**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

| **[MARK ONE]**                                     | ** ** | ** **                                                                                                              |
|---------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|
| **ý**                                              | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**  |
| ** **                                              | ** ** | ** **                                                                                                              |
| **For the quarterly period ended March 31,  2006** |
| ** **                                              | ** ** | ** **                                                                                                              |
| **OR**                                                  |
| ** **                                              | ** ** | ** **                                                                                                              |
| **o**                                                   | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |

 

**For the transition period from                to                **

 

**Commission File No. 000-30123**

 

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**FIRSTHORIZON PHARMACEUTICAL CORPORATION**

(Exact name of registrant as specified in itscharter)

 

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

 

**(770) 442-9707**

(Registrant’s telephone number, includingarea 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 shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes ý   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 accelerated filer o |   | Accelerated filerý |   | Non-accelerated filero |
|---------------------------|--------|-------------------------|--------|------------------------|

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).

 

o Yes ýNo

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 

As of April 21, 2006, there were **35,328,211**shares of the Registrant’s Common Stock outstanding.

 

 

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**FIRST HORIZON PHARMACEUTICAL CORPORATION**

**FORM 10-Q**

**INDEX**

 
| PART I.  | FINANCIAL INFORMATION                                                                                         |   |
|---------------|---------------------------------------------------------------------------------------------------------------|--------|
|          |                                                                                                          |   |
| Item 1.  | Consolidated Balance Sheets at March 31, 2006 and December 31,  2005                                |   |
|          |                                                                                                          |   |
|          | Consolidated Statements of Operations for  the three months ended March 31, 2006 and March 31, 2005 |   |
|          |                                                                                                          |   |
|          | Consolidated Statements of Cash Flows for  the three months ended March 31, 2006 and March 31, 2005 |   |
|          |                                                                                                          |   |
|          | Notes to Consolidated Financial Statements                                                                    |   |
|          |                                                                                                          |   |
| Item 2.       | Management’s Discussion and Analysis of Financial Condition and  Results of Operations                   |   |
|          |                                                                                                          |   |
| Item 3.       | Quantitative and Qualitative Disclosures about Market Risk                                                    |   |
|          |                                                                                                          |   |
| Item 4.       | Controls and Procedures                                                                                       |   |
|          |                                                                                                          |   |
| PART II. | OTHER  INFORMATION                                                                                            |   |
|          |                                                                                                          |   |
| Item  1.      | Legal  Proceedings                                                                                            |   |
|          |                                                                                                          |   |
| Item 2.       | Unregistered Sales of Equity Securities and Use of Proceeds                                                   |   |
|          |                                                                                                          |   |
| Item  5.      | Other  Information                                                                                            |   |
|          |                                                                                                          |   |
| Item 6.  | Exhibits                                                                                                      |   |
|          |                                                                                                          |   |
|          | Signatures                                                                                                    |   |
|          |                                                                                                          |   |
|          | Certifications                                                                                                |   |

 

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**PART I—FINANCIALINFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**FIRST HORIZON PHARMACEUTICAL CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                                        | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                        | ** ** | **(unaudited)**          | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                        |       |                     |       |                        |       |
| Current assets:                                                                                                                                                   |       |                     |       |                        |       |
| Cash and cash equivalents                                                                                                                                         |       | $                        | 27,794     |                        | $          | 17,043 |   |
| Marketable securities                                                                                                                                             |       | 107,168                  |       | 82,757                      |       |
| Accounts receivable, net of allowances of  $2,030 and $2,427 at March 31, 2006 and December 31, 2005,  respectively                                     |       | 26,005                   |       | 48,353                      |       |
| Inventories                                                                                                                                                       |       | 27,422                   |       | 28,924                      |       |
| Income taxes receivable                                                                                                                                           |       | 168                      |       | 547                         |       |
| Current deferred tax assets                                                                                                                                       |       | 3,668                    |       | 3,705                       |       |
| Other current assets                                                                                                                                              |       | 26,988                   |       | 23,059                      |       |
| Total current assets                                                                                                                                              |       | 219,213                  |       | 204,388                     |       |
| Property and equipment, net                                                                                                                                       |       | 5,131                    |       | 5,148                       |       |
| Other assets:                                                                                                                                                     |       |                     |       |                        |       |
| Intangibles, net                                                                                                                                                  |       | 314,909                  |       | 315,798                     |       |
| Other                                                                                                                                                             |       | 4,308                    |       | 4,371                       |       |
| Total other assets                                                                                                                                                |       | 319,217                  |       | 320,169                     |       |
| Total assets                                                                                                                                                      |       | $                        | 543,561    |                        | $          | 529,705 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                    |       |                     |       |                        |       |
| Current liabilities:                                                                                                                                              |       |                     |       |                        |       |
| Account payable                                                                                                                                                   |       | $                        | 12,355     |                        | $          | 12,093 |   |
| Accrued expenses                                                                                                                                                  |       | 15,894                   |       | 18,482                      |       |
| Total current liabilities                                                                                                                                         |       | 28,249                   |       | 30,575                      |       |
| Long-term liabilities:                                                                                                                                            |       |                     |       |                        |       |
| Convertible debt                                                                                                                                                  |       | 150,000                  |       | 150,000                     |       |
| Deferred tax liabilities                                                                                                                                          |       | 9,945                    |       | 8,803                       |       |
| Other long-term liabilities                                                                                                                                       |       | 182                      |       | 191                         |       |
| Total liabilities                                                                                                                                                 |       | 188,376                  |       | 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; 36,098,308 and 35,907,376 issued at March 31, 2006  and December 31, 2006, respectively |       | 36                       |       | 36                          |       |
| Additional paid-in capital                                                                                                                                        |       | 299,940                  |       | 292,639                     |       |
| Retained earnings                                                                                                                                                 |       | 91,650                   |       | 82,524                      |       |
| Deferred compensation                                                                                                                                             |       | (13,643                  | )          | (7,489                      | )          |
| Accumulated other comprehensive loss                                                                                                                              |       | (4,246                   | )          | (4,384                      | )          |
|                                                                                                                                                              |       | 373,737                  |       | 363,326                     |       |
| Less: Treasury stock at cost, Common stock,  800,000 and 1,000,000 shares at March 31, 2006 and December 31,  2005, respectively                        |       | (18,552                  | )          | (23,190                     | )          |
| Total stockholders’ equity                                                                                                                                   |       | 355,185                  |       | 340,136                     |       |
| Total liabilities and stockholders’ equity                                                                                                                   |       | $                        | 543,561    |                        | $          | 529,705 |   |

 

The accompanying notes are an integral part ofthese consolidated financial statements.

 

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**FIRST HORIZON PHARMACEUTICAL CORPORATION**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(unaudited, in thousands, except per sharedata)**

 
| ** **                                  | ** ** | **For The Three Months  Ended March 31,** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **2006**                                                           | ** ** | **2005** | ** ** |
| Net revenues                                |       | $                                                                  | 66,453     |   | $ | 40,957 |   |
| Operating costs and expenses:               |       |                                                               |       |   |   |
| Cost of revenues                            |       | 9,352                                                              |       | 7,169 |   |
| Selling, general and administrative expense |       | 34,516                                                             |       | 17,685 |   |
| Depreciation and amortization               |       | 6,514                                                              |       | 4,363 |   |
| Research and development expense            |       | 2,860                                                              |       | 265 |   |
| Total operating costs and expenses          |       |                                                               | 53,242     |   |   | 29,482 |   |
| Operating income                            |       | 13,211                                                             |       | 11,475 |   |
| Other (expense) income:                     |       |                                                               |       |   |   |
| Interest expense                            |       | (765                                                               | )          | (1,006 | ) |
| Interest income                             |       | 912                                                                |       | 1,042 |   |
| Other                                       |       | —                                                             |       | (16 | ) |
| Total other income                          |       |                                                               | 147        |   |   | 20 |   |
| Income before provision for income taxes    |       | 13,358                                                             |       | 11,495 |   |
| Provision for income taxes                  |       | (4,232                                                             | )          | (3,907 | ) |
| Net income                                  |       | $                                                                  | 9,126      |   | $ | 7,588 |   |
| Other comprehensive gain (loss)             |       | 138                                                                |       | (1,178 | ) |
| Comprehensive income                        |       | $                                                                  | 9,264      |   | $ | 6,410 |   |
| Net income per common share:                |       |                                                               |       |   |   |
| Basic earnings per common share             |       | $                                                                  | 0.26       |   | $ | 0.22 |   |
| Diluted earnings per common share           |       | $                                                                  | 0.23       |   | $ | 0.19 |   |
| Weighted average common shares outstanding: |       |                                                               |       |   |   |
| Basic                                       |       | 35,054                                                             |       | 35,066 |   |
| Diluted                                     |       | 42,596                                                             |       | 42,505 |   |

 

The accompanying notes are an integral part ofthese consolidated financial statements.

