       | %          |

 

The Company hasgranted stock options to officers, directors and employees as follows (sharesin thousands):
| ** **                             | ** ** | ** **          | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **    | ** ** |
|----------------------------------------|------------|---------------------|------------|--------------|------------|-----------------|------------|---------------|------------|
| ** **                             | ** ** | **Number of**  | ** ** | **Weighted** | ** ** | **Average**     | ** ** | **Aggregate** | ** ** |
| ** **                             | ** ** | **Shares**          | ** ** | **Average**  | ** ** | **Remaining**   | ** ** | **Intrinsic** | ** ** |
| ** **                             | ** ** | **Subject to** | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Value**     | ** ** |
| ** **                             | ** ** | **Issuance**        | ** ** | **Price**    | ** ** | **Term**        | ** ** | **($000)**    | ** ** |
| Outstanding at  December 31, 2005 |       | 2,579               |       | $            | 13.19      |            |       |          |       |   |
| Granted                                |       | 140                 |       | 16.93        |       |            |       |          |       |
| Cancelled                              |       | (113                | )          | 13.58        |       |            |       |          |       |
| Exercised                              |       | (433                | )          | 9.38         |       |            |       |          |       |
| Outstanding at June 30,  2006          |       | 2,173               |       | $            | 14.17      |            | 4.5 years  |          | $          | 30,791 |   |
|                                        |            |                     |            |              |            |                 |            |               |            |  |  |

 

The Company hadthe following stock options available for exercise (shares in thousands):
| ** **        | ** ** | **Weighted  Average** | ** ** | ** **         | ** ** | **Aggregate** | ** ** |
|-------------------|------------|-----------------------|------------|--------------------|------------|---------------|------------|
| ** **        | ** ** | **Remaining**         | ** ** | **Number of** | ** ** | **Intrinsic** | ** ** |
| ** **        | ** ** | **Contractual**       | ** ** | **Shares**         | ** ** | **Value**     | ** ** |
| ** **        | ** ** | **Term**              | ** ** | **Exercisable**    | ** ** | **($000)**    | ** ** |
| June 30, 2006     |       | 4.0                   |       | 1,121              |       | $             | 17,569     |   |
| March 31, 2006    |       | 4.0                   |       | 1,207              |       | $             | 17,963     |   |
| December 31, 2005 |       | 4.1                   |       | 1,237              |       | $             | 17,729     |   |

 

7

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The following table summarizes information regarding stock optionsoutstanding at June 30, 2006 (shares in thousands):
| **Range of  Exercise Prices** | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Remaining  Life (Yrs.)** | ** ** | **Weighted  Average  Outstanding  Option Price** | ** ** | **Options  Exercisable** | ** ** | **Weighted  Average  Exercisable  Option Price** | *** *** |
|-----------------------------------------|------------|--------------------------|------------|----------------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------|------------|-------------------------------------------------------|--------------|
| $ 1.67-$3.04                       |       | 102                      |       | 4.0                                                |       | $                                                     | 2.48       |                     | 30         |                                                  | $            | 2.44 |   |
| $ 3.15-$4.89                       |       | 247                      |       | 3.9                                                |       | 3.56                                                  |       | 82                       |       | 3.80                                                  |         |
| $ 5.08-$8.08                       |       | 93                       |       | 2.6                                                |       | 6.03                                                  |       | 45                       |       | 5.70                                                  |         |
| $10.47-$12.00                           |       | 473                      |       | 4.1                                                |       | 11.11                                                 |       | 305                      |       | 11.29                                                 |         |
| $13.38-$19.86                           |       | 534                      |       | 5.5                                                |       | 16.55                                                 |       | 140                      |       | 16.59                                                 |         |
| $20.28-$29.20                           |       | 724                      |       | 4.4                                                |       | 22.24                                                 |       | 519                      |       | 22.19                                                 |         |
|                                    |       | 2,173                    |       | 4.5                                                |       | $                                                     | 14.17      |                     | 1,121      |                                                  | $            | 15.99 |   |

 

Non-qualifiedstock options are priced at the fair market value of the Company’s stock on thedate of the grant and typically vest at the rate of 25% per year commencing onthe first anniversary date of the grant and expire on the seventh anniversarydate of the grant.  The Companyrecognized $0.8 million and $1.5 million of stock-based compensation expensefor stock options in the three and six months ended June 30, 2006 respectively.   The Company did not recognize anystock-based compensation expense for stock options in 2005.

In2005 and through June 30, 2006, the Company issued Restricted Shares toexecutives and employees. The following table summarizes restricted stockoutstanding at June 30, 2006 and changes during the six months ended (shares inthousands):
| ** **                             | ** ** | **Number of**  | ** ** | **Weighted** | ** ** |
|----------------------------------------|------------|---------------------|------------|--------------|------------|
| ** **                             | ** ** | **Shares**          | ** ** | **Average**  | ** ** |
| ** **                             | ** ** | **Subject to** | ** ** | **Share**    | ** ** |
| ** **                             | ** ** | **Issuance**        | ** ** | **Price**    | ** ** |
| Outstanding at  December 31, 2005 |       | 543                 |       | $            | 14.45      |   |
| Granted                                |       | 411                 |       | 16.99        |       |
| Cancelled                              |       | (76                 | )          | 14.96        |       |
| Exercised                              |       | (12                 | )          | 15.81        |       |
| Outstanding at June 30,  2006          |       | 866                 |       | $            | 15.59      |   |

 

Therestrictions on the restricted stock lapse according to one of two schedules.  Under one schedule, the restrictions willlapse when specific key performance objectives have been reached or on thefifth anniversary date of the issuance. Under the second schedule, the restrictions will lapse 25% annually overfour years.   The fair value of the restrictedstock is expensed over the period during which the restrictions lapse.  For the three and six months ended June 30,2006 the Company recognized $1.5 million and $0.8 million respectively, indeferred compensation expense related to the restricted shares. There was nocomparative expenses for the same periods in 2005.

