**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K**

 
| **(Mark One)** |
|----------------|
| ** **     |
| **ý**     | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**** ** |
|           |   |   |
|           |   | **for the fiscal year ended****December 31, 2005** |
|           |   |   |
| **OR**         |
|           |
| **o**          | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|           |   |   |
| ** **     | ** ** | **for the transition period from                         to                       .** |

 

**Commission file number****1-10581**

 

**Bentley Pharmaceuticals, Inc.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                              | ** ** | **No. 59-1513162** |
|-------------------------------------------|------------|-------------------------|
| (State or other  jurisdiction of          |       | (I.R.S. Employer        |
| incorporation or  organization)           |       | Identification No.)     |
|                                      |       |                    |
| **Bentley  Park**                         | ** ** | ** **              |
| **2 Holland  Way**                        |       |                    |
| **Exeter,  New Hampshire**                | ** ** | **03833**               |
| (Address of principal executive  offices) |       | (Zip Code)              |

 

Registrant’s telephone number, including areacode:**(603) 658-6100**

 

Securities registered pursuant to Section 12(b) ofthe Act:

 

| **Title of each class** | ** ** | **Name of each exchange on which registered** |
|----------------------------------------|------------|-----------------------------------------------------------------------------|
| **Common  Stock, $.02 par value**      | ** ** | **New York  Stock Exchange and Pacific Exchange**                           |
| **Preferred  Stock Purchase Rights**   | ** ** | **New York  Stock Exchange and Pacific Exchange**                           |

 

Securities registered pursuant to Section 12(g) ofthe Act:**None**

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.YES o  NO ý

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.YES o  NO ý

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. YES ý   NO o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. ý

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.(Check one):

 

| Large accelerated filer  o |   | Accelerated filer  ý |   | Non-accelerated filer  o |
|---------------------------------|--------|--------------------------------|--------|-------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Act). YES o  NO ý

 

Statethe aggregate market value of the voting and non-voting common equity held bynon-affiliates computed by reference to the price at which the common equitywas last sold, or the average bid and asked prices of such common equity, as ofthe last business day of the registrant’s most recently completed second fiscalquarter.

 

| **Title of Class**      | ** ** | **Aggregate Market Value *** | ** ** | **As of Close of Business on** |
|-----------------------------------|------------|---------------------------------------------|------------|---------------------------------------------------------|
| **Common  Stock, $.02 par value** | ** ** | **$161,184,788**                            | ** ** | **June 30,  2005**                                 |

 

Indicatethe number of shares outstanding of each of the registrant’s classes of commonstock, as of the latest practicable date.

 

| **Title of Class**      | ** ** | **Shares Outstanding** | ** ** | **As of Close of Business on** |
|-----------------------------------|------------|-----------------------------|------------|---------------------------------------------------------|
| **Common  Stock, $.02 par value** | ** ** | **21,926,191**              | ** ** | **March 8,  2006**                                 |

 

DOCUMENTS INCORPORATED BY REFERENCE

 

**ProxyStatement for the 2006 Annual Meeting of Stockholders - Incorporated by**

**Referenceinto Part III of this Annual Report on Form 10-K**

 

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*                          Excludes the Common Stock held by executive officers, directors andstockholders whose ownership exceeds 5% of the Common Stock outstanding at June 30,2005. This calculation does not reflect a determination that such persons areaffiliates for any other purposes. Calculation assumes no changes in ownershippositions of institutional holders with ownership positions greater than 5%from positions reported on their Schedule 13 filings for the year ended December 31,2004.

 

 

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**Part I**

** **

**Item 1.**                                                           Business

** **

**Overview**

 

We are an internationalspecialty pharmaceutical company, headquartered in the U.S., that is focusedon:

 

**•**                  development, licensing and sales of generic and brandedpharmaceutical products and active pharmaceutical ingredients (API) and themanufacturing of pharmaceuticals for others; and

 

**•**                  research, development and licensing/commercialization ofadvanced drug delivery technologies and pharmaceutical products.

 

Our pharmaceutical product sales and licensingactivities are based primarily in Spain, where we have a significant commercialpresence and manufacture and market approximately 100 products of variousdosages and strengths through three wholly-owned Spanish subsidiaries:Laboratorios Belmac, Laboratorios Davur and Laboratorios Rimafar. Bentley’sproducts include approximately 151 product presentations in four primarytherapeutic areas: cardiovascular, gastrointestinal, central nervous system andinfectious diseases. We continually add to our product portfolio in response toincreasing market demand for generic and branded therapeutic agents, and whenappropriate, divest portfolio products that we consider to be redundant or thathave become non-strategic. Although most of our sales of these products arecurrently in the Spanish market, we have recently focused on increasing oursales in other European countries and other geographic regions throughstrategic alliances with companies in these territories.

 

In April 2004, we purchased a manufacturingfacility located in Zaragoza, Spain that specializes in the manufacture of certainactive pharmaceutical ingredients. The facility has been approved by the U.S.Food and Drug Administration (FDA) for the manufacture of one ingredient formarketing and sale in the U.S. We are manufacturing and marketing theseproducts through our subsidiary, Bentley API. In November 2004, we enteredinto a collaboration agreement with Perrigo Company, the largest U.S.manufacturer of over-the-counter pharmaceutical and nutritional products forthe store brand market, to co-develop and market a generic pharmaceuticalproduct in the U.S. and potentially other markets. Our agreement with Perrigocontains provisions which allow us to collaborate on additional products in thefuture when mutually agreed upon. In August 2005, we formed an Irishsubsidiary, Bentley Pharmaceuticals Ireland Limited, to assist in our Europeanexpansion strategy. Bentley Pharmaceuticals Ireland Limited received its firstmarketing approval by the Irish Medicines Board in November 2005.

 

In our research and development activities, we haveU.S. and international patents and other proprietary rights to technologiesthat facilitate the absorption of drugs. We are developing products thatincorporate our drug delivery technologies and have licensed applications ofour proprietary CPE-215® drug delivery technology to Auxilium Pharmaceuticals, Inc.,which launched Testim® in the U.S. market, in February 2003. Testim, whichincorporates our CPE-215 drug delivery technology, is a gel indicated fortestosterone replacement therapy, which restores serum testosterone levels inmen and thereby improves symptoms of health problems associated with lowtestosterone levels (hypogonadism). Testim is approved for marketing inBelgium, Denmark, Finland, Germany, Greece, Iceland, Ireland, Luxembourg, theNetherlands, Norway, Portugal, Spain, Sweden and the United Kingdom and hasalso received scientific approval in Italy. In April 2005, Auxiliumentered into a co-promotion agreement with Oscient Pharmaceuticals Corp. Underthe terms of the agreement, Oscient promotes Testim to primary care physiciansin the U.S. using its 300-person sales force, while Auxilium continues topromote Testim to urologists, endocrinologists and select primary carephysicians. We are in discussions with other

 

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pharmaceuticaland biotechnology companies to form additional strategic alliances tofacilitate the development and commercialization of other products using ourdrug delivery technologies, including delivery of insulin to diabetic patientsintranasally, delivery of macromolecule therapeutics using a biodegradableNanacapletTM technology, and topical treatment of nail fungusinfections.

 

Our Common Stock trades on the New York StockExchange (*NYSE)* under the trade symbol *BNT*.

 

The parent company, Bentley Pharmaceuticals, Inc.,is incorporated in the State of Delaware. References in this report to “the Company”, “we”, “us” or “our” referto Bentley and its subsidiaries as a whole group, without regard to theseparate operations and obligations of each entity in the group, unless thecontext clearly indicates one of the entities in the group.

 

**Industry Overview**

 

*Pharmaceutical Industry in Europe*

 

The European Union, with an increasingly affluentpopulation of approximately 450 million people and approximately $144 billionin pharmaceutical sales in 2004, represents the second largest pharmaceuticalmarket in the world, according to IMS Health.

 

Many European countries exercise strict controlsover the prices of, and reimbursement for, pharmaceutical products. Thesecountries often have national health insurance systems that provide reimbursementfor prescription pharmaceuticals. The prices that these systems are willing topay for products affects the profitability of the product sales. However, giventhe varying priorities and economies of each of the European countries, priceconsistency has not been achieved and both the prices and reimbursement ratesoften vary dramatically from country to country.

 

A basic tenet of the European Union has beenencouraging the free movement of goods among all member states. Many Europeangovernments have policies in place that encourage sale of pharmaceuticalproducts at the lowest price available. As a result, an active network ofparallel importation has evolved in which products manufactured in one countryflow into other European countries. This effectively favors manufacturers whosecost of goods are lower, enabling them to more effectively compete on the basisof price.

 

Since Spain’s entry into the European Union in 1986,the Spanish pharmaceutical market has been evolving steadily into a market thatis increasingly similar to those of other countries in Western Europe and theU.S. With a population of approximately 40 million in 2005, Spain wasranked as the seventh largest pharmaceutical market in the world and fifthlargest in the European Union. Pharmaceutical sales in Spain reachedapproximately $11 billion in 2005, according to IMS Health.

 

Over the last decade, there has been significantevolution of patent protections of pharmaceutical products in Spain. Prior to1992, manufacturing processes for active pharmaceutical ingredients could bepatented in Spain, but active pharmaceutical ingredients could not be patentedas products. Commencing in

 

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late1992 active ingredients could be patented in Spain with protection running for20 years from the date of application. This was followed by Spanish legislationin December 1996 that created a legal class of genericpharmaceuticals. In Spain, generic products are required to be therapeuticallyequivalent, have a similar composition to that of the original branded productand have demonstrated safety and efficacy. Safety and efficacy is presumed ifthe original reference product has been commercialized in Spain for10 years. Generic products also must comply with product labelingrequirements and be priced at a discount, which is typically at least 30% lowerthan the original branded product price.

 

Although comprising less than 5.4% of the Spanishpharmaceutical market (less than 9.4% of the units of pharmaceutical productssold in Spain), generic pharmaceuticals are expected to significantly increasetheir market penetration due to increases in drug usage driven by an agingpopulation and opportunities to launch new generic products as patents expirefor blockbuster drugs. In response to the rise in healthcare costs, severalinitiatives are underway by the Spanish government to stimulate the use ofgeneric pharmaceuticals, including education, financial incentives toprescribing physicians and public campaigns. Due to the structure of theSpanish market for pharmaceutical products, producers generally market theirproducts to physicians and pharmacies to whom they emphasize a combination ofquality and price.

 

Generic pharmaceutical products in other Europeancountries have attained greater market share, with generics in major marketssuch as the United Kingdom and Germany achieving over 40% market share. Genericproducts have achieved a high proportion of the market in many of thesecountries due to government programs that encourage the prescription of genericpharmaceuticals. In some of these markets, competition has made price thesingle most significant factor in determining market share. This has favoredproducers of products that have cost structures that can support competitivepricing. In these markets, emphasis can be placed on selling to distributors atfavorable prices rather than the more expensive alternative of marketing tophysicians or consumers.

 

*Drug Delivery Industry*

 

Drug delivery companies develop technologies toimprove the administration of therapeutic compounds. These technologies aredesigned to enhance safety, efficacy, ease-of-use and patient compliance withprescribed therapy. Drug delivery technologies provide opportunities forpharmaceutical and biotechnology companies to extend their drug franchises aswell as develop new and innovative products. 

 

The vast majority of the drugs currently on themarket are taken orally or are administered by injection. Oral drug deliverymethods, while simple to use, typically subject drugs to degradation in thestomach, and during first-pass metabolism in the liver, before reaching thebloodstream. In order to achieve efficacy, higher drug dosages are often used,with increased risks of side effects. The injection of pharmaceuticals, whileavoiding first-pass metabolism in the liver, also has limitations, includingpain, which can lead to decreased patient acceptance and decreased compliancewith prescribed therapy. A decline in patient compliance can increase the riskof medical complications and lead to higher healthcare costs. Also, the costsof injectable drugs typically are higher as a result of the additional costsassociated with medical personnel to administer the injections, the need toprepare the product under sterile conditions and the costs associated with thepurchase and disposal of syringes.

 

Pharmaceutical and biotechnology companies look todrug delivery enhancements as a way of gaining a competitive advantage. Alternativedrug delivery technologies, which avoid first-pass metabolism and are lessinvasive, may also be sought by pharmaceutical and biotechnology companiesfor product line

 

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extensionsfor a branded drug and, in some cases, may possibly postpone competitionfrom generic equivalents. In order to maintain the competitiveness of theirproprietary drug candidates, large pharmaceutical companies seek deliveryenhancements that will increase safety and efficacy, reduce side effects andmake administration more convenient. Further, drug delivery companies can applytheir technologies to off-patent products to formulate their own proprietaryproducts, which they often commercialize by seeking marketing collaborationswith larger pharmaceutical companies that have greater capabilities andresources.

 

Developing safer and more efficacious methods ofdelivering existing drugs generally is less risky than attempting to discovernew drugs, because of lower development costs. On average, it takes 10 to15 years for an experimental new drug to progress from the laboratory tocommercialization in the U.S., with an average cost of approximately $800million to $900 million. Typically, only one in 5,000 compounds enteringpreclinical testing advances into human testing and only one in five compoundstested in humans is approved for commercialization. By contrast, drug deliverycompanies typically target drugs that already have been approved, have a trackrecord of safety and efficacy and have established markets for which there is aproven medical need. Consequently, clinical trials related to drug deliverytechnologies applied to previously-approved pharmaceuticals need only show thatthe new technologies deliver the drug without adverse side effects and with thesame clinical efficacy.

 

**Our Strategy**

 

Our objective is to be a leading specialtypharmaceutical company focused on:

 

•                  development,licensing and sale of a broad range of generic and branded pharmaceuticalproducts and active pharmaceutical ingredients in Spain, other parts of Europe,and other international markets, including the U.S. market; and

 

•                  advanceddrug delivery and formulation technologies to improve the delivery of new andexisting pharmaceuticals.

 

Our strategies to accomplish this objective include:

 

*Increase our product sales in Spain through targeted promotion andexpansion of our product portfolio and increase international sales*

 

We plan to increase our generic and branded productsales by expanding the portfolio of products manufactured in Spain and byforming strategic alliances to increase our sales outside of Spain. We areexpanding our product portfolio through the acquisition or licensing ofcurrently marketed and late stage pharmaceutical products. We directly promoteand sell these products in Spain through our own sales force of approximately 160full-time personnel focused on major cities throughout Spain. Outside Spain wesell through alliances with partners in other countries in Europe andelsewhere.

 

We focus on obtaining the rights to pharmaceuticalproducts that are less actively promoted by larger pharmaceutical companies orare in a late stage of development and have good potential for acceptance inour markets. We believe that we have expertise in assessing potential marketopportunities related to particular pharmaceuticals and in negotiating andacquiring from pharmaceutical companies the rights to market pharmaceuticals inSpain and other countries. Products that already are selling in the U.S. orother major markets demonstrate commercial viability and typically encounterfewer barriers to regulatory approval for introduction into other countries. Theacquisition and subsequent manufacture of these products will permit ourSpanish operations to more fully utilize our existing manufacturing capacity

 

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andallow us to further leverage our sales force by providing them with moreproducts to sell. We believe that we have developed particular expertise inmarketing pharmaceutical products to physicians and pharmacies in Spain.

 

Additionally, we have a strategic alliance with Tevagranting us the right to register and market certain of Teva’s pharmaceuticalproducts in Spain through our sales force of 156 full-time personnel who focuson major cities throughout Spain.

