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SECURITIES AND EXCHANGE COMMISSION

FORM 10-KSB

[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934 for the fiscal year ended: September 30, 2006 
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934 for the transition period from __________ to __________

Commission File Number: 000-30813

AlphaRx, Inc.

Delaware
      98-0177440(State or other jurisdiction
      of
      (I.R.S. Employer
      Identification No.)incorporation or
      organization)


200-168 Konrad Crescent, Markham, Ontario, Canada L3R 9T9

(905) 479-3245(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the
Exchange Act:

Title of Each Class
      Name of Exchange on Which RegisteredCommon Stock ($0.0001 par value)
      None


Check whether the issuer: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act of 1934 during the past 12 months (or
for such shorter period that the issuer was required to file such reports), and
(2) has been subject to such filing requirement for the past 90 days. YES X             NO _____

Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B contained in this form, and that no disclosure will be
contained, to the best of issuer's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]

Issuer's revenues for its most recent fiscal year ended September 30, 2006
were $ 1,024,774.

The aggregate market value of the issuer's common stock (the
only class of voting stock), held by non-affiliates was approximately $5,202,730
based on the average closing bid and ask price for the common stock on December
20, 2006.

As of December 20, 2006 there were 57,808,112 shares outstanding of the
issuer's common stock.

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AlphaRx, Inc.

FORM 10-KSB

For the Year Ended September 30, 2006

INDEX

|PART I     |                                                                                                                              |   
|---------- | ---------------------------------------------------------------------------------------------------------------------------- | --
|Item 1.    | Description of Business                                                                                                      | 3 
|Item 2.    | Description of Property                                                                                                      | 19
|Item 3.    | Legal Proceedings                                                                                                            | 19
|Item 4.    | Submission of Matters to a Vote of Security
    Holders                                                                      | 19
|           |                                                                                                                              |   
|PART II    |                                                                                                                              |   
|Item 5.    | Market for Common Equity and Related
    Stockholder Matters                                                                 | 20
|Item 6.    | Management Discussion and Analysis of
    Financial Condition                                                                | 21
|Item 7.    | Financial Statements for 2006 and 2005                                                                                       | 29
|Item 8.    | Changes in and Disagreements with Accountants
    on Accountingand Financial Disclosure                                      | 29
|Item 8A    | Controls and Procedures                                                                                                      | 30
|Item 8B    | Other Information                                                                                                            | 30
|PART III   |                                                                                                                              |   
|Item 9.    | Directors, Executive Officers, Promoters and
    Control Persons;
    Compliance with Section 16(a) of the Exchange
    Act. | 30
|Item 10.   | Executive Compensation                                                                                                       | 32
|Item 11.   | Security Ownership of Certain Beneficial
    Owners and Management                                                           | 35
|Item 12.   | Certain Relationships and Related
    Transactions                                                                           | 35
|Item 13.   | Exhibits and Reports on Form 8-K                                                                                             | 36
|Item 14.   | Principal Accountants Fees and Services                                                                                      | 37
|           |                                                                                                                              |   
|SIGNATURES | 39                                                                                                                          
|           |                                                                                                                              |   
|EXHIBITS   |                                                                                                                              | 40

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PART I

ITEM 1. DESCRIPTION OF BUSINESS

COMPANY BACKGROUND

In this annual report on Form 10-KSB, the "Company," "AlphaRx," "we," "us,"
and "our," refer collectively to AlphaRx, Inc., AlphaRx Canada Limited, our
wholly-owned subsidiary, 85% of AlphaRx International Holdings Limited and 85%
of Alpha Life Sciences Limited.

AlphaRx, Inc., formerly known as Logic Tech International Inc., was
incorporated in Delaware on August 8, 1997 as an intellectual property holding
company whose mission was to identify, acquire and develop new technologies or
products and devise commercial applications to be taken to market through
licensing or joint venture partners. Logic Tech International Inc. was renamed
AlphaRx, Inc. on January 28, 2000 and our common stock commenced trading on the
OTC Pink Sheets under the symbol "AHRX" on July 25, 2000. On October 12, 2000,
AlphaRx, Inc. common stock ceased trading on the Pink Sheets and began trading
on the Over The Counter Bulletin Board ("OTCBB") under the same symbol.
Subsequent to March 19, 2002, AlphaRx, Inc.s symbol was changed to "ALRX" after
a consolidation of its common stock on a 1 new for 5 old basis. All references
to AlphaRx, Inc. common stock have been retroactively restated.

Effective July 1, 2003 AlphaRx, Inc. acquired all of the shares of AlphaRx
Canada Limited for nominal value of $1. AlphaRx Canada Limited was dormant until
this time. AlphaRx Canada Limited was incorporated under the laws of Ontario in
order to streamline sales of the Companys products in the Canadian market.
Prior to this time AlphaRx Canada Limited had no material assets or any
liabilities and was wholly-owned by the President & CEO of AlphaRx, Inc.

Effective April 22, 2005 AlphaRx International Holdings
Limited (a British Virgin Island company and an 85% owned subsidiary of AlphaRx
Inc.) entered into a Joint Venture agreement with Basin Industrial Limited (a
British Virgin Islands Company and a wholly-owned subsidiary of Advance
Pharmaceutical Co. Ltd.). The Joint Venture, AlphaAP Inc., is involved in
manufacturing and marketing of certain of the Companys existing products.

The Company holds an indirect 42.5% interest in Alpha AP Inc. ("AAP"), a
joint venture established between the Company (via its AIH subsidiary) and Basin
Industrial Limited (an independent third party). As the Company contributes no
funds, and does not provide management or direction to the joint venture, the
Companys interest in the joint venture is not consolidated into the financial
statements. AIH will receive a 5% royalty on all revenues generated by AAP from
licensed product sales.

Effective June 22, 2006, New Super Limited, an independent
Hong Kong based corporation, subscribed for 1,500 shares of common stock of
AlphaRx International Holdings Ltd.("AIH"), previously a wholly-owned subsidiary
of the Company.

Effective June 30, 2006, AlphaRx International Holdings Limited. ("AIH")
acquired 100% of Alpha Life Sciences Ltd. ("ALS") for a nominal amount and the
assumption of approximately $63,000 of related party liabilities. ALS is
involved in obtaining necessary regulatory approvals for the manufacture and
distribution of the Companys products in the Asian market and continues to seek
out partners and collaborative arrangements for the Company.

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COMPANY OVERVIEW

We are a pharmaceutical company, engaged in the research and
development of innovative therapeutic products using advanced drug delivery
technologies, which we believe, can be combined with a broad range of
therapeutic products to improve their effectiveness.

Our central strategy is to seek alliances with pharmaceutical companies which
will assist us in completing the reformulation and development of the drugs and
which will initiate clinical trials and commercialize the products.

We have one product in Phase II clinical trials which has
been licensed by one of our partners for completion of trials and
commercialization, and several products in different stages of preclinical
development.

With only limited financial resources available to us, and with significant
competition in the over the counter arthritis and muscle pain relief category,
we have decided not to continue pursuing direct sales and marketing of Flexogan.
We will focus our resources on development of products and attempting to
establish local and international licensing and distribution arrangements and
joint ventures for our existing over the counter products. As we develop new
products additional offerings will become available.

We intend to use our proprietary drug delivery technologies in collaborative
arrangements with pharmaceutical companies to formulate their existing
commercialized drugs as well as drugs under development by them. By improving
drug efficacy and reducing side effects, we believe our drug delivery
technologies will provide pharmaceutical companies with the opportunity to
enhance the commercial value of their existing products and new drug candidates.
We also intend to develop either independently or jointly certain off-patent and
over-the-counter ("OTC") products utilizing our proprietary drug delivery
technologies.

In August 2003, we licensed Indaflex, our lead pharmaceutical
product under development, to Industria Farmaceutica Andromaco, S.A. de C.V. ("Andromaco")
for commercialization in Mexico. Subject to the terms of the Agreement,
Andromaco has the exclusive and non-transferable manufacturing rights and
distribution rights in Mexico for Indaflex and we receive 15% royalties of the
gross revenue from product sales. Furthermore, Andromaco is responsible for
funding and completing any clinical and regulatory activities in support of
Indaflex registration in Mexico. The Agreement has an initial term of five (5)
years commencing on the effective date, and it shall automatically be renewed on
terms as provided in the Agreement and shall not be terminated without cause. In
June, 2005, Andromaco launched Indaflex into the Mexican market.

We established AlphaRx International Holdings Limited ("AIH") in 2005 in
order to pursue sales activities in the Asia Pacific region with experienced and
established partners. AIH entered into a joint venture agreement with Basin
Industrial Limited (a Hong Kong based corporation  "Basin"), whereby AIH and
Basin will be equal holders of Alpha AP Inc., a company established in order to
manufacture and sell our existing and certain future products. AlphaRx, through
AIH, is to provide the products, manufacturing and distribution rights, whereas
Basin is to provide funding, day to day management, manufacturing and marketing
expertise.

We entered into a licensing and royalty agreement with Proprius
Pharmaceuticals, Inc. ("Proprius") during April, 2006. Under the agreement
Proprius has full development and commercialization rights to Indaflex, a
topical NSAID (Non-Steroidal Anti-inflammatory Drug) currently undergoing Phase
II human trials. Under the agreement we could collect up to $116 million in
milestone license fees and royalties from prduct sales. To date we have
collected the initial milestone license fee of $1 million. We anticipate
additional payments in our new fiscal year.

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We signed a Feasibility and Option agreement with a large global specialty
pharmaceutical company during November, 2006. Under the terms of the Agreement,
we will use our proprietary nanoparticle drug delivery platforms to formulate
three products to enhance their effectiveness in treating pre-defined disease
indications and of the three products, two are marketed products. The licensee
will have six months to evaluate the formulated products and exercise its option
right for a pre-negotiated License Agreement. We will eligible to receive
milestone and royalty payments from future product sales.

PRINCIPAL PRODUCT AND SERVICES AND PRINCIPAL MARKETS

Drug delivery companies apply proprietary technologies to create new
pharmaceutical products utilizing drugs developed by others. These products are
generally novel, cost-effective dosage forms that may provide any of several
benefits, including better control of drug concentration in the blood, improved
safety and efficacy, and ease of use and improved patient compliance. We believe
drug delivery technologies can provide pharmaceutical companies with a means of
developing new products as well as extending existing patents.

The increasing need to deliver medication to patients efficiently and with
fewer side effects has accelerated the development of new drug delivery systems.
Today, medication can be delivered to a patient through many different means of
delivery, including transdermal (through the skin), injection, implant and oral
methods. These delivery methods, however, continue to have certain limitations.
Transdermal patches are often inconvenient to apply can be irritating to the
skin and the rate of release can be difficult to control. Injections are
uncomfortable for most patients. Implants generally are administered in a
hospital or physician's office and frequently are not suitable for home use.
Oral administration remains the preferred method of administering medication.
Conventional oral drug administration, however, also has limitations in that
capsules and tablets have limited effectiveness in providing controlled drug
delivery, resulting frequently in drug release that is too rapid (causing
incomplete absorption of the drug), irritation to the gastrointestinal (GI)
tract and other side effects. In addition capsules and tablets cannot provide
localized therapy. Insoluble or poorly soluble drugs are a major problem for the
pharmaceutical industry, with over one-third of the drugs listed in the United
States' Pharmacopoeia being insoluble or poorly soluble in water. Further, most
approaches used to overcome insolubility result in clinical problems ranging
from poor and erratic bioavailability to serious side effects.

We are engaged in developing novel formulations of existing drugs that are
insoluble or poorly soluble in water, utilizing our proprietary Bioadhesive
Colloidal Dispersion (BCD) (henceforth, "BCD")drug delivery systems. Our
strategy is to develop patentable improved formulations of such drugs that are
soluble in human medicines. Our BCD drug delivery technology includes two
different approaches to improve the effectiveness of insoluble drugs and provide
new methods of delivery, namely, (i) CLD (Colloidal Lipid Dispersion System),
(ii) SECRET (Self Emulsifying Controlled Release Tablet System) and SLN (Solid
Lipid Nanoparticles) delvery system

The BCD drug delivery technology is designed to develop drugs
with major medical advantages, such as lower dosing, fewer side effects and
alternative dosage forms, as well as commercial advantages, such as extended
patent protection and broader use. We have a number of drugs under development,
certain of which have been successfully reformulated, utilizing our BCD
technology.

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PRODUCTS AND PRODUCT PIPLELINE

The following is a list of our products and candidates in the product
pipeline as well as their current stage of development:

|Brand Name                         | Application            | Delivery | Stage                  
|---------------------------------- | ---------------------- | -------- | -----------------------
|                                   |                        | Route    |                        
|Pharmaceuticals                    |                        |          |                        
|2.5% Indaflex                      | Osteoarthritis         | Topical  | Phase II*              
|Rifamsolin                         | Tuberculosis           | Oral     | Preclinical underway **
|Vansolin                           | Sepsis                 | I.V.     | Preclinical underway** 
|Zysolin                            | Pneumonia, Sepsis      | I.V.     | Preclinical underway** 
|Ocusolin                           | Ocular Infection       | Topical  | Preclinical underway** 
|                                   |                        |          |                        
|Binoxan                            | Ocular Inflammation    | Topical  | Preclinical underway** 
|AL0155                             | Ocular                 | Topical  | Preclinical underway** 
|                                   | Infection/Inflammation |          |                        
|Consumer Health (over-the-counter) |                        |         
|Flexogan                           | Analgesic              | Topical  | Market ready*          
|CoQ10ER                            | Nutritional Supplement | Oral     | Market ready*          
|Oncology                           |                        |          |                        
|Doxorubicin NP                     | Hepatic Cancer         | I.V.     | Preclinical +          
|Paclitaxel NP                      | Lung Cancer            | Oral     | Preclinical +          

*    Indaflex is approved for sale in Mexico, but must undergo
FDA approval for sale in United States and other countries. CoQ10ER and Flexogan
is approved for sale in Canada.

**  Preclinical activities include basic in vitro and in
vivo research attempting to adopt our Bioadhesive Colloidal Dispersion delivery
system to the respective drug while maintaining or improving efficacy and
effectiveness of the active ingredients. We anticipate that clinical trials, if
they take place at all, will initially be conducted in Canada, at test sites
which are pre-approved by both Health Canada and FDA.

+   Oncology market product research and development is being
undertaken in China via our 85% owned subsidiary AlphaRx International Holdings
Limited and its affiliate AlphaRx Life Sciences Ltd.

Indaflex is our only prescription drug at the clinical trial stage. We
completed a Phase I human trial for Indaflex in Canada during March, 2005. As of
December, 2006 Phase II enrolment objectives have been achieved. In total 220
patients have been enrolled, and about 175 patients have completed their test.
We anticipate that the trial will be completed and the results announced during
the first six months of 2007. Indaflex is a topical NSAID formulation intended
to be used in the treatment of arthritis. Indaflexs active ingredient,
Indomethacin, has a long-standing and proven clinical treatment record. With our
enhanced proprietary drug delivery system, we believe its clinical effectiveness
to be significantly enhanced. Topical Indaflex delivery is intended to
circumvent the significant gastro intestinal side-effects found with orally
ingested NSAIDs.

Rifamsolin is encapsulating Rifampicin, an antibiotic mainly used to treat
tuberculosis, in the Companys colloidal drug delivery platform for
intracellular delivery. This early stage drug candidate is currently going
through in-vitro and in-vivo studies including biodistribution study, evaluation
of the efficacy in murine infection models and toxicological studies.

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Vansolin is encapsulating Vancomycin, a broad spectrum antibiotic, in the
Companys nanoparticulate drug delivery platform for intracellular delivery.
This early stage drug candidate is currently going through in-vitro and in-vivo
studies including biodistribution study, evaluation of the efficacy in murine
infection models and toxicological studies.

Zysolin is encapsulating Gentamicin, a broad spectrum antibiotic, in the
Companys nanoparticulate drug delivery platform for intracellular delivery.
This early stage drug candidate is currently going through in-vitro and in-vivo
studies including biodistribution study, evaluation of the efficacy in murine
infection models and toxicological studies.

Ocusolin is a topical ophthalmic solution utilizing Gentamicin, in a
nanoparticulate formulation, that may be effective against a broad spectrum of
bacteria including strains resistant to more than one antibiotic. This early
stage drug candidate is currently going through in-vivo studies including
biodistribution study, evaluation of the efficacy in murine infection models and
toxicological studies.

Binoxan is a topical, non-acidic, non-steroidal anti-inflammatory pro-drug in
a colloidal formulation intended for the treatment of ocular inflammation, eye
pain and photophobia. This early stage drug candidate is currently going through
in-vivo studies including biodistribution study, evaluation of the efficacy in
murine infection models and toxicological studies.

AL0155 is a topical ophthalmic solution combining an antibiotic and NSAID in
a colloidal formulation intended for the treatment of ocular inflammation and
ocular infection. This early stage drug candidate is currently going through
in-vivo studies including biodistribution study, evaluation of the efficacy in
murine infection models and toxicological studies.

Flexogan is a series of topical arthritis and muscle pain relief creams.
Flexogan has a unique delivery formulation that increases the speed, volume, and
sustained duration of drug penetration through the skin in animal studies.

CoQ10 ER is a novel formulation incorporating the Companys
drug delivery process which completely disperses CoQ10 ER into sub-micron oil
droplets in the GI tract. The average size of these oil droplets is less than
200 nanometers. These oil droplets can easily penetrate the bilayer of human
cells and increase serum Coenzyme Q10 concentration according to one human trail
conducted by the Company.

We have recently been retained by a global specialty pharmaceutical company
to develop a new formulation for their proprietary drug products, using our
delivery technology. Should we be successful in this formulation we could
collect royalties on all future eye drop sales by this company in which our
delivery technology is utilized.

BIOADHESIVE COLLOIDAL DISPERSION (BCD) SYSTEMS

Our proprietary BCD oral and transdermal drug delivery technologies permit
formulations of drug-containing polymeric units that allow controlled delivery
of an incorporated hydrophobic drug (this process is referred to as our "BCD
Systems"). Although our formulations are proprietary, the polymers utilized in
our BCD Systems are commonly used in the food and drug industries. By using
different formulations of the polymers, we believe our BCD Systems are able to
provide continuous, controlled delivery of drugs of varying molecular complexity
and solubility.

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The BCD Systems are designed to provide orally and transdermally
administered, conveniently dosed, cost-effective drug therapy in a continuous,
controlled delivery over a multihour period. We believe our BCD Systems may
provide one or more of the following therapeutic advantages over conventional
methods of drug administration:

1. Enhanced Safety and Efficacy. We believe our BCD Systems may
improve the ratio of therapeutic effect to toxicity by decreasing the initial
peak concentrations of a drug, associated with toxicity, while maintaining
levels of the drug at therapeutic, subtoxic concentrations for an extended
period of time. Many drugs demonstrate optimal efficacy when concentrations are
maintained at therapeutic levels over an extended period of time. When a drug is
administered intermittently, the therapeutic concentration is often exceeded for
some period of time, and then rapidly drops below effective levels. Excessively
high concentrations are a major cause of side effects, while subtherapeutic
concentrations are ineffective.