 

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**FIRST HORIZON PHARMACEUTICAL CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(unaudited, in thousands)**

 
| ** **                                                                                   | ** ** | **For The Three Months** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                   | ** ** | **Ended March 31,**           | ** ** |
| ** **                                                                                   | ** ** | **2006**                                | ** ** | **2005** | ** ** |
| Cash flows from operating activities:                                                        |       |                                    |       |   |   |
| Net income                                                                                   |       | $                                       | 9,126      |   | $ | 7,588 |   |
| Adjustments to reconcile net income to net  cash (used in) provided by operating activities: |       |                                    |       |   |   |
| Depreciation and amortization                                                                |       | 6,514                                   |       | 4,363 |   |
| Non-cash compensation expense                                                                |       | 2,033                                   |       | — |   |
| Non-cash interest expense                                                                    |       | 84                                      |       | 84 |   |
| Deferred income tax expense                                                                  |       | 1,187                                   |       | 842 |   |
| Reduction in taxes payable—stock option  exercises                                      |       | —                                  |       | 138 |   |
| Changes in assets and liabilities, net of  acquired assets and liabilities:                  |       |                                    |       |   |   |
| Accounts receivable                                                                          |       | 22,348                                  |       | (359 | ) |
| Inventories                                                                                  |       | 1,502                                   |       | (14,723 | ) |
| Other current assets and other assets                                                        |       | (3,950                                  | )          | (2,211 | ) |
| Income taxes receivable                                                                      |       | 379                                     |       | 2,992 |   |
| Accrued expenses and other long-term  liabilities                                            |       | (1,694                                  | )          | (7,702 | ) |
| Accounts payable                                                                             |       | 262                                     |       | 4,703 |   |
| Net cash (used in) provided by operating  activities                                         |       | 37, 791                                 |       | (4,285 | ) |
| Cash flows from investing activities:                                                        |       |                                    |       |   |   |
| Purchase of products                                                                         |       | (5,000                                  | )          | (55,578 | ) |
| Purchase of property and equipment                                                           |       | (608                                    | )          | (575 | ) |
| Proceeds from sale of marketable securities                                                  |       | 13,148                                  |       | 51,122 |   |
| Purchase of marketable securities                                                            |       | (37,554                                 | )          | (3,877 | ) |
| Net cash used in investing activities                                                        |       | (30,014                                 | )          | (8,908 | ) |
| Cash flows from financing activities:                                                        |       |                                    |       |   |   |
| Repurchase of common stock                                                                   |       | —                                  |       | (2,094 | ) |
| Reduction in taxes payable—stock option  exercises                                      |       | 797                                     |       | — |   |
| Net proceeds from issuance of common stock                                                   |       | 2,052                                   |       | 311 |   |
| Net cash (used in) provided by financing  activities                                         |       | 2,849                                   |       | (1,783 | ) |
| Effect of foreign exchange rates on cash                                                     |       | 125                                     |       | (706 | ) |
| Net change in cash and cash equivalents                                                      |       | 10,751                                  |       | (15,682 | ) |
| Cash and cash equivalents, beginning of  period                                              |       | 17,043                                  |       | 36,586 |   |
| Cash and cash equivalents, end of period                                                     |       | $                                       | 27,794     |   | $ | 20,904 |   |
| Supplemental Cash Flow Information:                                                          |       |                                    |       |   |   |
| Cash paid for income taxes                                                                   |       | $                                       | 1,781      |   | $ | 122 |   |
| Cash paid for interest                                                                       |       | $                                       | 1,325      |   | $ | 1,325 |   |

 

The accompanying notes are an integral part ofthese consolidated financial statements.

 

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**FIRST HORIZON PHARMACEUTICAL CORPORATION**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**(unaudited)**

 

**1.****                                      Basisof Presentation**

 

The accompanying unaudited interim consolidated financial statementsreflect all adjustments (consisting solely of normal recurring adjustments)which management considers necessary for fair presentation of the financialposition, results of operations and cash flows of First Horizon PharmaceuticalCorporation (the “Company”) for the interim periods. Certain footnote disclosuresnormally included in financial statements prepared according to accountingprinciples generally accepted in the United States of America have beencondensed or omitted from these interim financial statements as permitted bythe rules and regulations of the Securities and Exchange Commission.Interim results are not necessarily indicative of results for the full year.The interim results should be read in conjunction with the financial statementsand notes thereto included in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2005 (File No. 000-30123).

 

**2.****                                      NewAccounting Pronouncements**

 

In March 2006, the Financial Accounting Standards Board (“FASB”)issued Statement 156, *Accounting for Servicingof Financial Assets,*which amends FAS 140, *Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities.*In a significant change to current guidance, theStatement of Financial Accountant Standards (“SFAS”) No. 156 permits anentity to choose either of the following subsequent measurement methods foreach class of separately recognized servicing assets and servicingliabilities:  (1) AmortizationMethod or (2) Fair Value Measurement Method. SFAS No. 156 iseffective as of the beginning of an entity’s first fiscal year that beginsafter September 15, 2006. The Company is currently reviewing the effect,if any, the proposed guidance will have on its financial statements.

 

In February 2006, the FASB issued SFAS 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 that arefreestanding 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 Company is currentlyreviewing the effect, if any, the proposed guidance will have on its financialstatements.

 

In July 2005, the FASB issued an exposure draft of a proposedinterpretation,*Accounting for Uncertain TaxPositions-an Interpretation of FASB Statement No. 109* (“SFAS No. 109”).This interpretation would apply to all open tax positions accounted for inaccordance with SFAS No. 109, including those acquired in businesscombinations. It is a proposed asset recognition approach to apply a dualthreshold for uncertain tax positions. The interpretation would allow therecognition of a tax benefit when it is probable that it could be sustainedupon audit. The interpretation defines “probable” as it is defined in SFASNo. 5, “*Accounting for Contingencies*.”FASB has not established an effective date for the interpretation. The Companyis currently reviewing the effect, if any, the proposed guidance will have onits financial statements.

 

In May 2005, the FASB issued Statement 154,*“Accounting Changes and Error Corrections, areplacement of APB Opinion No. 20 and FASB Statement No. 3.” *The standard requires retrospective application to prior periods’ financialstatements of a voluntary 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 standard is effective foraccounting changes and corrections of errors made occurring in fiscal yearsbeginning after December 15, 2005. The adoption of Statement of FinancialAccounting Standards (“SFAS”) No. 154 did not have a material impact onthe Company’s financial position or results of operations.

 

In December 2004, the Financial Accounting Standards Board (“FASB”)issued Statement 153, *“Exchanges ofNonmonetary Assets, an amendment of APB Opinion No.29.”* The standardis based on the principle that exchanges of nonmonetary assets should bemeasured based on the fair value of the assets exchanged and eliminates theexception under APB 

 

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Opinion No. 29 for an exchange of similar productive assets andreplaces it with an exception for exchanges of nonmonetary assets that do nothave commercial substance. The standard is effective for nonmonetary exchangesoccurring in fiscal periods beginning after June 15, 2005. The adoption ofSFAS no. 153 did not have a material impact on the Company’s financialposition or results of operations.

 

In December 2004, the FASB issued Statement 123 (revised 2004), *“Share-Based Payment.”* The standardeliminates 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 3 for the effect of the adoption on net income and earnings pershare.

 

**3.****                                      StockBased Compensation**

 

At March 31, 2006, the Company had three stock-based compensationplans, stock options, restricted shares and an employee stock ownership plan.Prior to December 31, 2005, the Company accounted for those plans under therecognition 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 (revised 2004) (“SFAS 123”), “*Accounting for Stock-Based Compensation*.” No stock-basedemployee compensation cost was recognized in the Statement of Operations forthe three months ended March 31, 2005, as all options granted under those planshad an exercise price equal to the market value of the underlying common stockon the date of grant. Effective January 1, 2006, the Company adopted the fairvalue recognition 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 three months ended March 31, 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 123, and (b) compensationcost for all share-based payments granted subsequent to January 1, 2006, basedon the grant-date fair value estimated in accordance with the provisions of SFAS123R. Results for prior periods have not been restated.

 

As a result of adopting SFAS 123R on January 1, 2006, the Company’sincome before income taxes and net income for the three months ended March 31,2006, are $2.0 million and $1.4 million lower, respectively, than if it hadcontinued to account for share-based compensation under APB No. 25. Basic anddiluted earnings per share for the three months ended March 31, 2006 would havebeen $0.29 and $0.26, respectively, if the Company had not adopted SFAS 123R,compared to reported basic and diluted earnings per share of $0.26 and $0.23,respectively.