 

We are expanding the sales of products outside ofSpain by developing alliances with strategic partners in targeted markets thatoffer compatible regulatory approval regimes and attractive margins. Most ofthese alliances relate to specific products that our partners have expertise inmarketing. We have already developed alliances in Portugal, Greece, the UnitedKingdom, Germany, Austria, Morocco, Poland and the Czech Republic for targetedproducts in these and other countries. In certain European countries that havea highly developed competitive market for generics based primarily on price, weintend to sell either directly or through our alliances to distributors. Incountries that require a sales force to market to physicians or consumers, weintend to continue to concentrate our efforts through alliances with entitiesthat have sales and marketing forces already in place. We have made and willcontinue to make, as necessary, modifications to our finished pharmaceuticalproducts manufacturing facility so that it will comply with Good ManufacturingPractices (GMP) of the FDA. These modifications should enable us to submit ourproducts for U.S. marketing approval by the FDA.

 

*Focus on commercializing our CPE-215*®*permeation platform technologyand developing proprietary products based on our other technologies*

 

We apply our drug delivery and oral drug formulationtechnologies in an effort to improve the performance of existing pharmaceuticalproducts with respect to their method of delivery and effectiveness. We also may beable to reduce manufacturing costs for certain products as a result of ourproprietary manufacturing processes.

 

Our CPE-215 technology enables the absorption ofdrugs across membranes of the skin, mouth, nose, vagina and eye. We believe ourCPE-215 technology can be incorporated into a wide variety of pharmaceuticalformats and products, including those formulated as creams, ointments, gels,solutions, lotions, sprays or patches. CPE-215 has a record of safety in humansas a food additive and fragrance and is currently listed on the FDA’s inactiveingredient list for approved drug products. Testim, the first product incorporatingour CPE-215 drug delivery technology, was approved by the FDA in October 2002and was launched in the U.S. market by our licensee, Auxilium, in February of2003. We are optimistic that this past experience with CPE-215 may resultin reduced preclinical development time relating to its use in new formulationsof previously approved compounds. We market our CPE-215 technology topharmaceutical and biotechnology companies whose products we believe wouldbenefit from its permeation properties.

 

We believe these benefits include:

 

•                  improvingefficacy as compared to oral administration, which subjects the drug to theeffects of first-pass metabolism;

 

•                  extendingthe period of market exclusivity for a branded compound based on the grant of apatent that incorporates new drug delivery methods;

 

•                  allowingbranded and generic drug companies to differentiate their products from thoseof competitors;

 

•                  improvingutilization of costly and/or scarce drugs and active ingredients;

 

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•                  expandingthe market to patients less suitable for injection, especially children and theelderly; and

 

•                  improvingpatient convenience and compliance, and lowering costs relative to a doctor’soffice visit for an injection.

 

In addition to marketing our CPE-215 technology topharmaceutical companies for application with their branded or genericproducts, we selectively apply this technology to our own development ofcertain products. We target compounds with established market demand or thatface limited market acceptance as a result of less efficient drug deliverymethods. We are currently working on applications of the CPE-215 technology tothe intranasal delivery of insulin to diabetic patients and the topicaltreatment of nail fungus infections.

 

We have been granted a patent in the U.S. for our oralformulation of acetaminophen. We have pending applications in Europe andelsewhere. We have also been granted a Spanish patent for our oral formulationsof omeprazole and lansoprazole. In the case of acetaminophen, we believe thatwe have developed dosages that result in:

 

•                  increasedsolubility in water for administration to patients who have difficultyswallowing pills;

 

•                  fasterrelief of pain and inflammation; and

 

•                  bettertaste.

 

With respect to omeprazoleand lansoprazole, we believe that we have created manufacturing processes that requireless time to efficiently produce our versions of these products.

 

Once we bring our internally developed products toan advanced stage of development, we intend to develop collaborativerelationships that leverage the clinical development and marketing and salescapabilities of our strategic partners. We believe that this will allow us tolicense our products on terms that are more favorable than those that would bepossible earlier in the development cycle. In Spain, we may market thesenew products directly through our existing sales force. We also seek tomanufacture and supply our pharmaceutical partners with the products theylicense from us.

 

**Our Proprietary Drug Technologies**

 

*Proprietary Drug Manufacturing Technologies*

 

We believe that there are several opportunities toenter into additional collaborations with pharmaceutical and biotechnologycompanies and expand our product lines using our proprietary drug technologies.For example, in November 2004, we entered into a collaboration agreementwith Perrigo Company, the largest U.S. manufacturer of over-the-counterpharmaceutical and nutritional products for the store brand market, to co-developand market a generic pharmaceutical product in the U.S. and potentially othermarkets.

 

*CPE-215 Permeation Platform Technology*

 

Our permeation platform technology consists ofa series of related chemical compounds that enable the absorption of awide variety of products across various biological membranes. Our primarycompound and the foundation for our drug delivery platform technology isCPE-215 (pentadecalactone). CPE-215, when combined with certain drugs, has beenshown to significantly increase the amount and rate of

 

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absorptionof those drugs through various biological membranes. By controlling the amountof CPE-215 that is combined with certain drugs, we have the ability to positivelyaffect the quantity and rate at which the drug is absorbed through biologicalmembranes. We believe that our CPE-215 technology is superior to certain othernon-injection and non-oral drug delivery systems based on the followingcharacteristics:

 

•                  broadapplicability - works with a wide range of pharmaceuticalcompounds, including water soluble and oil soluble and insoluble compounds aswell as high and low molecular weight compounds, including peptides andproteins;

 

•                  formatindependence - can be formulated into creams, ointments,gels, solutions, lotions and patches;

 

•                  biologicalmembrane independence - works across the biological membranes of theskin, mouth, nose, vagina and eye; and

 

•                  welltolerated - approved by the FDA for long-term topicaluse in Testim.

 

CPE-215 has a record of safety in humans as a foodadditive and fragrance and is currently listed on the FDA’s inactive ingredientlist for approved drug products. Testim, the first product incorporating our CPE-215drug delivery technology, was approved by the FDA in October 2002 and waslaunched in the U.S. market by our licensee, Auxilium, in February of 2003.We are optimistic that this past experience with CPE-215 may result inreduced preclinical development activities required for new product formulationsof previously approved pharmaceutical compounds.

 

*Solubility Enhancement Technology*

 

Our solubility enhancement technology involveschemical and manufacturing procedures that enhance compound solubility withoutchanging the compound’s therapeutic properties. Although this technology may beapplied to other chemical entities, to date we have incorporated thistechnology only in acetaminophen compounds, which are known to have problems ofinsolubility and undesirable taste. Based upon clinical studies completed in Europein 2001 and 2002, we believe that our technology enables us to develop anddeliver dosages of acetaminophen that make it highly dispersible, rapidlysoluble in water, better tasting and faster in reaching peak blood levels todeliver pain relief and reduce fever than other tablets or capsules. We believethe use of our technology will increase solubility, which will lessenundesirable side effects, such as flatulence in effervescent formulations andthe bitter taste of pills, which commonly are associated with acetaminophen andmany other oral medications. Patents have been filed on this technology, of whichone has been granted in the United States and others are pending in Europe andelsewhere.

 

*Oral Formulation Technologies*

 

Our oral formulation technologies involve theapplication of a proprietary manufacturing process as well as specializedequipment, each of which plays a role in producing pharmaceutical products,while reducing manufacturing time and costs. We have developed new methods formanufacturing products such as omeprazole, lansoprazole and other similarproducts that are stability-sensitive to humidity and temperature. We have beengranted a Spanish patent relating to these processes. The patent claims asinnovative the manufacturing process that renders these products more stable,while protecting active substances from gastric degradation utilizingmicrogranulation and microencapsulation techniques. These patented technologiescan contribute to our ability to compete against other companies whosemanufacturing processes are more costly and time consuming.

 

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*Nanocaplet Technology*

 

In May 2005 we announced the discovery andsynthesis of a thermodynamically stable, biodegradable Nanocaplet technologyfor the delivery of macromolecule therapeutics. This proprietary technology wasdiscovered as part of our four-year sponsored research program with theUniversity of New Hampshire Nanostructured Polymers Research Center. We havesuccessfully synthesized biodegradable nanovesicles, or nanocapsules, which areminute, chemical structures, that have been demonstrated in test animals toencapsulate and deliver insulin systematically through the intestinal mucosaand successfully reducing glucose levels. The insulin, which isstability-sensitive like many other peptides, was delivered intact in theseanimal studies. This discovery represents a significant advancement in drugdelivery technology and could lead to reduced reliance on certain injectedpharmaceuticals.

 

**Licensed Product**

 

*Topical Testosterone Gel*

 

In February 2003, our licensee, AuxiliumPharmaceuticals, Inc. launched Testim, a testosterone gel containing ourCPE-215 drug delivery system, in the United States. Testim is marketed by Auxiliumunder a license of our drug delivery technology. Testim is approved formarketing in Belgium, Denmark, Finland, Germany, Greece, Iceland, Ireland,Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden and the UnitedKingdom and has received scientific approval in Italy.

 

Testosterone replacement therapy is used to treatmen whose bodies produce insufficient amounts of testosterone (hypogonadism). Symptomsassociated with low testosterone levels in men include depression, decreasedlibido, erectile dysfunction, muscular atrophy, loss of energy, moodalterations, increased body fat and reduced bone density. Currently marketedhormone replacement therapies involve delivery of hormones by injections,through transdermal patches and by gels. Injection therapy has limitations,including pain, which can lead to decreased patient acceptance and decreased compliancewith prescribed therapy. Although patches have been able to alleviate many ofthe gastrointestinal side effects associated with oral delivery of hormones,patches, even in their smallest form, are often conspicuous and may resultin skin irritation or even inaccurate dosing, should the patch fall off. Thetransdermal delivery of hormones through gels, creams and lotions providescommercially attractive and efficacious alternatives to other current methodsof delivery. The worldwide testosterone replacement market has increased asmore baby-boomers enter middle age and more attention is focused on malehormonal deficiencies.

 

Testim resulted from our May 2000 research agreementwith Auxilium, a specialty pharmaceutical company that develops and marketsproducts for urologic and sexual health, pursuant to which Auxilium agreed todevelop and test various pharmaceutical compositions of topical testosteroneusing our CPE-215 technology. We licensed to Auxilium exclusive worldwiderights to develop, market and sell Testim, which rights became effective in September 2000.After Auxilium conducted clinical trials, a New Drug Application (NDA) wasapproved by the FDA on October 31, 2002. Testim was launched in the UnitedStates by Auxilium in February 2003. In June 2003, Testim wasapproved in the United Kingdom and in January 2004, Auxilium entered intoan agreement with Bayer Inc., a division of Bayer AG, to market Testim inCanada upon approval of Testim by the Canadian authorities. Additionally,Testim was launched in Germany in January 2005 by Auxilium’s partner,Ipsen.

 

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**Manufactured and Marketed Products**

 

In Spain, we manufacture and market approximately 100products of various dosages and strengths which include approximately 151product presentations in four primary therapeutic areas: cardiovascular,gastrointestinal, central nervous system and infectious diseases. We marketthese products primarily in Spain and have developed alliances with othercompanies that market our products, pursuant to license and supply agreements,in other countries, including Portugal, Greece, the United Kingdom, Germany,Austria, Morocco, Poland and the Czech Republic. In addition, we manufactureproducts that are marketed by other companies both in Spain and elsewhere. Ourgeneric and branded products are marketed to physicians, pharmacists andhospitals by our three Spanish sales and marketing organizations, LaboratoriosBelmac, Laboratorios Davur and Laboratorios Rimafar. We also marketover-the-counter products through Laboratorios Rimafar. There are approximately179,000 physicians and 21,000 pharmacies in Spain.

 

We continually review and modify our productportfolio. We add to our portfolio to respond to increasing market demand forgeneric and branded products in Spain and, when appropriate, we divest from ourportfolio products that we consider to be redundant or that have becomenon-strategic. We export a growing percentage of the pharmaceuticalsmanufactured by Laboratorios Belmac outside of Spain through local distributorsand brokers, particularly in Europe and Northern Africa.

 

*Branded Pharmaceutical Products*

 

Our branded pharmaceutical product line consists of 38products of various dosages and strengths, represented by approximately 20 trademarkedbrand names. Sales of branded pharmaceuticals accounted for approximately 23% ofour revenues in 2005, compared to 25% in 2004 and 29% in 2003. We market ourbranded and, to a lesser extent, certain of our generic and over-the-counterproducts through our Laboratorios Belmac subsidiary, which has approximately 71full-time sales personnel who focus on major cities throughout Spain.  Certain of our branded products are alsomarketed by the sales forces of Laboratorios Davur and Laboratorios Rimafar. Wesupplement our sales and marketing efforts for branded products throughadvertising in trade publications. Most of our branded products are known inthe industry as “branded generics” as they are being marketed by us under a “brand”name even though we are not the innovator of the product.

 

The following are descriptions of the brandedproducts that contribute significantly to our sales and gross profits:

 
| **Our Branded Product Name** | ** ** | **Active Ingredient**            | ** ** | **Innovator Product**        | ** ** | **Used to Treat**                       |
|------------------------------|------------|----------------------------------|------------|------------------------------|------------|-----------------------------------------|
|                         |       |                             |       |                         |       |                                    |
| Belmalipâ               |       | simvastatin                      |       | Zocorâ (Merck)          |       | elevated cholesterol                    |
|                         |       |                             |       |                         |       |                                    |
| Belmazolâ               |       | omeprazole                       |       | PrilosecÒ (AstraZeneca) |       | gastroesophageal reflux disease         |
|                         |       |                             |       |                         |       |                                    |
| Cimascal D Forteâ       |       | calcium carbonate and vitamin D3 |       | Calcite-Dâ (Riva)       |       | osteoporosis                            |
|                         |       |                             |       |                         |       |                                    |
| Codeisanâ               |       | codeine                          |       | Tricodeinâ (Solco)      |       | cough and bronchitis                    |
|                         |       |                             |       |                         |       |                                    |
| Enalapril Belmacâ  |       | enalapril maleate           |       | Vasotecâ (Merck)        |       | cardiovascular disease and hypertension |

 

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| **Our Branded Product Name** | ** ** | **Active Ingredient**              | ** ** | **Innovator Product**         | ** ** | **Used to Treat**               |
|------------------------------|------------|------------------------------------|------------|-------------------------------|------------|---------------------------------|
|                         |       |                               |       |                          |       |                            |
| IbumacÒ                 |       | ibuprofen                          |       | MotrinÒ (McNeil)         |       | rheumatoid arthritis            |
|                         |       |                               |       |                          |       |                            |
| Lanzol®                 |       | lansoprazole                       |       | Prevacid® (Tap)          |       | gastroesophageal reflux disease |
|                         |       |                               |       |                          |       |                            |
| Mio RelaxÒ              |       | carisoprodol                       |       | Somaâ (MedPointe)        |       | muscle spasms                   |
|                         |       |                               |       |                          |       |                            |
| Pentoxifilina Belmacâ   |       | pentoxifylline                     |       | Trental® (Aventis)       |       | peripheral arterial disease     |
|                         |       |                               |       |                          |       |                            |
| Senioralâ               |       | oxymetazoline and chlorpheniramine |       | Denoralâ (Aventis)       |       | cold and sinus congestion       |
|                         |       |                               |       |                          |       |                            |
| XetinÒ                  |       | paroxetine                         |       | PaxilÒ (GlaxoSmithKline) |       | depression                      |

 

*Generic Pharmaceutical Products*

 

Our generic pharmaceutical product line consists of 62products of various dosages and strengths. We entered the genericpharmaceutical market in Spain in September 2000. Laboratorios Davur, oursales and marketing organization devoted primarily to generic products, marketspharmaceutical products to physicians and pharmacists through a sales force ofapproximately 61 full-time sales personnel who focus on major cities throughoutSpain. Laboratorios Rimafar, our sales and marketing organization devotedprimarily to generics and over-the-counter products, markets to pharmaciststhrough a sales force of approximately 23 full-time sales personnel throughoutSpain. Laboratorios Belmac, to a lesser extent, also sells selected genericproducts through its sales force. We supplement our sales and marketing effortsfor generic products through advertising in trade publications.