2. Greater Patient and Caregiver Convenience. We believe our BCD
Systems may permit once-daily dosing for certain drugs that are currently
required to be administered several times daily, thereby promoting compliance
with dosing regimens. Patient non-compliance with dosing regimens has been
associated with increased costs by prolonging treatment duration, increasing the
likelihood of secondary or tertiary disease manifestation and contributing to
over-utilization of medical personnel and facilities. By improving patient
compliance, providers and third-party payers may reduce unnecessary expenditures
and improve therapeutic outcomes.

3. Expanding the Types of Drugs Capable of Oral Delivery.
Some drugs, including certain proteins (complex organic compounds of high
molecular weight containing numerous amino acids) and peptides (low molecular
weight compounds consisting of two or more amino acids), because of their large
molecular size and susceptibility to degradation in the GI tract, must currently
be administered by injection or by continuous infusion, which is typically done
in a hospital or other clinical setting. We believe our BCD Systems may permit
some of these drugs to be delivered orally and/or transdermally without the
necessity of visiting a hospital or clinic.

4. Proprietary Reformulation of Generic Products.We
believe our BCD Systems offer the potential to produce improved proprietary
formulations of off-patent drugs, differentiated from the existing generic
products by reduced dosing requirements, improved efficacy, decreased toxicity
or additional indications. The potential attraction here is the possibility to
repatent existing drugs due to the adaptation of our delivery systems, which may
differentiate the new drug from the existing drug.

DISTRIBUTION METHODS OF THE PRODUCTS AND SERVICES

We intend to have the BCD Systems used with as many pharmaceutical products
as possible. Our primary strategy is to establish collaborative relationships
with pharmaceutical and biotechnology companies to develop improved therapeutic
products utilizing our BCD Systems technology. The products will be jointly
developed, with the collaborative partner having primary responsibility to
clinically test, manufacture, market and sell the product, and we retaining
ownership of our technologies. We believe that our partnering strategy will
enable us to reduce our cash requirements while developing a larger potential
product portfolio. By providing new formulations of existing products using the
BCD Systems, we believe it will not only be able to offer our partners improved
products but also may provide them with the ability to extend the life of their
patents on such products, especially attractive to pharmaceutical companies
whose patents on existing products are close to expiration. Collaborations with
pharmaceutical and biotechnology companies are expected to provide near-term
revenues from sponsored development activities and future revenues from license
fees and royalties relating to the sale or sub-licensing of our products.

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We also intend to develop over-the-counter (OTC) and/or off-patent drug
products utilizing our BCD Systems, either independently or jointly by entering
into collaborative partnerships with pharmaceutical, biotechnology or other
healthcare companies. To reduce costs and time-to-market, we intend to select
those products that treat indications with clear-cut clinical end-points and
that are reformulations of existing compounds already approved by the FDA. We
believe that products utilizing the BCD Systems will provide favorable product
differentiation in the highly competitive generic and OTC drug product markets
at costs below those of other drug delivery systems, thereby enabling us and our
collaborative partners to compete more effectively in marketing improved
off-patent and OTC drug products. We are also seeking to establish alliances
with overseas sales and marketing partners for the initial sale of our future
generic products. We believe that due to the more favorable regulatory
environments in some foreign countries, we may be able to generate revenues from
these markets while awaiting FDA approval in the United States.

COMPETITION

There are other companies that have oral drug delivery technologies that
compete with the BCD Systems. The competitors have oral tablet products designed
to release the incorporated drugs over time. Each of these companies has a
patented technology with attributes different from ours, and in some cases with
different sites of delivery to the GI tract. We believe that we are the only
drug delivery company that is currently using polymeric based colloidal
dispersion controlled release technologies to develop products for oral and
transdermal drug delivery systems for enhanced solubility and bioavailability
for drugs that are not readily water soluble. We believe that this combination
of oral and transdermal drug delivery technologies differentiates us from other
oral drug delivery companies and will enable us to attract pharmaceutical
companies to incorporate their proprietary drugs into the BCD Systems and also
to differentiate any OTC and/or off-patent drugs that utilize the BCD Systems
from those of other drug delivery companies.

Competition in the areas of pharmaceutical products and drug delivery systems
is intense and this is expected to continue in the future. Competing
technologies may prove superior, either generally or in particular market
segments, in terms of factors such as cost, consumer satisfaction or drug
delivery profile. Our principal competitors in the business of developing and
applying drug delivery systems have substantially greater financial,
technological, marketing, personnel and research and development resources than
we do. In addition, we may face competition from pharmaceutical and
biotechnology companies that may develop or acquire drug delivery technologies.
Many of our potential collaborative partners have devoted and are continuing to
devote significant resources in the development of their own drug delivery
systems and technologies. Products incorporating our technologies will compete
both with products employing advanced drug delivery systems and with products in
conventional dosage forms. New drugs or future developments in alternate drug
delivery technologies may provide therapeutic or cost advantages over any
potential products which utilize the BCD Systems. There can be no assurance that
developments by others will not render any potential products utilizing the BCD
Systems non-competitive or obsolete. In addition, our competitive success will
depend heavily on entering into collaborative relationships on reasonable
commercial terms, commercial development of products incorporating the BCD
Systems, regulatory approvals, protection of intellectual property and market
acceptance of such products.

PATENTS, TRADEMARKS AND PROPRIETARY RIGHTS

It is our policy to file patent applications in the United States and certain
foreign jurisdictions for any drug formulations and any drug delivery
methodologies that we consider commercially viable. We have four United States
patent pending applications as follows: "Colloidal solid lipid vehicle for
pharmaceutical application" and "Hybrid
Lipid-Polymer Nanoparticulate Delivery Composition" for the use of Rifamsolin,
Zysolin, Vansolin & Ocusolin to treat Tuberculosis and other infectious
diseases, "Topical composition for acne treatment" and "Stabilization of benzoyl
peroxide in solution" for the use of NuProm to treat acne. We have also applied
for patents in Mexico, Japan and China under the title "Vehicle for topical
delivery of anti-inflammatory compounds" for the use of Indaflex to increase
efficacy of non steroidal anti-inflammatory drugs which are still pending.

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We currently have two issued United States patents as follows: "Toothpaste
comprisingbioadhesive submicron emulsion for improved delivery of
antibacterial and anticaries agents" for the use of certain oral care products
which have never been developed. This patent was issued on September 12, 2000
and will expire on June 17, 2019. "Vehicle for topical delivery of
anti-inflammatory compounds" for the use of Indaflex to increase efficacy of non
steroidal anti-inflammatory drugs. This patent was issued on November 21, 2006
and will expire on September 29, 2021.
No assurance can be given that our patent applications will be approved or
that any issued patents will provide competitive advantages for the BCD System
or our technologies or will not be challenged or circumvented by competitors.
With respect to any patents which may be issued from our applications, there can
be no assurance that claims allowed will be sufficient to protect our
technologies. Patent applications in the United States are maintained in secrecy
until a patent is issued and we cannot be certain that others have not filed
patent applications for technology covered by our pending applications or that
we were the first to file patent applications for such technology. Competitors
may have filed applications for, or may have received patents and may obtain
additional patents and proprietary rights relating to, compounds or processes
that may block our patent rights or compete without infringing our patent
rights. In addition, there can be no assurance that any patents issued to us
will not be challenged, invalidated or circumvented, or that the rights granted
thereunder will provide proprietary protection or commercial advantage to us.
We also rely on trade secrets and proprietary know-how which we seek to
protect, in part, through confidentiality agreements with employees,
consultants, collaborative partners and others. There can be no assurance that
these agreements will not be breached, that we will have adequate remedies for
any such breach or that our trade secrets will not otherwise become known or be
independently developed by competitors. Although potential collaborative
partners, research partners and consultants are not given access to our
proprietary trade secrets and know-how until they have executed confidentiality
agreements, these agreements may be breached by the other party or may otherwise
be of limited effectiveness or enforceability.
Trademarks

We have registered the following trademarks in Canada: "BCD", "Flexogan", "Indaflex","AlphaRx",
"PhytoScience", "NuProm", and "LipoLette". We have registered the following
trademarks in the United States: "Flexogan", "Indaflex", "LipoBloc", "NuProm", "Oralife".
We have also registered "Flexogan" in the Peoples Republic of China. In
connection with our Internet web site, we have registered with Network
Solutions, Inc., the internet domain name "AlphaRx.com" for our corporate
website.

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Proprietary Information
Much of our technology is dependent upon the knowledge, experience and skills
of key scientific and technical personnel. To protect the rights to our
proprietary technology, our policy requires all employees and consultants to
execute confidentiality agreements that prohibit the disclosure of confidential
information to anyone outside the Company. These agreements also require
disclosure and assignment to us of discoveries and inventions made by such
persons while devoted to Company activities.
MANUFACTURING, MARKETING AND SALES

We do not have and do not intend to establish in the foreseeable future
internal manufacturing capabilities. Rather, we intend to use the facilities of
our collaborative partners or those of contract manufacturers to manufacture
products using the BCD Systems. Our dependence on third parties for the
manufacture of products using the BCD Systems may adversely affect our ability
to develop and deliver such products on a timely and competitive basis. There
may not be sufficient manufacturing capacity available to us when, if ever, it
is ready to seek commercial sales of products using the BCD Systems. In
addition, we expect to rely on our collaborative partners or to develop
distributor arrangements to market and sell products using the BCD Systems. We
may not be able to enter into manufacturing, marketing or sales agreements on
reasonable commercial terms, or at all, with third parties. Failure to do so
would have a material adverse effect on us.
Applicable good manufacturing practices ("GMP") requirements and other rules
and regulations prescribed by foreign regulatory authorities will apply to the
manufacture of products using the BCD Systems. We will depend on the
manufacturers of products using the BCD Systems to comply with current good
manufacturing practices ("cGMP") and applicable foreign standards. Any failure
by a manufacturer of products using the BCD Systems to maintain cGMP or comply
with applicable foreign standards could delay or prevent their commercial sale.
This could have a material adverse effect on us.
We rely on Canadian Custom Packaging Inc., Patheon Inc. and
Andromaco to manufacture our products on a when needed basis. There are no
outstanding manufacturing orders or any conditional obligations outstanding to
any of these parties.
We are not actively pursuing the direct sales and marketing
of our market ready products or potential products due primarily to our limited
amount of financial resources. We do retain marketing and sales agents from time
to time on an as needed basis on a commission or flat fee basis and other
incentives.
GOVERNMENT REGULATION

We are subject to regulation under various federal laws regarding
pharmaceutical products and also various Canadian federal and provincial laws
regarding, among other things, occupational safety, environmental protection,
hazardous substance control and product advertising and promotion. In connection
with our research and development activities, AlphaRx is subject to federal,
provincial and local laws, rules, regulations and policies governing the use,
generation, manufacture, storage, air emission, effluent discharge, handling and
disposal of certain materials and wastes. We believe that we have complied with
these laws and regulations in all material respects and we have not been
required to take any action to correct any material non-compliance.
In the United States, pharmaceutical products, including any
drugs utilizing the BCD System, are subject to rigorous regulation by the FDA.
If a company fails to comply with applicable requirements, it may be subject to
administrative or judicially imposed sanctions such as civil penalties, criminal
prosecution of our officers and employees, injunctions, product seizure or
detention, product recalls, total or partial suspension of production, FDA
withdrawal of approved applications or FDA refusal to approve pending new drug
applications, premarket approval applications, or supplements to approved
applications.
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Prior to commencement of clinical studies involving human beings, preclinical
testing of new pharmaceutical products is generally conducted on animals in the
laboratory to evaluate the potential efficacy and the safety of the product. The
results of these studies are submitted to the FDA as a part of an IND
application, which must become effective before clinical testing in humans can
begin. Typically, clinical evaluation involves a time consuming and costly
three-phase process.
OTC products that comply with monographs issued by the FDA are subject to
various FDA regulations such as cGMP requirements, general and specific OTC
labelling requirements (including warning statements), the restriction against
advertising for conditions other than those stated in product labelling, and the
requirement that in addition to approved active ingredients OTC drugs contain
only safe and suitable inactive ingredients. OTC products and manufacturing
facilities are subject to FDA inspection, and failure to comply with applicable
regulatory requirements may lead to administrative or judicially imposed
penalties. If an OTC product differs from the terms of a monograph, it will, in
most cases, require FDA approval of an NDA for the product to be marketed.
In Canada and the United States, the manufacture and sale of
pharmaceutical products is rigorously controlled by the Canadian Health Products
and Food Branch ("HPFB") and the United States Food and Drug Administration
("FDA"), respectively. The laws of both countries require appropriate
manufacturing facilities and carefully controlled research, manufacturing and
testing of products. Pharmaceutical companies must establish control over
manufacturing and testing of their products, through the use of good
manufacturing practices ("GMP") before being allowed to market their products.
The safety and efficacy of a new product must be demonstrated through clinical
trials of the drug carried out under procedures acceptable to the HPFB and FDA.
In Canada, new in vivoproducts must pass through a
number of testing stages including pre-clinical testing and clinical trial
testing. Pre-clinical testing usually involves evaluating the products
pharmacokinetics, pharmacology and toxicology in animals. Successful results
(that is, potentially valuable pharmacological activity combined with an
acceptable level of toxicity) can lead to Investigational New Drug ("IND")
status. This enables the manufacturer of the new product to begin clinical
trials on humans.
In order to achieve IND status in Canada, a clinical trial
application ("CTA") must be filed with the HPFB. The submission must contain
specified information including the results of the preclinical tests completed
at the time of the submission together with any available data on testing in
humans. In addition, since the method of manufacture may affect the efficacy and
safety of a product, information on manufacturing methods and standards and the
stability of the substance and dosage form must be presented to enable the HPFB
to evaluate whether the product that may eventually be sold to the public has
been shown to be comparable to that determined to be effective and safe in the
clinical trials. Production methods and quality control procedures must be in
place to ensure that a product meets its specifications for identity and purity
and other parameters for assessing product quality. The submission must also
provide details on the testing that is to be performed, including who will be
performing the testing and where it will be performed.
Once the HPFB clears a CTA, clinical trials can begin.
Clinical trials are generally carried out in three phases. Phase I involves
studies to evaluate safety in humans. The new product is administered to
consenting subjects to determine the safety profile and prevalence of adverse
side effects. In many Phase I studies the effects of dosing and scheduling are
also studied. Phases II and III involve efficacy studies. Phase II trials seek
clues to clinical efficacy, while furthering the safety profile in patients with
the condition the product is intended to treat. In Phase III, controlled
clinical trials are conducted in which the product is administered to a large
number of patients who may receive benefit from the product. In Phase III, the
effectiveness of the new product is usually compared to that of a control or
accepted methods of treatment or best standard of care, in the anticipation that
significant clinical efficacy can be demonstrated. After clearance of the
initial CTA application, the manufacturer has certain reporting responsibilities
to the HPFB.
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If the clinical studies are successful, the manufacturer
submits a New Drug Submission ("NDS") (referred to in the United States as a New
Drug Application or "NDA" or Biologics Licence Application or "BLA") to the HPFB
for marketing approval. The NDS contains all information pertaining to the
proposed claims about the products performance including the results of the
pre-clinical and clinical studies. Information about a substance contained in an
NDS includes its proper name, its chemical name, details on its method of
manufacturing and purification and its biological, pharmacological and
toxicological properties. The NDS also gives information about the dosage form
of the product including the quantitative listing of all ingredients used in the
formulation, its method of manufacture, packaging and labelling, the results of
stability tests, its diagnostic or therapeutic claims and side effects as well
as details of the clinical studies to support the safety and efficacy of the
product. All aspects of the NDS are critically reviewed by the HPFB. Where an
NDS is found satisfactory and the manufacturing establishment(s) is found
satisfactory a Notice of Compliance is issued permitting the substance to be
sold.
The controls of a new product do not cease once it is on the
market. For example, a manufacturer of a new product must report any new
information received concerning serious side effects, including the failure of
the product to produce desired effects. In addition, if it is determined to be
in the interest of the public health, a Notice of Compliance for a new product
may be suspended and the new product may be removed from the market.
The requirements for in vivoproducts outlined for
Canada are similar to those in all major pharmaceutical markets and while the
tests carried out for Canada are likely to be acceptable for all other
countries, supplementary testing may be requested by individual regulatory
authorities during their assessment of any submissions by the Company.
In the United States, a manufacturer must prepare and file an
IND submission with the FDA before testing can begin on humans. An application
contains a variety of information about the products, including the results of
previous animal and human studies, the basic chemistry of the product and
manufacturing information. The submission also provides details on the testing
that is to be performed, including who will be performing the testing and where
it will be performed. As in Canada, human studies are characterized as Phase I,
Phase II or Phase III studies. Phase I studies focus on the safety profile of
the product, Phase II seeks clues as to efficacy, and Phase III seeks to
statistically confirm in larger trials the efficacy of the product.
After acceptance of the initial IND application, the
manufacturer has certain reporting responsibilities to the FDA including the
submission of yearly updates on the products safety. As the testing progresses
into Phases II and III, the focus shifts to the efficacy of the product and the
clinical studies that will enable the manufacturer to receive FDA approval for
the marketing of the product.
The process of completing clinical testing and obtaining
regulatory approval for a new product is, in general, likely to take a number of
years and require the expenditure of substantial resources. If an application is
submitted, there can be no assurance that the HPFB or FDA will review and
approve the marketing application in a timely manner. Even after initial
approval has been obtained, further studies may be required by an agency to
provide additional data or may be voluntarily conducted to gain approval for the
use of a product as a treatment for clinical indications other than those for
which the product was initially tested. Also, the HPFB and FDA require
post-market surveillance programs to monitor a products side effects. Results
of post-marketing programs may limit or expand the further marketing of
products. It is not possible to accurately predict the time required for new
product approval or the extent of clinical testing and documentation that may be
required by regulatory authorities. Any delays in obtaining, or failing to
obtain, regulatory approvals would significantly delay the development of
markets and the receipt of revenues from the sale of these products.
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In addition to the regulatory product approval framework,
pharmaceutical companies are subject to regulation under provincial, state and
federal law, including requirements regarding occupational safety, laboratory
practices, the use, handling and disposition of radioactive materials,
environmental protection and hazardous substance control, and may be subject to
other present and future local, provincial, state, federal and foreign
regulation, including possible future regulation of the biotechnology field.
Furthermore, even if required FDA approval has been obtained with respect to
a product, foreign regulatory approval of a product must also be obtained prior
to marketing the product internationally. Foreign approval procedures vary from
country to country and the time required for approval may delay or prevent
marketing. In certain instances we or our collaborative partners may seek
approval to market and sell certain of our products outside of the U.S. before
submitting an application for U.S. approval to the FDA. The regulatory
procedures for approval of new pharmaceutical products vary significantly among
foreign countries. The clinical testing requirements and the time required to
obtain foreign regulatory approvals may differ from that required for FDA
approval. Although there is now a centralized EU approval mechanism in place,
each EU country may nonetheless impose our own procedures and requirements, many
of which are time consuming and expensive, and some EU countries require price
approval as part of the regulatory process. Thus, there can be substantial
delays in obtaining required approval from both the FDA and foreign regulatory
authorities after the relevant applications are filed, and approval in any
single country may not be a meaningful indication that the product will
thereafter be approved in another country.
The foreign regulatory approval process includes all of the
risks associated with obtaining FDA approval set forth above, and approval by
the FDA does not ensure approval by the health authorities of any other country,
nor does the approval by foreign health authorities ensure approval by the FDA.
We presently have a licensed manufacturer and distributor in
Mexico - Andromaco. We rely on Andromaco to complete, maintain and adhere to the
required regulatory processes and procedures needed to manufacture and
distribute our product in Mexico. Andromaco is a large pharmaceutical
manufacturer in Mexico with more than 50 years of experience in manufacture,
marketing and distribution of drugs. We will attempt to complete licensing and
distribution arrangements in foreign countries and in the United States with
larger, experienced organizations to ensure that regulatory processes and
country-specific regulations are being observed and maintained.
RESEARCH AND DEVELOPMENT

We conduct our research and development activities in house and through
collaborative arrangements with universities, contract research organizations
and independent consultants. We are also dependent upon third parties to conduct
clinical studies, and to obtain FDA, Health Canada and other regulatory
approvals. Until recently all of our research and development activities took
place at our main offices in Canada. We have commenced research and development
of our oncology initiatives in China via our 85% owned subsidiary AlphaRx
International Holdings Limited.
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We anticipate incurring significant development expenditures
in the future as we continue our efforts to develop our present technologies and
new formulations and as we begin to research other technologies and to commence
or expand clinical studies of certain products.