Had compensationcosts for the Company’s options been determined using the Black-Scholes optionvaluation model prescribed by SFAS No. 123, *Accounting for Stock BasedCompensation*, for the three and six months ended 2006 and 2005 theCompany’s pro forma net income per common share would have been reported asfollows (in thousands, except per share amounts):

 
| ** **                                                                                                                    | ** ** | **For The Three Months  Ended June 30,** | ** ** | **For The Six Months  Ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                                                                                    | ** ** | **2006**                                                          | ** ** | **2005**                                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income as  reported                                                                                                       |       | $                                                                 | 10,172     |                                                            | $          | 8,004 |   | 19,299 |   | $ | 15,592 |   |
| Add:                                                                                                                          |       |                                                              |       |                                                            |       |   |   |   |   |
| Stock-based compensation expense included in  reported net earnings, net of related tax effects                               |       | 1,599                                                             |       | —                                                          |       | 2,965 |   | — |   |
| Deduct:                                                                                                                       |       |                                                              |       |                                                            |       |   |   |   |   |
| Total stock-based employee compensation expense  determined under fair value basis for all awards, net of related tax effects |       | (1,599                                                            | )          | (674                                                            | )          | (2,965 | ) | (1,159 | ) |
|                                                                                                                          |       |                                                              |       |                                                            |       |   |   |   |   |
| Pro forma                                                                                                                     |       | $                                                                 | 10,172     |                                                            | $          | 7,330 |   | $ | 19,299 |   | $ | 14,433 |   |
|                                                                                                                          |       |                                                              |       |                                                            |       |   |   |   |   |
| Net income per  common share—basic:                                                                                      |       |                                                              |       |                                                            |       |   |   |   |   |
| As reported                                                                                                                   |       | $                                                                 | 0.29       |                                                            | $          | 0.23 |   | $ | 0.55 |   | $ | 0.44 |   |
| Pro forma                                                                                                                     |       | $                                                                 | 0.29       |                                                            | $          | 0.21 |   | $ | 0.55 |   | $ | 0.41 |   |
|                                                                                                                          |       |                                                              |       |                                                            |       |   |   |   |   |
| Net income per  common share—diluted:                                                                                    |       |                                                              |       |                                                            |       |   |   |   |   |
| As reported                                                                                                                   |       | $                                                                 | 0.27       |                                                            | $          | 0.20 |   | $ | 0.49 |   | $ | 0.39 |   |
| Pro-forma                                                                                                                     |       | $                                                                 | 0.27       |                                                            | $          | 0.18 |   | $ | 0.49 |   | $ | 0.36 |   |

 

8

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

In2005, the Company began an Employee Stock Ownership Plan (“ESOP”), whichprovides benefits to substantially all employees. The annual contribution, ifany, to the plan is at the discretion of the Board of Directors of the Company.In February 2006, the Company distributed 200,000 shares to employeesunder this plan.  In the six months endedJune 30, 2006 and June 30, 2005 the Company recorded $1.4 million and $0.4million, respectively, in compensation expense for the ESOP.

**5.             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 no realized losses in the threeand six months ended June 30, 2006. At June 30, 2006, the Company hadtotal net unrealized losses from marketable securities of $1.9 million.

Thecarrying amount of available-for-sale securities and their approximate fair valuesat June 30, 2006 were as follows (in thousands):

 
| ** **                                      | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|-------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------------------|------------|
| U.S. Government  and Federal agency obligations |       | $                   | 38,032     |                         | $          | —                        |       | $                          | (1,105     | ) | $ | 36,927 |   |
| Corporate bonds                                 |       | 66,061              |       | —                       |       | (811                          | )          | 65,250                     |       |
| Total                                           |       | $                   | 104,093    |                         | $          | —                        |       | $                          | (1,916     | ) | $ | 102,177 |   |

 

Thefollowing table presents the age of gross unrealized losses and fair value byinvestment category for all securities in a loss position as of June 30, 2006(in thousands):

 
| ** **                                      | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total**                  | ** ** |
|-------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|----------------------------|------------|
| ** **                                      | ** ** | **Estimated  Fair  Value**             | ** ** | **Estimated  Unrealized  Losses**    | ** ** | **Estimated  Fair  Value** | ** ** | **Estimated  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** | **Estimated  Unrealized  Losses** | ** ** |
| U.S. Government  and Federal agency obligations |       | $                                      | 13,841     |                                 | $          | (221                       | )          | $ | 23,086 |   | $ | (884 | ) | $ | 36,927 |   | $ | (1,105 | ) |
| Corporate bonds                                 |       | 7,980                                  |       | (97                                  | )          | 31,331                     |       | (714 | ) | 39,311 |   | (811 | ) |
| Total                                           |       | $                                      | 21,821     |                                 | $          | (318                       | )          | $ | 54,417 |   | $ | (1,598 | ) | $ | 76,238 |   | $ | (1,916 | ) |

 

TheCompany has determined that its unrealized losses are temporary based on theminor amount of the losses compared to amortized cost and the short duration ofthe losses, as well as the credit worthiness of the investees. The Companyexpects that all losses will be recovered, and intends to hold securities torecovery. If market, industry and/or investee conditions deteriorate, wemay incur future impairments.

Theamortized cost and estimated fair value of marketable securities at June 30,2006 by contractual maturity are shown below (in thousands):

 
| ** **                                | ** ** | **Amortized  Cost** | ** ** | **Estimated  Fair Value** | ** ** |
|-------------------------------------------|------------|---------------------|------------|--------------------------------|------------|
| Due in one year  or less                  |       | $                   | 66,210     |                           | $          | 65,598 |   |
| Due after one  year through three years   |       | 30,990              |       | 29,918                         |       |
| Due after three  years through five years |       | 5,794               |       | 5,579                          |       |
| Due after five  years                     |       | 1,099               |       | 1,082                          |       |
|                                      |       | $                   | 104,093    |                           | $          | 102,177 |   |

 

Thecarrying amount of available-for-sale securities and their approximate fairvalues at December 31, 2005 were as follows (in thousands):

 
| ** **                                      | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|-------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------------------|------------|
| U.S. Government  and Federal agency obligations |       | $                   | 58,227     |                         | $          | —                        |       | $                          | (1,349     | ) | $ | 56,878 |   |
| Corporate bonds                                 |       | 26,520              |       | —                       |       | (641                          | )          | 25,879                     |       |
| Total                                           |       | $                   | 84,747     |                         | $          | —                        |       | $                          | (1,990     | ) | $ | 82,757 |   |