 

We believe we can grow by providing a more extensiveline of products to our generic products sales force for marketing to our physicianand pharmacy clients.

 

The following are descriptions of our genericproducts that contribute significantly to our sales and gross profits:

 
| **Our Generic Product Name**                      | ** ** | **Active Ingredient**       | ** ** | **Innovator Product**           | ** ** | **Used to Treat**                             |
|---------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|-----------------------------------------------|
|                                              |       |                        |       |                            |       |                                          |
| Amoxicilina Davurâ  Amoxicilina Belmacâ |       | amoxicillin trihydrate      |       | Amoxilâ  (GlaxoSmithKline) |       | infections                                    |
|                                              |       |                        |       |                            |       |                                          |
| Azitromicina Davur®                          |       | azithromycin                |       | Zithromax® (Pfizer)        |       | infections                                    |
|                                              |       |                        |       |                            |       |                                          |
| Ciprofloxacino Davurâ                        |       | ciprofloxacin hydrochloride |       | Ciproâ (Bayer)             |       | microbial infections, including anthrax       |
|                                              |       |                        |       |                            |       |                                          |
| Enalapril Davurâ                        |       | enalapril maleate      |       | Vasotecâ (Merck)           |       | cardiovascular disease  and hypertension |

 

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| **Our Generic Product Name**                                            | ** ** | **Active Ingredient**     | ** ** | **Innovator Product**         | ** ** | **Used to Treat**                     |
|-------------------------------------------------------------------------|------------|---------------------------|------------|-------------------------------|------------|---------------------------------------|
|                                                                    |       |                      |       |                          |       |                                  |
| Fluoxetina DavurâFluoxetina  RimafarâFluoxetina  Belmacâ |       | fluoxetine  hydrochloride |       | Prozacâ (Eli Lilly)      |       | depression                            |
|                                                                    |       |                      |       |                          |       |                                  |
| Ibuprofeno Davur®                                                  |       | ibuprofen                 |       | Motrin® (McNeil)         |       | pain, fever                           |
|                                                                    |       |                      |       |                          |       |                                  |
| Lansoprazol Davur®  Lansoprazol Rimafar®                      |       | lanoprazole               |       | Prevacid® (Tap)          |       | gastroesophageal reflux  disease |
|                                                                    |       |                      |       |                          |       |                                  |
| Mirtazapina Davur®                                                 |       | mirtazapine               |       | Remeron® (Organon)       |       | depression                            |
|                                                                    |       |                      |       |                          |       |                                  |
| Omeprazol Davur â  Omeprazol Rimafarâ                         |       | omeprazole                |       | PrilosecÒ (AstraZeneca)  |       | gastroesophageal reflux  disease |
|                                                                    |       |                      |       |                          |       |                                  |
| Paroxetina DavurÒ  Paroxetina RimafarÒ                        |       | paroxetine                |       | PaxilÒ (GlaxoSmithKline) |       | depression                            |
|                                                                    |       |                      |       |                          |       |                                  |
| Pentoxifilina Davurâ                                               |       | pentoxifylline            |       | Trental® (Aventis)       |       | peripheral arterial disease           |
|                                                                    |       |                      |       |                          |       |                                  |
| Selegilina Davur®                                                  |       | selegiline hydrochloride  |       | Eldepryl® (Somerset)     |       | Parkinson’s disease              |
|                                                                    |       |                      |       |                          |       |                                  |
| Sertralina Davur®                                                  |       | sertraline hydrochloride  |       | Zoloft® (Pfizer)         |       | depression                            |
|                                                                    |       |                      |       |                          |       |                                  |
| Simvastatina Davurâ  Simvastatina Rimafarâ                    |       | simvastatin               |       | Zocorâ (Merck)           |       | elevated cholesterol                  |
|                                                                    |       |                      |       |                          |       |                                  |
| Trimetazidina DavurÒ                                               |       | trimetazedine             |       | IdaptanÒ (Servier)       |       | coronary therapy                      |

 

*Sales to Licensees and Others*

 

In addition to manufacturing and selling our ownbranded and generic products, we license the right to market products to otherswithin and outside of Spain. These license agreements are usually accompaniedby long-term exclusive supply agreements, whereby our licensees purchase thelicensed products from our manufacturing facility. As of December 31, 2005,the Company’s Spanish operations have executed 142 license agreements, of which17 with customers in Spain and 64 with customers outside of Spain, coveractively marketed products that are generating revenues. The remaininglicenses, 2 with customers in Spain and 59 with customers outside of Spain, arefor products that are awaiting regulatory approvals. Additionally, we have 16contract manufacturing agreements in effect in Spain and 6 contract manufacturingagreements in effect for international customers. Our clients market theseproducts under their own names and with their own labeling. Many of theproducts we manufacture for others use the same active ingredients that areused in our own marketed products.

 

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*Strategic Alliance with Perrigo Company*

 

We entered into a product development, license andmanufacturing agreement with Perrigo Company in November 2004. Perrigo hasagreed to co-develop, market and sell in the U.S., and potentially othermarkets, a generic pharmaceutical product that can be manufactured by our activepharmaceutical ingredients manufacturing subsidiary, Bentley API, and related finishdosage forms produced by our manufacturing subsidiary, Laboratorios Belmac.

 

Under the agreement, Abbreviated New DrugApplications (ANDA) for the co-developed products will be submitted by Perrigoto the FDA. We, together with Perrigo, have identified a prescription drug forco-development and commercialization that will soon lose patent protection inthe U.S. Under the agreement, we and Perrigo share undisclosed percentages ofthe cost of development for each ANDA. The specific products and percentage ofdevelopment expenses have not been disclosed for competitive reasons. Ouragreement with Perrigo contains provisions which allow us to collaborate onadditional products in the future when mutually agreed upon.

 

*Alliance with Teva*

 

In July 2000, we entered into a five yearstrategic alliance with Teva, a world leader in generic pharmaceuticalproducts, pursuant to which we were granted a royalty-free, non-exclusivelicense to register and sell certain of Teva’s pharmaceutical products. Underthis license agreement, we register these products with Spain’s Ministry ofHealth and, upon approval, sell these products in Spain. We have anon-exclusive obligation to purchase the products from Teva, allowing us topurchase any of the products from sources other than Teva if we can demonstratethat Teva’s price for a product exceeds the current price from anotherqualified source and if Teva has not exercised its right to match the lowerprice. The original 5-year term of the collaboration with Teva expired in July 2005;however the collaboration agreement automatically renewed for a one-year term.We expect the agreement to continually renew for additional one-year terms untilor unless terminated by either party. We have received marketing approval for12 of these products, of which, one was launched in 2004 and three werelaunched in 2006, and 27 other product registrations have been submitted to theMinistry of Health and are pending approval. While there can be no assurancethat any future products will be co-developed and licensed from Teva beyond July 2006,the existing licensed products (approved and pending) will remain the propertyof the Company and Teva is expected to continue to supply either raw materialsor finished goods for those products for a period of at least five years fromthe launch of each product.

 

In addition, under a rights agreement entered intowith Teva in July 2000, we have granted Teva a right of first refusal topurchase Laboratorios Davur in the event that we decide to sell LaboratoriosDavur or Laboratorios Belmac. We also granted Teva the right to bid forLaboratorios Belmac in the event we intend to sell Laboratorios Belmac.

 

*Manufacturing*

 

Our 108,000 square-foot pharmaceutical product manufacturingfacility is located in Zaragoza, Spain. Our manufacturing facility complieswith GMPs in Europe and is capable of producing tablets, capsules, ointments,lotions, liquids and sachets, as well as microgranulated products. The facilityalso includes analytical chemistry, quality control, quality assurance and formulationresearch laboratories. We are also evaluating and making modifications to this manufacturingfacility so that it will comply with U.S. GMPs. These modifications should enableus to submit our products for marketing approval by the FDA.

 

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In April 2004, we purchased an 11,000 squarefoot manufacturing facility located in Zaragoza, Spain that specializes in themanufacture of certain active pharmaceutical ingredients. The facility has beenapproved by the U.S. Food and Drug Administration (FDA) for the manufacture ofone ingredient for marketing and sale in the U.S. We are manufacturing andmarketing these products through our subsidiary, Bentley API.

 

We have fully integrated manufacturing supportsystems, including quality assurance, quality control, regulatory complianceand inventory control. These support systems are designed to maintain highstandards of quality for our products and deliver reliable products andservices to our customers on a timely basis. We require a supply of quality rawmaterials and packaging materials to manufacture and package drug products. Historicallywe have not had difficulty obtaining raw materials and packaging materials fromsuppliers. Currently, we rely on approximately 61 suppliers to deliver ourrequired raw materials and packaging materials, most of which are supplied by 24of these entities. We have no reason to believe that we will be unable toprocure adequate supplies of raw materials and packaging materials on a timelybasis. Union Quimico Farmaceutica, S.A. is our primary supplier of omeprazole. Webelieve that alternative sources of omeprazole are available and we will obtainrequired governmental approval to source from them, if necessary.

 

**Products in Development**

 

The following are products that we are currentlydeveloping, listed in the order of our current priorities. Before they arecommercialized, they must be approved by regulatory authorities, such as the FDAor the Spanish Ministry of Health, in each jurisdiction where they will bemarketed or sold. See “Regulation” section of Item 1 for a discussion ofthe regulatory approval process.

 
| **Product Candidate**      | ** ** | **Technology** | ** ** | **Used to Treat**                         | ** ** | **Status**                                                                                    |
|----------------------------|------------|----------------|------------|-------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                       |       |           |       |                                      |       |                                                                                          |
| Generic products           |       | Various        |       | Various                                   |       | Bioequivalence and/or submitted for approval in the U.S., Spain,  Europe and other countries. |
|                       |       |           |       |                                      |       |                                                                                          |
| Intranasal insulin         |       | CPE-215        |       | Diabetes                                  |       | Phase I/II                                                                                    |
|                       |       |           |       |                                      |       |                                                                                          |
| Oral peptide delivery      |       | Nanocaplet     |       | Various                                   |       | Preclinical                                                                                   |
|                       |       |           |       |                                      |       |                                                                                          |
| Antifungal nail lacquer    |       | CPE-215        |       | Onychomycosis                             |       | Phase I/II                                                                                    |
|                       |       |           |       |                                      |       |                                                                                          |
| Topical hormonal therapy   |       | CPE-215        |       | Osteoporosis;  Erectile  dysfunction |       | Preclinical                                                                                   |
|                       |       |           |       |                                      |       |                                                                                          |
| Intranasal pain management |       | CPE-215        |       | Pain                                      |       | Preclinical                                                                                   |

 

*Generic Products*

 

We continually evaluate which pharmaceuticalproducts are good candidates for us to develop, test and market as genericproducts in Spain, the U.S. and elsewhere. We select products based on factorsincluding the timing of expiration of the patent on the innovator’s product,the ability of our manufacturing facility to efficiently produce the product,the availability and cost of the raw materials to produce the

 

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productas well as the potential market size and pricing that can be obtained for theproduct. Once we select a product, our scientists develop a generic formulationof the product, which then must be tested to determine if it is bioequivalentto the innovator’s product. Products are then submitted for marketing approvalby the relevant regulatory authorities, generally starting with Spain’sMinistry of Health.

 

In addition, under a strategic alliance, we and Perrigohave agreed to co-develop a generic pharmaceutical product that can bemanufactured by our active pharmaceutical ingredients manufacturing subsidiary,Bentley API, and related finish dosage forms produced by our manufacturingsubsidiary, Laboratorios Belmac. Through our alliance, Perrigo will market andsell this product in the U.S., and potentially other markets. Our agreementwith Perrigo contains provisions which allow us to collaborate on additionalproducts in the future when mutually agreed upon.

 

We attempt to have several generic products in eachstage of development so that we can have a steady pipeline of generic productintroductions. For competitive reasons, we generally do not disclose whichgeneric products we are developing.

 

*Intranasal Insulin*

 

We are developing intranasal formulations of insulinto treat patients suffering from Type I and Type II diabetes. Based onpreclinical studies at various universities and the results of our Phase I studyand preliminary results of our Phase II study, we believe our intranasalinsulin formulation can potentially achieve higher levels of bioavailabilitycompared to other drug delivery systems currently being developed. Our productis designed to deliver insulin through a small, discreet nasal spray that canbe carried in a patient’s pocket. Our formulation is designed to blunt theincrease in glucose following meals. Our formulation may greatly reducethe number of insulin injections required to be taken by Type I diabetics(those requiring insulin) and it may reduce the number of medicationscurrently required to be taken by Type II diabetics (those who are not requiredto take insulin).

 

In January 2004, we completed a Phase Iclinical trial of an intranasal insulin product formulation in healthy volunteers.The study was conducted by a clinical research organization in a hospitalsetting in Ireland in compliance with U.S. and European clinical standards, andprovided encouraging results. The clinical study consisted of 8 healthy(non-diabetic) human volunteers who, over several weeks, each received up tofour intranasal sprays of insulin utilizing our proprietary drug deliverytechnology. The study, which is designed to demonstrate safety, alsodemonstrated a consistent response in the group. Elevated blood insulin levelswere detected within 10 minutes of nasal administration, a peak increase atabout 20 minutes and return to pre-dose levels by 60-90 minutes. Baseline bloodglucose levels were quickly depressed in a dose-related manner, with a peakdecrease at about 40 minutes after nasal insulin administration. These resultswere also consistent with a decrease in the normal volunteers’ baseline bloodinsulin levels, as measured by plasma C-peptide, which occurred at about 60minutes after nasal insulin dosing.

 

Based on the results of this Phase I study, weproceeded with a Phase II protocol for evaluation in insulin-dependentdiabetics, which was completed in late 2004. This study has shown that aBentley formulation of insulin designed for intranasal administration showspreliminary evidence of efficacy, and appears to be well tolerated in patientvolunteers with insulin dependent diabetes mellitus. Additional work wasperformed in 2005 and is planned for the future, including continuedformulation development and additional Phase II studies.

 

Diabetes is a metabolic disorder affecting more than100 million people worldwide.

 

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Diabeticpatients who must endure frequent injections prefer less invasive methods ofadministering their medications. Alternative and more desirable methods ofdelivery would not only improve quality of life but also would contribute topatient compliance with prescribed therapy.

 

*Antifungal Nail Lacquer*

 

We have developed a topical nail lacquer fortreating fingernail and toenail fungal infections (onychomycosis). We completedtwo Phase I/II clinical trials for the treatment of nail fungal infections atthe University of Alabama at Birmingham in 2002 and 2003 utilizing aclotrimazole lacquer formulation containing CPE-215. According to the NationalOnychomycosis Society, nail fungus affects almost 30 million people,primarily between the ages of 40 and 65. Patients electing to take oral therapymust undergo blood monitoring during the course of treatment to monitor forliver damage.

 

*Topical Hormonal Therapy*

 

Our topical hormonal therapy incorporates the use ofmetabolic steroids that regulate most of the hormonal action in adult males. Hormonereplacement therapies using these metabolic steroids may have significantbenefits in treating a number of medical afflictions, including osteoporosisand sexual dysfunction. We have granted to Auxilium a worldwide license todevelop, market and sell a topical hormonal therapy containing our CPE-215technology. Auxilium, which has already incorporated our CPE-215 technologyinto Testim, is evaluating the formulations of this topical hormonal therapy product.