 

Prior to the adoption of SFAS 123R, the Company presented all taxbenefits of deductions resulting from the exercise of stock options asoperating cash flows in the Statement of Cash Flows. SFAS 123R requires thecash flows resulting from the tax benefits resulting from tax deductions inexcess of compensation cost recognized for those options (excess tax benefits)to be classified as financing cash flows. The $0.8 million excess tax benefitclassified as a financing cash inflow would have been classified as anoperating cash inflow if the Company had not adopted SFAS 123R.

 

The weighted average fair value per share of options granted during thethree months ended March 31, 2006 and 2005 is estimated at $12.56 and$15.17, respectively. The value of options is estimated on the date of thegrant using the following weighted average assumptions:

 
| ** **              | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
| Risk-free interest rate |       | 4.32     | %          | 3.79     | %          |
| Expected dividend yield |       | —   |       | —   |       |
| Expected lives          |       | 5 years  |       | 5 years  |       |
| Expected volatility     |       | 107.8    | %          | 117.02   | %          |

 

The Company has granted stock options andrestricted shares to officers, directors and employees as follows:

 
| ** **                            | ** ** | ** **     | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **    | ** ** |
|---------------------------------------|------------|----------------|------------|--------------|------------|-----------------|------------|---------------|------------|
| ** **                            | ** ** | **Number of**  | ** ** | **Weighted** | ** ** | **Average**     | ** ** | **Aggregate** | ** ** |
| ** **                            | ** ** | **Shares**     | ** ** | **Average**  | ** ** | **Remaining**   | ** ** | **Intrinsic** | ** ** |
| ** **                            | ** ** | **Subject to** | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Value**     | ** ** |
| ** **                            | ** ** | **Issuance**   | ** ** | **Price**    | ** ** | **Term**        | ** ** | **($000)**    | ** ** |
| Outstanding at December 31, 2005 |       | 3,121,936      |       | 13.19        |       |            |       |          |       |
| Granted                               |       | 469,500        |       | 15.79        |       |            |       |          |       |
| Cancelled                             |       | (126,202       | )          | 13.44        |       |            |       |          |       |
| Exercised                             |       | (190,932       | )          | 9.79         |       |            |       |          |       |
| Outstanding at March 31, 2006    |       | 3,274,302      |       | 13.93        |       | 4.9             |       | $             | 45,611     |   |
|                                       |            |                |            |              |            |                 |            |               |            |  |

 

In 2005 and through March 31, 2006, the Company issued RestrictedShares to executives and employees. Issuances in the first three months of 2006were as follows:

 
| **Date of Issuance** | ** ** | **Shares Issued** | ** ** | **Price of Shares** | ** ** | **Vesting Schedule** | ** ** |
|--------------------------------|------------|------------------------|------------|-------------------------------|------------|---------------------------|------------|
| January 24, 2006          |       | 86,500                 |       | $                             | 15.79      |                      | A          |   |
| January 24, 2006          |       | 254,000                |       | $                             | 15.79      |                      | B          |   |
| February 21, 2006         |       | 10,000                 |       | $                             | 18.87      |                      | A          |   |
| March 20, 2006            |       | 4,000                  |       | $                             | 23.22      |                      | B          |   |

 

Shares issued under vesting plan A, vest when specific key performanceobjectives have been reached or on the fifth anniversary date of the issuance. Sharesissued under vesting plan B, vest 25% annually over four years. For the threemonths ended March 31, 2006 and 2005 the Company recognized $0.7 millionand $0.0 million in deferred compensation expense related to the restrictedshares, respectively.

 

Had compensation costs for the Company’soptions been determined using the Black-Scholes option valuation modelprescribed by SFAS No. 123, “*Accounting for Stock BasedCompensation*,” for 2005 the Company’s pro forma net income percommon share would have been reported as follows (in thousands, except pershare amounts):

 
| ** **                                                                                                                             | ** ** | **For The Three  Months  Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                             | ** ** | **2005**                                    | ** ** |
| Net income as reported                                                                                                                 |       | $                                           | 7,588      |   |
| Add: Stock based compensation expense as  recorded, net of related tax effects                                                         |       | —                                      |       |
| Deduct: Total stock-based employee  compensation expense determined under fair value basis for all awards, net of  related tax effects |       | (485                                        | )          |
| Pro forma                                                                                                                              |       | $                                           | 7,103      |   |
| Net income per common share-basic:                                                                                                     |       |                                        |       |
| As reported                                                                                                                            |       | $                                           | 0.22       |   |
| Pro forma                                                                                                                              |       | $                                           | 0.20       |   |
| Net income per common share-diluted:                                                                                                   |       |                                        |       |
| As reported                                                                                                                            |       | $                                           | 0.19       |   |
| Pro-forma                                                                                                                              |       | $                                           | 0.18       |   |

 

The Black-Scholes option valuation model was not developed for use invaluing employee stock options. Instead, this model was developed for use inestimating the fair value of traded options, which have no vestingrestrictions, and are fully transferable, which differ significantly from theCompany’s stock option awards. In addition, option valuation models require theinput of highly subjective assumptions including the expected stock pricevolatility and expected survival rates of the options.

 

**4.****                                      MarketableSecurities**

 

The Company classifies its existing marketable securities asavailable-for-sale. All available-for-sale securities are classified as currentas the Company has the ability to use them for current operating and investingpurposes. There were no realized losses from marketable securities in the threemonths ended March 31, 2006. At March 31, 2006, the Company had totalnet unrealized losses from marketable securities of $2.0 million.

 

5

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The carrying amount of available-for-sale securities and theirapproximate fair values at March 31, 2006 were as follows (in thousands):

 
| ** **                                      | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
|-------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|-----------------|------------|
| U.S. Government and Federal agency  obligations |       | $                   | 58,134     |                         | $          | —                        |       | $               | (1,381     | ) | $ | 56,753 |   |
| Corporate bonds                                 |       | 51,045              |       | 2                            |       | (632                          | )          | 50,415          |       |
| Total                                           |       | $                   | 109,179    |                         | $          | 2                             |       | $               | (2,013     | ) | $ | 107,168 |   |

 

The following table presents the age of gross unrealized losses andfair value by investment category for all securities in a loss position as of March 31,2006 (in thousands):

 
| ** **                                      | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total**       | ** ** |
|-------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------------|------------|
| ** **                                      | ** ** | **Fair  Value**                        | ** ** | **Unrealized  Gain**                 | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** |
| U.S. Government and Federal agency  obligations |       | $                                      | —     |                                 | $          | —          |       | $ | 56,753 |   | $ | (1,381 | ) | $ | 56,753 |   | $ | (1,381 | ) |
| Corporate bonds                                 |       | —                                 |       | —                               |       | 25,157          |       | (632 | ) | 25,157 |   | (632 | ) |
| Total                                           |       | $                                      | —     |                                 | $          | —          |       | $ | 81,910 |   | $ | (2,013 | ) | $ | 81,910 |   | $ | (2,013 | ) |

 

The Company has determined that its unrealized losses are temporarybased on the minor amount of the losses compared to amortized cost and theshort duration of the losses, as well as the credit worthiness of theinvestees. The Company expects that all losses will be recovered, and intendsto hold securities to recovery. If market, industry and/or investee conditionsdeteriorate, we may incur future impairments.

 

The amortized cost and estimated fair value of marketable securities atMarch 31, 2006 by contractual maturity are shown below (in thousands):

 
| ** **                               | ** ** | **Cost** | ** ** | **Estimated  Fair Value** | ** ** |
|------------------------------------------|------------|----------|------------|--------------------------------|------------|
| Due in one year or less                  |       | $        | 52,347     |                           | $          | 52,019 |   |
| Due after one year through three years   |       | 46,059   |       | 44,732                         |       |
| Due after three years through five years |       | 7,581    |       | 7,335                          |       |
| Due after five years                     |       | 3,192    |       | 3,082                          |       |
|                                     |       | $        | 109,179    |                           | $          | 107,168 |   |

 

The carrying amount of available-for-sale securities and theirapproximate fair values at December 31, 2005 were as follows (inthousands):

 
| ** **                                      | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **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 |   |

 

**5.****                                      Inventories**

 

Inventories consist of purchased pharmaceutical products and are statedat the lower of cost or market. Cost is determined using the first-in,first-out method, and market is considered to be net realizable value.Inventories consist of finished product and bulk product awaiting processingand packaging into finished product. Inventories, net of reserves of $0.6 millionand $0.9 million at March 31, 2006 and December 31, 2005, respectively,consisted of (in thousands):

 
| ** **        | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------|------------|--------------------------|------------|-----------------------------|------------|
| Bulk product      |       | $                        | 3,206      |                        | $          | 2,406 |   |
| Finished product  |       | 24,216                   |       | 26,518                      |       |
| Total inventories |       | $                        | 27,422     |                        | $          | 28,924 |   |

 

6

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**6.****                                      IntangibleAssets**

 

In January 2006, the Company paid Bayer Healthcare AG a milestonepayment of $5.0 million for the licensing rights to Sular. The milestonepayment will be amortized over the remaining useful life of Sular.