PRODUCT LIABILITY AND OTHER INSURANCE

Our business involves exposure to potential product liability
risks that are inherent in the production, manufacture and sale of
pharmaceutical products. Any product liability claims could have a material
adverse effect on us.

Although we currently maintain product liability insurance of approximately
CAD $3,000,000 through third party insurers that provides coverage for product
liability claims, there can be no assurance that:

- 

we will be able to maintain product liability
  insurance on acceptable terms;

we will be able to secure increased coverage as the
  commercialization of the BCD Systems proceeds; or

any insurance will provide adequate protection
  against potential liabilities. 

We have property insurance coverage, materials in transit, kidnap and ransom,
and business interruption insurance coverage. Although we deem the coverage
amounts to be adequate to protect our interests, there is no assurance that the
insurance coverage would be adequate to protect us against all potential
liabilities. We do not carry directors and officers liability insurance due to
the prohibitive cost and limited coverage this insurance offers.
EMPLOYEES

We have seven full time employees, and three part time consultants on staff.
None of our staff is represented by a collective bargaining agreement, nor have
we experienced any work stoppage. We believe that our relations with our staff
are excellent.
RISK FACTORS

We provide the following cautionary discussion of risks, uncertainties and
possible inaccurate assumptions relevant to our business and our products. These
are factors that we think could cause our actual results to differ materially
from expected results. Other factors besides those listed here could also
adversely affect us.
We have significant historical losses and may continue to incur losses in the
future.

We have incurred annual operating losses since our inception. As a result, at
September 30, 2006, we had an accumulated deficit of approximately $ 14,534,237.
Our revenues for the years ended September 30, 2006 and September 30, 2005 were
$1,024,774 and $4,302 respectively. Our revenues have not been sufficient to
sustain our operations. Revenue for 2006 consisted primarily of license fee
revenues, and 2005 consisted exclusively of royalty revenues from sales of
Indaflex in Mexico. In order to achieve profitability our revenue streams will
have to increase and there is no assurance that revenues can increase to such a
level. We may never be profitable.

15We are subject to currency fluctuations which may affect our results
The majority of our expenses and some of our debt are in Canadian dollars,
while our revenues are primarily U.S. dollars. We also incur expenses in Hong
Kong dollars related to our far east subsidiaries. The fluctuation of the
Canadian dollar and Hong Kong dollar vis a vis the U.S. dollar could materially
impact our operating results and financial position.
We will require additional financing to sustain our operations, and our
ability to secure additional financing is uncertain.

We may be unable to raise on acceptable terms, if at all, the
substantial capital resources necessary to conduct our operations. If we are
unable to raise the required capital, we may be forced to limit some or all of
our research and development programs and related operations, curtail
commercialization of our product candidates and, ultimately, cease operations.
Our future capital requirements will depend on many factors, including:
continued scientific progress in our research programs;
  progress with preclinical studies and clinical trials;
  the magnitude and scope of our research and development programs;
  our ability to establish corporate partnerships and licensing
  arrangements;
  the time and costs involved in obtaining regulatory approvals;
  the costs involved in preparing, filing, prosecuting, maintaining,
  defending and enforcing patent claims;
  the potential need to develop, acquire or license new technologies and
  products;
  the continued ability to source loans from our private lenders;
  our efforts to sell and market our products through licensees,
  distributors and other partners; and
  other factors beyond our control.At September 30, 2006, we had a working capital deficiency of approximately
$176,129 as compared to a working capital deficiency of $75,925 as at September
30, 2005. The independent auditors' report for the year ended September 30, 2006
includes an explanatory paragraph stating that our recurring losses from
operations and working capital levels raise substantial doubt about our ability
to continue as a going concern.
We believe that satisfying our long-term capital requirements will require at
least the successful commercialization of one of our over-the-counter health
care products or one of our prescription drug candidates. Our products may never
become commercially successful.
We are subject to industry and government regulation

All of our products, clinical trials, and certain research and development
initiatives are regulated by Canadian health authorities, and if applicable, the
FDA in the United States, and similar governing bodies in Mexico, China and
elsewhere. Any changes in regulatory requirements, depth and breadth of clinical
trials, provisions, statutes, or regulations could adversely impact the cost and
duration of our research and development, product completion and related
operations.
We face significant competition in the over-the-counter health care market.

The over-the-counter health care market is highly competitive and is
characterized by the frequent introduction of new products, including the
migration of prescription drugs to the over-the-counter market, often
accompanied by major advertising and promotional support. These introductions
may adversely affect our business, especially because we compete in categories
in which product sales are highly influenced by advertising and promotions. Our
competitors include large over-the-counter pharmaceutical companies such as
Pfizer, Inc. and Johnson & Johnson, consumer products companies such as Procter
& Gamble Co., many of which have considerably greater financial and other
resources than we do and are not as highly leveraged as we are. These
competitors are thus better positioned to spend more on research and
development, employ more aggressive pricing strategies, utilize greater
purchasing power, build stronger vendor relationships and develop broader
distribution channels than us. In addition, our competitors may use aggressive
spending on trade promotions and advertising as a strategy for building market
share, at the expense of their competitors, including us. If we are unable to
introduce new and innovative products that are attractive to consumers, or are
unable to allocate sufficient resources to effectively advertise and promote our
products so that they achieve wide spread market acceptance, we may not be able
to compete effectively, and our operating results and financial condition may be
adversely affected.
16
Our competitors may include large pharmaceutical companies with superior
resources.

We are engaged in a rapidly changing and highly competitive field. To date,
we have concentrated our efforts primarily on one pharmaceutical product --
Indaflex  for treating osteoarthritis and other inflammatory indications. Like
the market for any pharmaceutical product, the market for treating arthritis and
these other indications has the potential for rapid, unpredictable and
significant technological change. Competition is intense from specialized
biotechnology companies, major pharmaceutical and chemical companies and
universities and research institutions. We currently have no products approved
for sale in the U.S. If we are successful in obtaining approval for one of our
products, our future competitors will have substantially greater financial
resources, research and development staffs and facilities, and regulatory
experience than we do. Major companies in the field of osteoporosis treatment
include Novartis, Wyeth, Merck, Eli Lilly, Aventis, and Procter & Gamble Co. Any
one of these potential competitors could, at any time, develop products or a
manufacturing process that could render our technology or products
non-competitive or obsolete.
Our success depends upon our ability to protect our intellectual property
rights.

We filed applications for U.S. patents relating to proprietary drug delivery
technologies and formulations that we have invented in the course of our
research. To date, one U.S. patent has been issued and other applications are
pending. We have also made patent application filings in selected foreign
countries. We face the risk that any of our pending applications will not issue
as patents. In addition, our patents may be found to be invalid or
unenforceable. Our business also is subject to the risk that our issued patents
will not provide us with significant competitive advantages if, for example, a
competitor were to independently develop or obtain similar or superior
technologies. To the extent we are unable to protect our patents and patent
applications, our investment in those technologies may not yield the benefits
that we expect.
We also rely on trade secrets to protect our inventions. Our policy is to
include confidentiality obligations in all research contracts, joint development
agreements and consulting relationships that provide access to our trade secrets
and other know-how. However, parties with confidentiality obligations could
breach their agreements causing us harm. If a secrecy obligation were to be
breached, we may not have the financial resources necessary for a legal
challenge. If licensees, consultants or other third parties use technological
information independently developed by them or by others in the development of
our products, disputes may arise from the use of this information and as to the
ownership rights to products developed using this information. These disputes
may not be resolved in our favour.
17
We are not aware of infringing on any third partys patents, nor are we aware
of any third party infringing on any of our patents or patent applications.
Our technology, clinical trials, or products could give rise to product
liability claims.

Our business exposes us to the risk of product liability claims that are a
part of human testing, manufacturing and sale of pharmaceutical products. The
administration of drugs to humans, whether in clinical trials or commercially,
can result in product liability claims even if our products are not actually at
fault for causing an injury. Furthermore, our products may cause, or may appear
to cause, adverse side effects or potentially dangerous drug interactions that
we may not learn about or understand fully until the drug is actually
manufactured and sold. Product liability claims can be expensive to defend and
may result in large judgments against us. Even if a product liability claim is
not successful, the adverse publicity, time, and expense involved in defending
such a claim may interfere with our business. We may not have sufficient
resources to defend against or satisfy these claims. We currently maintain
CAD$3,000,000 in product liability insurance coverage. However, these amounts
may not be sufficient to protect us against losses or may be unavailable in the
future on acceptable terms, if at all.
We may be unable to retain key employees or recruit additional qualified
personnel.

Because of the specialized scientific nature of our business, we are highly
dependent upon qualified scientific, technical, and managerial personnel. There
is intense competition for qualified personnel in our business. Therefore, we
may not be able to attract and retain the qualified personnel necessary for the
development of our business. The loss of the services of existing personnel, as
well as the failure to recruit additional key scientific, technical, and
managerial personnel in a timely manner would harm our research and development
programs and our business.
The market price of our common stock is volatile.

The market price of our common stock has been, and we expect it to continue
to be, highly unstable. Factors, including our announcement of technological
improvements or announcements by other companies, regulatory matters, research
and development activities, new or existing products or procedures, signing or
termination of licensing agreements, concerns about our financial condition,
operating results, litigation, government regulation, developments or disputes
relating to agreements, patents or proprietary rights, and public concern over
the safety of activities or products have had a significant impact on the market
price of our stock. We expect such factors to continue to impact our market
price for the foreseeable future.
Our common stock is classified as a "penny stock" under SEC rules which may
make it more difficult for our stockholders to resell our common stock.
Our common stock is traded on the OTC Bulletin Board. As a result, the
holders of our common stock may find it more difficult to obtain accurate
quotations concerning the market value of the stock. Stockholders also may
experience greater difficulties in attempting to sell the stock than if it was
listed on a stock exchange or quoted on the Nasdaq National Market or the Nasdaq
Small-Cap Market. Because AlphaRx common stock is not traded on a stock exchange
or on Nasdaq, and the market price of the common stock is less than $5.00 per
share, the common stock is classified as a "penny stock." Rule 15g-9 of the
Securities Exchange Act of 1934 imposes additional sales practice requirements
on broker-dealers that recommend the purchase or sale of penny stocks to persons
other than those who qualify as an "established customer" or an "accredited
investor." This includes the requirement that a broker-dealer must make a determination that investments in penny stocks are suitable for the
customer and must make special disclosures to the customer concerning the risks
of penny stocks. Application of the penny stock rules to our common stock could
adversely affect the market liquidity of the shares, which in turn may affect
the ability of holders of our common stock to resell the stock.

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We have a significant number of options and warrants outstanding that could
be exercised in the future. Subsequent resales of these and other shares could
cause the Companys stock price to decline. This could also make it more
difficult to raise funds at acceptable levels, via future securities offerings.
Lack of Independent Directors

We cannot guarantee that our Board of Directors will have a majority of
independent directors in the future. In the absence of a majority of independent
directors, our executive officers, who are also principal stockholders and
directors, could establish policies and enter into transactions without
independent review and approval thereof. This could present the potential for a
conflict of interest between the Company and its stockholders generally and the
controlling officers, stockholders or directors.
Ownership of our Common Stock by Current Officers and Directors

The present officers and directors own approximately 17.85% of the
outstanding shares of common stock, and are therefore no longer in a position to
elect all of our Directors and otherwise control the Company. The Company can no
longer be controlled by any single shareholder or the management group as a
whole. Shareholders have no cumulative voting rights. (See Security Ownership of
Certain Beneficial Owners and Management)
ITEM 2. DESCRIPTION OF PROPERTY

We lease approximately 2,930 square feet in Markham, Ontario, under a lease
which expires on November 30, 2008 for approximately $2,600 a month. We believe
that our existing properties are sufficient for our administrative, research and
development needs for the foreseeable future. We are searching for an office
(less than 500 square feet) in China for research and development initiatives
based in China. To date we have not located an acceptable space.
ITEM 3. LEGAL PROCEEDINGS

Farhad Walji has filed suit against AlphaRx, Inc. and AlphaRx Canada Limited
in the Supreme Court of British Columbia on August 23, 2002. Farhad Walji filed
a claim asking for $20,000 plus interest for allegedly providing $20,000
pursuant to a subscription agreement to purchase shares of AlphaRxs common
stock and damages resulting from lost opportunity. As of May, 2006 the case has
been formally dismissed by the courts and we no longer have any liability
relating to this or any other legal action.ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSDuring the quarter ended September 30, 2006 no matters were submitted to a
vote of security holders.

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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATIONOur common stock is traded over-the-counter and its quotations are carried in
the Electronic Bulletin Board of the National Association of Securities Dealers,
Inc.
The following table sets forth the range of high and low bid quotations for
our common stock for the periods indicated from sources we deem reliable.

|               |                            | High $ | Low $
|-------------- | -------------------------- | ------ | -----
|Fourth Quarter | (Ended September 30, 2006) | 0.12   | 0.08 
|Third Quarter  | (Ended June 30, 2006)      | 0.25   | 0.08 
|Second Quarter | (Ended March 31, 2006)     | 0.24   | 0.07 
|First Quarter  | (Ended December 31, 2005)  | 0.10   | 0.06 
|Fourth Quarter | (Ended September 30, 2005) | 0.13   | 0.07 
|Third Quarter  | (Ended June 30, 2005)      | 0.14   | 0.09 
|Second Quarter | (Ended March 31, 2005)     | 0.16   | 0.12 
|First Quarter  | (Ended December 31, 2004)  | 0.37   | 0.09 

The foregoing quotations reflect inter-dealer prices without retail mark-up,
mark-down or commissions and may not necessarily represent actual transactions.

Records of our stock transfer agent indicate that as of December 17, 2006
there were approximately 79 record holders of our common stock. This does not
include an indeterminate number of shareholders who may hold their shares in
"street name" or in nominee form.

DIVIDENDS

We have never declared any cash dividends and do not anticipate paying such
dividends in the near future. We anticipate all earnings, if any, over the next
twelve (12) to twenty - four (24) months will be retained for future investments
in business. Any future determination to pay cash dividends will be at the
discretion of the Board of Directors and will be dependent upon our results of
operations, financial conditions, contractual restrictions, and other factors
deemed relevant by the Board of Directors. We are under no contractual
restrictions in declaring or paying dividends to our common shareholders.

The future sale of presently outstanding "unregistered" and "restricted"
common stock of the Company by present members of management and persons who own
more than five percent of the outstanding voting securities of the Company may
have an adverse effect on the public market for our common stock.

STOCK OPTION PLANS

Under the 2000 Stock Option Plan we issued 1,150,000 options to purchase
shares of common stock with an exercise price of $0.10 per share. These options
expire in June, 2010.

Under the 2003 Stock Option Plan we issued 570,000 options to purchase shares
of common stock with exercise prices ranging from $0.50 - $0.69 per share. These
options expire from February to May, 2008.

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Under the 2004 Stock Option Plan approved by our stockholders
in July,2004, 24,000,000 shares of common stock were made available as options.
Under the 2004 Option Plan we issued the following options on November 15, 2004:
options to purchase up to 12,720,000 shares of common stock with an exercise
price of $0.15 per share; options to purchase up to 250,000 shares of common
stock with an exercise price of $0.40 per share; options to purchase up to
110,000 shares of common stock with an exercise price of $0.45 per share; and
options to purchase up to 140,000 shares of common stock with an exercise price
of $0.50 per share. A total of 13,220,000 options were issued, all of which
expire on November 15, 2014. These options were issued to management, directors
and consultants and vest 100% on November 15, 2005 as to 12,720,000 options and
November 15, 2004 as to the remaining 500,000 options which were allocated to
our consultants. On January 10, 2005 we issued 7,000,000 options under this plan
with an exercise price of $0.16 per share. These options were issued to
management and vest 100% on January 10, 2006.

On February 8, 2005 we issued options to purchase up to
390,000 shares of common stock to employees and consultants of the Company.
These options have an exercise price of $0.15, vest 100% on February 8, 2006,
and expire on February 8, 2015.

On May 25, 2005 we issued options to purchase up to 100,000
shares of common stock to a consultant of the Company. These options have an
exercise price of $0.13, vest 100% on May 25, 2005 and expire on May 25, 2015.

On October 17, 2005 we issued options to purchase up to
3,290,000 shares of common stock to employees of the Company including directors
and one external consultant. These options have an exercise price of $0.075,
vest 100% on October 17, 2006 and expire on October 17, 2015. There are no
options remaining to be granted under the 2004 Option Plan.

We adopted a new option plan  the 2006 Option Plan at our
Annual General Meeting held March 29, 2006. Under this plan we can issue up to
5,000,000 shares of common stock to employees, including directors and external
consultants. No options have been issued under this plan to date.

RECENT SALES OF UNREGISTERED SECURITIES

We did not issue any unregistered securities during the year ended September
30, 2006. We issued 300,000 shares of restricted stock on November 20, 2006 to a
consultant in lieu of $30,000 cash payment for services rendered.

During the three months ended December 31, 2004 we issued 5,203,470 shares of
common stock pursuant to the conversion of $520,437 in convertible debt. We also
issued warrants to purchase 10,406,940 shares of common stock at $0.30 per share
in connection with the conversion of debt. These securities were registered
pursuant to an SB-2 filed in September, 2004 and related amendments filed
periodically until August, 2005.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

The following discussion and analysis should be read in conjunction with the
Financial Statements and Notes included in Item 8 of this report. Except for the
historical information contained herein the foregoing discussion contains
forward-looking statements that involve risks and uncertainties. Our actual
results could differ materially from those projected in the forward-looking
statements discussed herein.

21

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GENERAL

AlphaRx is a drug delivery company specializing in the development of
innovative therapeutic products for the pharmaceutical and consumer health care
market. Our core competence is in the development of novel drug formulations for
therapeutic molecules or compounds that have exhibited poor gastro intestinal
absorption due to poor solubility or have yet be administerable to the human
body with an acceptable delivery method. Our drug delivery system is versatile
and offers significant flexibility in the development of suitable dosage
formulations. Our delivery systems can be adopted to administer drugs orally,
topically, or parenterally in order to meet the requirements of specific drug
molecules.