 

*Intranasal Pain Management*

 

Many people suffer from chronic moderate-to-severepain that is related to cancer, back problems and orthopedic injury. Thesepeople also may experience intermittent flares of pain that can occur eventhough they are taking analgesic medications on a fixed schedule for paincontrol. A severe flare of pain is called breakthrough pain because the painbreaks through the regular pain medication. About one-half to two-thirds ofpatients with chronic cancer-related pain also experience episodes ofbreakthrough cancer pain. Generally, breakthrough pain occurs without prioronset symptoms and may last from seconds to minutes or hours. Recentregulatory concerns, as well as civil litigation concerns, regarding the safetyof COX-2 inhibitors and other non-steroidal anti-inflammatory drugs may provideopportunities for alternative methods for treating pain.

 

Orally delivered pain products may not providerapid relief and typically demonstrate considerable patient-to-patientvariability in absorption. Injectable formulations of pain products providerapid and effective pain relief, but administration often requires professionalassistance or hospitalization. We believe an intranasal pain product couldprovide significant medical benefits over oral and injectable formulations.

 

Under a research agreement with Auxilium, weformulated the intranasal delivery of a pain management chemical agent usingour CPE-215 technology. Auxilium has the right to license this productapplication pursuant to our research agreement, but has not effected thelicense to date.

 

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**Intellectual Property**

 

We actively seek to protect our products andproprietary information by means of U.S. and foreign patents, trademarks andcontractual arrangements. Our success will depend in part on our abilityto obtain and enforce patents on our products, processes and technologies topreserve our trade secrets and other proprietary information and to avoidinfringing on the patents or proprietary rights of others. Our CPE-215technology is covered by our U.S. patent and 11 foreign patents, includingthose in Japan, Korea and most major European countries. These patents for ourCPE-215 technology expire in the U.S. in 2008 and in foreign countries between2006 and 2014. In 2003, we acquired a U.S. patent regarding our antifungal naillacquer product which expires in 2020. Patent applications for our antifungalnail lacquer are currently pending in Europe and other foreign countries. We alsohave multiple U.S. and international patents pending covering various applicationsof our CPE-215 technology, including testosterone and insulin compositions.

 

We have been granted a Spanish patent for our oralformulations of omeprazole and lansoprazole which expire in 2023.

 

We own approximately 110 trademarks forpharmaceutical products in Spain. In addition, we also rely on unpatentedproprietary technologies in the development and commercialization of ourproducts. We also depend upon the unpatentable skills, knowledge and experienceof our scientific and technical personnel, as well as those of our advisors,consultants and other contractors. To help protect our proprietary know-howthat is not patentable, and for inventions for which patents may bedifficult to enforce, we rely on trade secret protection and confidentialityagreements to protect our interests. To this end, we require employees,consultants and advisors to enter into agreements that prohibit the disclosureof confidential information and, where applicable, require disclosure andassignment to us of the ideas, developments, discoveries and inventions thatarise from their activities for us. Additionally, these confidentialityagreements require that our employees, consultants and advisors do not bring tous, or use without proper authorization, any third party’s proprietarytechnology.

 

**Competition**

 

All of our current and future products face strongcompetition both from new and existing drugs and drug delivery technologies.This competition includes national and multi-national pharmaceutical andhealthcare companies of all sizes. Many of these other pharmaceutical andhealthcare companies have far greater financial resources, technical staffs,research and development, and manufacturing and marketing capabilities. Webelieve that owning our own development, manufacturing and marketing facilitiesin Spain allows us to effectively compete with other pharmaceutical companiesin many markets. Our access to these resources enables us to control costsotherwise associated with contracting for the development, manufacture ormarketing of our products by other companies. These lower costs allow us tosell our products at competitive prices while maintaining profitable margins.

 

In Spain, we compete with both large multinationalcompanies and national Spanish companies, several of which produce productsthat compete with most of the products that we manufacture and market. InSpain, our principal competitors include companies such as Ratiopharm InternationalGmbH, Merck Sharp & Dohme de España, S.A. and Laboratorios Bayvit S.A.

 

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**Customers**

 

In Spain, our sales representatives fromLaboratorios Belmac, Laboratorios Davur and Laboratorios Rimafar activelypromote our products to physicians and retail pharmacists. We sell our productsdirectly to pharmaceutical distributors and indirectly to customers whopurchase our products from distributors. Outside Spain, we currently sell ourproducts to our strategic partners who then distribute our products directly orthrough distributors in their respective territories. We have begun to marketcertain products directly to distributors in selected markets outside of Spain.Our manufacturing facility also supplies branded and generic products tocustomers both within and outside of Spain, including the European Union,geographical Europe, Northern Africa and the Middle East, under licensing andsupply agreements or contract manufacturing arrangements. The wholesaledistributor network for pharmaceutical products in Europe and more specificallyin Spain in recent years has been subject to increasing consolidation, which weexpect will continue to increase our, and other industry participants’,customer concentration.

 

In the United States, we have entered into researchand license agreements with pharmaceutical companies, whereby we perform researchactivities and license product candidates in exchange for milestone paymentsand royalties and/or a share of profits derived from product sales.

 

In the past three years, only one of our customers,Cofares, accounted for more than ten percent of our consolidated total revenues.Sales to this customer accounted for approximately 12% of our consolidatedtotal revenues in 2005, 13% in 2004 and 14% in 2003. See Item 7 — Management’sDiscussion and Analysis of Financial Condition and Results of Operations and Note14 of the Notes to the Consolidated Financial Statements in Item 15 forfinancial information regarding geographic areas.

 

**Employees**

 

We employ approximately 420 people, 22 of whom areemployed in the U.S. and 398 of whom are employed in Spain, as of March 1,2006. Approximately 173 of these employees are principally engaged inmanufacturing activities, 156 in sales and marketing, 29 in product developmentand 62 in management and administration. In general, we consider our relationswith our employees to be good.

 

**Regulation**

 

Numerous governmental authorities in the U.S., Spainand other countries extensively regulate the activities of pharmaceuticalmanufacturers. If we fail to comply with the applicable requirements ofgovernmental authorities, we may be subject to administrative or judicialsanctions such as refusal of or delay in the approval of pending marketing applicationsor supplements to approved applications, warning letters, total or partialsuspension of production, fines, injunctions, product seizures or recalls, aswell as criminal prosecution.

 

*United States*

 

Prior to marketing most pharmaceutical products inthe U.S., the product must first be approved by the FDA. For new compounds, theregulatory approval process begins with preclinical laboratory and animaltesting. The approval process generally consists of the following fiveprincipal stages:

 

•                  Preclinicaltesting;

•                  Submissionand review by the FDA of an Investigational New Drug Exemption (IND)Application;

 

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•                  Clinicaltrials;

•                  Preparationand submission of the NDA; and

•                  FDA’sreview and approval/disapproval of the NDA.

 

In some cases, further clinical trials may alsobe required following approval.

 

The IND is submitted to the FDA when the appropriatepreclinical studies are completed and must be submitted to the FDA 30 daysbefore beginning clinical studies. The IND becomes effective if the FDA doesnot put the investigations described in the IND on clinical hold within 30 daysof receiving the IND for filing.

 

Human clinical trials typically are conducted inthree sequential phases. Some clinical trials may include aspects of morethan one phase.

 

•                  PhaseI involves the initial introduction of the pharmaceutical compound into patientsor healthy human volunteers; the emphasis is on testing for dosage tolerance,metabolism, excretion, clinical pharmacology, safety (adverse effects) andpossibly early evidence of effectiveness.

 

•                  PhaseII involves the first controlled clinical trial involving patients who have thetargeted disease or condition and consists of safety and efficacy studies. Thestudies may be divided into early Phase II (or II A), during which studiesare performed to determine initial efficacy and late Phase II (or II B) which may consistof placebo-controlled trials in a larger number of patients.

 

•                  PhaseIII involves large scale, long-term, well controlled efficacy and safetystudies within an expanded patient population, frequently at multiple clinicalstudy sites.

 

Throughout the drug development process, the INDmust be updated continually with protocol amendments, information amendments,IND Safety Reports and Annual Reports. The FDA carefully reviews all datasubmitted and holds meetings with the sponsor at key stages to discuss thepreclinical and clinical plans and results.

 

The clinical, chemistry, statistics, biopharmaceuticals,microbiology (if applicable) and nonclinical data that has been collected overmany years of development is submitted to the FDA in an NDA. Additionally, anNDA will contain complete chemistry, manufacturing and controls information,demonstrating that the applicant is capable of consistently manufacturing adrug product of appropriate strength, quality and purity. An NDA is anapplication requesting FDA approval to market a new drug for human use ininterstate commerce.

 

NDAs are allocated varying review priorities basedon a number of factors, including the severity of the disease, the availabilityof alternative treatments and the risks and benefits demonstrated in clinicaltrials. Additional animal studies or clinical trials may be requestedduring the FDA review process and may delay marketing approval. After FDAapproval for the initial indications, further clinical trials are necessary togain approval for the use of the product for any additional indications. The FDAmay also require post-marketing testing to monitor for adverse effects, andin some cases to provide additional information on efficacy, which can involvesignificant expense. Our products under development and future products to bedeveloped must go through the approval process delineated above prior togaining approval by the FDA for commercialization.

 

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FDA approval is also required for the marketing ofgeneric equivalents of an existing drug. An ANDA is required to be submitted tothe FDA for approval. When processing an ANDA, the FDA, in lieu of therequirement for conducting complete clinical studies, requires bioavailabilityand/or bioequivalence studies. Bioavailability indicates the rate and extent ofabsorption and levels of concentration of a drug product in the body.Bioequivalence compares the bioavailability of one drug product (in this case,the generic product under review) with another (usually the innovator product).When bioequivalence is established, the rate of absorption and levels ofconcentration of the generic drug in the body will closely approximate those ofthe previously approved drug. An ANDA may only be submitted for a drug onthe basis that it is the equivalent to a previously approved drug.

 

In addition to obtaining FDA approval for eachproduct, each manufacturer of drugs must register its manufacturing facilitieswith the FDA, and must list the drug products it manufactures at each facility.Domestic manufacturing establishments are subject to biennial inspections bythe FDA and must comply with current GMPs for drugs. To supply products for usein the U.S., foreign manufacturing establishments must also comply with U.S. GMPsand are subject to inspection by the FDA. Such inspections generally take placeupon submission of an NDA or ANDA to the FDA or at any other time deemednecessary by the FDA and can impact both the approval of drugs, and a company’sability to continue manufacturing following approval.

 

*Europe*

 

As a pharmaceutical manufacturer in Spain, which isa member of the European Union, we are subject to the regulations enacted bythe European Union that require us to obtain manufacturing, marketing andpricing authorizations to commercialize pharmaceutical products in Spain.

 

Pharmaceutical manufacturers in Europe must obtain marketingapproval from the regulatory authority of each country in which they intend tomarket a product. In Spain, that authority is the Spanish Ministry of Health. Thedevelopment process in Europe is similar to that in the United States describedabove, with the same three clinical phases for branded drugs and bioequivalencestudies for generic drugs to assure their safety and efficacy. A dossier mustbe prepared for each pharmaceutical product and, upon approval of the product,it may be marketed in that country. In Spain, generic products aregenerally approved approximately one year after submission, while brandedproducts take considerably longer. Spain and several other European countriesalso regulate the price that can be charged to the patient for each product inaddition to setting the amount that the public insurance programs willreimburse for each product, which directly affects a product’s profitability.In late October 2003, the Spanish government enacted a regulation thatreduced the prices that the government reimburses for certain prescriptionpharmaceutical products. These new prices became effective on December 26,2003, but were voluntarily implemented by some companies, including our Spanishsubsidiaries, on December 1, 2003. (See Item 7 — Management’s Discussionand Analysis of Financial Condition and Results of Operations for morediscussion of regulation in Spain.)

 

Spain’s Council of Ministers has recently forwardedto Parliament a proposed medicines bill. The proposed bill states that when adoctor writes a prescription by active ingredient, rather than brand name, thepharmacist would dispense the lowest-priced product. If several products haveequally low prices, the pharmacist should favor the generic product. Ifapproved, all drugs which have been reimbursed for at least ten years, oreleven years if they have gained a new indication, would be placed into areference-price group with products containing the same active pharmaceuticalingredients and delivery form. The reference price would be calculated as anaverage of the three lowest prices in the group. Where the reference pricewould result in price cuts of more than 30% to a product, companies would beable to reduce the price of that product gradually. Where a brand has held amarketing authorization for at least ten years, its current price

 

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wouldbe cut by 20%, providing an equivalent generic product is at a lower price inanother European Union member state. Any product priced below €2.00 (orapproximately $2.40) would be exempt from the reference price provisions. Wecannot assure you whether this proposal may be enacted in some form, if atall, or the impact it may have if enacted.

 

In order to speed approvals within European Unioncountries, the European Union has established a mutual recognition procedure. Whena manufacturer submits a pharmaceutical product for marketing approval, it mustdesignate whether the filing will serve as a reference authorization for otherEuropean Union countries and, if so, which specific European countries. If thefiling is not designated as a mutual recognition reference filing, then otherapplications must be made individually to other countries for approval to begranted in those other countries. If the filing is designated as a reference authorization,then the authority in the initial country is required to evaluate thesubmission on the basis of its own domestic standards as well as the standardsof each of the countries listed by the manufacturer. As the standards forpharmaceutical approvals have not been harmonized among the various EuropeanUnion members, certain aspects of the filing must comply with standards thatvary by country. In addition, the process for initial evaluation of mutualrecognition filings is generally significantly longer than that for nationalfilings and, as a result, companies often choose not to use this process fortheir first approval. However, if the filing is approved for the reference andthe mutual recognition countries, the manufacturer would be permitted to marketthe product in all of the jurisdictions selected.

 

A manufacturing facility is required to obtain ageneral permit to operate a pharmaceutical business certifying that its facilitiescomply with European GMPs. These permits are granted by the nationalauthorities in the country of manufacture and other European countries rely onregulation by the authority of the country of manufacture.

 

*Trends in Healthcare Regulation*

 

The cost of healthcare continues to be a subject ofinvestigation and action by governmental agencies, legislative bodies andprivate organizations. Many countries, in Europe and elsewhere, directly orindirectly through reimbursement limitations, control the selling prices andreimbursement prices of certain healthcare products. For example, in Spain,prices for prescription pharmaceutical products must be approved by Spain’sMinistry of Health. In order to help control rising healthcare costs, theMinistry of Health, in recent years, has encouraged the substitution ofgeneric-equivalent products, as described above. There can be no assurance thatthe government in Spain or in other countries will not implement additionalprice reductions in the future.

 

In Spain and in certain other European countries,there are regulations that prohibit a pharmacy from substituting anotherproduct if a doctor’s prescription has specified a specific product for thatpatient. Recently, there has been intense scrutiny of pharmacists to assurethat they are complying with this regulation. Other European countries permitthe pharmacist to substitute products more freely than Spain. Any change inthis regulation may negatively affect our sales in Spain, as our productsare often prescribed by brand name by the physicians.

 

In Western Europe, efforts are under way by theEuropean Union to harmonize technical standards for many products, includingdrugs, to make more uniform the requirements for marketing approval fromthe various regulatory agencies.