 

Intangible assets which are not deemed to have an indefinite life areamortized on a straight line basis over their respective useful lives.

 

The following table reflects the components of intangible assets as of March 31,2006 (in thousands):

 
| ** **                     | ** ** | **Gross Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Amount** | ** ** | **Expected Life** | ** ** |
|--------------------------------|------------|-----------------------|------------|-------------------------------|------------|---------------------|------------|------------------------|------------|
| Licensing rights               |       | $                     | 361,040    |                          | $          | (64,680             | )          | $                      | 296,360    |   | 10 to 20 years |   |
| Trade names                    |       | 11,060                |       | (2,431                        | )          | 8,629               |       | 15 to 20 years         |       |
| Contracts                      |       | 8,300                 |       | (6,907                        | )          | 1,393               |       | 5 years                |       |
| Supply/Distribution agreements |       | 10,350                |       | (4,210                        | )          | 6,140               |       | 1 to 10 years          |       |
| Other intangibles              |       | 3,108                 |       | (721                          | )          | 2,387               |       | 20 years               |       |
| Total                          |       | $                     | 393,858    |                          | $          | (78,949             | )          | $                      | 314,909    |   |   |   |

 

The following table reflects the components of intangible assets as of December 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 months ended March 31, 2006, amortization expenserelated to the intangible assets was $5.8 million. Amortization is calculatedon a straight-line basis over the estimated useful life of the intangibleasset. Estimated annual amortization expense for each of the five succeedingfiscal years is as follows (in thousands):

 

| **Fiscal year ended December 31:** | ** ** | **Amount** | ** ** |
|--------------------------------------------------------|------------|------------|------------|
| 2006                                                   |       | $          | 23,127     |   |
| 2007                                                   |       | 21,822     |       |
| 2008                                                   |       | 21,571     |       |
| 2009                                                   |       | 21,571     |       |
| 2010                                                   |       | 21,571     |       |
|                                                        |            |            |            |  |

 

**7.****                                      OtherLong-Term Assets**

 

Other assets at March 31, 2006 and December 31, 2005consisted of the following (in thousands):

 

| ** **                   | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Capitalized finance costs    |       | $                        | 4,249      |                        | $          | 4,312 |   |
| Deposits                     |       | 59                       |       | 59                          |       |
| Total Long-Term other assets |       | $                        | 4,308      |                        | $          | 4,371 |   |

 

**8.****                                      AccruedExpenses**

 

Accrued expenses at March 31, 2006 and December 31, 2005consisted of the following (in thousands):

 

| ** **                         | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Employee compensation and benefits |       | $                        | 2,658      |                        | $          | 4,111 |   |
| Product returns                    |       | 1,244                    |       | 1,090                       |       |
| Product rebates                    |       | 2,590                    |       | 2,441                       |       |
| Sales deductions                   |       | 2,917                    |       | 2,802                       |       |
| Accrued royalties                  |       | 4,688                    |       | 5,082                       |       |
| Other                              |       | 1,797                    |       | 2,956                       |       |
|                               |       | $                        | 15,894     |                        | $          | 18,482 |   |

 

7

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**9.****                                      Long-termDebt**

 

In March 2004, the Company issued a total of $150.0 millionof its 1.75% senior subordinated contingent convertible notes due (the “2004Notes”) in 2024 in transactions that were exempt from registration in relianceupon Rule 144A and other available exemptions under the Securities Act.The 2004 Notes are due March 8, 2024 and accrued interest is payablesemi-annually in arrears on March 8 and September 8 of each year,which commenced on September 8, 2004. In addition to the interest on the 2004Notes, after March 8, 2007, the Company will also pay contingent interestduring specified six-month periods if the average trading price of the 2004Notes per $1,000 principal amount for the five day trading period ending on thethird trading day immediately preceding the first day of the applicablesix-month period equals $1,200 or more. During any period when contingentinterest is payable, it will be payable at a rate equal to 0.5% per annum. Asthis contingent interest feature is based on the underlying trading price ofthe 2004 Notes, the contingent interest qualifies as an embedded derivative. Asof March 31, 2006, management determined that the fair value of thiscontingent interest embedded derivative was not material. The net proceeds fromthis issuance, after deducting offering expenses, were approximately $145.4 million.Financing costs of $4.6 million were incurred with the issuance which arebeing amortized on a straight line basis over the life of the notes and areincluded in other assets in the consolidated balance sheet.

 

Holders of the 2004 Notes may initially convert the 2004 Notesinto shares of the Company’s common stock at a conversion rate of 45.1467shares per $1,000 principal amount of the 2004 Notes, which is equivalent to aconversion price of $22.15 per share, subject to anti-dilution adjustments,before the close of business on March 8, 2024. Holders may convert the2004 Notes only under the following circumstances: (1) during any calendarquarter commencing after June 30, 2004, if the closing sales price of theCompany’s common stock exceeds 120% of the conversion price for at least 20trading days in the 30 consecutive trading days ending on the last trading dayof the preceding calendar quarter; (2) if the 2004 Notes have been calledfor redemption; (3) during the five trading day period immediatelyfollowing any nine consecutive trading day period in which the trading price ofthe 2004 Notes per $1,000 principal amount for each day of that period was lessthan 95% of the product of the closing price of the Company’s common stock andthe number of shares of common stock issuable upon conversion of $1,000principal amount of the 2004 Notes; or (4) the occurrence of specifiedcorporate transactions.

 

The Company has the option to redeem the 2004 Notes beginning March 13,2007 at a price equal to 100% of their aggregate principal amount, plus accruedand unpaid interest, including contingent interest, if any.

 

The holders of the 2004 Notes have the option to require the Company torepurchase the 2004 Notes on March 8 of 2009, 2014 and 2019, and upon achange in control, at a price equal to 100% of their aggregate principalamount, plus accrued and unpaid interest, including contingent interest, ifany.

 

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

 

In  March 2006, the Company commencedan exchange offer whereby it is offering to exchange the 2004 Notes issued in March 2004with new notes (the “New Notes”) that, among other things, would require theCompany to redeem the $150.0 million 2004 Notes with cash instead of commonstock. In April 2006, the exchange offer was extended to May 2, 2006.  As an incentive to the 2004 Note holders toexchange the 2004 Notes for New Notes, the Company will pay to each exchangingholder an exchange fee equal to 0.75% of the face value of each 2004 Noteexchanged, for a potential aggregate maximum exchange fee of $1,125,000.

 

While the terms of New Notes will be substantially similar to the termsof the 2004 Notes, certain material differences between the 2004 Notes and the NewNotes are described below.

 

Upon conversion, the Company will deliver, for each New Note,consideration (the “conversion value”) having a value equal to the product ofthe conversion rate (initially, approximately 45.1467, subject to adjustment)multiplied by the average of the closing price of our common stock on theNasdaq National Market on each of the five consecutive trading days beginningon the third trading day following the conversion date of New Notes (the “applicablestock price”). This consideration will be paid in cash (the “required cashamount”) in an amount equal to the lesser of (a) the aggregate principalamount of New Notes on the conversion date or (b) the conversion value,and the remainder will be paid in shares of our common stock. The number ofshares to be delivered will equal (a)(i) the conversion value minus (ii) therequired cash amount, divided by (b) the applicable stock price.

 

8

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A holder that surrenders New Notes for conversion in connection withcertain fundamental 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 our 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 eventsincluded in the 2004 Notes which would constitute a change of control (asdefined in the indenture relating to the 2004 Notes), a fundamental change willalso include the occurrence of any transaction or event or any series oftransactions or events in connection with which all or substantially all of ourcommon stock is exchanged for, converted into, acquired for or constitutessolely the right to receive stock, other securities, other property, assets orcash, unless either:

 

(a)          the persons that “beneficiallyowned,” the shares of our voting stock immediately prior to such transaction, “beneficiallyown,” shares of the surviving or continuing corporation’s voting stockrepresenting at least a majority of the total voting power of all outstandingclasses of voting stock of such corporation or

 

(b)         both of the followingconditions are satisfied:

 

(i)                                     at least 90% ofthe consideration (other than cash payments for fractional shares or pursuantto statutory appraisal rights) in such transaction consists of common stock,ordinary shares or American Depository Shares, and any associated rights,traded on a U.S. national securities exchange or quoted on the Nasdaq NationalMarket (or that will be so traded or quoted when issued or exchanged inconnection with such transaction) and

 

(ii)                                  as a result ofsuch transaction, the consideration due upon conversion of New Notes shall bepayable solely in shares of such securities, and any associated rights and cashfor fractional shares.