During 2003 we initiated commercialization of our products commencing with
sales of Flexogan in the Canadian market. It became evident during 2005 that we
required more substantial financial resources to pursue Flexogan marketing
strategy. We determined that completion of Phase II Indaflex clinical trials was
the most appropriate course of action with the resources remaining. Should we be
successful in raising additional funding we will continue to pursue completion
of Phase II Indaflex clinical trials as our primary objective.

We signed a licensing agreement with Andromaco in August 2003
for the commercialization of our lead pharmaceutical products "Indaflex" in
Mexico. Mexican health authorities gave approval to Andromaco to start sales of
Indaflex in Mexico. We collected our first royalties from Indaflex sales in the
year ended September 30, 2005 and continue to collect royalties.

We established a wholly-owned subsidiary  AlphaRx
International Holdings Limited ("AIH") in April, 2005 and entered into a Joint
Venture Agreement with Basin Industrial Limited (a wholly-owned subsidiary of
Advance Pharmaceutical Co. Ltd.). The joint venture  AlphaAP Inc., will be
involved in the manufacture and marketing of certain existing and future
products in the far east. AlphaAP remains inactive until local health
authorities in Hong Kong and China grant approval to commence over the counter
sales of certain products.

On May 1, 2006 we announced that AIH has entered into an
agreement with China Lianyungang City Golden Enterprises Limited ("China Party")
to establish a Joint Venture in mainland China. The Joint Venture intends to
establish a manufacturing facility in Lianyungang City, Jiangsu Province and a
distribution network in order to manufacture and market pharmaceutical products
licensed by AIH. In addition AIH will help to develop branded generic products
in lieu of capital payment into the Joint Venture. China Party has agreed to
inject working capital of RMB 250 million (approximately $31 million) into the
Joint Venture in the form of equity. AIH will own 30% of the Joint Venture
common stock and China Company will own 70%. AIH is also to receive a 5% royalty
on all AIH licensed product sales generated by the Joint Venture.

In June, 2006 AIH issued 1,500 shares of its common stock to
New Super Limited ("NSL") in accordance with an agreement concluded during
April, 2006. The shares were issued for total cash consideration of $HK 10
million (about $1,288,826). There are presently 10,000 shares of common stock
issued and outstanding, of which 85% are owned by us. In accordance with SAB No.
51, we have accounted for the issuance of our subsidiarys stock as a capital
transaction. Considering that AIH is essentially a nonoperating entity, and that
the capital infusion was meant for commencement of business development in Asia
region, gain recognition was not appropriate.

Effective June 30, 2006, AlphaRx International Holdings Limited. ("AIH")
acquired 100% of Alpha Life Sciences Ltd. ("ALS") for a nominal amount and the
assumption of approximately $63,000 of related party liabilities. ALS is
involved in obtaining necessary regulatory approvals for the manufacture and
distribution of the Companys products in the Asian market.

22

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During November, 2006 we signed a feasibility and option
agreement with a large U.S. based pharmaceutical company. Under the agreement we
will use our proprietary nanoparticle drug delivery platforms to formulate three
products to enhance their effectiveness. Two products are currently marketed
products. Should our delivery platform be adopted we will be eligible to receive
milestone payments and royalty payments based on future product sales utilizing
our delivery technology. We will also generate consulting revenues in relation
to the reformulations.

Please refer to the table under Product Pipeline, Item 1 for
the current status of our product research and development activities. We have
one pharmaceutical drug in the clinical trial stage (Phase 1 completed in March,
2005, Phase II nearing completion as of November, 2006), and several
pharmaceutical drugs in the preclinical stage.

The costs incurred for each of these initiatives to date
cannot be readily determined because (i) there is no clear distinction between
initiatives in order to be able to differentiate between them; (ii) all
initiatives have a common goal and that is to adopt our Bioadhesive Colloidal
Dispersion ("BCD") drug delivery system to the specific drug in order to improve
that drugs effectiveness; and (iii) we do not maintain a time control system to
differentiate research and development activities.

The nature, timing and estimated costs to complete a project
and anticipated completion dates cannot be estimated because: (i) the nature of
research is experimental and we could encounter unforeseen situations which
could significantly delay project completion or require us to abandon the
project; (ii) timing to complete a project depends, to a certain extent, on
financial resources and we cannot predict with any degree of certainty that
financial resources will be available when needed to complete any specific
project and (iii) cost estimates cannot be predicted with any acceptable degree
of accuracy due to unforeseen issues arising during the clinical stages or the
approval stages of any specific initiative.

If we cannot complete our research and development
initiatives on a timely basis consequences to our operations could be
significant to the point where the initiative would be delayed or even
abandoned. We would also face the risk of competitors developing the same or
similar products and being first to market. Finally, our failure to develop
products on a timely basis could substantially impair our ability to generate
revenues and materially harm our financial position.

We cannot predict the timing of material net cash inflows
from significant projects due to a number of factors including (i) availability
of financial resources required to market a new product, (ii) our lack of
experience in bringing a new product to market successfully and gaining market
share; (iii) competitors products and the nature and timing of their marketing
initiatives.

We intend to continue investing in the further development of our drug
delivery technologies and to actively seek collaborators and licensees to
accelerate the development and commercialization of products incorporating our
drug delivery systems. Depending upon a variety of factors, including
collaborative arrangements, available personnel and financial resources, we will
conduct or fund clinical trials on such products and will undertake the
associated regulatory activities.

23

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RESULTS OF OPERATIONS

YEAR ENDED SEPTEMBER 30, 2006 AS COMPARED TO YEAR ENDED SEPTEMBER 30, 2005

License Fees and Royalties

In keeping with our central strategy of seeking alliances
with larger pharmaceutical companies, we signed a license agreement with
Proprius Pharmaceuticals, Inc. during April, 2006. As a result we recognized and
received $1 million in license fees during the year  our first such revenue
stream. Total revenues for the year ended September 30, 2006 were $1,024,774 as
compared to $4,302 generated a year ago, an increase of $1,020,472. Royalty
revenues from Indaflex sales in Mexico increased to $24,774 for the year ended
September 30, 2006 as compared to $4,302 generated a year ago. Royalty revenues
continue to increase based on increased sales of Indaflex in Mexico.

General and Administrative Expenses

General and administrative expenses were $813,231 for the
year ended September 30, 2006 as compared to $650,965 incurred for the same
period a year ago, an increase of $162,266 or about 25%. We incurred about
$194,000 in administrative expenses during the year, in relation to the
establishment of Alpharx International Holdings Limited and Alpha Life Sciences
Ltd., our 85% owned subsidiaries. The major administrative expenses related to
our new subsidiaries included hiring of a general manager for ALS and AIH,
initial accounting, legal, regulatory applications and related travel for our
products in China and Hong Kong. There was no comparable expense in 2005.

Stock Based Compensation Expense and Warrant Amortization

Stock based compensation expense and warrant amortization
totalled $968,837 for the year ended September 30, 2006 as compared to
$2,009,920 for the same period a year ago. We issued warrants in conjunction
with promissory notes during the year ended September 30, 2006. Warrant
amortization for the year totalled $251,720 with no comparable expense in the
previous year. We also issued 3,290,000 options during the year, resulting in
$717,117 in total stock based compensation expense. This compares to issuance of
20,710,000 options during the year ended September 30, 2005 which resulted in
stock based compensation expense of $2,009,920. There remains about $253,000 in
warrant amortization to be expensed in fiscal 2007 as well as $10,720 in stock
based compensation expense related to issuance of options during 2006. We
anticipate issuance of additional options and warrants in the future, which will
continue to result in stock based compensation expense and may result in warrant
amortization expense.

Research and Development Expenses

Research and development expenses include costs for
scientific personnel, supplies, equipment, outsourced clinical and other
research activities, consultants, and other costs directly related to research
and development of new and existing products. We are now incurring research and
development expenses both in China for oncology product initiatives and in
Canada for all other product initiatives.

During 2006 we stopped incurring costs related to Indaflex
clinical trials. Effective April, 2006 all future costs related to Indaflex
clinical trials and commercialization are being borne by Proprius
Pharmaceuticals, Inc. in return for full commercialization and sub-licensing
rights in the U.S and other regions.

Research and development expenses totalled $1,417,700 for the
year ended September 30, 2006 as compared to $1,337,503 incurred for the same
period a year ago, an increase of $80,197 or about 6%. We incurred about
$994,000 related to Indaflex clinical trials during 2006 as compared to about
$1,170,000 during 2005, a decrease of about $176,000. Offsetting this decrease
were additional expenditures related to outside consultants of approximately
$118,000, and certain salaried staff now focusing on other initiatives,
increased equipment leases, and research expenditures commencing in China.

24

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We anticipate continued spending on research and development in the future.
The degree and pace of expenditures will depend primarily on financial resources
available to us.

Sales and Marketing Expenses

Sales and marketing expenses totalled $59,889 for the year
ended September 30, 2006 as compared to $21,021 incurred during the same period
a year ago, an increase of $38,868 or about 185%. Sales commission of $50,000
was paid in 2006 related to license fees collected with no comparable expense in
2005.

Sales commissions will continue in future, based on
collection of license fee milestones. We also expect to continue business
development expenditures, and sales consulting. We no longer intend to incur
expenses related to marketing of our products, as our business partners and
licensees will be involved in the selling of our products, and related marketing
expenditures.

Depreciation Expense

Depreciation expense totalled $74,307 for the year ended
September 30, 2006 as compared to $54,077 incurred for the same period a year
ago, an increase of $20,230 or about 37%. We purchased about $124,000 in capital
assets, primarily scientific research and testing equipment during 2006, leading
to an increase in depreciation.

Interest Expense

We incurred $67,410 in interest expense during 2006 as a
result of our borrowings and the issuance of promissory notes yielding interest
ranging from 10% - 12% per annum. This compares to $22,804 in net interest
income generated during 2005. Interest income was generated during 2005 from
cash on deposit, such cash being sourced from a private placement completed
during September, 2004.

Minority Interest

We issued 1,500 shares of our subsidiarys common stock (AlphaRx
International Holdings Limited "AIH") to New Super Limited ("NSL") in June, 2006
in exchange for a cash infusion of $HK 10 million (about $1,288,826). There are
presently 10,000 shares of common stock of AIH issued and outstanding, of which
85% are owned by us. In accordance with SAB No. 51, we have accounted for the
issuance of our subsidiarys stock as a capital transaction. A minority interest
credit of $33,316 for the year ended September 30, 2006 has resulted in a
corresponding reduction of our consolidated expenses, this amount representing
NSLs portion of AIHs loss.

Net Loss before Discontinued Operations

The above income and expenses resulted in a net loss before
discontinued operations of $2,343,284 for the year ending September 30, 2006 as
compared to a net loss of $4,046,380 incurred for the same period a year ago.

Discontinued Operations

During 2003 the Company introduced Flexogan products to the
Canadian market. Marketing of these products was underway, and initial orders
from customers were received. Further growth in sales resulted in 2004,
primarily as a result of one order from a national drug chain. Repeat orders
were proving to be more challenging during 2004 and 2005, even while an expanded
marketing campaign was underway.

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We completed a private placement during late 2004 in order to
fund our core research and development activities as well as continuation of our
marketing campaign for Flexogan. Although substantial amounts were spent on
marketing during 2005, sales growth did not materialize. This was due, in large
part, to new competitive product introductions into the pain relief segment of
the market by large pharmaceutical companies and other independents. Marketing
and sales programs for these competitive products were substantial, and
significantly larger than we could afford if we were to compete effectively. We
continued to sell our products into 2006 while seeking marketing and sales
partners to take over the Flexogan line.

We determined to discontinue direct sales of Flexogan
because: (a) we were not able to source a qualified marketing partner to take
over direct sales of Flexogan; (b) we did not have adequate financial resources
or expertise to market Flexogan on a longer term basis, and (c) we concluded
there was a better overall opportunity for success if we focused on drug
development and enhancement while allowing our partners and potential partners
to market our products in return for royalties and, or license fees.

Loss from discontinued operations described above totalled
$179,009 for the year ended September 30, 2006 as compared to a loss of $805,744
for the same period a year ago, a reduction of $626,735. The reduction in loss
was due primarily to reduced marketing expenditures. For the year ended
September 2006 we incurred $34,251 in sales and marketing expenses for Flexogan
products as compared to $640,538 incurred for the same period a year ago, a
reduction of $606,287.

Net Loss

Including the loss from discontinued operations and all other
expense and income items described above, we incurred a net loss of $2,522,293
for the year ended September 30, 2006 as compared to a net loss of $4,852,124
for the year ended September 30, 2005.

Cumulative Translation Adjustment

The cumulative translation adjustment stems from unrealized
foreign exchange gains and losses stemming from translation of foreign currency
subsidiaries into U.S. dollars. Although the cumulative translation adjustment
is reflected in the statement of operations, it is reflected after the net loss
and flows into shareholders equity directly. There was no comparable cumulative
translation adjustment in 2005.

YEAR ENDED SEPTEMBER 30, 2005 AS COMPARED TO YEAR ENDED SEPTEMBER 30, 2004 AS
RESTATED

Royalty revenues

Royalties for the year ended September 30, 2005 were $4,302 as compared to
nil for the same period a year ago. These royalties are based on sales of
Indaflex in Mexico by one of our licensees. There were no comparable revenue
streams for the same period a year ago. Revenues from the sales of Flexogan are
included in discontinued operations in the financial statements.

General and Administrative Expenses

General and administrative expenses were $650,965 for the year ended
September 30, 2005 as compared to $427,138 for the prior year, an increase of
$223,827 or about 52%. Legal fees related primarily to patent applications
increased to about $162,000 from about $74,000 in the prior year and increase of
about $88,000. Stock based compensation expense related to granting of options
to consultants was $62,300 with no comparable expense in the prior year. We also
entered into a financial services advisory agreement during 2005, incurring an
expense of $80,000 with no comparable expense in the prior year.

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Stock Based Compensation Expense

We decided to adopt the fair value accounting method for
employee stock options as per SFAS 123(R) using the modified retrospective
application method, effective April 1, 2005. Resultingly, we recorded $2,009,920
in stock based compensation expense related to employee options granted during
the year. There was no comparable expense in the prior year.

Research and Development Expenses

Research and development expenses include costs for scientific personnel,
supplies, equipment, outsourced clinical and other research activities,
consultants, and other costs directly related to research and development of new
and existing products.

Research and development expenses for the year ended September 30, 2005
totalled $1,337,503 as compared to $ 360,467 incurred for the same period a year
ago, an increase of $977,036 or approximately 271%. We completed Phase 1
clinical trials and initiated Phase II clinical trials for Indaflex during the
year ended September 30, 2005. We incurred about $1,170,000 for Indaflex trials
for the year ending September 30, 2005 inclusive of test batch manufacture,
salaries, benefits, consulting expense, and equipment leasing as compared to
about $192,000 incurred for the prior year  an increase of about $978,000.
Additional development expenditures will consume most of our financial resources
until the trials have been completed.

Sales and Marketing Expenses

Sales and marketing expenses were $21,021 for the year ended
September 30, 2005 as compared to $65,519 incurred for the same period a year
ago, a decrease of $44,498 or about 68%. With limited funding available we
curtailed marketing expenditures during our fourth quarter and focused our
remaining resources on Indaflex clinical trials.

Depreciation

Depreciation was $54,077 for the year ended September 30,
2005 as compared to $36,447 for the same period a year ago, an increase of
$17,630 or about 48%. Additional research equipment purchases of about $103,000
during the latter half of fiscal 2004 and about $45,000 during 2005 have served
to increase depreciation expense during 2005.

Interest income/expense

We generated interest income of $22,804 for the year ended
September 30, 2005 as compared to net interest expense incurred of $1,153,871
for the same period a year ago. Included in net interest expense for 2004 is
$1,161,000 in interest charges related to the issuance of convertible debt with
a beneficial conversion feature in March, 2004. The Company generated interest
income from term deposits as a result of a private placement completed in
September, 2004 in the amount of $3,410,027, net of issuance expenses.

27

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Net Loss before Discontinued Operations

The above income and expenses resulted in a net loss before
discontinued operations of $4,046,380 for the year ended September 30, 2005 as
compared to a net loss, as restated, of $2,273,442 for the same period a year
ago.

Discontinued Operations

Discontinued operations relate to direct sales of Flexogan in
the Canadian market which commenced in fiscal 2003 and which abated at the end
of 2006. The loss from discontinued operations for 2005 totalled $805,744 as
compared to a loss of $660,398 incurred during the same period a year ago, an
increase of $145,346 or about 22%. Our gross margin in 2005 was $35,139 as
compared to a gross margin of $230,501 in 2004. Offsetting gross margins in 2005
were administrative expenses of $200,345 and sales and marketing expenses of
$640,358. This compares to 2004 administrative expenses of $170,175 and sales
and marketing expenses of $720,724.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2006 the Company had a working capital
deficiency of $176,129 as compared to a working capital deficiency of $75,925 as
at September 30, 2005. We have licensing arrangements with Andromaco and with
Proprius Pharmaceuticals, Inc., which provide our commercial source of funding
based on achieving milestones and/or sales of our products. We also have
established a joint venture  AlphaAp Inc, which will pay us royalties once
sales commence in the far east. We continue to seek out similar licensing and
royalty arrangements with established and experienced partners in order to
expand our revenue base.

Immediate capital needs are sourced via directors loans and
other private sources, and to that effect, we have borrowed approximately
$105,000 subsequent to September 30 for working capital purposes. Since
inception, we have financed operations primarily from the issuance of common
stock. We expect to continue common stock issuances and issuance of promissory
notes to fund our ongoing activities.

We currently do not have sufficient resources to complete the
commercialization of all of our proposed products or to carry out our entire
business strategy. Therefore, we will need to raise additional capital to fund
our operations sometime in the future. We cannot be certain that any financing
will be available when needed. Any additional equity financings will be dilutive
to our existing shareholders, and debt financing, if available, may involve
restrictive covenants on our business and also the issuance of warrants or
conversion features which may further dilute our existing shareholders.

We expect to continue to spend capital on:

1. research and development programs; 
2. preclinical studies and clinical trials; 
3. regulatory proceses; and 
4. sales and marketing activities, but unrelated to direct sales.

The amount of capital we may need will depend on many factors, including:

1. the progress, timing and scope of our research and
development programs; 
2. the progress, timing and scope of our preclinical studies and clinical
trials; 
3. the time and cost necessary to obtain regulatory approvals;

28

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4. the time and cost necessary to establish licensing and similar marketing
arrangements in order to generate royalty and license fee revenues; 
5. the time and cost necessary to respond to technological and market
developments; and
6. new collaborative, licensing and other commercial relationships that we may
establish.

The inability to raise capital would have a material adverse effect on the
Company.

OFF BALANCE SHEET ARRANGEMENTS

We do not have any off balance sheet arrangements that are material and
which, in our opinion, could become material in the future.