 

In the United States, most states have enactedgeneric substitution legislation requiring or permitting a dispensingpharmacist to substitute a generic version of a prescribed innovator drug.Federal and state governments continue their efforts to reduce costs ofsubsidized healthcare programs, including

 

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restrictionson amounts agencies will reimburse for the use of products. Efforts to reducehealthcare costs are also being made in the private sector. Healthcareproviders have responded by instituting various cost reduction and containmentmeasures of their own. It is not possible to predict the extent to which we orthe healthcare industry in general might be affected by these changes.

 

Continuing reviews of the utilization, safety andefficacy of healthcare products and their components are being conducted byindustry, government agencies and others. These studies, which employincreasingly sophisticated methods and techniques, can call into question theutilization, safety and efficacy of previously marketed products and in somecases have resulted, and may in the future result, in the discontinuanceof such products and give rise to claims for damages from persons who believethey have been injured as a result of their use. Similar consequences can ariseas a result of adverse events, which can impact both innovator and genericversions of the same drug. We maintain product liability insurance for suchpotential claims; however, no such claims have ever been asserted against us.

 

*Other Regulations*

 

We believe that we comply with environmental lawsthat apply to us and we do not anticipate that continuing compliance will havea material effect on our financial condition or results of operations.

 

**Available Information**

 

Copies of reports filed by us pursuant to Section 13(a) or15(d) of the Securities Exchange Act of 1934, including Annual Reports on Form 10-K,Quarterly Reports on Form 10-Q, Current Reports on Form 8-K andamendments to those reports may be accessed from our website atwww.bentleypharm.com, free of charge, as soon as reasonably practicable afterwe electronically file such reports with, or furnish such reports to, theSecurities and Exchange Commission. Alternatively, these reports can beaccessed through a query at the website of the Securities and ExchangeCommission at www.sec.gov.

 

**Item1A.**  Risk Factors

 

You should carefully consider the following discussionof risks and uncertainties that we face in our business. The risks describedbelow are not the only risks we face. Additional risks that we do not yet knowof or that we currently think are immaterial may also impair our businessoperations. If any of the events or circumstances described below actuallyoccurs, our business, financial condition, or results of operations could bematerially adversely affected. In such case, the trading price of our commonstock could decline and you may lose all, or part of your investment.

 

**Our growth depends on identifying drugs suitable for our drug deliverytechnologies and expanding our generic and branded drug operations.**

 

We believe that our growth depends on theidentification of pharmaceutical products that are suitable for delivery usingour proprietary technologies. Our principal drug delivery technology is ourCPE-215 technology. This technology, like certain other drug deliverytechnologies, operates to increase the amount and rate of absorption of certaindrugs across biological membranes. This technology does not operateindependently and must be coupled with suitable pharmaceutical products inorder to provide value. Consequently, our growth will depend to a great extenton identifying and commercializing these suitable drugs with respect to whichwe intend to expend significant resources and efforts. Identifying suitable

 

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productsis a lengthy and complex process that may not succeed. Even if identified,products may not be available to us or we may otherwise be unable toenter into licenses or other agreements for their use. In our efforts toidentify suitable products, we compete with other drug delivery companies withgreater research and development, financial, marketing and sales resources. Ifwe do not effectively identify drugs to be used with our technologies, improvethe delivery of drugs with our technologies and bring the improved drugs tocommercial success, then we may not be able to continue our growth and wewill be adversely affected.

 

We intend to expend significant resources andefforts toward identifying and commercializing products and technologies toexpand our generic and branded drug operations in Spain and to expand sales ofthese products outside Spain. Although we already manufacture and marketgeneric and branded drugs in Spain, the growth of these operations inparticular and the Company in general will depend to a great extent onidentifying and commercializing additional such drugs for which we haveexisting capacity and infrastructure and, to a lesser extent, on increasingsales of existing products. Identifying and pursuing these new opportunitiesinvolves significant time and expense and we may not succeed. Even ifidentified, these products and technologies may not be commerciallysuccessful. Once identified, products to be manufactured and/or marketed by usunder generic or branded names are subject to successful negotiation ofacceptable economic and legal terms, and successful progress of the productthrough commercialization, as to which we cannot assure you. When expandingoutside Spain, we expect to compete in new geographic areas which are governedby regulatory regimes that we have not operated under before. In these efforts,we compete with other pharmaceutical companies having generic and branded drugoperations with greater financial, marketing and sales resources and experiencein the geographic areas in which they operate. If we do not effectivelyidentify generic and branded drugs and technologies and bring them tocommercial success, then we will not be able to continue our growth and we willbe adversely affected.

 

The growth of our generic and branded operations may beadversely impacted by claims by others that our products infringe on theproprietary rights of their existing “brand-name” products. Companies thatproduce brand pharmaceutical products routinely bring litigation againstcompanies who seek regulatory approval to manufacture and market generic formsof their branded products and may attempt to secure injunctions that willprevent the generic competitors from eroding their market share. Thesecompanies may allege patent infringement or other violations ofintellectual property rights, which must be decided by the courts.

 

**Products using our technologies are in various stages of developmentand may not achieve commercial success.**

 

Independently as well as in conjunction withstrategic partners, we are investigating the use of our technologies withrespect to a variety of pharmaceutical compounds and products that are invarious stages of development. We are unable to predict whether any of theseproducts will receive regulatory approvals or be successfully developed,manufactured or commercialized. Further, due to the extended testing andregulatory review process required before marketing clearance can be obtained,the time periods before commercialization of any of these products are long anduncertain. Risks during development include the possibility that:

 

•                  anyor all of the proposed products will be found to be ineffective;

 

•                  theproposed products will have adverse side effects or will otherwise fail toreceive necessary regulatory approvals;

 

•                  theproposed products may be effective but uneconomical to market; or

 

•                  otherpharmaceutical companies may market equivalent or superior products.

 

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**If medical doctors do not prescribe our products orthe medical profession does not accept our products, our ability to grow ourrevenues will be limited.**

 

Our business is dependent on market acceptance ofour products by physicians, hospitals, pharmacists, patients and the medicalcommunity. Willingness to prescribe our products depends on many factors,including:

 

•                  perceivedefficacy of our products;

 

•                  convenienceand ease of administration;

 

•                  prevalenceand severity of adverse side effects in both clinical trials and commercialuse;

 

•                  availabilityof alternative treatments;

 

•                  costeffectiveness;

 

•                  effectivenessof our marketing strategy and the pricing of our products;

 

•                  publicityconcerning our products or competing products; and

 

•                  ourability to obtain third-party coverage or reimbursement.

 

Even though regulatory approval has been receivedfor Testim, and even if we receive regulatory approval and satisfy the abovecriteria for any other product candidates developed by us or incorporating ourdrug delivery technology, physicians may not prescribe these products ifwe do not promote the products effectively. Factors that could affect oursuccess in marketing our products include:

 

•                  theeffectiveness of our sales force;

 

•                  theeffectiveness of our production, distribution and marketing capabilities;

 

•                  thesuccess of competing products; and

 

•                  theavailability and extent of reimbursement from third-party payors.

 

If any of our products or product candidates failsto achieve market acceptance, we may not be able to market and sell theproducts successfully, which would limit our ability to generate revenue.

 

**We will rely on strategic partners to conduct clinical trials andcommercialize products that use our drug delivery technologies.**

 

In light of our limited development resources andthe significant time, expense, expertise and infrastructure necessary to bringnew drugs and formulations from inception to market, we are particularlydependent on resources from third parties to commercialize productsincorporating our technologies. Our strategy involves forming alliances withothers to develop, manufacture, market and sell our products in the UnitedStates and other countries. We entered into an agreement with Perrigo Companyin November 2004 and continue to pursue strategic partners for thesepurposes. We may not be successful in finding other strategic partners orin otherwise obtaining financing, in which case the development of our productswould be delayed or curtailed.

 

We must enter into agreements with strategicpartners to conduct clinical trials, manufacturing, marketing and salesnecessary to commercialize product candidates. In addition, our ability toapply our drug delivery technologies to any proprietary drugs will depend onour ability to establish and maintain strategic partnerships or othercollaborative arrangements with the holders of proprietary rights to such

 

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drugs.Arrangements with strategic partners may be established through a singlecomprehensive agreement or may evolve over time through a series ofdiscrete agreements, such as letters of intent, research agreements and licenseagreements. We cannot assure you that we will be able to establish suchstrategic partnerships or collaborative arrangements on favorable terms or atall or that any agreement entered into with a strategic partner will lead tofurther agreements or ultimately result in commercialization of a product.

 

In collaborative arrangements, we will depend on theefforts of our strategic partners and will have limited participation in thedevelopment, manufacture, marketing and commercialization of the productssubject to the collaboration. We cannot assure you that these strategicpartnerships or collaborative arrangements will be successful, nor can weassure you that strategic partners or collaborators will not pursue alternativetechnologies or develop alternative products on their own or with others,including our competitors. In addition, our collaborators or contractmanufacturers may be subject to regulatory oversight which could delay orprohibit our development and commercialization efforts. Moreover, we could havedisputes with our existing or future strategic partners or collaborators. Anysuch disagreements could lead to delays in the research, development orcommercialization of potential products or could result in time-consuming andexpensive litigation or arbitration.

 

**If we are unable to meet our responsibilities underany of our agreements, we may lose potential business and be subject topenalties and other damages.**

 

We are a party to a number of agreements pursuant towhich we are required to perform certain tasks in accordance withspecified schedules such as manufacturing of products, timing and success ofresearch and development goals, etc. Should we not meet these deadlines andrequirements, our counterparties can take actions specified in these agreementswhich could substantially reduce the amount of revenues the Company wouldreceive, or terminate the related agreements. Additionally, in accordance withthe terms of these agreements, the Company may be forced to pay penaltiesor other damages to our counterparties for breaching these agreements.

 

We expect to enter into additional agreements in thefuture. These agreements may impose various development, funding or otherobligations on us. If we breach any of these obligations, the counterparty may havethe right to terminate the agreement or seek other remedies, which couldsignificantly reduce expected profits to the Company.

 

Disputes may arise with respect to agreementsregarding the manufacturing, development and commercialization of any products,including products which incorporate our intellectual property. These disputescould lead to delays in commercialization of products incorporating ourtechnologies or termination of the agreements.

 

**A significant portion of our revenues are generated by the sale ofproducts formulated from one active ingredient.**

 

Spanish sales from our omeprazole product lineaccounted for approximately 18% and 22% of our consolidated total revenues in2005 and 2004, respectively. The active pharmaceutical ingredient for ouromeprazole products is currently purchased from one supplier. If we lose andcannot effectively replace our supplier or are otherwise unable to continue thesales of our omeprazole products, our revenues would decline significantly.

 

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**Pharmaceutical pricing, changes in third-party reimbursement andgovernmental mandates are uncertain and may adversely affect us.**

 

Our revenues and profitability may be adverselyaffected by the continuing efforts of governmental and third-party payors tocontain or reduce the costs of healthcare. A substantial portion of ouroperations consists of marketing and manufacturing, primarily in Spain andother parts of Europe generic and branded pharmaceutical products. The use ofgeneric drugs is regulated in Spain, the U.S. and many other countries, and issubject to many changing and competing public policy considerations. Inaddition, in certain markets, such as Spain, pricing or profitability ofprescription pharmaceuticals is subject to government control throughreimbursement limitations. Specifically, prices for prescription pharmaceuticalproducts in Spain must be approved by Spain’s Ministry of Health. In order tohelp control rising healthcare costs, the Ministry of Health, in recent years,has encouraged the substitution of generic-equivalent products. In furtherefforts to reduce healthcare costs, the Ministry of Health had beencontemplating new laws and regulations that would significantly reduce themarket prices of certain pharmaceutical products, including generic-equivalentdrugs. For example, in late October 2003, the Spanish government enacted aregulation that reduced the prices that the government reimbursed for certainprescription pharmaceutical products. The regulation affected six of ourchemical entities sold in Spain, including the chemical entities omeprazole,simvastatin and enalapril, which reduced our 2004 revenues by approximately$13.8 million.

 

Spain’s Council of Ministers has recently forwardedto Parliament a proposed medicines bill. The proposed bill states that when adoctor writes a prescription by active ingredient, rather than brand name, thepharmacist would dispense the lowest-priced product. If several products haveequally low prices, the pharmacist should favor the generic product. Ifapproved, all drugs which have been reimbursed for at least ten years, oreleven years if they have gained a new indication, would be placed into areference-price group with products containing the same active pharmaceuticalingredients and delivery form. The reference price would be calculated as anaverage of the three lowest prices in the group. Where the reference pricewould result in price cuts of more than 30% to a product, companies would beable to reduce the price of that product gradually. Where a brand has held amarketing authorization for at least ten years, its current price would be cutby 20%, providing an equivalent generic product is at a lower price in anotherEuropean Union member state. Any product priced below €2.00 (or approximately$2.40) would be exempt from the reference price provisions. We cannot assureyou whether this proposal may be enacted in some form, if at all, or theimpact it may have if enacted.

 

Successful commercialization of many of ourproducts, including those using our permeation technologies as well as ourgeneric and branded products, may depend on the availability ofreimbursement for the cost of such products and related treatment fromthird-party healthcare payors, such as the government, private insurance plansand managed care organizations. Third-party payors are increasingly challengingthe price of medical products and services. Such reimbursement may not beavailable for any of our products at all or for the duration of the recommendedtreatment with a drug, which could materially adversely affect our ability tocommercialize that drug. The increasing emphasis on managed care in the U.S.continues to increase the pressure on pharmaceutical pricing. Some governmentalagencies, including those in Spain, can compel companies to continue to produceproducts that are not profitable for the company due to insufficient supply. Inthe U.S., there have been a number of federal and state proposals to implementsimilar government controls. We anticipate that there will continue to be anumber of proposals in the U.S., as has been the case in many foreign markets.The announcement or adoption of such proposals could adversely affect us.Further, our ability to commercialize our products may be adverselyaffected to the extent that such proposals materially adversely affect thebusiness, financial condition and profitability of companies that areprospective strategic partners.

 

The cost of healthcare in Spain, the U.S. andelsewhere continues to be a subject of investigation and action by variousgovernmental agencies. Certain resulting legislative proposals may adverselyaffect

 

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us.For example, governmental actions to further reduce or eliminate reimbursementfor drugs may directly diminish our markets. In addition, legislativesafety and efficacy measures may be invoked that lengthen and increase thecosts of drug approval processes. Further, social, economic and other broadpolicy legislation may induce unpredictable changes in the healthcareenvironment. We cannot assure you whether any of these measures may beenacted in some form, if at all, or the impact they may have if enacted.

 

**If our clinical trials fail, we will be unable to market products.**

 

Any human pharmaceutical product developed by uswould require clearance by the FDA for sales in the United States, by Spain’sMinistry of Health for sales in Spain and by comparable regulatory agencies forsales in other countries. In the case of non-generic products, the process ofconducting clinical trials and obtaining FDA and other regulatory approvals islengthy and expensive and we cannot be assured of success. In order to obtainFDA approval of any new product candidates using our technologies, an NDA mustbe submitted to the FDA demonstrating that the product candidate, based onpreclinical research, animal studies and human clinical trials, is safe forhumans and effective for its intended use. Positive results from preclinicalstudies and early clinical trials do not ensure positive results in more advancedclinical trials designed to permit application for regulatory approval. We may suffersignificant setbacks in clinical trials, even in cases where earlier clinicaltrials show promising results. Any of our new product candidates may produceundesirable side effects in humans that could cause us or regulatoryauthorities to interrupt, delay or halt clinical trials of a product candidate.We, the FDA or other regulatory authorities, may suspend our clinicaltrials at any time if we or they believe the trial participants faceunacceptable health risks or if they find deficiencies in any of our regulatorysubmissions. Other factors that can cause delay or terminate our clinicaltrials include:

 

•                  slowor insufficient patient enrollment;

 

•                  slowrecruitment and completion of necessary institutional approvals at clinicalsites;

 

•                  longertreatment time required to demonstrate efficacy;

 

•                  lackof sufficient supplies of the product candidate;

 

•                  adversemedical reactions or side effects in treated patients;

 

•                  lackof effectiveness of the product candidate being tested;

 

•                  regulatoryrequests for additional clinical trials; and

 

•                  instabilityof the pharmaceutical formulations.