 

The Company had no debt other than the aforementioned notes outstandingat March 31, 2006 or December 31, 2005.

 

**10.****                               CreditAgreement**

 

On February 11, 2003, the Company entered into a$20.0 million senior secured revolving credit facility with variouslenders and LaSalle Bank National Association, as administrative agent.Borrowings may be used for working capital requirements and generalcorporate purposes. Borrowings are secured by substantially all of the Company’sassets. Borrowings bear interest at the Company’s option at the base rate ineffect from time to time plus an applicable margin or the Eurodollar rate, plusan applicable margin. The applicable margin will vary dependent upon theCompany’s leverage ratio in effect from time to time. The revolving facilitymatures on August 11, 2006. The revolving loan contains various covenants,including covenants relative to maintaining financial ratios and earningslevels, limitations on acquisitions, dispositions, mergers and capitalexpenditures, limitations on incurring additional indebtedness and aprohibition on payment of dividends and certain issuances of capital stock. Asof March 31, 2006, there was no outstanding balance on the CreditAgreement. For the three months ended March 31, 2006, there were noborrowings or repayments under the Credit Agreement.

 

**11.****                               ShareBuyback Program**

 

The Company adopted a new share repurchase program effective August 3,2005, that authorizes the repurchase of up to $20.0 million of its outstandingshares of common stock over the next twelve months with no periodic sub-limitson the amount of repurchases. This plan replaces all prior share repurchaseplans and will expire on August 2, 2006. There have been no repurchasesunder the Program in 2006. As of March 31, 2006, $15.6 million is available forrepurchases under the provision.

 

**12.****                               EarningsPer Share**

 

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

 
| ** **                                                         | ** ** | **For the three months  ended March 31,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **2006**                                                           | ** ** | **2005** | ** ** |
| Net income                                                         |       | $                                                                  | 9,126      |   | $ | 7,588 |   |
| Add: Interest expense on contingent  convertible debt (net of tax) |       | 490                                                                |       | 478 |   |
| Adjusted net income                                                |       | $                                                                  | 9,616      |   | $ | 8,066 |   |
| Weighted average common shares  outstanding-basic                  |       | 35,054                                                             |       | 35,066 |   |
| Dilutive effect of stock options and  restricted stock             |       | 770                                                                |       | 667 |   |
| Dilutive effect of contingent convertible  debt                    |       | 6,772                                                              |       | 6,772 |   |
| Weighted average common shares  outstanding-diluted                |       | 42,596                                                             |       | 42,505 |   |
| Basic net income per share:                                        |       | $                                                                  | 0.26       |   | $ | 0.22 |   |
| Diluted net income per share:                                      |       | $                                                                  | 0.23       |   | $ | 0.19 |   |

 

9

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For the three months ended March 31, 2006, there were 609,055 potentialcommon shares outstanding that were excluded from the diluted net income pershare calculation because their effect would have been anti-dilutive.

 

**13.****                               SegmentReporting**

 

The Company is engaged solely in the business of marketing and sellingprescription pharmaceutical products. Accordingly, the Company’s business isclassified in a single reportable segment, the sale and marketing ofprescription products. Prescription products include a variety of brandedpharmaceuticals for the treatment of cardiovascular, obstetrical andgynecological, and gastroenterological conditions and disorders.

 

The following presents revenues for prescription products by area of treatment:

 
| ** **          | ** ** | **For The Three  Months Ended  March 31,** | ** ** |
|---------------------|------------|----------------------------------------------------------------|------------|
| ** **          | ** ** | **2006**                                                       | ** ** | **2005** | ** ** |
| Cardiovascular      |       | $                                                              | 46,810     |   | $ | 19,471 |   |
| Women’s health |       | 13,742                                                         |       | 12,458 |   |
| Non promoted        |       | 5,901                                                          |       | 9,028 |   |
| Net revenues        |       | $                                                              | 66,453     |   | $ | 40,957 |   |

 

**14.****                               Commitmentsand Contingencies**

 

First Horizon, certain former and current officers and directors aredefendants in a consolidated securities lawsuit filed on August 22, 2002in the United States District Court for the Northern District of Georgia.Plaintiffs in the class action alleged in general terms that we violatedSections 11 and 12(a)(a) of the Securities Act of 1933 and that weviolated Sections 10(b) and 20(a) of the Securities Exchange Act of1934 and Rule 10b-5 promulgated thereunder. In an amended complaint,Plaintiffs claim that we issued a series of materially false andmisleading statements to the market in connection with our public offering on April 24,2002 and thereafter relating to alleged “channel stuffing” activities. Theamended compliant also alleged controlling person liability on behalf ofcertain of our officers under Section 15 of the Securities Act of 1933 andSection 20 of the Securities Exchange Act of 1934. Plaintiffs seek anunspecified amount of compensatory damages.

 

On September 29, 2004, the U.S. District Court for the NorthernDistrict of Georgia dismissed, without prejudice, the class actionlawsuit. Although the class action lawsuit was dismissed, the courtgranted the plaintiffs the right to refile their lawsuit provided that theplaintiffs pay all of the defendant’s fees and costs associated with filing themotions to dismiss the lawsuit. Plaintiffs did not file a second amendedcomplaint as permitted, but instead filed a motion asking the District Court toreconsider its September 29, 2004 order and lift the condition that theymust pay defendants’ fees and costs before further amendment. On June 22,2005, the District Court denied plaintiffs’ motion and gave them anotheropportunity to amend if they pay defendants’ fees and costs. Once again,plaintiffs chose not to file a second amended complaint. Instead, plaintiffsfiled an appeal to the United States Court of Appeals for the Eleventh Circuit.This appeal is currently pending.

 

The Company is also involved with other various legal proceedingsincident to the course of business. None of these proceedings are expected tohave a material adverse effect on the consolidated financial statements.

 

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

 

The following should be read with the consolidated financial statementsand related footnotes and Management’s Discussion and Analysis of Results ofOperations and Financial Condition included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005 (File No. 000-30123). Theresults discussed below are not necessarily 

 

10

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indicative of the results to be expected in any future periods. Thefollowing discussion contains forward-looking statements that are subject torisks and uncertainties, which could cause actual results to differ from thestatements made.

 

**Overview**

 

First Horizon Pharmaceutical Corporation, or the Company, is aspecialty pharmaceutical company that markets, develops and sells brand nameprescription products. Our key products focus on two therapeutic categories,Cardiology and Women’s Health. Our key marketed products include:

 

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

 

Our current operating plan focuses first on maximizing the sales of ourexisting product 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.

 

We currently market and sell 15 products, eight of which are activelypromoted and which accounted for approximately 91% our total sales for the quarterended March 31, 2006. We promote our products through our nationwide salesand marketing force in approximately 525 territories, targetinghigh-prescribing primary care physicians, endocrinologists, cardiologists,obstetricians and gynecologists.

 

**Results of Operations**

 

*Net Revenue.*Netrevenue for the quarter ended March 31, 2006 increased by $25.5 millionor 62% to $66.5 million, as compared to $41.0 million for the threemonths ended March 31, 2005. Net revenue from our promoted products increasedby $28.6 million for the three months ended March 31, 2006 as a result ofgrowth from increased detailing, as well as continued success in the executionof our marketing strategy. The increase in revenue of our promoted products waspartially offset by a reduction in non-promoted product revenues of $3.1 million,primarily from our Tanafed and Robinul Lines as we ceased promotion of theseproducts as a result of generic entries into the market.

 

**Product Overview**

 
| ** **      | ** ** | **Change in total dispensed prescriptions  for the three months ended March 31, 2006  compared to the three months ended March 31, 2005(a)** | ** ** | **Change in new dispensed prescriptions  for the three months ended March 31, 2006  compared to the three months ended March 31, 2005(a)** | ** ** |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Sular           |       | 17                                                                                                                                                                                                                                          | %          |                                                                                                                                                                                                                                      | 32         | % |   |
| Fortamet (b)    |       | 48                                                                                                                                                                                                                                          | %          |                                                                                                                                                                                                                                      | 22         | % |   |
| Altoprev        |       | (22                                                                                                                                                                                                                                         | )%         |                                                                                                                                                                                                                                      | (13        | )% |   |
| Triglide(c)     |       | N/A                                                                                                                                                                                                                                         |       |                                                                                                                                                                                                                                      | N/A        |   |   |
| Nitrolingual(d) |       | (11                                                                                                                                                                                                                                         | )%         |                                                                                                                                                                                                                                      | (11        | )% |   |
| Prenate Elite   |       | (12                                                                                                                                                                                                                                         | )%         |                                                                                                                                                                                                                                      | (20        | )% |   |
| OptiNate (e)    |       | N/A                                                                                                                                                                                                                                         |       |                                                                                                                                                                                                                                      | N/A        |   |   |
| Ponstel         |       | 5                                                                                                                                                                                                                                           | %          |                                                                                                                                                                                                                                      | 5          | % |   |

 

----

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

 

*(b)**                              *Fortamet was launched in May, 2004, by AndrxCorporation.