Contractual Obligations and Commitments

Excluding trade accounts payable, discontinued operations liabilities and
accrued liabilities, the Company is committed to the following contractual
obligations and commitments.

|                            | 2007     | 2008    | 2009    | 2010  
|--------------------------- | -------- | ------- | ------- | ------
|Operating Lease Obligations | $ 81,541 | $66,747 | $22,693 | $1,931
|Notes Payable (1)           | 780,323  | -       | -       | -     
|Total                       | $861,864 | $66,747 | $22,693 | $1,931

(1) Includes accrued interest accruing at rates ranging from 10% -12% per
annum.

Certain Factors that may Affect Future Results

Certain of the information contained in this document constitutes
"forward-looking statements", including but not limited to those with respect to
the future revenues, our development strategy, involve known and unknown risks,
uncertainties, and other factors which may cause our actual results, performance
or achievements to be materially different from any future results, performance
or achievements expressed or implied by such forward-looking statements. Such
factors include, among others, the risks and uncertainties associated with a
drug delivery company including a history of net losses, unproven technology,
lack of manufacturing experience, current and potential competitors with
significant technical and marketing resources, need for future capital and
dependence on collaborative partners and on key personnel. Additionally, we are
subject to the risks and uncertainties associated with all drug delivery
companies, including compliance with government regulations and the possibility
of patent infringement litigation, as well as those factors disclosed in our
documents filed from time to time with the United States Securities and Exchange
Commission.

ITEM 7. FINANCIAL STATEMENTS FOR 2006 AND 2005

The financial statements for the fiscal year ending September 30, 2006 and
2005, required by Item 7 are set forth on pages F-1 through F-20.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable

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ITEM 8A. CONTROLS AND PROCEDURES

The Companys chief executive officer and the Companys chief financial
officer and principal accounting officer are responsible for establishing and
maintaining disclosure controls and procedures for the Company.
Evaluation of Disclosure Controls and Procedures
Based on their evaluation as of September 30, 2006, the chief executive
officer and the chief financial officer have concluded that the Companys
disclosure controls and procedures (as defined in Rule 13a-14(c) and 15d-15(e)
of the Securities Exchange Act of 1934, as amended) are effective to ensure that
information required to be disclosed by the Company in reports that the Company
files or submits under the Securities Exchange Act, as amended, is recorded,
processed, summarized and reported within the time periods specified in the
rules and forms of the Securities and Exchange Commission.
Changes in Internal Controls
The chief executive officer and the chief financial officer and principal
accounting officer have concluded that there were no significant changes in the
Companys internal controls over financial reporting or in any other areas that
could significantly affect the Companys internal controls subsequent to the
date of their most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
ITEM 8B. OTHER INFORMATION

None.

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

The following table sets forth, as of December 15, 2006, the name, age, and
position of each of our executive officers and directors:

|Name                             | Age | Position                               | Term           
|-------------------------------- | --- | -------------------------------------- | ---------------
|                                 |     |                                        |                
|Michael M. Lee                   | 43  | Chairman
    of the Board of Directors
|                                 |     | Chief Executive
    Officer            | Since 8/8/1997 
|                                 |     |                                        |                
|Marcel Urbanc, C.A.              | 50  | Chief Financial
    Officer and        |                
|                                 |     | Principal Accounting
    Officer       |                
|                                 |     |                                        |                
|Joseph Schwarz, Ph.D             | 52  | Chief Scientist                        |                
|                                 |     |                                        |                
|Michael Weisspapir,
    MD, Ph.D | 50  | Chief Medical Officer                  |                
|                                 |     |                                        |                
|Sandro Persia                    | 36  | Secretary/Treasurer                    |                
|                                 |     |                                        |                
|Dr. David Milroy                 | 55  | Director                               | Since 4/15/2003
|                                 |     |                                        |                
|Dr. Ford Moore                   | 55  | Director                               | Since 4/15/2003

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Michael M. Lee: Mr. Lee is a founder of the Company. Mr. Lee
has over 15 years of business experience in the areas of high tech development,
marketing and corporate finance. Mr. Lee holds a B.Sc. in Applied Mathematics
from the University of Western Ontario. Mr Lee founded the company in August
1997.
Marcel Urbanc, C.A.:Mr. Urbanc obtained his Chartered Accountant
designation in 1985 after articling with Arthur Andersen & Co. for 3 years.
Prior to joining the Company, Mr. Urbanc served as Controller and then VP
Finance & CFO of Oasis Technology Ltd., a software company involved in
transaction processing from 1994 to 2002. During his tenure at Oasis private
equity funding of approximately $45,000,000 was raised. Mr Urbanc has been with
the company since March, 2003.
Joseph Schwarz, Ph.D.: Dr. Schwarz is our chief scientist. Dr. Schwarz has
extensive experience in the research and development of controlled release drug
delivery systems, his areas of expertise cover controlled delivery of drugs,
colloidal and microcorpusculate drug delivery systems, submicron emulsions (SME),
transdermal delivery (topical and systemic). Dr. Schwarz has published more than
40 articles in various scientific journals and has written over 20 patents and
patent applications. Dr. Schwarz was the senior scientist at Pharmos Ltd., a
publicly traded U.S. pharmaceuticals company from 1991 to 1995. From 1995 to
1997 he was the senior scientist in the research and development department of
TEVA Pharmaceuticals Ltd. From 1997 to 1998, Dr. Schwarz was the senior
scientist of D-PHARM, a pharmaceuticals concern located in Israel. From 1998 to
1999 Dr. Schwarz served as a part time consultant to the Company and has been
with the company since that time.
Michael Weisspapir, M.D., Ph.D.:Dr. Weisspapir has 19 years of
successful experience in experimental medicine and extensive experience in
interdisciplinary research and development in experimental pharmacology,
immunopharmacology, toxicology and neuroscience. Prior to joining the Company,
Dr. Weisspapir held a variety of research positions at the University of Tel
Aviv and Rabin Medical Center, Israel and the University Health Network,
University of Toronto, Canada.
Sandro Persia: Mr. Persia joined Logic Tech Corp. in 1989 as Marketing
Manager and promoted to Vice President in 1996. Mr. Persia has extensive
business experience in high tech marketing and sales. Mr. Persia holds a diploma
in business administration from the Seneca College.
David Milroy, D.D.S. M.R.C.D. (C): Dr. Milroy is a Certified Oral &
Maxillofacial Surgeon and has been in private practice in Richmond Hill,
Woodbridge, and Port Hope, Ontario for the past twenty years. He graduated from
the University of Toronto, Faculty of Dentistry with a Doctor of Dental Surgery
degree in 1976 and a Residency in Oral & Maxillofacial Surgery at the University
of Toronto, Toronto General and Toronto Doctors Hospitals in 1982.
Ford Moore, D.D.S. F.R.C.D. (C): Dr. Moore is a certified Oral &
Maxillofacial Surgeon, is engaged in a full-time private practice in Newmarket,
Ontario which he established in 1981. Dr. Moore graduated from the University of
Toronto with a Doctor of Dental Surgery degree in 1976, and completed a hospital
Residency in Oral Surgery and Anesthesia at Toronto General Hospital, Toronto
Doctors Hospital and the University of Toronto in 1980.

All directors will hold office until the next annual stockholders meeting
and until their successors have been elected or qualified or until their death,
resignation, retirement, removal, or disqualification. Vacancies on the board
will be filled by a majority vote of the remaining directors. Officers of the
Company serve at the discretion of the board of directors.
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Compensation of Directors

Effective as of March, 2005, non-management directors receive
an annual fee of CAD $3,000 as well as meeting attendance fees of CAD $500 or
CAD $250. Directors are reimbursed for direct out-of-pocket expenses for
attendance at meetings of the Board of Directors and for expenses incurred for
and on behalf of the Company.
Board of Directors Committees

We were not able to attract an independent director with financial experience
to sit on our board or our audit committee. The two independent board members
who sat on the audit committee had no financial experience. It was determined
that the audit committee be disbanded until appropriate qualified independent
directors can be located. Based on the size of the organization  seven full
time employees, and 3 part time consultants, effective controls over financial
reporting and internal financial controls can still be effectively maintained
without an audit committee.
The board of directors has not yet established a compensation committee.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

Section 16(a) of the Exchange Act requires directors,
officers and persons who own more than 10% of a registered class of our equity
securities to file reports of ownership and change in ownership with the
Securities and Exchange Commission. Directors, officers and greater than 10%
shareholders are required by SEC regulations to furnish us with copies of all
Section 16(a) forms they file.
Based solely upon our review of the copies of such forms that
we received during the fiscal year ended September 30, 2006, we believe that
each person who at any time during the fiscal year was a director, officer, or
beneficial owner of more than ten percent of our common stock complied with all
Section 16(a) filing requirements during such fiscal year.
CODE OF ETHICS

We have not adopted a formal code of ethics at this time, as
our focus has been on our product development and enhancement. We do follow what
are considered proper business ethics and labor law in Canada ensures that our
employees are treated with a minimum standard of care and consideration.
ITEM 10. EXECUTIVE COMPENSATION

Summary Compensation
The table below summarizes the compensation received by the Company's Chief
Executive Officer for the fiscal years ended September 30, 2006, 2005 and 2004
and each other executive officer of the Company who received compensation in
excess of $40,000 for services rendered during any of those years ("named
executive officers").

32

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|                             |      |            |           | LONG TERM   
|---------------------------- | ---- | ---------- | --------- | ------------
|                             |      |            |           | COMPENSATION
|                             |      |            |           | SECURITIES  
|NAME AND                     |      |            |           | UNDERLYING  
|PRINCIPAL POSITION           | YEAR | SALARY ($) | BONUS ($) | OPTION (#)  
|Michael M. Lee               | 2006 | 110,279    | 0         | 800,000     
|President & C.E.O.           | 2005 | 45,510     | 0         | 13,000,000  
|                             | 2004 | 29,531     | 0         | --          
|Joseph Schwarz               | 2006 | 123,946    | 0         | 200,000     
|Chief Scientist              | 2005 | 125,267    | 0         | 3,000,000   
|                             | 2004 | 22,731     | 0         | --          
|Michael Weisspapir           | 2006 | 111,508    | 0         | 200,000     
|Chief Medical Scientist      | 2005 | 114,534    | 0         | 3,000,000   
|                             | 2004 | 59,100     | 0         | --          
|Marcel Urbanc                | 2006 | 25,939     | 0         | 200,000     
|Chief Financial Officer and  | 2005 | 52,664     | 0         | 270,000     
|Principal Accounting Officer | 2004 | 36,218     | 0         | --          

Aggregated Option Exercises In Last Fiscal Year 
and Fiscal Year End Option Values

The following table sets forth certain information regarding exercises of
stock options during the fiscal year ended September 30, 2006 by the named
executive officers. Value of unexercised options is considered to be the
difference between exercise price and market price of $0.10 per share on
September 30, 2006. No options were exercised by the named executive officers
during fiscal 2006 or any prior year.

|Name               | Number of Exercisable
    Options at | Value of Unexercised
    In-The-Money
|------------------ | ------------------------------------ | -------------------------------------
|                   | Fiscal Year-End (#)                  | Options at Fiscal Year-End
    (#)   
|                   | Exercisable/Unexercisable *          | Exercisable/Unexercisable            
|                   |                                      |                                      
|Michael M. Lee     | 13,550,000/800,000                   | $0/$20,000                           
|Marcel Urbanc      | 350,000/200,000                      | $0/$5,000                            
|Joseph Schwarz     | 3,330,000/200,000                    | $0/$5,000                            
|Michael Weisspapir | 3,280,000/200,000                    | $0/$5,000                            

* On October 17, 2005 the following options were granted to the above named
executive officers: M. Lee  800,000; J. Schwarz  200,000; M. Weisspapir 
200,000; and M Urbanc  200,000.

2003 Stock Option Plan

The 2003 Plan is administered by the board of directors, which determines
which directors, officers, employees, consultants, scientific advisors and
independent contractors of the Corporation are to be granted options, the number
of shares subject to the options granted, the exercise price of the options, and
certain terms and conditions of the options. No options may be granted under the
2003 Plan more than ten years after the date the 2003 Plan is adopted by the
board of directors, and no options granted under the 2003 Plan may be exercised
after the expiration of ten years from date of grant. The board of directors may
delegate administration of the 2003 Plan, including the power to grant options
to persons who are not officers or directors of the Corporation, to a Stock
Option Committee, composed of members of the board of directors.

33

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We have reserved 1,500,000 common shares under the 2003 Plan for issuance
under option or restricted stock purchase agreements. As of January 26, 2004
there were 645,000 options granted under this Plan. The 2003 Stock Option Plan
was considered no longer adequate for our future needs and hence the Company
adopted the 2004 Plan described below.

2004 Stock Option Plan

The 2004 Plan is administered by the board of directors, which determines
which directors, officers, employees, consultants, scientific advisors and
independent contractors of the Company are to be granted options, the number of
shares subject to the options granted, the exercise price of the options, and
certain terms and conditions of the options. The board of directors may delegate
administration of the 2004 Plan, including the power to grant options to persons
who are not officers or directors of the Corporation, to a Stock Option
Committee, composed of members of the board of directors. The board of
directors, in its sole discretion, may amend, modify or terminate the 2004 Plan
at any time without restriction. However, no amendment may, without stockholder
approval, increase the total number of shares of stock which may be issued under
the 2004 Plan (other than increases to reflect stock dividends, stock splits or
other relevant capitalization changes). There are 24,000,000 authorized shares
of our Common Stock that are not issued or outstanding, reserved for
implementation of the 2004 Plan.

On November 15, 2004 the Company granted 13,220,000 options under the 2004
Plan to 14 individuals including officers, directors and consultants. On January
10, 2005 the Company granted 7,000,000 options under the 2004 Plan to Michael
Lee  President. On February 8, 2005 the Company granted 390,000 options under
the 2004 Plan to 5 individuals including officers, employees and consultants. On
May 25, 2005 the Company granted 100,000 options under the 2004 Plan to a
consultant of the Company. On October 17, 2005 the Company granted 3,290,000
options to employees and directors of the Company as well as to one external
consultant. There are no options remaining to be granted under the 2004 Plan.

2006 Stock Option Plan

A majority of shareholders approved the 2006 Option Plan at the Annual
General Meeting held March 29, 2006. Under this plan up to 5,000,000 options may
be granted. As of December 21, 2006 no options have been granted under the 2006
Option Plan, nor have any options been exercised under any of the above plans.

Equity Compensation Plan Information

|                                                           | Number of Securities | Weighted-         | Number of securities  
|---------------------------------------------------------- | -------------------- | ----------------- | ----------------------
|                                                           | to be issued upon    | Average           | remaining available   
|                                                           | exercise of          | Exercise Price of | for future issuance   
|                                                           | outstanding options, | outstanding       | under equity          
|                                                           | warrants, and rights | options,          | compensation plans    
|                                                           |                      | warrants, and     | (excluding securities 
|                                                           |                      | rights            | reflected in the first
|                                                           |                      |                   | two columns           
|                                                           |                      |                   |                       
|Equity Compensation Plans Approved
    by Security Holders | 25,720,000           | $0.16             | 5,000,000 *           
|                                                           |                      |                   |                       
|Equity Compensation Plans Not Approved by Security Holders | None                 | None              | None                  
|                                                           |                      |                   |                       
|                                                           |                      |                   |                       
|Total                                                      | 25,720,000           | $0.16             | 5,000,000             

* This amount represents options made available to management, employees and
consultants as approved by shareholders at the Annual General Meeting held March
29, 2006. None of these options have been granted to date.

34

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ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth information with respect to ownership of the
Companys securities by its officers and directors and by any person (including
any "group") who is the beneficial owner of more than 5% of the Companys common
stock. The total number of shares authorized is 250,000,000 shares of common
stock, each of which has a par value of $0.0001. As of December 15, 2006 there
were 57,808,112 shares of common stock issued and outstanding.

|Name and Address                                  | Amount and Nature of | Percent of
|------------------------------------------------- | -------------------- | ----------
|Of Owner                                          | Beneficial Owner     | Class     
|                                                  |                      |           
|Michael Lee(1)                                    | 8,308,686 shares     | 14.37%    
|Joseph Schwarz(2)                                 | 602,500 shares       | 1.04%     
|Ford Moore(3)                                     | 492,579 shares       | 0.85%     
|Michael Weisspapir(2)                             | 457,500 shares       | 0.79%     
|David Milroy(3)                                   | 425,000 shares       | 0.74%     
|Marcel Urbanc(2)                                  | 20,000 shares        | 0.03%     
|Sandro Persia(2)                                  | 16,000 shares        | 0.03%     
|All directors and officers as a group (7 persons) | 10,322,265 shares    | 17.85%    

(1)

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

During the year ended September 30, 2006, Michael Lee, Chief Executive
Officer and Director, has loaned us $153,148 on which $16,357 of interest has
accrued. We have issued promissory notes to Messr. Lee promising to repay the
loan amounts within one year issuance. These notes carry interest in the range
of 10% - 12% per annum and are unsecured. These funds were used for general
corporate purposes.

35

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During the year ended September 30, 2006, Dr. Ford Moore, Director, has
loaned us $107,363 on which $10,056 in interest has accrued. We have issued
promissory notes to Dr. Moore promising to repay the loan amounts within one
year of issuance. These notes carry interest at the rate of 12% per annum and
are unsecured. These funds were used for general corporate purposes.

During the year ended September 30, 2006, Dr. David Milroy, Director, has
loaned us $61,873 on which $7,708 in interest has accrued. We have issued
promissory notes to Dr. Milroy promising to repay the loan amounts within one
year of issuance. These notes carry interest at the rate of 12% per annum and
are unsecured. These funds were used for general corporate purposes.

Except as disclosed above, during the past two years, there have been no
other material transactions, series of similar transactions or currently
proposed transactions, to which the Company was or is to be a party, in which
the amount involved exceeds $60,000 and in which any director or executive
officer, or any security holder who is known to the Company to own of record or
beneficially more than five percent of the Company's common stock, or any member
of the immediate family of any of the foregoing persons, had a material
interest.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits. Exhibits required to be attached by Item 601 of Regulation S-B
are listed in the Index to Exhibits beginning after Item 14 of this Form 10-KSB,
which is incorporated herein by reference.

(b) On December 16, 2004 we reported the issuance of a press release
regarding the manufacture of test batches for our Indaflex clinical trials.

On May 13, 2005 we informed the SEC of the necessity to
restate certain prior periods based on the beneficial conversion feature related
to the issuance of senior convertible debt during the period February to April,
2004.

On May 16, 2005 we filed an amended 8K regarding the original 8K filed May
13, 2005.

On May 18, 2005 we filed an 8K regarding the entry into a
material definitive agreement between AlphaRx International Holdings Limited ("AIH"),
a wholly owned subsidiary, and Basin Industrial Ltd., an independent, wholly
owned subsidiary of Advanced Pharmaceutical Ltd..

On June 3, 2005 we filed an 8K regarding a press release issued on June 2,
2005 commenting on Indaflex Phase 1 clinical trial results.

On June 6, 2005 we filed an 8K regarding a Joint Venture
established between AIH and Basin Industrial Ltd. AlphaAP Inc., the Joint
Venture to be established, will be used to market certain products in the Asia
Pacific Region.

On June 17, 2005 we filed an 8K regarding the official launch
of Indaflex in Mexico. Indaflex must complete further clinical trials in Canada
and the United States to be able to market Indaflex in those countries.