 

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**6.             Inventories**

Inventoriesconsist of purchased pharmaceutical products and are stated at the lower ofcost or market. Cost is determined using the first-in, first-out method, andmarket is considered to be net realizable value. Inventories consist offinished product and bulk product awaiting processing and packaging intofinished product. Inventories, net of reserves of $0.1 million and $0.9 millionat June 30, 2006 and December 31, 2005, respectively, consisted of (inthousands):

 
| ** **        | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------|------------|-------------------------|------------|-----------------------------|------------|
| Bulk product      |       | $                       | 3,739      |                        | $          | 2,406 |   |
| Finished product  |       | 22,969                  |       | 26,518                      |       |
| Total inventories |       | $                       | 26,708     |                        | $          | 28,924 |   |

 

**7.             Intangible Assets**

InJanuary 2006, the Company paid Bayer Healthcare AG a milestone payment of$5.0 million for the licensing rights to Sular. The milestone payment will beamortized over the remaining useful life of Sular.

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

Thefollowing table reflects the components of intangible assets as of June 30,2006 (in thousands):

 
| ** **                      | ** ** | **Gross Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Amount** | ** ** | **Expected Life** | ** ** |
|---------------------------------|------------|-----------------------|------------|-------------------------------|------------|---------------------|------------|------------------------|------------|
| Licensing rights                |       | $                     | 361,040    |                          | $          | (69,637             | )          | $                      | 291,403    |   | 10 to 20 years |   |
| Trade names                     |       | 11,060                |       | (2,569                        | )          | 8,491               |       | 15 to 20 years         |       |
| Contracts                       |       | 8,300                 |       | (7,322                        | )          | 978                 |       | 5 years                |       |
| Supply/Distribution  agreements |       | 10,350                |       | (4,468                        | )          | 5,882               |       | 1 to 10 years          |       |
| Other  intangibles              |       | 3,108                 |       | (760                          | )          | 2,348               |       | 20 years               |       |
| Total                           |       | $                     | 393,858    |                          | $          | (84,756             | )          | $                      | 309,102    |   |   |   |

 

Thefollowing table reflects the components of intangible assets as ofDecember 31, 2005 (in thousands):

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

 

For the three and six months ended June 30,2006, amortization expense related to the intangible assets was $5.8 millionand $11.7 million, respectively. Amortization is calculated on a straight-linebasis over the estimated useful life of the intangible asset, and the Companyestimates the annual amortization expense for each of the five succeedingfiscal years to be as follows (in thousands):

 
| **Fiscal year ended December 31:** | ** ** | **Amount** | ** ** |
|--------------------------------------------------------|------------|------------|------------|
| 2006                                                   |       | $          | 23,127     |   |
| 2007                                                   |       | 21,818     |       |
| 2008                                                   |       | 21,571     |       |
| 2009                                                   |       | 21,571     |       |
| 2010                                                   |       | 21,571     |       |
|                                                        |            |            |            |  |

 

**8.             Other Long-Term Assets**

Otherassets at June 30, 2006 and December 31, 2005 consisted of the following(in thousands):
| ** **                    | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Capitalized  finance costs    |       | $                       | 5,242      |                        | $          | 4,312 |   |
| Deposits                      |       | 59                      |       | 59                          |       |
| Total long-term other  assets |       | $                       | 5,301      |                        | $          | 4,371 |   |

 

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**9.             Accrued Expenses**

Accruedexpenses at June 30, 2006 and December 31, 2005 consisted of the following(in thousands):

 
| ** **                          | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Employee  compensation and benefits |       | $                       | 3,538      |                        | $          | 4,111 |   |
| Product returns                     |       | 1,003                   |       | 1,090                       |       |
| Product rebates                     |       | 2,748                   |       | 2,441                       |       |
| Sales deductions                    |       | 3,593                   |       | 2,802                       |       |
| Accrued  royalties                  |       | 4,670                   |       | 5,082                       |       |
| Other                               |       | 2,632                   |       | 2,956                       |       |
|                                |       | $                       | 18,184     |                        | $          | 18,482 |   |

 

**10.          Long-term Debt**

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

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

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

(a)   thepersons that “beneficially owned,” the shares of our voting stock immediatelyprior to such transaction, “beneficially own,” shares of the surviving orcontinuing corporation’s voting stock representing at least a majority of thetotal voting power of all outstanding classes of voting stock of suchcorporation or

11

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(b)   both of the followingconditions are satisfied:

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

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

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

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

TheCompany had no debt other than the aforementioned notes outstanding at June 30,2006 or December 31, 2005.

**11.          Credit Agreement**

OnFebruary 11, 2003, the Company entered into a $20.0 million seniorsecured revolving credit facility with various lenders and LaSalle BankNational Association, as administrative agent. Borrowings may be used forworking capital requirements and general corporate purposes. Borrowings aresecured by substantially all of the Company’s assets. Borrowings bear interestat the Company’s option at the base rate in effect from time to time plus anapplicable margin or the Eurodollar rate, plus an applicable margin. Theapplicable margin will vary dependent upon the Company’s leverage ratio ineffect from time to time. The revolving facility matures on August 11,2006. The revolving loan contains various covenants, including covenantsrelative to maintaining financial ratios and earnings levels, limitations onacquisitions, dispositions, mergers and capital expenditures, limitations onincurring additional indebtedness and a prohibition on payment of dividends andcertain issuances of capital stock. As of June 30, 2006, there was nooutstanding balance on the Credit Agreement. For the three months ended June30, 2006, there were no borrowings or repayments under the Credit Agreement.