 

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

 

*(d)*                               We believe that IMS data does not captureprescriptions of Nitrolingual from some of the non-retail channels and 

 

11

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prescriptiontrends in the non-retail channel which may have a significant impact onthe reported change.

 

*(e)*                                OptiNate was launched in March 2005.

 

Net revenues of the Cardiology products (namely Sular, Fortamet,Altoprev, Triglide and Nitrolingual) were $46.8 million for the three months endedMarch 31, 2006, compared to $19.5 million for the three months ended March 31,2005. The increase was primarily due to the launch of Altoprev and Fortamet in April 2005,the continued growth of Sular, the launch of Triglide in July 2005, aswell as price increases implemented during 2005 and 2006.

 

Net revenues of the promoted Women’s Health products (namely PrenateElite, OptiNate and Ponstel), were $13.7 million for the three months endedMarch 31, 2006 compared to $12.4 million for the three months ended March 31,2005. This increase is primarily related to price increases implemented during2005 and 2006, as well as increased sales of Ponstel related to prescriptiongrowth.

 

Net revenues of our non-promoted products decreased $3.1 million, to $5.9million for the three months ended March 31, 2006 compared to $9.0 for thethree months ended March 31, 2005. This decrease was a result of anintroduction of knock-offs and a generic of the Tanafed and Robinul lines.

 

*Cost of Revenues.*Costof revenues for the three months ended March 31, 2006 were $9.4 millioncompared to $7.2 million for the three months ended March 31, 2005.The increase in cost of revenues is directly related to the increase in unitssold and a change in product mix for the three months ended March 31, 2006as compared to the three months ended March 31, 2005.

 

*Gross Margin.*Grossmargin for the three months ended March 31, 2006 was 86.0% compared to 82.5%for the three months ended March 31, 2005. This increase in gross marginwas the result of the change in product mix from the prior year primarily dueto the acquisitions of Fortamet and Altoprev completed in the second quarter of2005 and the successful launches of OptiNate and Triglide in the second andthird quarters of 2005, respectively. Also contributing to the increased grossmargins were price increases implemented during 2005 and 2006.

 

*Selling, General and Administrative Expenses.*Selling, general and administrative expenses increased$16.8 million, or 94.9%, to $34.5 million for the three months ended March 31,2006, compared to $17.7 million for the three months ended March 31,2005. The increase in selling, general and administrative expenses is dueprimarily to the addition of approximately 115 sales representatives and anincrease in royalty and commission expenses related to higher revenues. Additionally,we recognized $1.7 million in stock based compensation in the three monthsended March 31, 2006. There were no similar expenses for the three monthsended March 31, 2005.

 

*Depreciation and Amortization Expense.*Depreciationand amortization expense increased $2.1 million to $6.5 million for the threemonths ended March 31, 2006, compared to $4.4 million for the threemonths ended March 31, 2005. This increase is primarily related to theaddition of Fortamet and Altoprev in March 2005 and Triglide in July 2005.

 

*Research and Development Expense.*Researchand development expense increased $2.6 million to $2.9 million forthe three months ended March 31, 2006, compared to $0.3 million for the threemonths ended March 31, 2005. This increase was primarily related togreater activity in the development program for lifecycle managementinitiatives for our products and management’s increased emphasis on development.Additionally, we recognized $0.3 million in stock based compensation for ourresearch and development department in the three months ended March 31,2006. There were no similar expenses for the three months ended March 31,2005.

 

*Interest Expense.*Interestexpense was $0.8 million for the three months ended March 31, 2006,compared to $1.0 million for the three months ended March 31, 2005. Theinterest expense is primarily related to the issuance of the $150.0 milliondebt security discussed in note 9 to our financial statements containedelsewhere in this Report on Form 10-Q.

 

*Interest Income.*Interestincome was $0.9 million for the three months ended March 31, 2006,compared to $1.0 million for the three months ended March 31, 2005. Theinterest income is primarily related to the marketable securities balances.

 

*Provision for Income Taxes.*Incometaxes were provided for at a rate of 31.7% for the three months ended March 31,2006, compared to 34.0% for the three months ended March 31, 2005. Thisdecrease in the effective tax rate is due to the change 

 

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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.

 

**Liquidity and Capital Resources**

 

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

 

Our cash and cash equivalents were $27.8 million on March 31,2006. Net cash provided by operating activities for the three months ended March 31,2006 was $37.8 million. This increase of cash was the result of net incomefor the quarter of $9.1 million (adjusted for non-cash items of depreciationand amortization of $6.5 million, compensation expense of $2.0 million,deferred income tax expense of $1.2 million and non-cash interest expense of$0.1 million), a decrease of accounts receivable of $22.4 million; adecrease in inventory of $1.5 million; a decrease in the income taxreceivable of  $0.4 million;and anincrease of accounts payable of $0.3 million. These providers of cash werepartially offset by an increase of other current assets and other assets of $4.0million and the decrease of accrued expenses of $1.7 million.

 

Our cash and cash equivalents were $20.9 million on March 31,2005. Net cash used by operating activities for the three months ended March 31,2005 was $4.3 million. This use of cash was the result of an increase ofinventory on hand of $14.7 million primarily as a result of new products;a decrease in accrued expenses and other long-term liabilities of$7.7 million; an increase in other current assets and other assets of$2.2 million; and an increase in accounts receivable of $0.4 million.Partially offsetting the use of cash from operations was cash generated fromnet income of $7.6 million, an increase in accounts payable of$4.7 million, a decrease in the income tax receivable of$3.0 million, non-cash expenses including depreciation and amortizationexpenses of $4.4 million and as well as $1.0 million in other non-cashtax transactions of interset expense, deferred income tax expense andreductions in taxes payable for stock option exercises.

 

We maintain supply agreements with third party suppliers for most ofour products. Some of these supply agreements contain minimum purchaserequirements. For most of these supply agreements, we believe that ourinventory requirements and related purchases of inventory will exceed theminimum purchase requirement in 2006. In those cases in which we do not believeour purchases will exceed the minimum purchase requirements, we are seeking tonegotiate waivers or modifications of the minimum purchase requirements.

 

Net cash used in investing activities for the three months ended March 31,2006 was $30.0 million. The uses of cash were related to a Sular milestoneof $5.0 million, marketable securities of $37.5 million and thepurchases of property and equipment of $0.6 million. Partially offsettingthese uses of cash were the sales of marketable securities of $13.1 million.

 

Net cash used in investing activities for the three months ended March 31,2005 was $8.9 million. The uses of cash were for the purchase of products of$55.6 million related to the Company’s acquisition of Fortamet andAltoprev, as well as a sales milestone related to Sular, marketable securitiesof $3.9 million and the purchases of property and equipment of $0.5 million.Partially offsetting these uses of cash were the sales of marketable securitiesof $51.1 million. This liquidation of marketable securities was directlyrelated to the $50.6 million acquisition of product licenses for Fortametand Altoprev and the $5.0 million additional purchase price milestonepayment for Sular.

 

Net cash provided by financing activities was $2.9 million for thequarter ended March 31, 2006 resulting from the issuance of common stockfor $2.1 million and the reduction in taxes payable related to stock optionexercises of $0.8 million.

 

Net cash used in financing activities was $1.8 million for thequarter ended March 31, 2005 resulting from our repurchase of our commonstock for $2.1 million. Partially offsetting this net cash used was$0.3 million from the exercise of common stock options.

 

During the three months ended March 31, 2006, there were noborrowings or repayments under our $20 million senior credit facility.

 

We believe that our current balance of cash and cash equivalents andcash which we expect to generate from operations, as well as the availabilityof our credit facility, will be adequate to fund our current working capitalrequirements for at least the next 12 months. However, in the event thatwe make significant acquisitions in the future, we may be required toraise additional funds through additional borrowings or the issuance of debt orequity securities.

 

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In March 2004, the Company issued a total of $150.0 millionof its 1.75% senior subordinated contingent convertible notes due (the “2004Notes”) in 2024 in transactions that were exempt from registration in relianceupon Rule 144A and other available exemptions under the Securities Act.The 2004 Notes are due March 8, 2024 and accrued interest is payablesemi-annually in arrears on March 8 and September 8 of each year,which commenced on September 8, 2004. In addition to the interest on the2004 Notes, after March 8, 2007, the Company will also pay contingent interestduring specified six-month periods if the average trading price of the 2004Notes per $1,000 principal amount for the five day trading period ending on thethird trading day immediately preceding the first day of the applicablesix-month period equals $1,200 or more. During any period when contingentinterest is payable, it will be payable at a rate equal to 0.5% per annum. Asthis contingent interest feature is based on the underlying trading price ofthe 2004 Notes, the contingent interest qualifies as an embedded derivative. Asof March 31, 2006, management determined that the fair value of thiscontingent interest embedded derivative was not material. The net proceeds fromthis issuance, after deducting offering expenses, were approximately $145.4 million.Financing costs of $4.6 million were incurred with the issuance which arebeing amortized on a straight line basis over the life of the notes and areincluded in other assets in the consolidated balance sheet.