 

**Our patent positions and intendedproprietary or similar protections are uncertain.**

 

We have filed numerous patent applications and havebeen granted licenses to, or have acquired, a number of patents. We cannotassure you, however, that our pending applications will be issued as patents orthat any of our issued or licensed patents will afford adequate protection tous or our licensees. We cannot determine the ultimate scope and validity ofpatents that are now owned by or may be granted to third parties, theextent to which we may wish, or be required, to acquire rights under suchpatents or the cost or availability of such rights. In the event that patentprotection for technologies expire, or are not extended, revenues derived fromsuch technologies may be reduced significantly.

 

Competitors may interfere with our patentprocess in a variety of ways. Competitors may claim that they invented theclaimed invention prior to us. Competitors also may claim that we areinfringing their

 

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patents,interfering with or preventing the use of our technologies. Competitors also may contestour patents by showing the patent examiner that the invention was not original,was not novel or was obvious. A competitor could claim that our issued patentsare not valid for a variety of other reasons as well. If a person claims weinfringe their technology, we could face a number of consequences, includinglawsuits, which take significant time and can be very expensive, payment ofsubstantial damages for infringement, prohibition from selling or licensing theproduct unless the patent holder licenses the patent to us, or reformulation,if possible, of the product so it does not infringe, which could requiresubstantial time and expense.

 

Examples of the risk of infringement claims are thedifferent legal proceedings commenced against us in Madrid by Merck &Co. Inc. and its Spanish subsidiary, GlaxoSmithKline S.A. and its Spanishsubsidiaries, and Ethypharm S.A. and its Spanish subsidiaries, in each casealleging that we violated their respective patents. As discussed in more detailin “Item 3—Legal Proceedings” we cannot assure you that similar actions willnot be brought against us, or that these actions or any such similar actionswill not have an adverse effect on us.

 

We also rely on trade secrets, unpatented proprietarytechnologies and continuing technological innovations in the development andcommercialization of our products. We cannot assure you that others will notindependently develop the same or similar technologies or obtain access to ourproprietary technologies. It is unclear whether our trade secrets will beprotected under law. While we use reasonable efforts to protect our tradesecrets, our employees or consultants may unintentionally or willfullydisclose our information to competitors. Our employees and consultants withaccess to our proprietary information have entered into or are subject toconfidentiality arrangements with us and have agreed to disclose and assign tous any ideas, developments, discoveries and inventions that arise from theiractivities for us. We cannot assure you, however, that others may notacquire or independently develop similar technologies or, if effective patentsin applicable countries are not issued with respect to our products ortechnologies, that we will be able to maintain information pertinent to suchresearch as proprietary technologies or trade secrets. Enforcing a claim thatanother person has illegally obtained and is using our trade secrets, likepatent litigation, is expensive and time consuming, and the outcome isunpredictable. In addition, we may be subject to the jurisdiction ofcourts outside the U.S., some of which may be less willing to protecttrade secrets.

 

**Regulatory approvals must be obtained and maintained for productsincorporating our technologies and, if approvals are delayed or withdrawn, wewill be unable to commercialize these products.**

 

Government regulations in the United States, Spainand other countries have a significant impact on our business and affect theresearch and development, manufacture and marketing of products incorporatingour technologies. In the United States, Spain and other countries, governmentalagencies have the authority to regulate the distribution, manufacture and saleof drugs. Failure to comply with applicable regulatory requirements can, amongother things, result in fines, suspension or withdrawal of regulatoryapprovals, product recalls, operating restrictions and/or criminal prosecution.In addition, governmental regulations may be established that could prevent,delay, modify or rescind regulatory approval of our products.

 

**Our business will suffer ifwe fail to comply with federal regulations and rules of the Securities andExchange Commission and New York Stock Exchange relating to corporategovernance reform.**

 

As a public company, we are subject to certainfederal regulations and the rules and regulations of the Securities andExchange Commission and the New York Stock Exchange. The Sarbanes-Oxley Act of2002 required more stringent accounting, corporate fraud and securities laws.To implement this legislation,

 

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theSecurities and Exchange Commission has adopted new rules and may adoptadditional rules pertaining to, among other things, additional disclosureand reporting requirements, including requirements relating to internal controlprocedures. The New York Stock Exchange has also adopted various rules relatingto corporate governance. Our reputation and financial results could bematerially harmed by any failure by us to comply with any current or future rules orregulations relating to the Sarbanes-Oxley Act or to any other federalcorporate or stock exchange reform measures.

 

**Sustained compliance with the requirements of the Sarbanes-Oxley Act of2002 may require a reallocation of resources that would otherwise bededicated to operating our business.**

 

The Sarbanes-Oxley Act of 2002 imposed significantnew administrative burdens on publicly traded companies. We have incuredsignificant incremental costs in complying with the provisions of theSarbanes-Oxley Act. We cannot assure you that these additional costs willresult in any increase in revenue or that they will not have a material adverseeffect on our financial results. In addition, because we are a small companywith relatively few employees, the individuals responsible for complying withthe statutory and regulatory requirements also have responsibility for businessmatters. As a result, our business may suffer if these individuals areforced to spend a disproportionate amount of time on compliance matters.

 

**Implementation of new information systems could causebusiness interruptions and negatively affect our profitability and cash flows.**

 

We recentlyimplemented a new inventory warehouse system to enhance operationalefficiencies and provide more effective management of our logistics. Thisimplementation enabled us to better meet the challenges related to ourcontinued growth and the needs of our customers. We also plan to upgrade andreplace certain of our financial systems to help enable us to meet the newchallenges of the new regulatory environment including regulations imposed bythe Sarbanes-Oxley Act of 2002. We expect that, over time, new systems willresult in improved business processes and increased operating efficiencies. Asour employees become familiar with the new systems, we expect that some errors may occur,some of which could adversely impact our business and financial results. Therecan be no assurance that the systems will perform as expected or that theanticipated improvements in business processes and operating efficiencies willbe achieved. In the event of serious system malfunctions or deficiencies, wemight experience business interruptions, which could adversely impact on ourresults of operations, financial condition and cash flows.

 

**If we are unable to obtain marketing approvals to sell our products incountries other than Spain, we may not be able to obtain additionalrevenues from sales in those countries.**

 

We cannot assure you that products that haveobtained marketing approval in Spain will be approved for marketing elsewhere.If we are unable to obtain marketing approval for our products in countriesother than Spain, we may not be able to obtain additional revenues fromsales in those countries.

 

**We must comply with Good Manufacturing Practices in the production ofpharmaceutical products.**

 

Any manufacturing facility for pharmaceuticalproducts to be marketed in the United States is subject to FDA inspection andinspections by other government agencies both before and after approval of an

 

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NDAto determine compliance with the FDA’s GMPs requirements, as well as local,state and other federal regulations. Manufacturing facilities for our compoundsto be marketed in European countries and elsewhere are also subject to EuropeanUnion and/or other applicable GMP regulations. Facilities used to produce ourcompounds may not achieve or maintain compliance with GMP or other requirements.The GMP regulations are complex and, if we fail to comply with them, it couldlead to rejection or delay of an NDA or comparable application. Any delay inapproval of an NDA or comparable application would delay product launch.Violation of GMP requirements after approval of an NDA or comparableapplication, could result in remedial action, penalties and/or delays inproduction.

 

**We have only one manufacturing facility that can be used to manufactureour pharmaceutical products for sale to others. We have only one manufacturingfacility that can be used to manufacture active pharmaceutical ingredients forsale to others.**

 

All of our manufactured pharmaceutical products aremanufactured in one factory in Zaragoza, Spain. Although we have constructedthe factory with redundant lines for our most significant products that are inseparate areas of the factory, and installed a fire suppression system, thedestruction of the factory by a fire or other catastrophe would have a materialimpact on our revenues until we are able to rebuild the factory or secure analternative manufacturing site.

 

Similarly, all of our manufactured activepharmaceutical ingredients are manufactured in one factory in Zaragoza, Spain.A fire or other catastrophe would have a material impact on our revenues untilwe are able to rebuild the factory or secure an alternative manufacturing site.

 

**We operate a significant portion of our business in, and plan to expandfurther into, markets outside the United States, which subjects us toadditional business risks.**

 

During the year ended December 31, 2005, 72% ofour revenues were derived from sales made by our Spanish subsidiaries in Spainand 22% of our revenues were derived from sales made by our Spanishsubsidiaries to customers in other foreign countries. We believe that the mostsubstantial portion of our revenues will continue to be derived from sales inforeign countries. Conducting business internationally subjects us to a numberof risks and uncertainties, including:

 

•                  unexpecteddelays or changes in regulatory requirements;

 

•                  difficultiesand costs related to complying with a wide variety of complex foreign laws andtreaties;

 

•                  delaysand expenses associated with tariffs and other trade barriers;

 

•                  restrictionson and impediments to repatriation of our funds and our customers’ ability tomake payments to us;

 

•                  politicaland economic instability;

 

•                  actsof terrorism or war;

 

•                  difficultiesand costs associated with staffing and managing international operations andimplementing, maintaining and improving financial controls;

 

•                  dependenceupon independent sales representatives and other indirect resellers who may notbe as effective and reliable as our employees;

 

•                  inadequateor uncertain protection of intellectual property in foreign countries;

 

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•                  increaseddifficulty in collecting accounts receivable and longer accounts receivablecycles in certain foreign countries;

 

•                  adversetax consequences or overlapping tax structures; and

 

•                  limitationson the remittance of dividends by foreign subsidiaries.

 

**Currency fluctuations could have a material adverse impact on ourbusiness.**

 

Our revenues may be impacted by fluctuations inlocal currencies due to the fact that 94% of our revenues currently aregenerated by our Spanish subsidiaries, Laboratorios Belmac, Laboratorios Davur,Laboratorios Rimafar and Bentley API. Fluctuations in the value of the Euro, inrelation to the U.S. Dollar had a significant impact on our operations duringthe interim periods of 2005, but did not have a significant effect on ouroperations during the year ended December 31, 2005. We do not currentlyengage in foreign exchange hedging transactions to manage our foreign currencyexposure because much of our expenditures are in the same currency as ourrevenues. Our foreign operations expose us to a number of currency relatedrisks, including the following:

 

•                  fluctuationsin currency exchange rates;

 

•                  limitationson the conversion of foreign currency; and

 

•                  fluctuationsof the carrying value of long lived assets.

 

**If we cannot keep pace with rapid technological change and meet theintense competition in our industry, we may not succeed.**

 

Our success depends, in part, on achieving andmaintaining a competitive position in the development of products andtechnologies in a rapidly evolving industry. If we are unable to continue todevelop and/or acquire competitive products and technologies, our current andpotential strategic partners may choose to adopt the drug deliverytechnologies of our competitors. We also compete generally with other drugdelivery, biotechnology and pharmaceutical companies engaged in the developmentof alternative drug delivery technologies or new drug research and testing.Many of these competitors have substantially greater financial, technological,manufacturing, marketing, managerial and research and development resources andexperience than we do and represent significant competition for us. Ourcompetitors may succeed in developing competing technologies or obtaininggovernmental approval for products before we achieve success, if at all. Theproducts of our competitors may gain market acceptance more rapidly thanour products. Developments by competitors may render our existing or proposedproducts noncompetitive or obsolete.

 

Our competitive positions in our generic and brandeddrug operations as well as with our drug delivery technologies are uncertainand subject to risks. In Spain, and in other countries, we must demonstratebioequivalence of our generic products, which may be challenged by brandedand other generic competitors as well as regulatory authorities. In order todemonstrate bioequivalence of our generic products, we must show that the rateand extent of absorption and levels of concentration of our generic productsare not statistically different from innovators’ products that have previouslybeen approved by the regulatory authorities of the respective country, whenadministered at the same dosage level under similar clinical conditions.

 

The competitive position of our drug deliverytechnologies is subject to the possible development by others of superiortechnologies. Other drug delivery technologies, including oral and injectionmethods,

 

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havewide acceptance, notwithstanding certain drawbacks, and are the subject ofimprovement efforts by other entities having greater resources. In addition,our drug delivery technologies are limited by the number and commercial magnitudeof drugs with which they can successfully be combined.

 

**We may be unable to meet increasing expenses and demands on ourresources from future growth, if any, or to effectively pursue additionalbusiness opportunities.**

 

We routinely consider acquisition and investmentopportunities, although we have no current agreements or commitments withrespect to any acquisitions or investments. Any future acquisitions orinvestments would further challenge our resources. If we do not properly meetthe increasing expenses and demands on our resources from future growth, wewill be adversely affected. To properly manage our growth, we must, among otherthings, implement additional and improve existing administrative, financial,marketing, operational and research and development systems, procedures andcontrols on a timely basis. We may also need to expand our staff in theseand other areas. We may not be able to complete the improvements to oursystems, procedures and controls necessary to support our future operations ina timely manner. We may not be able to hire, train, integrate, retain,motivate and manage required personnel, successfully integrate acquisitions orinvestments, nor successfully identify, manage and pursue existing andpotential market opportunities. We plan to invest approximately $22.6 millionin capital expenditures during the year ending December 31, 2006,including $10.0 million that was budgeted in 2005, but now planned for 2006. Weplan to expand our API manufacturing facility, expand our pharmaceuticalproduct manufacturing facility and add new production lines in order to be ableto accommodate the level of operations and growth that is anticipated as aresult of the Company’s expansion beyond the borders of Spain and the U.S.market. We plan to finance these expenditures from a combination of cash flowfrom operations, borrowings, and existing cash balances. If we fail to generateadditional revenue in excess of increased operating expenses in any fiscalperiod, we may incur losses.

 

**Our operations could be adversely affected if we are unable to raise orobtain needed funding.**

 

Substantial time and financial and other resourceswill be required to complete ongoing development and clinical testing of ourproprietary products. Regulatory efforts and collaborative arrangements alsowill be necessary for our products that are currently under development andtesting in order for them to be marketed. Assuming we continue our operationsas presently conducted, we believe that we have sufficient working capital tomeet our needs for at least the next twenty-four months. However our revenuesfrom operations and cash may not be sufficient over the next several yearsfor commercializing all of the products we are currently developing.Consequently, we may seek strategic partners for various phases ofdevelopment, marketing and commercialization of product candidates employingour technologies. Further, we cannot assure you as to the sufficiency of ourresources or the time required to complete any ongoing development and clinicaltesting, since the extent to which we conduct such testing is dependent onresource allocation decisions that we make from time to time based on numerousfinancial as well as operational conditions.

 

In addition to development and other costs, weexpect to incur capital expenditures from time to time. These capitalexpenditures will be influenced by our regulatory compliance efforts, oursuccess, if any, at developing collaborative arrangements with strategicpartners, our needs for additional facilities and capital equipment and thegrowth, if any, of our business in general. There can be no assurance that wewill receive additional funding on favorable terms if at all, or that we willbe successful in attracting strategic partners. If we cannot raise funds orengage strategic partners on acceptable terms when needed, we may not beable to continue our research and development activities, develop or enhanceour products and services,

 

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takeadvantage of future opportunities, grow our business or respond to competitivepressures or unanticipated requirements.