**12.          Share Buyback Program**

TheCompany adopted a new share repurchase program effective August 3, 2005,that authorizes the repurchase of up to $20.0 million of its outstanding sharesof common stock over the next twelve months with no periodic sub-limits on theamount of repurchases. This plan replaces all prior share repurchase plans andwill expire on August 2, 2006. As of June 30, 2006, $8.6 million isavailable for repurchases under the provision.

 
| ** **                        | ** ** | ** **         | ** ** | ** **         | ** ** | ** **                        | ** ** | **Approximate Dollar**        | ** ** |
|-----------------------------------|------------|--------------------|------------|--------------------|------------|-----------------------------------|------------|------------------------------------|------------|
| ** **                        | ** ** | **Total**          | ** ** | ** **         | ** ** | **Total Number of**     | ** ** | **Value of Shares**      | ** ** |
| ** **                        | ** ** | **Number of** | ** ** | **Average**        | ** ** | **Shares Purchased as** | ** ** | **that May Yet Be** | ** ** |
| ** **                        | ** ** | **Shares**         | ** ** | **Price**          | ** ** | **Part of Publicly**    | ** ** | **Purchased Under**           | ** ** |
| **Fiscal Period**            | ** ** | **Purchased**      | ** ** | **Per Share** | ** ** | **Announced Plans**          | ** ** | **the Plans**                 | ** ** |
|                              |       |               |       |               |       |                              |       |                               |       |
| January 1  through March 31, 2006 |       | —             |       | $                  | —     |                              | —     |                               | $          | 15,563,420 |   |
| April 1 through  May 31, 2006     |       | —             |       | $                  | —     |                              | —     |                               | $          | 15,563,420 |   |
| June 1 through  June 30, 2006     |       | 334,100            |       | $                  | 20.71      |                              | 334,100    |                               | $          | 8,631,399 |   |
| Total                             |       | 334,100            |       | $                  | 20.71      |                              | 334,100    |                               |       |   |

 

On August 3, 2006,the Company adopted a new share repurchase program authorizing the repurchaseof up to $30.0 million of outstanding common stock.  The program expires on August 2, 2007.

 

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**13.          Earnings Per Share**

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

 
| ** **                                                                 | ** ** | **For The Three Months  Ended June 30,** | ** ** | **For The Six Months  Ended June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2006**                                                          | ** ** | **2005**                                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income                                                                 |       | $                                                                 | 10,172     |                                                            | $          | 8,004 |   | $ | 19,299 |   | $ | 15,592 |   |
| Add: Interest  expense on the old contingent convertible notes, net of tax |       | 161                                                               |       | 485                                                             |       | 643 |   | 970 |   |
|                                                                       |       |                                                              |       |                                                            |       |   |   |   |   |
| Adjusted net  income                                                       |       | $                                                                 | 10,333     |                                                            | $          | 8,489 |   | 19,942 |   | $ | 16,562 |   |
|                                                                       |       |                                                              |       |                                                            |       |   |   |   |   |
| Weighted average  common shares outstanding—basic                     |       | 35,346                                                            |       | 35,029                                                          |       | 35,201 |   | 35,047 |   |
| Diluted effect  of stock options restricted shares and convertible debt    |       | 3,204                                                             |       | 7,386                                                           |       | 5,401 |   | 7,406 |   |
|                                                                       |       |                                                              |       |                                                            |       |   |   |   |   |
| Weighted average  common shares outstanding—diluted                   |       | 38,550                                                            |       | 42,415                                                          |       | 40,602 |   | 42,453 |   |
|                                                                       |       |                                                              |       |                                                            |       |   |   |   |   |
| Basic earnings  per common share:                                          |       | $                                                                 | 0.29       |                                                            | $          | 0.23 |   | $ | 0.55 |   | $ | 0.44 |   |
|                                                                       |       |                                                              |       |                                                            |       |   |   |   |   |
| Diluted earnings per  common share:                                        |       | $                                                                 | 0.27       |                                                            | $          | 0.20 |   | $ | 0.49 |   | $ | 0.39 |   |

 

Forthe three months ended June 30, 2006, there were 112,932 potential commonshares outstanding and 35,500 shares of unvested restricted stock that wereexcluded from the diluted net income per share calculation because their effectwould have been anti-dilutive.  For thesix months ended June 30, 2006, there were 577,806 potential common sharesoutstanding and 46,250 shares of unvested restricted stock that were excludedfrom the diluted net income per share calculation because their effect wouldhave been anti-dilutive.

**14.          Segment Reporting**

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

Thefollowing presents revenues for prescription products by area of treatment:

 
| ** **               | ** ** | **For The Three Months  Ended June 30,** | ** ** | **For The Six Months  Ended June 30,** | ** ** |
|--------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                                          | ** ** | **2005**                                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Cardiovascular/Metabolic |       | $                                                                 | 58,236     |                                                            | $          | 34,754 |   | $ | 105,046 |   | $ | 54,225 |   |
| Women’s Health      |       | 11,426                                                            |       | 10,098                                                          |       | 25,139 |   | 22,723 |   |
| Non Promoted             |       | 2,737                                                             |       | 4,964                                                           |       | 8,667 |   | 13,825 |   |
|                     |       |                                                              |       |                                                            |       |   |   |   |   |
| Net revenues             |       | $                                                                 | 72,399     |                                                            | $          | 49,816 |   | $ | 138,852 |   | $ | 90,773 |   |

 

**15.          Commitments and Contingencies**

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

OnSeptember 29, 2004, the U.S. District Court for the Northern District ofGeorgia dismissed, without prejudice, the class action lawsuit. Althoughthe lawsuit was dismissed, the court granted the plaintiffs the right to refileprovided that the plaintiffs pay all of the defendant’s fees and costsassociated with filing the motion to dismiss the lawsuit. Plaintiffs did notfile a second amended complaint as permitted, but instead filed a motion askingthe District Court to reconsider its September 29, 2004 order and lift thecondition that they must pay defendants’ fees and costs before furtheramendment. On June 22, 2005, the District Court denied plaintiffs’ motionand gave them another opportunity to amend if they pay defendants’ fees andcosts. Once again, plaintiffs chose not 

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to file a second amendedcomplaint. Instead, plaintiffs filed an appeal to the United States Court ofAppeals for the Eleventh Circuit. This appeal is currently pending.  No accrual is recorded in the Company’sfinancial statements related to this case as the Company believes that its riskof loss is remote.