On June 28, 2005 we filed an 8K reporting that the test batches for our
Indaflex clinical trials were completed.

36

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On June 29, 2005 we filed an 8K describing in more detail,
the Joint Venture agreement between AIH (our wholly owned subsidiary) and Basin
Industrial Ltd. (a wholly owned subsidiary of Advanced Pharmaceutical Ltd.).
Both parties will own 50% of AlphaAP Inc., a company to be established.

On July 13, 2005 we released an 8K indicating that Health Canada provided
approval for Phase 2 human trials with Indaflex.

On July 14, 2005 we filed an 8K regarding board approval to allow AlphaAP
Inc. (50% owned Joint Venture) to buy up to 10% of our outstanding common stock
in the open market.

On July 18, 2005 we filed an 8K regarding a press release, providing an
update on our antibiotic development program.

On April 19, 2006 we reported on a press release regarding a
license agreement that we entered into with Proprius Pharmaceuticals, Inc. Under
the agreement, we will receive an upfront payment of $1 million and will be
eligible to receive additional clinical and sales milestone payments of up to
$116 million for the successful development and commercialization of Indaflex,
as well as royalties on all future sales.

On May 3, 2006 we reported on a press release regarding a
joint venture agreement entered into between our wholly owned subsidiary 
AlphaRx International Holdings Ltd and China Lianyungang City Golden Enterprises
Limited ("China Party") to establish a Joint Venture company in mainland China.
The China Party has agreed to provide funding of up to RMB 250 million (about
$31 million) to establish a manufacturing facility and a distribution network in
order to produce and market certain products and to develop new novel branded
generic products in China.

On November 6, 2006, we filed an 8K reporting on a Feasibility and Option
Agreement with a global pharmaceutical company based in U.S.

Under the agreement, we granted them an exclusive option to acquire an
exclusive worldwide license to our nanoparticle delivery systems for the
development, manufacture and commercialization of certain products in certain
indications. In return, they agreed to pay us an upfront fee, as well as
additional payments upon the achievement of specified milestones and royalty
payments from future product sales that utilize our delivery systems. They will
have the sole responsibility for obtaining all regulatory approvals necessary
for commercialization of these products at their own expense.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Audit Fees : For the year ended September 30, 2006 we
incurred approximately $25,814 in external audit fees, and quarterly reviews in
connection with statutory and regulatory filings to our principal accountants as
compared to approximately $22,073 for the year ended September 30, 2005.

Audit-Related Fees: For the years ended September 30, 2006 and 2005 we
incurred no fees for assurance and related services by the principal accountant.

Tax Fees: For the year ended September 30, 2006 we incurred no tax
related fees to our principal accountant as compared to approximately $3,230 for
the year ended September 30, 2005.

All Other Fees: For the year ended September 30, 2006 and 2005 we paid no
other fees to our principal accountant.

37

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Audit Committees Pre-Approval Policies and Procedures: 
The Company currently does not have a designated Audit Committee, and
accordingly, the Companys Board of Directors policy is to pre-approve all audit
and permissible non-audit services provided by the independent auditors. These
services may include audit services, audit-related services, tax services and
other services. The independent auditors and management are required to
periodically report to the Companys Board of Directors regarding the extent of
the services to be provided. Pre-approval is generally provided prior to the
service commencing.



SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.

DATED: December 21, 2006

| | ALPHARx, INC.                
| | -----------------------------
| |                              
| | By: /s/ Michael M. Lee       
| | Michael M. Lee, President and
| | Chief Executive Officer      
| |                              
| | By: /s/ Marcel Urbanc        
| | Marcel Urbanc                
| | Chief Financial Officer and  
| | Principal Accounting Officer 

38

---

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant, in
the capacities, and on the dates, indicated.
DATED: December 21, 2006
ALPHARx, INC.

| | Directors:                  
| | ----------------------------
| |                             
| |                             
| | /s/ Michael M. Lee          
| | Michael M. Lee, Director and
| | Chairman of the Board       
| |                             
| |                             
| | /s/ David Milroy            
| | David Milroy, Director      
| |                             
| |                             
| | /s/ Ford Moore              
| | Ford Moore, Director        

39

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INDEX TO EXHIBITS

|EXHIBIT | PAGE |                                                                                                                                                                                  
|------- | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NO.     | NO.  | DESCRIPTION                                                                                                                                                                      
|        |      |                                                                                                                                                                                  
|3(i)(a) | *    | Certificate of Incorporation dated August 8,
    1997 (incorporated by reference to the Form 10-SB filed on June 16,
    2000).                                                  
|        |      |                                                                                                                                                                                  
|3(i)(b) | *    | Amendment to Certificate of Incorporation
    dated January 26, 2000 (incorporated by reference to the Form 10-SB
    filed on June 16, 2000).                                   
|        |      |                                                                                                                                                                                  
|3(i)(c) | *    | Amended and Restated Certificate of
    Incorporation dated July 20, 2000 (incorporated by reference to the Form 10-KSB
    filed on December 31, 2001).                         
|        |      |                                                                                                                                                                                  
|3(ii)   | *    | Bylaws dated August 11, 1997 (incorporated by
    reference to the Form 10-KSB filed on June 16, 2000).                                                                          
|        |      |                                                                                                                                                                                  
|10.1    | *    | 2000 Stock Option Plan adopted June 20, 2000
    (incorporated by reference to the Form 10-KSB filed on December 31, 2001).                                                      
|        |      |                                                                                                                                                                                  
|10.2    | *    | Manufacturing and Distribution License
    Agreement with Industria Farmaceutica Andromaco, S.A. de C.V. (incorporated by
    reference to the Form 10KSB filed on July 8, 2005).
|        |      |                                                                                                                                                                                  
|10.3    | *    | 2004 Stock Option Plan adopted March 29, 2005
    (incorporated by reference to the 10KSB filed on December 29, 2005)                                                            
|        |      |                                                                                                                                                                                  
|10.4    | *    | 2006 Stock Option Plan adopted March 29, 2006
    (incorporated by reference to the 10KSB filed on December 21, 2006)                                                            
|        |      |                                                                                                                                                                                  
|31.1    | 41   | Certification of C.E.O. Pursuant to Section
    302 of the Sarbanes-Oxley Act of 2002.                                                                                           
|        |      |                                                                                                                                                                                  
|31.2    | 42   | Certification of C.F.O. Pursuant to Section
    302 of the Sarbanes-Oxley Act of 2002.                                                                                           
|        |      |                                                                                                                                                                                  
|32.1    | 43   | Certification of Michael Lee pursuant to
    Section 1350 of Chapter 63 of Title 18 United States Code.                                                                          
|        |      |                                                                                                                                                                                  
|32.2    | 44   | Certification of Marcel Urbanc pursuant to
    Section 1350 of Chapter 63 of Title 18 United States Code.                                                                        

40

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EXHIBIT 31.1

I, Michael Lee, President and Chief Executive Officer of AlphaRx, certify
that:

1.

2.     Based on my knowledge, this annual report does not
contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by
this annual report;

3.     Based on my knowledge, the financial statements,
and other financial information included in this annual report, fairly present
in all material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this annual
report;

4.     I am responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and
15d-14) for the registrant and have:

a) designed such disclosure controls and procedures
to ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to me by others within those entities,
particularly during the period in which this annual report is being prepared;

b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and

c) presented in this annual report my conclusions
about the effectiveness of the disclosure controls and procedures based on my
evaluation as of the Evaluation Date;

5.     We have disclosed, based on my most recent
evaluation, to the registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent functions):

a) all significant deficiencies in the design or
operation of internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in internal
controls; and

b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the registrant's
internal controls; and

6.     I have indicated in this annual report whether
there were significant changes in internal controls or in other factors that
could significantly affect internal controls subsequent to the date of my most
recent evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.

Date: December 21, 2006

/s/ Michael Lee

Michael Lee, 
President and Chief Executive Officer

41

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EXHIBIT 31.2

I, Marcel Urbanc, Principal Accounting Officer and Chief Financial Officer of
AlphaRx, certify that:

1.     I have reviewed this annual report on Form 10-KSB
of AlphaRx, Inc.;

2.     Based on my knowledge, this annual report does not
contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by
this annual report;

3.     Based on my knowledge, the financial statements,
and other financial information included in this annual report, fairly present
in all material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this annual
report;

4.     I am responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and
15d-14) for the registrant and have:

a) designed such disclosure controls and procedures
to ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to me by others within those entities,
particularly during the period in which this annual report is being prepared;

b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and

c) presented in this annual report my conclusions
about the effectiveness of the disclosure controls and procedures based on my
evaluation as of the Evaluation Date;

5.     We have disclosed, based on my most recent
evaluation, to the registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent functions):

a) all significant deficiencies in the design or
operation of internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in internal
controls; and

b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the registrant's
internal controls; and

6.     I have indicated in this annual report whether
there were significant changes in internal controls or in other factors that
could significantly affect internal controls subsequent to the date of my most
recent evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.

Date: December 21, 2006

/s/ Marcel Urbanc

Marcel Urbanc, 
Chief Financial Officer and Principal Accounting Officer

42

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EXHIBIT 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, 
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the annual report of AlphaRx, Inc. on Form 10-KSB for the
period ending September 30, 2006 as filed with the Securities and Exchange
Commission on the date hereof, Michael Lee, as chief executive officer of
AlphaRx, Inc., does hereby certify, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the
best of his knowledge:

1.

2.

/s/ Michael LeeMichael Lee 
President and Chief Executive Officer 
December 21, 2006

43

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EXHIBIT 32.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, 
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the annual report of AlphaRx, Inc. on Form 10-KSB for the
period ending September 30, 2006 as filed with the Securities and Exchange
Commission on the date hereof, Marcel Urbanc, as chief financial officer and
principal accounting officer of AlphaRx, Inc., does hereby certify, pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, that to the best of his knowledge:
1. This 10-KSB report fully complies with the requirements of Section 13(a)
  of the Exchange Act; and
  2. The information contained in this 10-KSB report fairly presents, in all
  material respects, the financial condition and result of operations of AlphaRx,
  Inc.
/s/ Marcel UrbancMarcel Urbanc 
Chief Financial Officer and Principal Accounting Officer 
December 21, 200644

ALPHARx, INC. 
CONSOLIDATED FINANCIAL STATEMENTS AND AUDIT REPORT 
SEPTEMBER 30, 2006 AND 2005

|TABLE OF CONTENTS                                                              
|-------------------------------------------------------------------------------
|                                                                               
|CONSOLIDATED FINANCIAL STATEMENTS FOR 2006 AND
    2005                        
|                                                                               
|REPORT OF INDEPENDENT REGISTERED PUBLIC
    ACCOUNTING FIRM                    
|                                                                               
|CONSOLIDATED BALANCE SHEETS FOR 2006 AND 2005                                  
|                                                                               
|CONSOLIDATED STATEMENTS OF OPERATIONS FOR 2006
    AND 2005                    
|                                                                               
|CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
    (DEFICIT) FOR 2006 AND 2005
|                                                                               
|CONSOLIDATED STATEMENTS OF CASH FLOWS FOR 2006
    AND 2005                    
|                                                                               
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                     



F - 1

---



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of 
AlphaRx, Inc.

We have audited the accompanying consolidated balance sheets
of AlphaRx, Inc. (incorporated in the State of Delaware) as at September 30,
2006 and 2005 and the related consolidated statements of operations, cash flows
and stockholders equity (deficit) for the years then ended. These consolidated financial
statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

We conducted our audits in accordance with the standards of
the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the consolidated financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements
referred to above present fairly, in all material respects, the financial
position of AlphaRx, Inc. as at September 30, 2006 and 2005 and the results of
its operations and its cash flows for the years then ended in accordance with
generally accepted accounting principles in the United States of America.

The accompanying consolidated financial statements have been
prepared assuming that the Company will continue as a going concern. As
discussed in Note 1 to the consolidated financial statements, the Company has
suffered recurring losses from operations that raise substantial doubt about its
ability to continue as a going concern. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty. Should the Company be unable to continue as a going concern,
certain assets and liabilities will have to be adjusted to their liquidation
values.

|                             | "SCHWARTZ LEVITSKY FELDMAN LLP"
|---------------------------- | -------------------------------
|                             |                                
|Toronto, Ontario,
    Canada |                                
|November 21, 2006            | Chartered Accountants          
|                             |                                

F-2

---

ALPHARx, INC. CONSOLIDATED BALANCE SHEETS 
AS AT SEPTEMBER 30, 2006 AND 2005
(All amounts in US Dollars)

|                                                                                                       |   | 2006         |   | 2005        
|------------------------------------------------------------------------------------------------------ | - | ------------ | - | ------------
|CURRENT ASSETS                                                                                         |   |              |   |             
|                                                                                                       |   |              |   |             
|Cash and Cash Equivalents                                                                              | $ | 987,753      | $ | 193,458     
|Marketable Securities                                                                                  |   | 176,418      |   | -           
|Accounts Receivable, net (note 3)                                                                      |   | 10,770       |   | 40,245      
|Prepaid Expenses and Other Assets                                                                      |   | 9,506        |   | 12,736      
|Discontinued Operations (note 4)                                                                       |   | 4,474        |   | 90,022      
|TOTAL CURRENT ASSETS                                                                                   |   | 1,188,921    |   | 336,461     
|                                                                                                       |   |              |   |             
|PROPERTY, PLANT &
    EQUIPMENT, net (note 5)                                                          |   | 282,679      |   | 232,975     
|OTHER ASSETS                                                                                           |   |              |   |             
|Licensing Right (note 6)                                                                               |   | 1            |   | 1           
|TOTAL ASSETS                                                                                           |   | 1,471,601    |   | 569,437     
|                                                                                                       |   |              |   |             
|CURRENT LIABILITIES                                                                                    |   |              |   |             
|Accounts Payable and Accrued Liabilities (note 7)                                                      |   | 532,509      |   | 340,775     
|Notes Payable (note 8)                                                                                 |   | 780,323      |   | -           
|Litigation Liabilities (note 9)                                                                        |   | -            |   | 25,000      
|Discontinued Operations (note 4)                                                                       |   | 52,218       |   | 46,611      
|TOTAL CURRENT LIABILITIES                                                                              |   | 1,365,050    |   | 412,386     
|                                                                                                       |   |              |   |             
|MINORITY INTEREST
    (note 10)                                                                        |   | 161,283      |   | -           
|CONTINGENCIES & COMMITMENTS (notes 9 and 11)                                                           |   |              |   |             
|                                                                                                       |   |              |   |             
|SHAREHOLDERS EQUITY/(DEFICIT)                                                                         |   |              |   |             
|Common Stock: $ 0.0001
    par value,                                                                  |   |              |   |             
|Authorized: 250,000,000 shares 2006 and 2005; Issued and outstanding:
    57,508,112 (notes 12 and 19) |   | 5,752        |   | 5,752       
|Additional paid-in capital                                                                             |   | 14,479,082   |   | 12,163,243  
|Accumulated Other Comprehensive Loss                                                                   |   | (5,329)      |   | -           
|Deficit                                                                                                |   | (14,534,237) |   | (12,011,944)
|                                                                                                       |   |              |   |             
|TOTAL SHAREHOLDERS EQUITY/(DEFICIT)                                                                   |   | (54,732)     |   | 157,051     
|                                                                                                       |   |              |   |             
|TOTAL LIABILITIES AND
    SHAREHOLDERS EQUITY/(DEFICIT)                                               | $ | 1,471,601    | $ | 569,437     

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

F-3

---

ALPHARx, INC. CONSOLIDATED STATEMENTS OF OPERATIONS 
FOR THE YEARS ENDED SEPTEMBER 30, 2006 AND 2005(All amounts in US
Dollars)

|                                                            |   | 2006        |   | 2005       
|----------------------------------------------------------- | - | ----------- | - | -----------
|                                                            |   |             |   |            
|LICENSE FEES AND ROYALTIES                                  |   | 1,024,774   |   | 4,302      
|                                                            |   |             |   |            
|                                                            |   |             |   |            
|GENERAL AND
    ADMINISTRATIVE EXPENSES                     |   | 813,231     |   | 650,965    
|STOCK BASED COMPENSATION EXPENSE AND WARRANT AMORTIZATION   |   | 968,837     |   | 2,009,920  
|RESEARCH AND
    DEVELOPMENT EXPENSES                       |   | 1,417,700   |   | 1,337,503  
|SALES AND MARKETING EXPENSES                                |   | 59,889      |   | 21,021     
|DEPRECIATION                                                |   | 74,307      |   | 54,077     
|LOSS
    FROM OPERATIONS                                    |   | (2,309,190) |   | (4,069,184)
|                                                            |   |             |   |            
|OTHER INCOME AND
    EXPENSES                               |   |             |   |            
|                                                            |   |             |   |            
|INTEREST (EXPENSE)/INCOME, NET                              |   | (67,410)    |   | 22,804     
|                                                            |   |             |   |            
|LOSS BEFORE INCOME
    TAXES                                |   | (2,376,600) |   | (4,046,380)
|                                                            |   |             |   |            
|INCOME TAX (note 12)                                        |   | -           |   | -          
|                                                            |   |             |   |            
|LOSS BEFORE MINORITY
    INTEREST                           |   | (2,376,600) |   | (4,046,380)
|MINORITY INTEREST                                           |   | 33,316      |   | -          
|LOSS BEFORE
    DISCONTINUED OPERATIONS                     |   | (2,343,284) |   | (4,046,380)
|LOSS
    FROM OPERATIONS OF DISCONTINUED COMPONENT (note 4) |   | (179,009)   |   | (805,744)  
|NET LOSS                                                    |   | (2,522,293) |   | (4,852,124)
|CUMULATIVE TRANSLATION ADJUSTMENT                           |   | (5,329)     |   | -          
|COMPREHENSIVE LOSS                                          | $ | (2,527,622) | $ | (4,852,124)
|                                                            |   |             |   |            
|NET
    LOSS PER COMMON SHARE, BASIC & DILUTED              | $ | (0.04)      | $ | (0.08)     
|                                                            |   |             |   |            
|WEIGHTED AVERAGE
    NUMBER OF COMMON SHARES OUTSTANDING    |   | 57,508,112  |   | 57,251,521 