 

Holders of the 2004 Notes may initially convert the 2004 Notesinto shares of the Company’s common stock at a conversion rate of 45.1467shares per $1,000 principal amount of the 2004 Notes, which is equivalent to aconversion price of $22.15 per share, subject to anti-dilution adjustments, beforethe close of business on March 8, 2024. Holders may convert the 2004Notes only under the following circumstances: (1) during any calendarquarter commencing after June 30, 2004, if the closing sales price of theCompany’s common stock exceeds 120% of the conversion price for at least 20trading days in the 30 consecutive trading days ending on the last trading dayof the preceding calendar quarter; (2) if the 2004 Notes have been calledfor redemption; (3) during the five trading day period immediatelyfollowing any nine consecutive trading day period in which the trading price ofthe 2004 Notes per $1,000 principal amount for each day of that period was lessthan 95% of the product of the closing price of the Company’s common stock andthe number of shares of common stock issuable upon conversion of $1,000principal amount of the 2004 Notes; or (4) the occurrence of specifiedcorporate transactions.

 

The Company has the option to redeem the 2004 Notes beginning March 13,2007 at a price equal to 100% of their aggregate principal amount, plus accruedand unpaid interest, including contingent interest, if any.

 

The holders of the 2004 Notes have the option to require the Company torepurchase the 2004 Notes on March 8 of 2009, 2014 and 2019, and upon a changein control, at a price equal to 100% of their aggregate principal amount, plusaccrued and unpaid interest, including contingent interest, if any.

 

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

 

In  March 2006, the Companycommenced an exchange offer whereby it is offering to exchange the 2004 Notesissued in March 2004 with new notes (the “New Notes”) that, among otherthings, would require the Company to redeem the $150.0 million 2004 Notes withcash instead of common stock. In April 2006, the exchange offer wasextended to May 2, 2006. As an incentive to the 2004 Note holders toexchange the 2004 Notes for New Notes, the Company will pay to each exchangingholder an exchange fee equal to a 75% of the face value of each 2004 Noteexchanged, for a potential aggregate maximum exchange fee of $1,125,000.

 

While the terms of New Notes will be substantially similar to the termsof the 2004 Notes, certain material differences between the 2004 Notes and the NewNotes are described below.

 

Upon conversion, the Company will deliver, for each New Note,consideration (the “conversion value”) having a value equal to the product ofthe conversion rate (initially, approximately 45.1467, subject to adjustment)multiplied by the average of the closing price of our common stock on theNasdaq National Market on each of the five consecutive trading days beginningon the third trading day following the conversion date of New Notes (the “applicablestock price”). This consideration will be paid in cash (the “required cashamount”) in an amount equal to the lesser of (a) the aggregate principalamount of New Notes on the conversion date or (b) the conversion value,and the remainder will be paid in shares of our common stock. The number ofshares to be delivered will equal (a)(i) the conversion value minus (ii) therequired cash amount, divided by (b) the applicable stock price.

 

A holder that surrenders New Notes for conversion in connection withcertain fundamental 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 our 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

 

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In addition to the eventsincluded in 2004 Notes which would constitute a change of control (as definedin the indenture relating to 2004 Notes), a fundamental change will alsoinclude the occurrence of any transaction or event or any series oftransactions or events in connection with which all or substantially all of ourcommon stock is exchanged for, converted into, acquired for or constitutessolely the right to receive stock, other securities, other property, assets orcash, unless either:

 

(a)          the persons that “beneficiallyowned,” the shares of our voting stock immediately prior to such transaction, “beneficiallyown,” shares of the surviving or continuing corporation’s voting stockrepresenting at least a majority of the total voting power of all outstandingclasses of voting stock of such corporation or

 

(b)         both of the followingconditions are satisfied:

 

(i)                                     at least 90% ofthe consideration (other than cash payments for fractional shares or pursuantto statutory appraisal rights) in such transaction consists of common stock,ordinary shares or American Depository Shares, and any associated rights,traded on a U.S. national securities exchange or quoted on the Nasdaq NationalMarket (or that will be so traded or quoted when issued or exchanged inconnection with such transaction) and

 

(ii)                                  as a result ofsuch transaction, the consideration due upon conversion of New Notes shall bepayable solely in shares of such securities, and any associated rights and cashfor fractional shares.

 

The Company had no debt other than the aforementioned notes outstandingat March 31, 2006 or December 31, 2005.

 

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 borrowmonies under the revolving facility for working capital requirements andgeneral corporate purposes. Borrowings are secured by substantially all of ourassets. Borrowings bear interest at our option at the base rate in effect fromtime to time plus an applicable margin or the Eurodollar rate, plus anapplicable margin. The applicable margin will vary dependent upon our leverageratio in effect from time-to-time. As of March 31, 2006, we had noborrowings outstanding under this facility. The revolving facility, as amended,matures on August 11, 2006. Fees payable under the revolving facilityinclude a one-time commitment fee of 0.685% of the stated amount of thefacility, an unused commitment fee based on funds committed but not borrowedunder the revolving facility at rates which vary dependent upon our leverageratio in effect from time-to-time and letter of credit fees equal to 0.25% perannum of the face amount of letters of credit issued and outstanding under therevolving facility. The revolving facility may be prepaid fromtime-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.

 

**Critical Accounting Policies**

 

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

 

•                       *Allowance for 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 periodiccustomer specific review when needed. If we over or under estimate the level ofaccounts receivable that will not be paid, there may be a material impactto 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.

 

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•                       *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 our returnpolicy, and record a related reserve at the time of sale. These amounts arededucted from our gross sales to determine our net revenues. Our estimates takeinto 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, there may bea material impact to our financial statements.

 

•                       *Liabilities assumed with the acquisition of productrights.* In connection withthe acquisition of product rights, we assume certain liabilities for returns ofproduct shipped by the seller prior to the acquisition date. At the acquisitiondate, we estimate the amount of the assumed liabilities based on actual salesreturn data from the seller and include that amount in the allocation of thetotal purchase price. We review the estimated liability on an annual basis. Ifwe over or under estimate liabilities assumed, there may be a materialimpact to our financial statements.

 

•                       *Intangible assets*.  When we acquire the rights to manufacture andsell a product, we record the aggregate purchase price, along with the value ofthe product related liabilities that we assume, as intangible assets. We usethe assistance of valuation experts to help us allocate the purchase price tothe fair value of the various intangible assets that we have acquired. Then, wemust estimate the economic useful life of each of these intangible assets inorder to amortize their cost as an expense in our statement of operations overthe estimated economic useful life of the related asset. The factors that drivethe actual economic useful life of a pharmaceutical product are inherentlyuncertain, and include patent and other intellectual property protection,physician loyalty and prescribing patterns, competition by products prescribedfor similar indications, future introductions of competing products not yet FDAapproved, the impact of promotional efforts and many other factors. We use allof these factors in initially estimating the economic useful lives of ourproducts, and we also continuously monitor these factors for indications ofappropriate revisions.

 

In assessing the recoverability of its intangible assets, we must makeassumptions regarding estimated future cash flows and other factors. If theestimated undiscounted future cash flows do not exceed the carrying value ofthe intangible assets, we must determine the fair value of the intangibleassets. If the fair value of the intangible assets is less than its carrying value,an impairment loss will be recognized in an amount equal to the difference. Wereview intangible assets for impairment at least annually and whenever eventsor changes in circumstances indicate that the carrying amount of an asset may notbe recoverable. Such events or changes in circumstances may include butare not limited to, lack of promotional sensitivity, the introduction ofcompetitive products and changes in government regulations. If we determinethat an intangible asset is impaired, a non-cash impairment charge will berecognized. If we should incur an impairment loss, there may be a materialimpact to the financial statements.

 

•                       *Income Taxes*.  Income taxes are provided for under theliability method. This approach requires the recognition of deferred tax assetsand liabilities for the expected future tax consequences of differences betweenthe tax basis of assets or liabilities and their carrying amounts in theconsolidated financial statements. A valuation allowance is provided for deferredtax assets if it is more likely than not that these items will either expirebefore we are able to realize their benefit or if future deductibility isuncertain.