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

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTSOF OPERATIONS**

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

**Overview**

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

 

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

 

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

Wecurrently market and sell 15 products, eight of which are actively promoted andwhich accounted for approximately 96.2% and 93.8% our total sales for the threeand six months ended June 30, 2006, respectively. We promote our productsthrough our nationwide sales marketing force of approximately 525 salesrepresentatives, targeting high-prescribing primary care physicians,endocrinologists, cardiologists, obstetricians and gynecologists.

**Resultsof Operations**

*Net Revenue.*    Net revenues for thethree months ended June 30, 2006 increased $22.6 million or 45.3% to$72.4 million, as compared to $49.8 million for the three monthsended June 30, 2005. Net revenues for the six months ended June 30,2006 increased $48.1 million or 53.0% to $138.9 million, as compared to $90.8million for the six months ended June 30, 2005. Net revenues from ourpromoted products increased by $24.8 million and $53.2 million for the threeand six months ended June 30, 2006, respectively, as a result of growth fromincreased promotion, as well as continued success in the execution of ourmarketing strategy.  The increase inrevenue of our promoted products was partially offset by a reduction ofnon-promoted product revenues of $2.1 million and $5.2 million for the threeand six months ended June 30, 2006, respectively.  This reduction is primarily from our Tanafedand Robinul Lines as we ceased promotion of these products as a result ofgeneric entries into the market in the fourth quarter of 2005.

**ProductOverview**

 
| ** **      | ** ** | **Change in total dispensed prescriptions  for the three months ended June 30, 2006  compared to the three months ended  June 30, 2005(a)** | ** ** | **Change in new dispensed prescriptions  for the three months ended June 30, 2006  compared to the three months ended  June 30, 2005(a)** | ** ** |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Sular           |       |    18.9  %                                                                                                                                                                                                             |       |   25.8  %                                                                                                                                                                                                                 |       |
| Fortamet        |       |    2.25  %                                                                                                                                                                                                             |       |   1.34  %                                                                                                                                                                                                                 |       |
| Altoprev        |       |   (28.0)%                                                                                                                                                                                                                   |       |  (27.5)%                                                                                                                                                                                                                       |       |
| Triglide(b)     |       | N/A                                                                                                                                                                                                                                   |       | N/A                                                                                                                                                                                                                                 |       |
| Nitrolingual(c) |       |    (8.7)%                                                                                                                                                                                                              |       |   (8.4)%                                                                                                                                                                                                                  |       |
| Prenate Elite   |       |   (22.7)%                                                                                                                                                                                                                   |       |  (23.1)%                                                                                                                                                                                                                       |       |
| OptiNate (d)    |       |  215.6  %                                                                                                                                                                                                                        |       |   73.1  %                                                                                                                                                                                                                 |       |
| Ponstel         |       |  (11.4)%                                                                                                                                                                                                                         |       |  (13.7)%                                                                                                                                                                                                                       |       |

 

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

*(b)         *Triglide was launched in July 2005.

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

*(d)*          OptiNate was launched inMarch 2005.

Net revenues from our Cardiolovascular and Metabolicproducts (namely Sular, Fortamet, Altoprev and Nitrolingual) were $58.2 millionand $105.0 million for the three and six months ended June 30, 2006, comparedto $34.8 million and $54.2 million for the three and six months ended June 30,2005, respectively.  The increase wasprimarily due to the launch of Altoprev and Fortamet in April 2005, thecontinued growth of Sular, the launch of Triglide in July 2005, as well asprice increases implemented during 2005 and 2006.

Net revenues from our promoted Women’s Health products (namely PrenateElite, OptiNate and Ponstel), were $11.4 million and $25.1 million for thethree and six months ended June 30, 2006 compared to $10.1 millionand $22.7 million for the three and six months ended June 30, 2005. Thisincrease is primarily related to the successful launch of our women’s healthsales force in the first quarter of 2006 and continued growth of our marketshare for OptiNate.

Net revenues for our non-promoted products were $2.8 million and $8.7million for the three and six months ended June 30, 2006 compared to $4.9million and $13.9 million for the three and six months ended June 30,2005.   This reduction is primarily fromour Tanafed and Robinul Lines as we ceased promotion of these products as aresult of generic entries into the market in the first quarter of 2005.

*Cost of Revenues.*    Cost of revenues forthe three and six months ended June 30, 2006 were $10.5 million and $19.9million compared to $7.4 million and $14.5 million for the three and six monthsended June 30, 2005. The increase in cost of revenues is related to the changein product mix and the increase in sales for the three and six months endedJune 30, 2006 as compared to the equivalent periods ending June 30, 2005.

*Gross Margin.*    Gross margin for the three and six months endedJune 30, 2006 were 85.4% and 85.7%, respectively, compared to 85.2% and 84.0%for the three and six months ended June 30, 2005, respectively.  This increase in gross margin for the threeand six months ended June 30, 2006 is the result of a change in product mixfrom the prior year primarily as the result of the prior year acquisitions andprice increases.

 

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*Selling, General and Administrative Expenses.*    Selling, general andadministrative expenses increased $12.4 million, or 51.5%, to$36.5 million for the three months ended June 30, 2006, compared to $24.1million for the three months ended June 30, 2005. Selling, general andadministrative expenses increased $29.2 million, or 69.9%, to $71.0 millionfor the six months ended June 30, 2006, compared to $41.8 million for thesix months ended June 30, 2005. This increase in selling, general and administrative expenses is dueprimarily to the addition of 115 sales representatives and an increase inroyalty and commission expenses related to higher revenues.  Additionally, we recognized $2.0 million and$3.7 million in stock based compensation expense for the three and sixmonths ended June 30, 2006, respectively, as compared to $0.4 million for thethree and six months ended June 30, 2005.

*Depreciation and Amortization Expense.*    Depreciation andamortization expense increased $0.8 million, or 14.0%, to $6.5 millionfor the quarter ended June 30, 2006 compared to $5.7 million for thequarter ended June 30, 2005. Depreciation and amortization expenseincreased $2.9 million, or 28.7%, to $13.0 million for the six months endedJune 30, 2006 compared to $10.1 million for the six months ended June 30,2005.  This increase is primarily relatedto the increase in amortizable intangible assets as a result of the purchase ofFortamet and Altoprev, the launch of Triglide and a $5.0 million milestonepayment to Bayer in January 2006.