 

**If we undertake an acquisition, we will incur avariety of costs, and we may never realize the anticipated benefits of theacquisition.**

 

One of our strategies for business expansion is theacquisition of additional technologies, products and product candidates. We may attemptto acquire these product candidates, or other potentially beneficialtechnologies, through the acquisition of businesses, services or products thatwe believe are a strategic fit with our business. Although we currently have nocommitments or agreements with respect to any acquisitions, if we undertake anacquisition, the process of integrating the acquired business, technology,service or product may result in unforeseen operating difficulties andexpenditures and may divert significant management attention from ourongoing business operations. Moreover, we may fail to realize theanticipated benefits of any acquisition for a variety of reasons such as anacquired technology or product candidate proving to not be safe or effective inlater clinical trials. We may fund any future acquisition by issuingequity or debt securities, which could dilute your ownership percentage orlimit our financial or operating flexibility as a result of restrictivecovenants related to new debt. Acquisition efforts can consume significantmanagement attention and require substantial expenditures, which could detractfrom our other programs. In addition, we may devote resources to potentialacquisitions that are never completed.

 

**If we do not successfully manage our growth, ourbusiness goals may not be achieved.**

 

Expansion has placed, and is expected to continue toplace, a significant strain on our management, operational and financialresources. To manage further growth, we will be required to continue to improveexisting, and implement additional, operational and financial systems,procedures and controls, and hire, train and manage additional employees. Ourcurrent and planned personnel, systems, procedures and controls may not beadequate to support our anticipated growth and we may not be able to hire,train, retain, motivate and manage required personnel. Our failure to managegrowth effectively could limit our ability to achieve our business goals.

 

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**If we cannot attract and retain key personnel, we may not be ableto execute our business plan as anticipated.**

 

Our success is dependent on our ability to attractand retain qualified, experienced personnel. We face significant competition inrecruiting competent personnel. Because the location of our headquarters is inan area with relatively few pharmaceutical companies recruiting candidates hasbeen more difficult, as many candidates prefer to work in places with a broadpharmaceutical industry presence. The loss of key personnel, or the inabilityto attract and retain additional, competent employees, could adversely affectour business and financial results.

 

We have assigned many key responsibilities withinour company to, and are dependent on, a relatively small number of individuals.If we lose the services of our Chief Executive Officer, President, ChiefFinancial Officer, Chief Medical Officer, or the Managing Director of EuropeanSubsidiaries, our ability to execute our business plan in the manner wecurrently anticipate would be adversely affected. We maintain key person lifeinsurance only for our Chief Executive Officer and President. We have anemployment agreement with each of our key personnel.

 

**We may incur substantial liabilities and may be required tolimit commercialization of our products in response to product liabilityclaims.**

 

The testing and marketing of medical productsentails an inherent risk of product liability. We may be held liable tothe extent that there are any adverse reactions from the use of our products.Some of our products involve new methods of delivery for drugs, some of which may requireprecautions to prevent unintended use, especially since they are designed forpatients’ self-use rather than being administered by medical professionals. TheFDA may require us to develop a comprehensive risk management program forour products. The failure of these measures could result in harmful sideeffects or death. As a result, consumers, regulatory agencies, pharmaceuticalcompanies or others might make claims against us. If we cannot successfullydefend ourselves against product liability claims, we may incursubstantial liabilities, lose market share or be required to limitcommercialization of our products.

 

Our inability to obtain sufficient product liabilityinsurance at an acceptable cost to protect against potential product liabilityclaims could inhibit or prevent the commercialization of pharmaceuticalproducts we develop alone or with corporate collaborators. We maintain productliability insurance in the amount of €3 million (approximately $3.6million U.S. Dollars) and clinical trial insurance in connection with ourclinical testing activities in various amounts on a study-by-study basis. Whilemanagement believes that this insurance is reasonable, we cannot assure youthat any of this coverage will be adequate to protect us in the event of aclaim. We, or any corporate collaborators, may not be able to obtain ormaintain insurance at a reasonable cost, if at all. Even if our agreements withany future corporate collaborators entitle us to indemnification againstlosses, such indemnification may not be available or adequate if any claimarises. Our agreement with Perrigo Company requires us to secure productliability insurance equal to $10 million upon commercialization of the productbeing developed. There can be no assurance that we will be able to secure suchan amount of coverage at a reasonable cost or at all or that if secured, thatit will be adequate to protect us in the event of a claim.

 

**Our revenues, operating results and cash flows may fluctuatein future periods and we may fail to meet investor expectations, which may causethe price of our common stock to decline.**

 

Variations in our quarterly and year-end operatingresults are difficult to predict and may fluctuate significantly fromperiod to period. If our sales or operating results fall below the expectations

 

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ofinvestors or securities analysts, the price of our common stock could declinesubstantially. In addition to the other factors discussed under these “RiskFactors,” specific factors that may cause fluctuations in our operatingresults include:

 

•                  demandand pricing for our products, including changes in wholesaler purchasing;

 

•                  governmentor private healthcare reimbursement policies;

 

•                  physician,pharmacy and patient acceptance of any of our current or future products;

 

•                  patternsor cost structures for our products;

 

•                  introductionof competing products, including generics;

 

•                  anyinterruption in the manufacturing or distribution of Testim or any of ourfuture products;

 

•                  ouroperating expenses which fluctuate due to growth of our business;

 

•                  timingand size of any new product or technology acquisitions we may complete;and

 

•                  variationsin our rates of product returns and allowances.

 

Forecasting our revenues is complicated bydifficulties in estimating inventory levels at our wholesalers and pharmacies,the timing of purchases by wholesalers and retailers to replenish inventory andthe occurrence and amount of product returns.

 

**Your percentage of ownership and voting power and the price of ourcommon stock may decrease as a result of events that increase the numberof our outstanding shares.**

 

As of December 31, 2005, we had the following capitalstructure:

 
| ** **                                                              | ** ** | **No. of Shares** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------|------------|
|                                                                    |       |                   |       |
| *Common Stock outstanding*                                              | * *   | *21,923,142*           | * *   |
|                                                                    |       |                   |       |
| *Common stock issuable upon:*                                           |       |                   |       |
| *Exercise  of options which are outstanding*                            | * *   | *3,916,378*            | * *   |
| *Exercise  of options which are available for grant*                    | * *   | *438,029*              | * *   |
|                                                                    |       |                   |       |
| *Total common stock outstanding assuming  exercise of all of the above* | * *   | *26,277,549*           | * *   |

 

As of December 31, 2005, we had outstandingoptions to purchase 3,916,378 shares of common stock at exercise prices rangingfrom $2.00 to $15.83 (exercisable at a weighted average of $8.72 per share), ofwhich 3,076,253 were then vested and exercisable. We may conduct futureofferings of our common stock or other securities with rights to convert thesecurities into shares of our common stock. Exercise of our outstanding optionsinto shares of our common stock may significantly and negatively affectthe market price for our common stock as well as decrease your percentageownership and voting power.

 

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**Our stock price is volatile.**

 

The market prices for our securities and forsecurities of emerging growth companies have historically been highly volatile.During the two years ended March 10, 2006, the price of our common stock hasranged from a high of $22.90 to a low of $6.50. Future announcements concerningus or our competitors may have a significant impact on the market price ofour common stock. Factors which may affect our market price include:

 

•                  progressof our relationships with strategic partners;

 

•                  resultsof clinical studies and regulatory reviews;

 

•                  technologicalinnovations by us or our competitors;

 

•                  marketconditions in the pharmaceutical, drug delivery and biotechnology industries;

 

•                  effectof regulatory authorities on pricing of products;

 

•                  competitiveproducts;

 

•                  financings;

 

•                  salesor the possibility of sales of our common stock;

 

•                  ourresults of operations and financial condition;

 

•                  proprietaryrights;

 

•                  publicconcern as to the safety or commercial value of our products; and

 

•                  generaleconomic conditions.

 

These uncertainties may adversely affect the marketprice of our common stock. Furthermore, the stock market has experiencedsignificant price and volume fluctuation unrelated to the operating performanceof particular companies. These market fluctuations may also adverselyaffect the market price of our common stock.

 

**Delaware law and provisions in our certificate of incorporation, bylawsand stockholder rights plan may prevent or discourage third parties orstockholders from attempting to replace the management of the Company.**

 

As a Delaware company, we are subject to Section 203of the Delaware General Corporation Law, as amended, which is a statutoryprovision intended to discourage certain takeover attempts that are notapproved by the board of directors. Section 203 prohibits a Delawarecorporation from engaging in any business combination with any interestedstockholder for a period of three years following the date that suchstockholder became an interested stockholder subject to certain exceptions.

 

Our certificate of incorporation and bylaws includeprovisions that also may have the effect of discouraging, delaying orpreventing a change in control or an unsolicited acquisition proposal that astockholder might consider favorable. Our board of directors is divided intothree classes with staggered three-year terms, which makes it more difficultfor an acquiror to change the overall composition of the board in a shortperiod of time. The affirmative vote of at least two-thirds of our outstandingshares is required to approve a merger, a sale or lease of all or substantiallyall of our assets, certain other business combinations or dissolution orliquidation, and an affirmative vote of two-thirds of our outstanding shares is

 

36

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requiredto amend or repeal any provision in our certificate of incorporation relatingto our directors and officers as well as certain other provisions in ourcertificate of incorporation. Additionally, our certificate of incorporationauthorizes our board of directors to issue preferred stock in one or more series withthe rights, obligations and preferences of each series to be determined byour board without stockholder approval. Our staggered board, the super-majorityvoting provisions and the potential issuance of preferred stock may havethe effect of delaying, preventing or discouraging third parties orstockholders from attempting to replace our management.

 

To the same potential effect, we have a stockholderrights plan designed to prevent a potential acquirer from gaining control of uswithout adequately compensating our shareholders and to protect us fromcoercive takeover attempts. The rights will become exercisable only if anyperson or group of affiliated persons beneficially acquires 15% or more of ourcommon stock. Under certain circumstances, each holder of a right (other thanthe person or group who acquired 15% or more of our common stock) is entitledto purchase a defined number of shares of our common stock at 50% of its marketprice at the time that the right becomes exercisable.

 

**Item 1B.**                                                  Unresolved Staff Comments 

 

None.

 

**Item 2.**                                                           Properties 

 

We own a 15,700 square foot commercial buildingsituated on approximately 14 acres of land in Exeter, New Hampshire that servesas our corporate headquarters and research and development laboratory. It islocated approximately 45 minutes north of Boston, Massachusetts.

 

We also own a 108,000 square foot facility inZaragoza, Spain, which accommodates our pharmaceutical products manufacturingplant, warehouse, research and development laboratory and office space.

 

We own an 11,000 square foot active pharmaceuticalingredients manufacturing facility in Zaragoza, Spain and during 2005 wepurchased adjacent parcels of land totaling approximately four acres forexpansion of our active pharmaceutical ingredients manufacturing operation. TheAPI manufacturing facility is located in an industrial park and we haveacquired sufficient acreage adjacent thereto to accommodate future expansion.

 

We lease a 13,000 square foot facility in SanSebastian de los Reyes, Spain, an area northwest of Madrid, which houses theadministrative offices for our Spanish and European operations. The lease forthis facility expires in 2008.

 

We believe that each of our facilities hassufficient space for our current needs and our contemplated expansion in thenear future. Our manufacturing facilities are currently operating atapproximately 70% of capacity, if operating for two shifts per day, five daysper week.

 

**Item 3.****                                                          ****Legal Proceedings**

 

On February 4, 2002, we were notified that alegal proceeding had been commenced against us by Merck &Co. Inc. and its Spanish subsidiary, Merck Sharp & Dohme deEspaña, S.A., alleging that we

 

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violatedtheir patents in our production of simvastatin products and requested aninjunction ordering us to not manufacture or market the products. The case wasbrought against our Spanish subsidiaries in the 39th First Instance Court of the City of Madrid.After a hearing on February 18, 2002, the court refused to grant therequested injunction and dismissed the case on February 25, 2002, awardingus with court costs and legal fees. Merck appealed the award of fees, but theMadrid Court of Appeal rejected its allegations and upheld the First Instancedecision in our favor.

 

Merck filed an infringement action against us inanother proceeding brought in the 19th First Instance Court of the City of Madrid, ofwhich we received notice on January 23, 2003. In this case, Merck alsoalleged violation of its patents in the production of simvastatin products,requested an order that we cease manufacturing the products and demandeddamages during the period of manufacture. After a trial with respect to thismatter held on February 19 and 20, 2004, the court, on April 8, 2004,ruled in our favor, again awarding us with court costs and legal fees. Merckappealed this ruling, but the Madrid Court of Appeal upheld the First Instancejudgment on all grounds, rejecting Merck’s appeal (judgment rendered on February 21,2006, served to the parties on March 6, 2006). Merck has the ability toappeal this judgment before the Spanish Supreme Court.

 

On January 10, 2004, we were notified that alegal proceeding had been commenced against us by Smith Kline Beecham PLC,Smith Kline Beecham, S.A. and GlaxoSmithKline S.A. alleging that we violatetheir patents in our production of paroxetine products and requesting an orderrequiring us to not manufacture or market the products. The case was broughtagainst our Spanish subsidiaries in the 50th First Instance Court of the City of Madrid. Thisproceeding followed a preliminary injunction that the same plaintiffs attemptedto bring against us in 2003, which was dismissed. We filed a response to thissuit in February 2004 that included a counterclaim requesting that thecourt declare the asserted patent invalid. On May 11, 2005, theSpanish Court terminated these judicial proceedings upon agreement among theparties to dismiss, without recourse, all paroxetine-related patentinfringement claims in Spain.

 

On September 27, 2004, we were served with acomplaint in an action captioned Ethypharm S.A. France & EthypharmS.A. Spain v. Bentley Pharmaceuticals, Inc., U.S. District Court forthe District of Delaware, Civil Action No. 04-1300 (SLR). In this action,Ethypharm S.A., a French-based drug delivery company, and its Spanish affiliate(collectively, “Ethypharm”), allege that since March 2002 we and ourSpanish subsidiary Laboratorios Belmac, S.A. (“Belmac”) misappropriatedunspecified Ethypharm trade secrets and confidential information and used thatinformation in the manufacture of omeprazole, one of Belmac’s pharmaceuticalproducts. Based on Ethypharm’s primary allegation of misappropriation of tradesecrets, the complaint also asserted counts of fraud, unjust enrichment, andintentional interference with actual and prospective business relationships.Ethypharm’s complaint seeks injunctive relief as well as damages. On September 26,2005, the Court granted our motion to dismiss two counts, Count 1 (Fraud) andCount 3 (Unjust Enrichment), of Ethypharm’s complaint but denied our motion todismiss the complaint in its entirety without prejudice to its being renewedafter the completion of discovery on the issue of agency. We intend to contestthe case vigorously.

 

On April 11, 2005, Ethypharm’s Spanishaffiliate, Ethypharm S.A., filed suit against Belmac S.A. in the CommercialCourt No. 5 of Madrid, Spain. The complaint alleges that Belmac refused torenew its contract with Ethypharm for the manufacture of omeprazole whichexpired on March 22, 2002, and that after that date Belmac’s continuedmanufacture of omeprazole pursuant to its own patented technology has infringedEthypharm’s Spanish Patent No. ES9301319. In its complaint, Ethypharmseeks an order from the court declaring Belmac to be in violation of Ethypharm’spatent, preventing further sales of omeprazole by Belmac using processes thatallegedly infringe Ethypharm’s patent, and awarding monetary damages. On July 5,2005, Belmac filed an answer and counterclaim which denies Ethypharm’s materialallegations and seeks a declaration that Ethypharm’s patent is invalid.