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

F-4

---

ALPHARx, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY (DEFICIT)
FOR THE YEARS ENDED SEPTEMBER 30, 2006 AND 2005 
(All amounts in US Dollars)

|                                                                                           | Common Stock |        |             |             |              
|------------------------------------------------------------------------------------------ | ------------ | ------ | ----------- | ----------- | -------------
|                                                                                           |              |        |             | Accumulated |              
|                                                                                           |              |        | Additional  | Other Com-  |              
|                                                                                           | Number of    |        | Paid in     | prehensive  |              
|                                                                                           | Shares       | Amount | Capital     | Loss        | (Deficit)    
|                                                                                           |              |        |             |             |              
|Balance, as of September 30, 2004                                                          | 52,304,642   | $5,232 | $9,580,035  | -           | $(7,159,820) 
|                                                                                           |              |        |             |             |              
|Conversion of Promissory Notes                                                             | 5,203,470    | 520    | 510,988     |             |              
|                                                                                           |              |        |             |             |              
|Issuance of Stock Options
    for consulting services                                      |              |        | 62,300      |             |              
|                                                                                           |              |        |             |             |              
|Stock Based Compensation                                                                   |              |        | 2,009,920   |             |              
|                                                                                           |              |        |             |             |              
|Net Loss for the Year                                                                      |              |        |             |             | (4,852,124)  
|                                                                                           |              |        |             |             |              
|Balance, as of September 30, 2005                                                          | 57,508,112   | $5,752 | $12,163,243 | -           | $(12,011,944)
|                                                                                           |              |        |             |             |              
|Issuance of Stock Options
    for consulting services                                      |              |        | 233,838     |             |              
|                                                                                           |              |        |             |             |              
|Stock Based Compensation                                                                   |              |        | 483,279     |             |              
|                                                                                           |              |        |             |             |              
|Unamortized Warrant
    Discount                                                           |              |        | 504,495     |             |              
|                                                                                           |              |        |             |             |              
|Net Loss for the Year                                                                      |              |        |             |             | (2,522,293)  
|                                                                                           |              |        |             |             |              
|Subsidiary Common Stock
    Issuance                                                       |              |        | 1,094,227   |             |              
|                                                                                           |              |        |             |             |              
|Foreign Currency Translation                                                               |              |        |             | (5,329)     |              
|                                                                                           |              |        |             |             |              
|Balance, as of September 30, 2006                                                          | 57,508,112   | $5,752 | $14,479,082 | $(5,329)    | $(14,534,237)
|                                                                                           |              |        |             |             |              
|The accompanying notes are an integral part
    of these consolidated financial statements

F-5

---

ALPHARx, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS 
FOR THE YEARS ENDED SEPTEMBER 30, 2006 AND 2005 
(All amounts in US Dollars)

|                                                                                                          |   | 2006        |   | 2005       
|--------------------------------------------------------------------------------------------------------- | - | ----------- | - | -----------
|                                                                                                          |   |             |   |            
|CASH FLOWS FROM OPERATING
    ACTIVITIES                                                                  |   |             |   |            
|Loss before discontinued
    operations                                                                   | $ | (2,343,284) | $ | (4,046,380)
|Adjustments to reconcile net
    loss to net cash used in operating activities:                           |   |             |   |            
|Depreciation and amortization                                                                             |   | 74,307      |   | 54,077     
|Warrant Amortization                                                                                      |   | 251,720     |   | -          
|Employee stock based
    compensation expense                                                             |   | 483,279     |   | 2,009,920  
|Options Issued For Services
    Rendered                                                                  |   | 233,838     |   | 62,300     
|Changes in assets and
    liabilities:                                                                    |   |             |   |            
|Increase in Marketable
    Securities                                                                     |   | (176,418)   |   | -          
|Decrease in Accounts Receivable                                                                           |   | 29,475      |   | 9,685      
|Decrease in Prepaid Expenses                                                                              |   | 3,230       |   | 54,904     
|Accrued Interest on Notes
    Payable                                                                     |   | 65,333      |   | -          
|Increase in Accounts Payable
    and Accrued Liabilities                                                  |   | 166,734     |   | 61,704     
|Discontinued Operations (note
    4)                                                                      |   | (87,854)    |   | (668,883)  
|NET CASH USED IN OPERATING
    ACTIVITIES                                                                 |   | (1,299,640) |   | (2,462,673)
|                                                                                                          |   |             |   |            
|CASH FLOWS FROM INVESTING
    ACTIVITIES                                                                  |   |             |   |            
|Purchase of Machinery &
    Equipment                                                                     |   | (124,011)   |   | (45,519)   
|                                                                                                          |   |             |   |            
|NET CASH USED IN INVESTING
    ACTIVITIES                                                                 |   | (124,011)   |   | (45,519)   
|                                                                                                          |   |             |   |            
|CASH FLOWS FROM FINANCING ACTIVITIES                                                                      |   |             |   |            
|Issuance of 15% equity in
    subsidiary common stock                                                     |   | 1,094,227   |   | -          
|Minority Interest                                                                                         |   | 161,283     |   | -          
|Issuance (repayment) of Notes
    Payable, net of discount (note 8)                                       |   | 463,270     |   | (154,392)  
|Discount on issuance of Notes
    Payable                                                                 |   | 504,495     |   | -          
|                                                                                                          |   |             |   |            
|NET CASH PROVIDED BY (USED
    IN) FINANCING ACTIVITIES                                                   |   | 2,223,275   |   | (154,392)  
|                                                                                                          |   |             |   |            
|NET INCREASE/(DECREASE) IN
    CASH                                                                       |   | 799,624     |   | (2,662,584)
|FOREIGN EXCHANGE TRANSLATION                                                                              |   | (5,329)     |   | -          
|CASH, and cash equivalents,
    beginning of year                                                         |   | 193,458     |   | 2,856,042  
|                                                                                                          |   |             |   |            
|CASH, and cash equivalents, end of year                                                                   | $ | 987,753     | $ | 193,458    
|SUPPLEMENTARY
    DISCLOSURE:                                                                             |   |             |   |            
|The statement of cash flows has been prepared
    using the indirect method as defined under SFAS No. 95. |   |             |   |            
|Income Tax Paid                                                                                           | $ | -           | $ | -          
|Interest Paid                                                                                             | $ | 5,073       | $ | 154,674    

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

F-6

---

ALPHARX, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
SEPTEMBER 30, 2006 AND 2005 
(All amounts in US Dollars)
NOTE 1. NATURE OF BUSINESS AND GOING CONCERN
ALPHARX, INC. (the "Company") was incorporated under the laws
of the State of Delaware on August 8, 1997. AlphaRx Inc. is an emerging
pharmaceutical company specializing in the formulation of therapeutic products
using proprietary drug delivery technologies.
Effective June 30, 2006, AlphaRx International Holdings
Limited. ("AIH") acquired 100% of Alpha Life Sciences Ltd. ("ALS") for a nominal
amount and the assumption of approximately $63,000 of related party liabilities.
ALS is involved in obtaining necessary regulatory approvals for the manufacture
and distribution of the Companys products in the Asian market.
Effective June 22, 2006, New Super Limited, an independent
Hong Kong based corporation, subscribed for 1,500 shares of common stock of
AlphaRx International Holdings Ltd.("AIH"), previously a wholly-owned subsidiary
of the Company.
Effective April 22, 2005 AlphaRx International Holdings
Limited (a British Virgin Island company and an 85% owned subsidiary of AlphaRx
Inc.) entered into a Joint Venture agreement with Basin Industrial Limited (a
British Virgin Islands Company and a wholly-owned subsidiary of Advance
Pharmaceutical Co. Ltd.). The Joint Venture, AlphaAP Inc., is involved in
manufacturing and marketing of certain of the Companys existing products.
The Company holds an indirect 42.5% interest in AlphaAP
Inc.("AAP"), a joint venture established between the Company (via its AIH
subsidiary) and Basin Industrial Limited (an independent third party). As the
Company contributes no funds, and does not provide management or direction to
the joint venture, the Companys interest in the joint venture is not
consolidated into the financial statements. AIH will receive a 5% royalty on all
revenues generated by AAP.
The consolidated financial statements reflect the activities
of the Company, 100% of AlphaRx Canada Limited and 85% of AlphaRx International
Holdings Limited and ALS (AIHs wholly owned subsidiary). All material
inter-company accounts and transactions have been eliminated.
The accompanying consolidated financial statements have been
prepared on a going concern basis, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business.
Accordingly, they do not include any adjustments relating to the realization of
the carrying value of assets or the amounts and classification of liabilities
that might be necessary should the Company be unable to continue as a going
concern. Continuance of the Company as a going concern is dependent on its
future profitability and on the on-going support of its shareholders, affiliates
and creditors.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

This summary of significant accounting policies is presented
to assist in understanding the Companys consolidated financial statements. The
consolidated financial statements and notes are representations of the Companys
management who is responsible for their integrity and objectivity. These
accounting policies conform to generally accepted accounting principles in the
United States of America and have been consistently applied in the preparation
of the consolidated financial statements.

F-7

---

Cash and Cash Equivalents

Cash and cash equivalents includes cash on hand, amounts on
deposit with banks, and any other highly liquid investments purchased with a
maturity of three months or less which are readily convertible to cash. The
carrying amount approximates fair value because of the immediate liquidity or
short maturity of these instruments.
Trading Securities

We consider our investment portfolio and marketable equity
investments as trading in nature as defined in SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities". Accordingly, these
investments are recorded at fair value, which is based on quoted market rates.
Any gains and losses are recognized in earnings in the current period.
Fair Value of Financial Instruments

The carrying amount of the Companys accounts receivable,
accounts payable, accrued liabilities, litigation liabilities and notes payable
approximates their fair value because of the short maturity of these
instruments.
Long-Term Financial Instruments

The fair value of each of the Corporations long-term
financial assets is based on the amount of future cash flows associated with
each instrument discounted using an estimate of what the Company's current
borrowing rate for similar instruments of comparable maturity would be.
It is of the managements opinion that the Company is not
exposed to significant interest rate risk, credit risk or currency risks arising
from these financial instruments.
Inventory

Inventory is recorded at the lower of cost and net realizable
value. Cost is determined on the first-in first-out basis.
Foreign Currency Translation

The Company maintains the books and records of AlphaRx Canada
Ltd. in Canadian dollars, and the books and records of Alpha Life Sciences Ltd.
and AlphaRx International Holdings Ltd. in Hong Kong dollars, their respective
functional currencies. The records of these companies are converted to US
dollars, the reporting currency. The translation method used is the current rate
method which is the method mandated by SFAS 52 where the functional currency is
the foreign currency. Under the current rate method all assets and liabilities
are translated at the current rate, stockholders equity accounts are translated
at historical rates and revenues and expenses are translated at average rates
for the year. Cumulative net translation adjustments related to equity accounts
are included as a separate component of shareholders equity.
F-8
Earnings or Loss Per Share

The Company adopted FAS No.128, "Earnings per Share", which
requires disclosure on the financial statements of "basic" and "diluted"
earnings (loss) per share. Basic earnings (loss) per share is computed by
dividing net income (loss) by the weighted average number of common shares
outstanding for the year. Diluted earnings (loss) per share is computed by
dividing net income (loss) by the weighted average number of common shares
outstanding plus common stock equivalents (if dilutive) related to stock options
and warrants for each year.
Income Taxes

The Company accounts for income tax under the provision of
Statement of Financial Accounting Standards No. 109, which requires recognition
of deferred tax assets and liabilities for the expected future tax consequences
of events that have been included in the financial statement or tax returns.
Deferred income taxes are provided using the liability method. Under the
liability method, deferred income taxes are recognized for all significant
temporary differences between the tax and financial statement bases of assets
and liabilities.
Effects of changes in enacted tax laws on deferred tax assets
and liabilities are reflected as adjustments to tax expense in the period of
enactment. Deferred tax assets may be reduced, if deemed necessary based on a
judgmental assessment of available evidence, by a valuation allowance for the
amount of any tax benefits which are more likely, based on current
circumstances, not expected to be realized.
Property Plant and Equipment

Property plant and equipment are stated at cost. Depreciation
is calculated by using the Modified Accelerated Cost Recovery System Method for
financial reporting as well as for income tax purposes at rates based on the
following estimated useful lives:

Furniture and Fixtures
      7 yearsMachinery and
      Equipment
      3 - 7
      yearsLeasehold Improvements
      10 years


The Company capitalizes expenditures that materially increase
assets lives and expenses ordinary repairs and maintenance to operations as
incurred. When assets are sold or disposed or otherwise fully depreciated, the
cost and related accumulated depreciation is removed from the accounts and any
gain or loss is included in the statement of income and retained earnings.

Research and Development

All research and development costs are charged to expense as
incurred. These costs include in house and contracted research and development,
travel to explore and evaluate new products, raw materials, lab supplies and
other costs related directly to research and development of new and existing
products.

Revenue Recognition

Revenues related to license fees and royalties are recognized
when persuasive evidence of an arrangement exists, the fee is fixed or
determinable, and collectability is probable. Should there be any future
obligations or deliverables related to the license fees, revenue is deferred and
not recognized until those obligations and or deliverables have been satisfied.
Any advance payments or deposits received in relation to license fees are
deferred until those obligations or deliverables have been satisfied. Royalty
payments are not received in advance but rather, are paid to the Company based
on previous period sales by licensees.

F-9

---



Sales represent the invoiced value of goods supplied to
customers. Revenues are recognized upon the passage of title to the customers,
provided that the collection of the proceeds from sales are reasonably assured.
A reserve for returns is considered periodically based on actual or anticipated
returns from customers. The Company policy is not to accept returns, however,
under certain circumstances returns are accepted to maintain good customer
relations.

Use of Estimates

The preparation of consolidated financial statements in
conformity with generally accepted accounting principles in the United States of
America requires management to make estimates and assumptions that affect
certain reported amounts of assets and liabilities and disclosures of contingent
assets and liabilities at the date of the consolidated financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Significant estimates include
the fair valuation of warrants issued and estimated lives of capital assets.
These estimates are reviewed periodically and as adjustments become necessary,
they are reported in earnings in the period in which they become known.

Long-Lived Assets

The Company adopted the provisions of SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of which has been superseded by SFAS No. 144. SFAS No. 144 requires
that long-lived assets to be held and used by an entity be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Management used its best
estimate of the undiscounted cash flows to evaluate the carrying amount and have
determined that no impairment has occurred.

Intangible Assets

Intangible assets with an indefinite useful economic life are
tested annually for impairment and periodically if events or circumstances
warrant such a test in accordance with SFAS 142. An impairment loss is
recognized if the carrying amount exceeds the fair value.

Concentrations of Credit Risks and Revenues

The Companys receivables are unsecured and are generally due
in 30 Days. Currently, the Company does not have a diverse customer base. In
excess of 90% of our revenues during 2006 were derived from one customer and we
continue to rely on this customer for the majority of our foreseeable future
revenues. Reserves for uncollectible receivables are determined by us
periodically based on best estimates available and historical data, as well as
the economic and financial status of our debtors.

Stock Based Compensation

The Company has adopted the fair value accounting for
employee stock options as per SFAS 123(R) using the modified retrospective
application method, effective April 1, 2005. The fair value of the stock options
are amortized into income over the vesting period of the options.

Comprehensive Income

The Company follows Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income". This statement establishes
reporting standards and presentation methods of comprehensive income and its
components. Comprehensive income is net income plus certain items that are
recorded directly to shareholders equity, bypassing net income. With the
exception of foreign exchange gains and losses, the Company has no other
components in its comprehensive income (loss) accounts.

F-10

---



Recent Pronouncements

SFAS No. 151 - "Inventory Costs, an Amendment of ARB No. 43,
Chapter 4." SFAS No. 151 retains the general principle of ARB No. 43, Chapter 4,
"Inventory Pricing," that inventories are presumed to be stated at cost;
however, it amends ARB No. 43 to clarify that abnormal amounts of idle
facilities, freight, handling costs and spoilage should be recognized as current
period expenses. Also, SFAS No. 151 requires fixed overhead costs be allocated
to inventories based on normal production capacity. The guidance in SAFS No. 151
is effective for inventory costs incurred during fiscal years beginning after
June 15, 2005.

SFAS 123 (Revised) - "Share Based Payment," which will
require the Company to measure the cost of employee services received in
exchange for an award of equity instruments based on the grant-date fair value
of the award. That cost will be recognized over the period during which an
employee is required to provide service in exchange for the awardthe requisite
service period. No compensation cost is recognized for equity instruments for
which employees do not render the requisite service. The grant-date fair value
of employee share options and similar instruments will be estimated using
option-pricing models adjusted for the unique characteristics of those
instruments. SFAS No. 123 (Revised) eliminates the use of APB Opinion No. 25.
SFAS No. 123 (Revised) is effective for the first interim or annual reporting
period that begins after December 15, 2005. Early adoption for interim or annual
periods for which financial statements or interim reports have not been issued
is encouraged.

SFAS 152 - In December 2004, the FASB issued SFAS No. 152
"Accounting for Real Estate TimeSharing Transactions - an amendment of FASB
Statements No. 66 and 67" ("SFAS 152"). This statement amends FASB Statement No.
66 "Accounting for Sales of Real Estate" to reference the financial accounting
and reporting guidance for real estate time-sharing transactions that is
provided in AICPA Statement of Position 04-2 "Accounting for Real Estate
Time-Sharing Transactions" ("SOP 04-2"). SFAS 152 also amends FASB Statement No.
67 "Accounting for Costs and Initial Rental Operations of Real Estate Projects"
to state that the guidance for incidental operations and costs incurred to sell
real estate projects does not apply to real estate time-sharing transactions,
with the accounting for those operations and costs being subject to the guidance
in SOP 04-2. The provisions of SFAS 152 are effective in fiscal years beginning
after June 15, 2005.

SFAS 153 - In December 2004, the FASB issued SFAS No. 153
"Exchanges of Non-monetary Assets - an amendment of APB Opinion No. 29" ("SFAS
153"). SFAS 153 replaces the exception from fair value measurement in APB
Opinion No. 29 for non-monetary exchanges of similar productive assets with a
general exception from fair value measurement for exchanges of non-monetary
assets that do not have commercial substance. A non-monetary exchange has
commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. SFAS 153 is effective for all
interim periods beginning after June 15, 2005.

SFAS 154- In May 2005, the FASB issued SFAS 154 "Accounting
Changes and Error Corrections". The statement replaces APB Opinion No. 20,
Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim
Financial Statements. SFAS 154 requires companies to apply voluntary changes in
accounting principles retrospectively whenever practicable. SFAS 154 is
effective for accounting changes and correction of errors made in fiscal years
beginning after December 15, 2005.

SFAS 155- In February 2006, the FASB issued SFAS 155
"Accounting for Certain Hybrid Financial Instrumentsan amendment of FASB
Statements No. 133 and 140". This Statement amends FASB Statements No. 133,
Accounting for Derivative Instruments and Hedging Activities, and No. 140,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities. This Statement resolves issues addressed in Statement 133
Implementation Issue No. D1, "Application of Statement 133 to Beneficial Interests in Securitized Financial Assets." SFAS 155
is effective in fiscal years beginning after September 15, 2006.

F-11

---



SFAS 156  In March 2006, the FASB issued SFAS 156
"Accounting for Servicing of Financial Assets". This Statement amends FASB
Statement No. 140, Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities, with respect to the accounting for
separately recognized servicing assets and servicing liabilities. SFAS 156 is
effective in fiscal years beginning after September 15, 2006.

SFAS 157  In September 2006, the FASB issued SFAS 157 "Fair
Value Measurements". This Statement defines fair value, establishes a framework
for measuring fair value in generally accepted accounting principles (GAAP), and
expands disclosures about fair value measurements. This Statement applies under
other accounting pronouncements that require or permit fair value measurements,
the Board having previously concluded in those accounting pronouncements that
fair value is the relevant measurement attribute. Accordingly, this Statement
does not require any new fair value measurements. However, for some entities,
the application of this Statement will change current practice. SFAS 157 is
effective in fiscal years beginning after November 15, 2007.