*Research and Development Expense.*    Research anddevelopment expense increased $3.4 million to $4.0 million for thethree months ended June 30, 2006 compared to $0.6 million for the three monthsended June 30, 2005. Research and development expense increased $5.9 million to$6.8 million for the six months ended June 30, 2006 compared to $0.9 millionfor the same period in 2005.  Theseincreases were primarily related to greater activity in the development programfor lifecycle management initiatives for our products and management’sincreased emphasis on development. Additionally, we recognized $0.4 million and $0.7 million in stock basedcompensation expenses for the three and six months ended June 30, 2006,respectively.  There were no similarexpenses for the three and six months ended June 30, 2005.

*Interest Expense.*    Interest expense was$0.8 million and $1.5 million for the three and six months endedJune 30, 2006 compared to $1.0 million and $1.4 million for the three andsix months ended June 30, 2005.  Thedecrease is due to borrowings under the Company’s line of credit during thesecond quarter of 2005.  There have been noborrowings in fiscal 2006.  The interestexpense is primarily from the $150.0 million contingent convertible notesdiscussed in note 10 to our financial statements contained elsewhere in thisReport on Form 10-Q.

*Interest Income.*    Interest income was$1.1 million and $2.0 million for the three and six months ended June30, 2006, compared to $0.9 million and $1.7 million for the three and sixmonths ended June 30, 2005. The increase in interest income for the six monthsended June 30, 2006 is primarily due to a higher average cash and marketablesecurities balance as a result of cash generation from sales and higher returnson current investments.

*Provision for Income Taxes.*    Income taxes wereprovided for at a rate of 32.8% and 32.3% for the three and six months endedJune 30, 2006, respectively, compared to 31.0% and 32.5% for the three and sixmonths ended June 30, 2005. This increase in the effective rate is due to thechange in the mix of tax jurisdictions, both domestic and international, as aresult 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.

**Liquidityand Capital Resources**

Our cash and cash equivalents were $30.8 million on June 30, 2006compared to $13.4 million in the prior year. Net cash provided by operatingactivities for the six months ended June 30, 2006 was $42.0 million. Thissource of cash was primarily the result of net income of $19.3 million,resulting primarily from the sales of our promoted products, a decrease inaccounts receivable of $4.2 million, as a result of an overall reduction in ourdays sales outstanding, an increase in accounts payable of $2.8 million,primarily related to increased business volume, a decrease in inventory of $2.2million, primarily related to increased sales and an increase in accrued expensesand other long-term liabilities, primarily related to increased commissions androyalties as a result of increased sales of $1.1 million. Additional providersof cash include non-cash items of depreciation and amortization of $13.0million, stock based compensation expenses of $4.4 million, interest expense of$0.2 million and deferred income tax expenses of $2.6 million. Partiallyoffsetting these providers of cash were uses of cash were increase in incometax receivable of $7.2 million related primarily to estimated tax payments madeduring the year.

Our cash and cash equivalents were $13.4 million on June 30, 2005. Netcash provided by operating activities for the six months ended June 30, 2005was $0.3 million. This source of cash was primarily the result of net income of$15.6 million, resulting primarily from the sales of our promotedproducts,  non-cash expenses includingdepreciation and amortization of $10.1 million, marketable securitiesimpairment of $0.7 million, taxes payable of $0.5 million and interest of $0.2million, deferred income tax expense of $1.5 million, a decrease in income taxreceivable of $1.3 million, and an increase in accrued expenses and otherlong-term liabilities of $1.4 million, primarily related to the increasedroyalties for the addition of Fortamet and Altoprev. Partially offsetting thesource of cash from operations was an increase in inventories of $18.1 million,primarily due to the addition of Fortamet and Altoprev, and an increase inother current assets and other assets of $3.7 million, due to the increase ofFortamet and Altoprev samples, an increase in accounts receivable of $3.1million, due primarily to increased sales, and a decrease in accounts payableof $6.1 million, primarily related to timing of income payments to vendors.

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Net cash used in investing activities for the six months ended June 30,2006 was $26.2 million. The primary uses of this cash was for the purchaseof marketable securities, of $61.5 million which was $42.2 million inmaturing investments that were reinvested upon maturity, and $19.3 millionof investment of cash generated from operations, the purchase of property andequipment, primarily for new office furniture and computer systems for the newhome office, of $1.9 million, and $5.0 million for a milestonepayment to Bayer.

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

Net cash used in financing activities was $2.5 million for the sixmonths ended June 30, 2006 primarily resulting from the repurchase of ourcommon stock for $6.9 million and the costs associated with the exchange of thecontingent convertible debt, discussed in footnote 10 of our financialstatements, of $1.8 million. Partially offsetting this net cash used was $4.1 millionfor the issuances of common stock related to executive and employee stockoptions and $2.1 million for a non-cash reduction in taxes payable relating tostock options.

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

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

On February 11, 2003, we entered into a $20 million seniorsecured revolving credit facility with various lenders and LaSalle BankNational Association, as administrative agent. Subject to the satisfaction ofcertain borrowing base requirements, we may from time-to-time borrow moniesunder the revolving facility for working capital requirements and generalcorporate purposes. Borrowings are secured by substantially all of our assets.Borrowings bear interest at our option at the base rate in effect from time totime plus an applicable margin or the Eurodollar rate, plus an applicablemargin. The applicable margin will vary dependent upon our leverage ratio ineffect from time-to-time. As of June 30, 2006, we had no borrowings outstandingunder this facility.  The revolvingfacility, as amended, matures on August 11, 2006. Fees payable under therevolving facility include a one-time commitment fee of 0.685% of the statedamount of the facility, an unused commitment fee based on funds committed butnot borrowed under the revolving facility at rates which vary dependent uponour leverage ratio in effect from time-to-time and letter of credit fees equalto 0.25% per annum of the face amount of letters of credit issued andoutstanding under the revolving facility. The revolving facility may be prepaidfrom time-to-time or terminated at our discretion without penalty.