 

Developing the provision for income taxes requires significant judgmentand expertise in international, federal and state income tax laws, regulationsand strategies, including the determination of deferred tax assets andliabilities and, if necessary, any valuation allowances that may berequired for deferred tax assets. Our judgments and tax strategies are subjectto audit by various taxing authorities. While we believe we have providedadequately for our income tax liabilities in our consolidated financialstatements, adverse determinations by these taxing authorities could have amaterial adverse effect on our consolidated financial condition and results ofoperations.

 

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

 

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**Forward Looking Statements **

 

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

 

•                  Wemay not attain expected revenues and earnings;

 

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

 

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

 

•                  Thepotential growth rate for our promoted products may be limited by slowergrowth for the class of drugs to which our promoted products belong andunfavorable clinical studies about such class of drugs;

 

•                  Wemay encounter problems in the manufacture or supply of our products, forwhich we depend entirely on third parties;

 

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

 

•                  Wemay not be able to protect our competitive position for our promotedproducts from patent infringers;

 

•                  Altoprevhas experienced manufacturing issues. If the issues recur and cannot beresolved, our ability to acquire the product for sale and sampling will beadversely affected;

 

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

 

•                  Wemay incur unexpected costs in integrating new products into ouroperations;

 

•                  Wemay be unable to develop or market line extensions for our productsincluding Prenate, Sular, Triglide, Altoprev and Fortamet, or, even ifdeveloped, obtain patent protection for our line extensions; further, introductionsby us of line extensions of our existing products may require that we makeunexpected changes in our estimates for future product returns and reserves forobsolete inventory; if these risks occur, our operating results would beadversely affected;

 

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

 

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

 

•                  Wedepend on a small senior management group, the departure of any member of whichwould likely adversely affect our business;

 

•                  Anadverse interpretation or ruling by one of the taxing jurisdictions in which weoperate could adversely impact our operating results;

 

•                  Asmall number of customers accounts for a large portion of our sales and theloss of one of them, or changes in their purchasing patterns, could result insubstantially reduced sales, substantially and adversely impacting ourfinancial results;

 

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

 

•                  Sideeffects or marketing or manufacturing problems with our products could result inproduct liability claims which could be costly to defend and could result inthe withdrawal or recall of products from the market;

 

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•                  Werely on operational data obtained from IMS, an industry accepted data source.IMS data may not accurately reflect actual prescriptions (for instance, webelieve IMS data does not capture all product prescriptions from somenon-retail channels);

 

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

 

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

 

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

 

•                  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.

 

These risk factors are not exhaustive. We may not have correctlyidentified and appropriately assessed all factors affecting our business andthe publicly available and other information with respect to these matters may notbe complete and correct. Additional risks and uncertainties not presently knownto us or that we currently believe to be immaterial also may adverselyimpact us. Should any risks and uncertainties develop into actual events, thesedevelopments could have material adverse effects on our business, financialcondition, and results of operations. For these reasons, we caution you not toplace undue reliance on our forward-looking statements.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

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

 

**Foreign Currency Exchange Risk**

 

Our purchases of Sular, Triglide and Nitrolingual are made in Euros.Although we did not enter into any forward contracts in the first quarter of2006, we may eliminate risks from foreign currency fluctuations after thetime of shipment of product by entering into forward contracts for thesepurchases of inventory at the time of product shipments. The Company’s earningsand cash flows could be adversely affected in the future by the relationship ofthe U.S. dollar with foreign currencies.

 

**Market Risk on Investments**

 

The fair value of our investment portfolio would be negatively affectedby an increase in interest rates. Since the majority of the Company’s investmentsare fixed 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 months ended March 31, 2006. At March 31, 2006, theCompany had total net unrealized losses from marketable securities of $2.0 million.

 

**Market Risk on Variable Rate Debt**

 

In connection with borrowings incurred under the senior securedrevolving credit facility arranged by LaSalle Bank, N.A., we could experiencemarket risk with respect to changes in the general level of the interest ratesand its effect upon our interest expense. Borrowings under this facility bearinterest at variable rates. Because such rates are variable, an increase ininterest rates will result in additional interest expense and a reduction ininterest rates will result in reduced interest expense. Accordingly, ourpresent exposure to interest rate fluctuations is primarily dependent on ratechanges that may occur while borrowings under the senior secured creditfacility are outstanding. On March 31, 2006 there was no debt outstandingunder this facility.

 

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**Market Risk on Fixed Rate Debt**

 

The Company’s long-term fixed interest rate senior subordinatedcontingent convertible notes are also subject to market risk. Fixed rate debtoutstanding at March 31, 2006 was $150.0 million with an interestrate of 1.75%. All other things being equal, the fair market value of theCompany’s fixed rate debt will increase as rates decline and will decrease asrates rise. The fixed rate notes outstanding totaling $150.0 million at March 31,2006 had a fair value of $179.7 million based on quoted market rates.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controls andProcedures**

 

We maintain a set of disclosure controls and procedures that aredesigned to ensure that information required to be disclosed in the reportsthat we file under the Securities Exchange Act of 1934, as amended (“ExchangeAct”), is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms. We carried out an evaluation underthe supervision and with the participation of management, including ourPresident and Chief Executive Officer and our Chief Financial Officer, of theeffectiveness of the design and operation of First Horizon’s disclosurecontrols and procedures pursuant to Rule 13a-15(e) of the 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’s rules andforms and (ii) such information is accumulated and communicated to ourmanagement, including our President and Chief Executive Officer and our ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure.

 

**Changes in Internal Control over FinancialReporting**

 

There has been no change in First Horizon’s primary internal controlsover financial reporting during the first fiscal quarter of 2006, that hasmaterially affected, or is reasonably likely to materially affect First Horizon’sinternal controls over financial reporting.

 

**PART II—OTHERINFORMATION**

 

**ITEM 1: LEGAL PROCEEDINGS**

 

First Horizon, certain former and current officers and directors aredefendants in a consolidated securities lawsuit filed on August 22, 2002in the United States District Court for the Northern District of Georgia.Plaintiffs in the class action alleged in general terms that we violatedSections 11 and 12(a)(a) of the Securities Act of 1933 and that weviolated Sections 10(b) and 20(a) of the Securities Exchange Act of1934 and Rule 10b-5 promulgated thereunder. In an amended complaint,Plaintiffs claim that we issued a series of materially false and misleadingstatements to the market in connection with our public offering on April 24,2002 and thereafter relating to alleged “channel stuffing” activities. Theamended compliant also alleged controlling person liability on behalf ofcertain of our officers under Section 15 of the Securities Act of 1933 andSection 20 of the Securities Exchange Act of 1934. Plaintiffs seek anunspecified amount of compensatory damages.

 

On September 29, 2004, the U.S. District Court for the NorthernDistrict of Georgia dismissed, without prejudice, the class actionlawsuit. Although the class action lawsuit was dismissed, the courtgranted the plaintiffs the right to refile their lawsuit provided that theplaintiffs pay all of the defendant’s fees and costs associated with filing themotions to dismiss the lawsuit. Plaintiffs did not file a second amendedcomplaint as permitted, but instead filed a motion asking the District Court toreconsider its September 29, 2004 order and lift the condition that theymust pay defendants’ fees and costs before further amendment. On June 22,2005, the District Court denied plaintiffs’ motion and gave them anotheropportunity to amend if they pay defendants’ fees and costs. Once again,plaintiffs chose not to file a second amended complaint. Instead, plaintiffsfiled an appeal to the United States Court of Appeals for the Eleventh Circuit.This appeal is currently pending.

 

The Company is also involved with other various routine legalproceedings incident to the course of business. None of these proceedings areexpected to have a material adverse effect on the consolidated financialstatements.

 

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**ITEM 2: UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

None.

 

**ITEM 5: OTHER INFORMATION**

 

None.

 

**ITEM 6: EXHIBITS**

 
| 10.1 |   | Employment agreement between the Company and Larry Dillaha dated  April 26, 2006                                                                                                                                  |
|------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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.                      |

 

**SIGNATURES**

 

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

 
| ** **                |       | **FIRST HORIZON PHARMACEUTICAL  CORPORATION**(Registrant) |
|---------------------------|------------|-----------------------------------------------------------|
| ** **                | ** ** | ** **                                                |
| Date: April 27, 2006 | By:        | /s/ PATRICK P. FOURTEAU                                   |
|                      |       | Patrick P. Fourteau                                       |
|                      |       | *Chief Executive Officer and President*                   |
|                      |       | *(principal executive officer)*                           |
|                      |       |                                                      |
| Date: April 27, 2006 | By:        | /s/ DARRELL BORNE                                         |
|                      |       | Darrell Borne                                             |
|                      |       | *Chief Financial Officer, Secretary and  Treasurer*  |
|                      |       | *(principal accounting and financial  officer)*           |

 

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