SFAS 158  In September 2006, the FASB issued SFAS 158
"Employers Accounting for Defined Benefit Pension and Other Postretirement
Plansan amendment of FASB Statements No. 87, 88, 106, and 132(R)". This
Statement improves financial reporting by requiring an employer to recognize the
overfunded or underfunded status of a defined benefit postretirement plan (other
than a multiemployer plan) as an asset or liability in its statement of
financial position and to recognize changes in that funded status in the year in
which the changes occur through comprehensive income of a business entity or
changes in unrestricted net assets of a not-for-profit organization. This
Statement also improves financial reporting by requiring an employer to measure
the funded status of a plan as of the date of its year-end statement of
financial position, with limited exceptions. SFAS 158 is effective as of the end
of the fiscal year ending after December 15, 2006.

FIN 48  In June 2006, the FASB issued FIN 48 "Accounting for
Uncertainty in Income Taxes". This interpretation clarifies the accounting for
uncertainty in income taxes recognized in an enterprises financial statements
in accordance with FASB Statement No. 109  Accounting for Income Taxes.

The Company believes that the above standards would not have
a material impact on its financial position, results of operations or cash flows
with the exception of SFAS 123(Revised) which does and may continue to have a
material impact on results of operations.

NOTE 3. ACCOUNTS RECEIVABLE

|                                  |   | 2006   |   | 2005  
|--------------------------------- | - | ------ | - | ------
|                                  |   |        |   |       
|Accounts receivable               | $ | 10,770 | $ | 40,245
|Less: Allowance for
    bad debts |   | -      |   | -     
|                                  |   |        |   |       
|                                  | $ | 10,770 | $ | 40,245

The Company carries accounts receivable at the amounts it
deems to be collectible. Accordingly, the Company provides allowances for
accounts receivable it deems to be uncollectible based on managements best
estimates. Recoveries are recognized in the period they are received. The
ultimate amount of accounts receivable that becomes uncollectible could differ
from those estimated.

F-12

---



NOTE 4. DISCONTINUED OPERATIONS

During 2003 the Company introduced Flexogan products to the
Canadian market. Marketing of these products was underway, and initial orders
from customers were received. Further growth in sales resulted in 2004,
primarily as a result of one order from a national drug chain. Repeat orders
were proving to be more challenging during 2004, even while an expanded
marketing campaign was underway.

We completed a private placement during late 2004 in order to
continue our core research and development activities as well as continuation of
our marketing campaign for Flexogan. Although substantial amounts were spent on
marketing during 2005, sales growth did not materialize. This was due, in large
part, to new product introductions into the pain relief segment of the market by
large pharmaceutical companies and other independents. Marketing and sales
programs for these competitive products were substantial, and significantly
larger than we could afford. We continued to sell our products into 2006 while
seeking marketing and sales partners to take over the Flexogan line.

We determined to discontinue direct sales of Flexogan
because: (a) we were not able to source a qualified marketing partner to take
over direct sales of Flexogan; (b) we did not have adequate financial resources
or expertise to market Flexogan on a longer term basis, and (c) we concluded
there was a better overall opportunity for success if we focused on drug
development and enhancement while allowing our partners and potential partners
to market our products in return for royalty and, or license payments.

The statements of income (loss) and balance sheets for the Discontinued
Operations are seen below:

|Income Statements                            |   | 2006      |  |   | 2005     
|-------------------------------------------- | - | --------- |  | - | ---------
|                                             |   |           |  |   |          
|Sales                                        | $ | 27,176    |  | $ | 64,247   
|Cost of Sales                                |   | 9,092     |  |   | 29,108   
|Gross Margin                                 |   | 18,084    |  |   | 35,139   
|                                             |   |           |  |   |          
|General and
    Administrative Expenses      |   | 162,842   |  |   | 200,345  
|Sales and Marketing
    Expenses             |   | 34,251    |  |   | 640,538  
|                                             |   |           |  |   |          
|Income Taxes                                 |   | -         |  |   | -        
|                                             |   |           |  |   |          
|Gain (loss) from
    Discontinued Operations | $ | (179,009) |  | $ | (805,744)
|                                             |   |           |  |   |          
|Balance Sheets                               |   |           |  |   |          
|                                             |   |           |  |   |          
|Accounts Receivable                          |   | -         |  | $ | 4,549    
|Inventory                                    |   |           |  |   | 81,166   
|Other Assets                                 |   | 4,474     |  |   | 4,307    
|Total Current Assets                         |   | 4,474     |  |   | 90,022   
|                                             |   |           |  |   |          
|Accounts Payable and
    Accrued Liabilities |   | 52,218    |  |   | 46,611   
|Total Current
    Liabilities                |   | 52,218    |  |   | 46,611   
|                                             |   |           |  |   |          
|Net Assets
    (Liabilities)                 | $ | (47,744)  |  | $ | 43,411   

F-13

---

NOTE 5. PROPERTY, PLANT & EQUIPMENT2006
    
    
    2005Leasehold Improvements
    $
    20,481
    
    $
    21,553Furniture & Fixtures
    
    35,770
    
    
    31,590Machinery & Equipment
    
    456,894
    
    
    335,264COST
    
    513,145
    
    
    388,407Less: Accumulated depreciation/amortizationLeasehold Improvements
    
    10,082
    
    
    7,598Furniture & Fixtures
    
    19,492
    
    
    13,003Machinery & Equipment
    
    200,892
    
    
    134,831230,466
    
    
    155,432NET
    $
    282,679
    
    $
    232,975NOTE 6. LICENSING RIGHTIn January 2003, the Company entered into a sub-licence
agreement with a third party drug research company for the world-wide
commercialization of an experimental cancer drug. The cost of this sub-licence
agreement was $230,000 which was paid by cash of $190,000 and shares with a
value of $40,000. Costs to bring this drug to market are currently prohibitive
for the Company, and having unsuccessfully attempted to resell these
commercialization rights, they have been written down to a nominal value.
NOTE 7. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities are comprised of the
following:

|                           |   | 2006    |  |   | 2005   
|-------------------------- | - | ------- |  | - | -------
|                           |   |         |  |   |        
|Trade
    Accounts Payable | $ | 334,046 |  | $ | 231,663
|Accrued
    Liabilities    |   | 198,463 |  |   | 109,112
|                           |   |         |  |   |        
|                           | $ | 532,509 |  | $ | 340,775

Accrued liabilities as at September 30, 2006 include $30,000
which was subsequently paid out in the form of common stock. See also Note 19 
Subsequent Events.

NOTE 8. NOTES PAYABLE

The Company and its subsidiaries issued $967,765 in
promissory notes, net of repayments during the year ended September 30, 2006.
These promissory notes bear interest at rates of 10% - 12% per annum and are
repayable on or before the first anniversary date of issuance. See also Note 16
 Related Party Transactions and Note 19  Subsequent Events.

In conjunction with these promissory notes the Company issued
warrants. (See also Note 15  Warrants). This in turn required a discount to be
established and to be amortized over the life of the promissory notes.

|Promissory Notes
    Issued, net: | $967,765 
|--------------------------------- | ---------
|Discount established              | (504,495)
|Interest accrued                  | 65,333   
|Discount amortized                | 251,720  
|Promissory Notes
    Payable      |          
|September 30, 2006:               | $780,323 

F-14

---

During the year ended September 30, 2005, the Company
converted $520,347 in convertible promissory notes into 5,203,470 shares of
common stock plus warrants to purchase 10,406,940 shares of common stock at an
exercise price of $0.30 per share. These warrants expire during September and
October, 2007.
NOTE 9. LITIGATION LIABILITIES

The Company received court documentation that the lawsuit
filed against it in 2002 was dismissed as of May, 2006. Accordingly the
remaining litigation liability has been reversed as the Company is no longer
liable for any damages or legal fees related to this action.
NOTE 10. MINORITY INTEREST

Effective June 22, 2006, AlphaRx International Holdings Ltd.
("AIH") issued 1,500 shares of its common stock to New Super Limited ("NSL"), an
independent Hong Kong based corporation, at a price of approximately $HK 6,667
per share or $HK 10 million in cash. (USD $1,288,826). There are now 10,000
common shares outstanding of which 8,500 or 85% belong to the Company. Prior to
the transaction the Company owned 100% of AIH. With the consolidation of only
85% of AIH, a minority interest was established, representing amounts owing to
the minority shareholder. The capital infusion into AIH is accounted for as
additional paid in capital on the consolidated financial statements of the
Company.
In accordance with the agreement between the Company and NSL,
there will be an additional issuance of AIH stock from treasury for total
consideration of $HK 10 million, in exchange for an additional 15% of common
stock. Once the final infusion is completed, NSL will own 30% of AIH.
NOTE 11. COMMITMENTS

Leases
The Company leases scientific research and development
equipment, its main premises and an automobile. The aggregate minimum annual and
total payments due under these leases are as follows:Year
      Amount2007
      $81,5412008
      $66,7472009
      $22,6932010
      $ 1,931TOTAL
      $172,912NOTE 12. COMMON STOCK

The Company is authorized to issue up to 250,000,000 shares
of common stock. As of September 30, 2006 and 2005, there remains issued and
outstanding 57,508,112 shares of common stock which has a stated par value of
$0.0001 per share. There was no common stock issued during 2006. See also Note
19  Subsequent Events.
F-15
During 2005, convertible notes totalling $520,347 were
converted into 5,203,470 shares of common stock at $0.10 per share and
10,406,940 warrants to purchase shares of common stock at an exercise price of
$0.30 per share. These warrants expire between September 1, 2007 and October 13,
2007.
NOTE 13. INCOME TAXES

The tax effect of significant temporary differences
representing deferred tax assets is as follows:2005
    
    
    2004Deferred tax assets:Operating loss carry forwards
    $
    3,572,650
    
    $
    2,872,665Valuation allowance
    
    3,572,650
    
    
    2,872,665Net deferred tax assets
    
    -
    
    
    -These losses expire in varying amounts between 2010 and 2025.
NOTE 14. STOCK OPTION PLANS

The Company has a Stock Option Plan (the "plan") under which
directors, officers, key employees, and certain independent contractors may be
granted options to purchase shares of the Companys authorized but unissued
common stock. This initial option plan was terminated in 2001. Under this plan,
the option exercise price is $0.10. Outstanding stock options granted under this
plan will remain in effect until the expiration date specified in those options.
Options currently expire no later than 10 years from the grant date and
generally vest within five years. Proceeds received by the Company from
exercises of stock options are credited to common stock and additional paid-in
capital. Additional information with respect to the plans stock option activity
is as follows:Number
    of
    
    Weighted
    AverageShares
    
    Exercise PriceOptions exercisable at
    September 30, 2004, 2005and 2006
    1,150,000
    
    $0.10The Company adopted a new option plan on February 10, 2003
under which options to purchase 1,500,000 common shares will be granted to
certain key employees, consultants and directors. Under this plan, the option
exercise price and its fair market value are determined to be $0.50 - $0.69. All
options will expire on February 10, 2008 and will vest, and become exercisable
in three instalments. Proceeds received by the Company from exercises of stock
options are credited to common stock and additional paid-in capital. Additional
information with respect to this plans stock option activity is as follows:Number
    of
    
    Weighted
    AverageShares
    
    Exercise PriceOptions exercisable at
    September 30, 2004, 2005and 2006
    570,000
    
    $0.63The Company did not grant any stock options during 2004. The
Company, via written consent from a majority of the holders of common stock,
approved the adoption of a new option plan during July, 2004. Under this plan
the Company has issued the maximum number of options permitted totaling
24,000,000 options to purchase common stock. Additional information with respect
to this plans stock option activity is as follows:
F-16Number
    of
    
    Weighted
    AverageShares
    
    Exercise PriceOutstanding at July
    24, 2004 (plan adoption)
    -Granted during fiscal
    2004
    -Granted during fiscal
    2005
    20,710,000
    
    $0.16Options outstanding
    September 30, 2005
    20,710,000
    
    $0.16Granted during fiscal
    2006
    3,290,000
    
    $0.075Exercised/Cancelled
    -Outstanding as of
    September 30, 2006
    24,000,000
    
    $0.15Options exercisable at
    September 30, 2006
    20,710,000
    
    $0.16
Grant
    Quantity
    Option
    Expiry
    Fair Value
    Risk
    Expected
    Expected
    ExpectedDate
    Granted
    Price
    
    
    Free
    Life
    Volatility
    DividendRateNov 15,
    13,220,000
    $0.15
    Nov 15,
    $1,448,922
    2.32%
    10
    185%
    NIL2004
    
    to
    2014
    
    
    years$0.50Jan 10,
    7,000,000
    $0.15
    Feb 8,
    $1,045,056
    2.02%
    10
    177%
    NIL2005
    
    
    2015
    
    
    yearsFeb 8,
    390,000
    $0.15
    Feb 8,
    $53,894
    1.93%
    10
    156%
    NIL2005
    
    
    2015
    
    
    yearsMay 25,
    100,000
    $0.13
    May 25,
    $7,627
    2.00%
    10
    70%
    NIL2005
    
    
    2015
    
    
    yearsOct 17,
    3,290,000
    $0.075
    Oct 17,
    $244,559
    4.50%
    10
    75%
    NIL2005
    
    
    2015
    
    
    years24,000,000
    
    $2,800,058All options have vested, except for the 3,290,000 granted
October 17, 2005 which fully vest on the first anniversary of the grant date.
There remains $10,720 to be expensed as at September 30, 2006 in regards to the
options granted above.
A majority of shareholders approved the 2006 Option Plan at
the Annual General Meeting held March 29, 2006. Under this plan up to 5,000,000
options may be granted. As of September 30, 2006 no options have been granted
under the 2006 Option Plan, nor have any options been exercised under any of the
above plans.
The Company has adopted the fair value accounting for
employee stock options as per SFAS 123(R) using the modified retrospective
application method, effective April 1, 2005. As a result, the Company recorded
$717,117 in stock based compensation expense related to employee options during
the year using the Black-Scholes option pricing model (2005 -$2,009,920). The
Company also recorded $62,300 in administrative expenses related to the options
granted to consultants using the Black-Scholes option pricing model during 2005.
Had the Company continued to use APB 25, and not reflected
employee stock based compensation expense, net loss and net loss per share both
pre-tax and after tax basis would have been as follows:F-17
As reported
    using
    
    
    Pro Forma
    perSFAS 123(R)
    
    
    APB 25Stock Based
    compensation
    $
    717,117
    
    $
    233,838Net Loss
    (pre-tax/after tax)
    $
    (2,522,293)
    
    $
    (2,039,014)Basic and Diluted Loss
    per share
    $
    (0.04)
    
    $
    (0.04)NOTE 15. WARRANTS

The Company has the following warrants outstanding to
purchase common stock at September 30, 2006 and 2005:

F-18

---



|                                                                    | 2006       | 2005      
|------------------------------------------------------------------- | ---------- | ----------
|Warrants issued in
    conjunction with financing costs whereby     |            |           
|one warrant entitles
    the holder to purchase one share of        |            |           
|common stock at an
    exercise price of $1.10, expiring            |            |           
|December 19, 2007.                                                  | 670,275    | 670,275   
|                                                                    |            |           
|Warrants issued in
    conjunction with financing costs whereby     |            |           
|one warrant entitles
    the holder to purchase one share of        |            |           
|common stock at an
    exercise price of $0.65 expiring June 17,    |            |           
|2006.                                                               | -          | 75,524    
|                                                                    |            |           
|Warrants issued in
    return for financial advisory services       |            |           
|whereby one warrant
    entitles the holder to purchase one share   |            |           
|of common stock at an
    exercise price of $0.05, expiring         |            |           
|September 1, 2007.                                                  | 3,000,000  | 3,000,000 
|                                                                    |            |           
|Warrants issued in
    conjunction with financing costs whereby     |            |           
|one warrant entitles
    the holder to purchase one share of        |            |           
|common stock at an
    exercise price of $0.15, expiring            |            |           
|September 1, 2007.                                                  | 2,994,642  | 2,994,642 
|                                                                    |            |           
|Warrants issued in
    conjunction with financing costs whereby     |            |           
|one warrant entitles
    the holder to purchase one share of        |            |           
|common stock at an
    exercise price of $0.30, expiring            |            |           
|September 1, 2007                                                   | 2,287,669  | 2,287,669 
|                                                                    |            |           
|Warrants issued in
    conjunction with conversion of promissory    |            |           
|notes and in
    conjunction with the private placement completed   |            |           
|during July and
    September, 2004. One warrant entitles the       |            |           
|holder to purchase one
    share of common stock at an exercise     |            |           
|price of $0.30,
    expiring between July 21 and September 1,       |            |           
|2007.                                                               | 39,931,492 | 39,931,492
|                                                                    |            |           
|Warrants issued in
    conjunction with the conversion of           |            |           
|promissory notes and
    in conjunction with the private            |            |           
|placement completed
    during July and September, 2004. One        |            |           
|warrant entitles the
    holder to purchase one share of common     |            |           
|stock at an exercise
    price of $0.30, expiring October 13, 2007. | 5,204,160  | 5,204,160 
|                                                                    |            |           
|Warrants issued in
    conjunction with issuance of promissory      |            |           
|notes during 2006
    whereby one warrant entitles the holder to    |            |           
|purchase one share of
    common stock at an exercise price of      |            |           
|$0.10, expiring
    between February 13, and September 30, 2008.    | 5,524,453  | -         
|                                                                    |            |           
|                                                                    | 59,612,691 | 54,163,762

NOTE 16. RELATED PARTY TRANSACTIONS

The Company sourced some of its funding during the year from
the directors. The directors loaned the Company approximately $322,385 during
the year ended September 30, 2006 taking back promissory notes. Interest accrued
on these loans totals approximately $34,120 as at September 30, 2006. Interest
rates on these loans range from 10% - 12% per annum. The loans are repayable on
or before the first anniversary date of issuance and are unsecured. There were
no similar transactions during the year ended September 30, 2005.

F-19

---



NOTE 17. SEGMENTED INFORMATION

The Company operates in one business segment, namely human
therapeutics. Results of operations are reported on a consolidated basis for
segment reporting purposes. Consolidated disclosures about revenue streams and
long lived assets by geographic area are seen below.

Revenues

The majority of our revenues for the year ended September 30,
2006 were derived from license fees received from one of our partners. For the
year ended September 30, 2005 we derived our revenues from royalties generated
by Indaflex sales in Mexico.

|                        | Years ended September 30,
|----------------------- | -------------------------
|Revenue Stream          | 2006                     
|License Fees            | $ 1,000,000              
|Royalties               | 24,774                   
|Total Revenues          | $1,024,774               
|                        |                          
|Long Lived Assets       |                          
|                        | Years ended September 30,
|Long Lived Assets       | 2006                     
|North America           | $280,635                 
|Asia                    | 2,044                    
|Total Long Lived Assets | $282,679                 

NOTE 18. RECLASSIFICATIONS

Certain amounts from prior year have been reclassified to
conform with current years presentation. In particular there has been a change
in presentation to account for the discontinuance of Flexogan sales in 2006.

NOTE 19. SUBSEQUENT EVENTS

We issued 300,000 shares of common stock on November 20, 2006
in lieu of a cash payment of $30,000 to a consultant of the Company.

We borrowed approximately $105,000 subsequent to September
30, 2006 via issuance of unsecured promissory notes. These notes bear interest
at 12% per annum, and are repayable on or before the first anniversary date of
issuance.

F -20

---