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

**CriticalAccounting Policies**

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

·        *Allowance for doubtful accounts.* We are required to estimate the level ofaccounts receivable recorded on our balance sheet which will ultimately not bepaid. Among other things, this assessment requires analysis of the financialstrength of our customers, which can be highly subjective. Our policy is toestimate bad debt expense based on prior experience supplemented by a periodic 

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

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

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

·        *Intangible assets*. When we acquire the rights to manufacture and sell a product, we recordthe aggregate purchase price, along with the value of the product relatedliabilities that we assume, as intangible assets. We use the assistance ofvaluation experts to help us allocate the purchase price to the fair value ofthe various intangible assets that we have acquired. Then, we must estimate theeconomic useful life of each of these intangible assets in order to amortizetheir cost as an expense in our statement of operations over the estimatedeconomic useful life of the related asset. The factors that drive the actualeconomic useful life of a pharmaceutical product are inherently uncertain, andinclude patent and other intellectual property protection, physician loyaltyand prescribing patterns, competition by products prescribed for similarindications, future introductions of competing products not yet FDA approved,the impact of promotional efforts and many other factors. We use all of thesefactors in initially estimating the economic useful lives of our products, andwe also continuously monitor these factors for indications of appropriate 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 or changesin circumstances 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 will be recognized. If we should incur an impairment loss,there may be a material impact to the financial statements.

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

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

·        *Inventory obsolescence.* Our products have shelf lives ranging from 24to 48 months. We must estimate the amount of 

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inventory recorded on our balance sheet that will notbe sold prior to expiration. This estimate requires analysis of forecasteddemand for our products, our promotional focus, amounts of our productscurrently held by our customers and the impact on our products of competingproducts. If we over or under estimate the amount of inventory that will not besold prior to expiration, there may be a material impact to our financialstatements.

**ForwardLooking Statements**

This Quarterly Report contains forward-lookingstatements within the meaning of the Private Securities LitigationReform Act of 1995. These statements involve a number of risks anduncertainties. Although our forward-looking statements reflect the good faithjudgment of our management, these statements can only be based on facts andfactors currently known by us. Consequently, forward-looking statements areinherently subject to risks and uncertainties, and actual results and outcomesmay differ materially from results and outcomes discussed in theforward-looking statements. Risks to our business include, without limitation:

·      We may not attain expected revenuesand earnings;

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

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

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

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

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

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

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

·      Sales of our Tanafed and Robinul productshave been adversely affected by the introduction of knock-off and genericproducts, respectively;

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

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

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

·      Our licensor/supplier can terminate our rightsto commercialize Nitrolingual and the 60 dose size of this product has not yetmet our expectation;

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

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

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

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

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

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

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

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

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

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

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

·                  Someunforeseen difficulties may occur.

Theserisk factors are not exhaustive. We may not have correctly identified and appropriatelyassessed all factors affecting our business and the publicly available andother information with respect to these matters may not be complete andcorrect. Additional risks and uncertainties not presently known to us or thatwe currently believe to be immaterial also may adversely impact us. Shouldany risks and uncertainties develop into actual events, these developmentscould have material adverse effects on our business, financial condition, andresults of operations. For these reasons, we caution you not to place unduereliance on our forward-looking statements.

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

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

**ForeignCurrency Exchange Risk**

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

**MarketRisk on Investments**

Thefair value of our investment portfolio would be negatively affected by anincrease in interest rates. Since the majority of the Company’s investments arefixed rate interest-bearing securities and therefore subject to the risk ofloss in market value from an increase in rates or a change in the underlyingrisk of the issuers of the notes, the Company’s future earnings and cash flowscould be affected adversely if the Company were to sell the securities prior totheir maturity date. There were no realized losses from the sale of investmentsfor the three and six months ended June 30, 2006. At June 30, 2006, the Companyhad total net unrealized losses from marketable securities of $1.9 million.

**MarketRisk on Variable Rate Debt**

Inconnection with borrowings incurred under the senior secured revolving creditfacility arranged by LaSalle Bank, N.A., we could experience market risk withrespect to changes in the general level of the interest rates and its effectupon our interest expense. Borrowings under this facility bear interest atvariable rates. Because such rates are variable, an increase in interest rateswill result in additional interest expense and a reduction in interest rateswill result in reduced interest expense. Accordingly, our present exposure tointerest rate fluctuations is primarily dependent on rate changes thatmay occur while borrowings under the senior secured credit 

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facility areoutstanding. On June 30, 2006 there was no debt outstanding under thisfacility.

**MarketRisk on Fixed Rate Debt**

TheCompany’s long-term fixed interest rate senior subordinated contingentconvertible notes are also subject to market risk. Fixed rate debt outstandingat June 30, 2006 was $150.0 million with an interest rate of 1.75%. Allother things being equal, the fair market value of the Company’s fixed ratedebt will increase as rates decline and will decrease as rates rise. The fixedrate notes outstanding totaling $150.0 million at June 30, 2006 had a fairvalue of $160.8 million based on quoted market rates.

**ITEM 4. CONTROLSAND PROCEDURES**

**Evaluationof Disclosure Controls and Procedures**

Wemaintain a set of disclosure controls and procedures that are designed toensure that information required to be disclosed in the reports that we fileunder the Securities Exchange Act of 1934, as amended (“Exchange Act”), isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms. We carried out an evaluation under thesupervision and with the participation of management, including our Presidentand Chief Executive Officer and our Chief Financial Officer, of theeffectiveness of the design and operation of Sciele Pharma’s disclosurecontrols and procedures pursuant to Rule 13a-15(e) of the ExchangeAct as of the end of the period covered by this report. Our President and ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures provide reasonable assurance as of the end of theperiod for which the report is being filed that (i) information requiredto be disclosed in our reports under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SEC’srules and forms and (ii) such information is accumulated andcommunicated to our management, including our President and Chief ExecutiveOfficer and our Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure.

**Changesin Internal Control over Financial Reporting**

There havebeen no changes in Sciele Pharma’s primary internal controls over financialreporting during the second fiscal quarter of 2006, that have materiallyaffected, or is reasonably likely to materially affect, Sciele Pharma’s internalcontrols over financial reporting.

**PART II—OTHERINFORMATION**

**ITEM 1: LEGALPROCEEDINGS**

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

OnSeptember 29, 2004, the U.S. District Court for the Northern District ofGeorgia dismissed, without prejudice, the class action lawsuit. Althoughthe lawsuit was dismissed, the court granted the plaintiffs the right to refileprovided that the plaintiffs pay all of the defendant’s fees and costsassociated with filing the motion to dismiss the lawsuit. Plaintiffs did notfile a second amended complaint as permitted, but instead filed a motion askingthe District Court to reconsider its September 29, 2004 order and lift thecondition that they must pay defendants’ fees and costs before furtheramendment. On June 22, 2005, the District Court denied plaintiffs’ motionand gave them another opportunity to amend if they pay defendants’ fees andcosts. Once again, plaintiffs chose not to file a second amended complaint.Instead, plaintiffs filed an appeal to the United States Court of Appeals forthe Eleventh Circuit. This appeal is currently pending.  No accrual is recorded in the Company’sfinancial statements related to this case as the Company believes that its riskof loss is remote.

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

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

TheCompany adopted a new share repurchase program effective August 3, 2005,that authorized the repurchase of up to $20.0 million of its outstanding sharesof common stock over the next twelve months with no periodic sub-limits on theamount of repurchases. This plan replaced all prior share repurchase plans and expiredon August 2, 2006. As of June 30, 2006, $8.6 million was available forrepurchases under the provision.

 

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| ** **                        | ** ** | ** **         | ** ** | ** **    | ** ** | ** **                        | ** ** | **Approximate Dollar**        | ** ** |
|-----------------------------------|------------|--------------------|------------|---------------|------------|-----------------------------------|------------|------------------------------------|------------|
| ** **                        | ** ** | **Total**          | ** ** | ** **    | ** ** | **Total Number of**     | ** ** | **Value of Shares**      | ** ** |
| ** **                        | ** ** | **Number of** | ** ** | **Average**   | ** ** | **Shares Purchased as** | ** ** | **that May Yet Be** | ** ** |
| ** **                        | ** ** | **Shares**         | ** ** | **Price**     | ** ** | **Part of Publicly**    | ** ** | **Purchased Under**           | ** ** |
| **Fiscal Period**            | ** ** | ** **         | ** ** | **Purchased** | ** ** | **Per Share**                | ** ** | **Announced Plans**           | ** ** | **the Plans** | ** ** |
|                              |       |               |       |          |       |                              |       |                               |       |
| January 1  through March 31, 2006 |       | —             |       | $             | —     |                              | —     |                               | $          | 15,563,420 |   |
| April 1 through  May 31, 2006     |       | —             |       | —        |       | —                            |       | 15,563,420                         |       |
| June 1 through  June 30, 2006     |       | 334,100            |       | 20.71         |       | 334,100                           |       | 8,631,399                          |       |
| Total                             |       | 334,100            |       | $             | 20.71      |                              | 334,100    |                               |       |   |
|                                   |            |                    |            |               |            |                                   |            |                                    |            |  |  |  |  |

 

On August 3, 2006,the Company adopted a new share repurchase program authorizing the repurchaseof up to $30.0 million of outstanding common stock.  The program expires on August 2, 2006.

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

The Company heldits 2006 annual meeting of stockholders on June 15, 2006.  The stockholders considered three proposals:(1) the election of Class A directors, (2) the amendment of the Company’scertificate of incorporation to change the Company’s name from First HorizonPharmaceutical Corporation to Sciele Pharma, Inc., and (3) the ratification ofthe appointment of BDO Seidman, LLP as the Company’s independent registeredpublic accounting firm for the year ending December 31, 2006.  All three proposals were approved by the stockholders.  The following is certain information withrespect to each proposal.

Proposal 1.  The election of Class A directors.
| **Nominee**    | ** ** | **Votes For** | ** ** | **Votes  Withheld** |
|----------------|------------|---------------|------------|---------------------|
| John N. Kapoor |       | 29,537,402    |       | 3,910,698           |
| Jerry N. Ellis |       | 32,465,578    |       | 982,522             |

 

The Class A directorswill serve a three year term.  The termof office of the following directors continued after the meeting:
| **Class B  Directors** | ** ** | **Class C  Directors** |
|------------------------|------------|------------------------|
| Patrick P. Fourteau    |       | Pierre Lapalme         |
| Jon S. Saxe            |       | William J. Robinson    |
|                   |       | Patrick J. Zenner      |

 

Proposal 2.  The change of the Company’s name.

Votes For:32,668,647  Votes Against: 772,464        Abstentions: 6,989

Proposal 3.  The ratification of the appointment of BDOSeidman, LLP.

Votes For: 33,434,105  VotesAgainst: 10,428         Abstentions:3,567

**ITEM 5:OTHER INFORMATION**

None.

**ITEM 6:EXHIBITS**
| 31.1 |   | Certifications of Chief Executive Officer and  President pursuant to Securities Exchange Act Rules 13a-14 and 15d-14,  as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.             |
|------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.2 |   | Certifications of Chief Financial Officer, Secretary  and Treasurer pursuant to Securities Exchange Act Rules 13a-14 and  15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
| 32.1 |   | Certification of Chief Executive Officer and President  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                  |
| 32.2 |   | Certification of Chief Financial Officer, Secretary  and Treasurer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                       |

 

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**SIGNATURES**

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

 
|                      | ** ** | **SCIELE  PHARMA, INC.**(Registrant) |
|----------------------|------------|--------------------------------------|
| ** **           | ** ** | ** **                           |
| ** **           | ** ** | ** **                           | ** ** | ** ** |
| Date: August 8, 2006 |       | By:                                  |   | /s/ PATRICK P. FOURTEAU |
|                 |       |                                 |   | Patrick P. Fourteau |
|                 | * *   | * *                             |   | *Chief Executive Officer and President* |
|                 | * *   | * *                             |   | *(principal executive officer)* |
|                 | * *   | * *                             |   | * * |
| Date: August 8, 2006 |       | By:                                  |   | /s/ DARRELL BORNE |
|                 |       |                                 |   | Darrell Borne |
|                 | * *   | * *                             |   | *Executive Vice President and Chief Financial  Officer, Secretary and Treasurer* |
|                 | * *   | * *                             |   | *(principal accounting and financial officer)* |

 

 

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