 

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Ethypharmhas responded to Belmac’s counterclaim. No trial date has been set. Belmacintends to defend the case vigorously.

 

In January 2005, we were notified that a legalproceeding had been commenced against us by Pfizer Inc and its Spanishsubsidiary Pfizer, S.A. requesting an order requiring us to not manufacture ormarket our amlodipine products. The case was brought against Laboratorios DavurS.L. in the 3rd Commercial Court of the City ofBarcelona. After an initial hearing the court imposed an injunction,preventing us from launching our amlodipine products. However, upon appeal, thecourt lifted the requested injunction and awarded us with court costs and legalfees.

 

We are a party to various other legal actions thatarose in the ordinary course of business. We do not expect that resolution ofthese matters will have, individually or in the aggregate, a material adverseeffect on our financial position, results of operations or cash flows.

 

**Item 4.****                                                          ****Submission of Matters to a Voteof Security Holders**

 

None.

 

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**Part II**

 

**Item 5.****                                                          ****Market for Registrant’s CommonEquity, Related Stockholder Matters and Issuer Purchases of Equity Securities**

 

The following table sets forth, for the periodsindicated, the range of quarterly high and low sales prices for our commonstock as reported on the New York Stock Exchange (beginning May 12, 2004 –and on the American Stock Exchange prior thereto) under the symbol “BNT.” Ourcommon stock began trading on the New York Stock Exchange on May 12, 2004and on the Pacific Exchange on March 27, 1996.

 
| ** **                                      | ** ** | **High** | ** ** | **Low**  | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
| ***Fiscal Year Ended December 31, 2004***  | * *   | * * | * *   | * * | * *   |
| *First Quarter*                                 | * *   | *$*      | *14.76*    | * * | *$*        | *10.62* | * * |
| *Second Quarter*                                | * *   | *14.10*  | * *   | *11.20*  | * *   |
| *Third Quarter*                                 | * *   | *13.89*  | * *   | *9.52*   | * *   |
| *Fourth Quarter*                                | * *   | *11.40*  | * *   | *8.35*   | * *   |
| * *                                        | * *   | * * | * *   | * * | * *   |
| ***Fiscal Year Ended December 31, 2005***  | * *   | * * | * *   | * * | * *   |
| *First Quarter*                                 | * *   | *11.02*  | * *   | *7.25*   | * *   |
| *Second Quarter*                                | * *   | *12.10*  | * *   | *6.50*   | * *   |
| *Third Quarter*                                 | * *   | *12.95*  | * *   | *10.63*  | * *   |
| *Fourth Quarter*                                | * *   | *20.80*  | * *   | *11.27*  | * *   |
| * *                                        | * *   | * * | * *   | * * | * *   |
| ***Fiscal Year Ending December 31, 2006*** | * *   | * * | * *   | * * | * *   |
| *First Quarter (through March 10, 2006)*   | * *   | *22.90*  | * *   | *14.02*  | * *   |
|                                                 |            |          |            |          |            |  |  |

 

As of March 10, 2006 there were 1,018 holdersof record of our common stock, which does not reflect stockholders whose sharesare held in street name.

 

**Dividends**

 

We have never paid cash dividends on our common stockand we do not intend to pay dividends in the foreseeable future. We intend toretain future earnings in order to finance the growth and development of ourbusiness.

 

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**Issuer Purchases of Equity Securities**

 
| ** **                                            | ** ** | **(a)  Total Number  of Shares  (or Units)  Purchased (1)** | ** ** | **(b)  Average  Price  Paid per  Share  (or  Unit)(2)** | ** ** | **(c)  Total Number  of Shares  (or Units) Purchased as  Part of Publicly  Announced  Plans or  Programs** | ** ** | **(d)  Maximum  Number  (or approximate  dollar value)  of Shares (or  Units) that  may yet be  Purchased  under the Plans  or  Programs** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------------------|------------|---------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                            | ** ** | ** **                                                  | ** ** | ** **                                              | ** ** | ** **                                                                                                      | ** ** | ** **                                                                                                                                      | ** ** |
| October 1, 2005 through October 31,  2005   |       | —                                                      |       | $                                                       | —     |                                                                                                            | —     |                                                                                                                                            | —     |   |
| November 1, 2005 through November 30,  2005 |       | —                                                      |       | —                                                  |       | —                                                                                                          |       | —                                                                                                                                          |       |
| December 1, 2005 through December 31,  2005 |       | 65,711                                                      |       | 18.454                                                  |       | —                                                                                                          |       | —                                                                                                                                          |       |
|                                                  |       |                                                        |       |                                                    |       |                                                                                                            |       |                                                                                                                                            |       |
| Total                                                 |       | 65,711                                                      |       | $                                                       | 18.454     |                                                                                                            | —     |                                                                                                                                            | —     |   |

 

**(1)**              Represents shares tendered to the Company atfair market value from option holders using mature stock to exercise vestedstock options and satisfy minimum tax withholding liabilities.

 

**(2)****             **Weighted average of the high and low prices onthe NYSE on the dates of exercise.

 

**Item6.**           Selected Financial Data

 

The following sets forth the selected ConsolidatedIncome Statement data for the years ended December 31, 2001, 2002, 2003,2004 and 2005 and Consolidated Balance Sheet data as of December 31, 2001,2002, 2003, 2004 and 2005, all of which are derived from our auditedConsolidated Financial Statements and related notes. The following ConsolidatedIncome Statement data for the years ended December 31, 2003, 2004 and 2005and Consolidated Balance Sheet data as of December 31, 2004 and 2005should be read together with our Consolidated Financial Statements and relatednotes appearing elsewhere in Item 15 and “Management’s Discussion and Analysisof Financial Condition and Results of Operations” of this Annual Report on Form 10-K.The Consolidated Income Statement data for the years ended December 31,2001 and 2002 and the Consolidated Balance Sheet data as of December 31,2001, 2002 and 2003 are derived from our audited Consolidated FinancialStatements and related notes not included in this Annual Report on Form 10-K.

 

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**Consolidated Income Statement Data**

 
| ** **                                              | ** ** | **For the Year Ended December 31,** | ** ** |
|---------------------------------------------------------|------------|------------------------------------------|------------|
| **(in thousands, except per share  data)**              | ** ** | **2001**                                 | ** ** | **2002** | ** ** | **2003** | ** ** | **2004(a)** | ** ** | **2005(b)** | ** ** |
| * *                                                | * *   | * *                                 | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Total  revenues*                                       | * *   | *$*                                      | *26,411*   | * * | *$* | *39,136* | * * | *$* | *64,676* | * * | *$* | *73,393* | * * | *$* | *97,730* | * * |
| *Cost of  net product sales*                            | * *   | *11,462*                                 | * *   | *16,477* | * * | *26,399* | * * | *34,893* | * * | *46,161* | * * |
| *Gross  profit*                                         | * *   | *14,949*                                 | * *   | *22,659* | * * | *38,277* | * * | *38,500* | * * | *51,569* | * * |
| *Operating  expenses*                                   | * *   | *16,137*                                 | * *   | *19,277* | * * | *26,848* | * * | *29,805* | * * | *35,903* | * * |
| *Gain on  sale of drug licenses*                        | * *   | *5,050*                                  | * *   | *650* | * * | *—* | * * | *—* | * * | *—* | * * |
| *Other  income (expenses)*                              | * *   | *(49*                                    | *)*        | *138* | * * | *91* | * * | *1,800* | * * | *729* | * * |
| *Income  before income taxes*                           | * *   | *3,813*                                  | * *   | *4,170* | * * | *11,520* | * * | *10,495* | * * | *16,395* | * * |
| *Provision  for income taxes*                           | * *   | *2,452*                                  | * *   | *2,534* | * * | *5,423* | * * | *4,805* | * * | *5,476* | * * |
| *Net  income*                                           | * *   | *$*                                      | *1,361*    | * * | *$* | *1,636* | * * | *$* | *6,097* | * * | *$* | *5,690* | * * | *$* | *10,919* | * * |
| * *                                                | * *   | * *                                 | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Net  income per common share - basic*                  | * *   | *$*                                      | *0.10*     | * * | *$* | *0.10* | * * | *$* | *0.34* | * * | *$* | *0.27* | * * | *$* | *0.51* | * * |
| * *                                                | * *   | * *                                 | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Net  income per common share - diluted*                | * *   | *$*                                      | *0.08*     | * * | *$* | *0.08* | * * | *$* | *0.28* | * * | *$* | *0.25* | * * | *$* | *0.48* | * * |
| * *                                                | * *   | * *                                 | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Weighted  average common shares outstanding - basic*   | * *   | *14,196*                                 | * *   | *16,569* | * * | *17,997* | * * | *20,901* | * * | *21,558* | * * |
| * *                                                | * *   | * *                                 | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Weighted  average common shares outstanding - diluted* | * *   | *16,147*                                 | * *   | *19,798* | * * | *21,637* | * * | *22,627* | * * | *22,929* | * * |

 

(a)          *Other income (expenses)*for the year ended December 31, 2004 includes the reversal of previouslyaccrued tax assessments totaling $1,467,000. These assessments had been accruedto be paid to the Spanish government as a vehicle to help reduce the impact ofthe rising health care costs in Spain. Due to changes in the pharmaceuticalindustry in Spain and a change in the Spanish political environment, theseliabilities no longer exist. Accordingly, these accruals were reversed duringthe second quarter of 2004. Additionally, a reclass of approximately$342,000 has been made between *Depreciation andamortization* and *Cost of net product sales*for depreciation on certain fixed assets to conform with the 2005presentation format.

 

(b)         *Total revenues* forthe year ended December 31, 2005 include a change in estimate of royaltyrevenues earned of approximately $1,092,000 recorded in the fourth quarter of2005. This change in estimate of royalty revenues earned is based upon publiclyavailable data determined to be more accurate than the source of datapreviously relied upon by management in estimating the sell-through ofprescriptions dispensed.

 

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**Consolidated Balance Sheet Data**

 
| ** **                      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-----------------------|------------|
| **(in thousands)**              | ** ** | **2001**              | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| * *                        | * *   | * *              | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Working capital*               | * *   | *$*                   | *6,276*    | * * | *$* | *30,703* | * * | *$* | *46,181* | * * | *$* | *47,114* | * * | *$* | *46,397* | * * |
| * *                        | * *   | * *              | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Current assets*                | * *   | *$*                   | *15,839*   | * * | *$* | *43,972* | * * | *$* | *66,899* | * * | *$* | *74,710* | * * | *$* | *75,077* | * * |
| *Non-current assets*            | * *   | *16,280*              | * *   | *20,720* | * * | *33,564* | * * | *47,220* | * * | *49,143* | * * |
| *Total assets*                  | * *   | *$*                   | *32,119*   | * * | *$* | *64,692* | * * | *$* | *100,463* | * * | *$* | *121,930* | * * | *$* | *124,220* | * * |
| * *                        | * *   | * *              | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Current liabilities*           | * *   | *$*                   | *9,563*    | * * | *$* | *13,269* | * * | *$* | *20,718* | * * | *$* | *27,596* | * * | *$* | *28,680* | * * |
| *Long-term debt*                | * *   | *142*                 | * *   | *345* | * * | *369* | * * | *349* | * * | *—* | * * |
| *Other non-current liabilities* | * *   | *1,990*               | * *   | *2,327* | * * | *3,211* | * * | *4,328* | * * | *3,951* | * * |
| *Total liabilities*             | * *   | *$*                   | *11,695*   | * * | *$* | *15,941* | * * | *$* | *24,298* | * * | *$* | *32,273* | * * | *$* | *32,631* | * * |
| * *                        | * *   | * *              | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Redeemable preferred stock*    | * *   | *$*                   | *—*   | * * | *$* | *—* | * * | *$* | *—* | * * | *$* | *—* | * * | *$* | *—* | * * |
| * *                        | * *   | * *              | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| *Stockholders’ equity*     | * *   | *$*                   | *20,424*   | * * | *$* | *48,751* | * * | *$* | *76,165* | * * | *$* | *89,657* | * * | *$* | *91,589* | * * |

 

43

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**Item 7.****                                                          ****Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

The following discussion and analysis should be readin conjunction with the Financial Statements and related Notes included in Item8 of this report. Except for the historical information contained herein theforegoing discussion contains forward-looking statements that involve risks anduncertainties. Our actual results could differ materially from those projectedin the forward-looking statements discussed herein.

 

Words such as “expect”, “anticipate”, “intend”, “believe”,“will”, “may”, “could”, “should”, “project”, “estimate” and similar words areused to identify forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995. These forward-lookingstatements, including, but not limited to, the statements in the BusinessSection, Management’s Discussion and Analysis of Financial Condition andResults of Operations, Risk Factors and other sections in this report, are notbased on historical facts, but rather reflect our current expectationsconcerning future results and events. The forward-looking statements includestatements about our strategy, the prospects of our technologies and researchand development efforts, our plans to enter into more collaborativerelationships, our prospects for revenue growth outside of Spain, anticipatedfinancial results and the prospects for growth of our business. Although webelieve that the expectations reflected in the forward-looking statements arereasonable, such statements involve known and unknown risks, uncertainties andother factors that may cause our actual results, performance orachievements to be different from any future results, performance andachievements expressed or implied by these statements, including the risksoutlined in the Risk Factors section and elsewhere in this report. You arecautioned not to place undue reliance on these forward-looking statements. Weundertake no obligation to publicly update or revise any forward-lookingstatements, whether as the result of new information, future events orotherwise.

 

**Overview**

 

We are a specialty pharmaceutical company focusedon:

 

•                  development,licensing and sales of generic and branded pharmaceutical products and activepharmaceutical ingredients and the manufacturing of pharmaceuticals for othersin Spain, other parts of Europe and international markets, including the U.S.market; and

 

•                  research,development and licensing/commercialization of advanced proprietary drugdelivery technologies for new and existing pharmaceutical products.

 

*Branded and Generic Pharmaceuticals*

 

Our pharmaceutical product sales activities arebased in Spain, where we have a significant commercial presence and wemanufacture and market approximately 100 pharmaceutical products of variousdosages and strengths. These products include approximately 151 product presentationsin four primary therapeutic areas: cardiovascular, gastrointestinal, centralnervous system and infectious diseases. In 2005, approximately 25% of ourproduct revenues were derived from two of our product lines. We market ourbranded and generic products to physicians, pharmacists and hospitals throughour three separate sales and marketing organizations based in Spain:Laboratorios Belmac, Laboratorios Davur and Laboratorios Rimafar. As prices forprescription pharmaceuticals have been lowered in Spain by action of theMinistry of Health, which has authority to approve pharmaceutical prices, weare working to improve the efficiency of our manufacturing operations to reduceour costs, while also increasing sales. We have recently focused

 

44

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onincreasing our sales in other European countries and other geographic regionsthrough strategic alliances with distributors in these territories. We also targetmarkets that offer compatible regulatory approval regimes and attractiveproduct margins. In August 2005, we formed an Irish subsidiary, BentleyPharmaceuticals Ireland Limited, to assist in our European expansion strategy.Bentley Pharmaceuticals Ireland Limited received its first marketing approvalby the Irish Medicines Board in November 2005. There were no significant revenuesin Bentley Pharmaceuticals Ireland in 2005.

 

In addition, we expect to grow our business byacquiring rights to market additional products to sell through our organizationand our strategic alliances. We continually acquire rights to new products inresponse to increasing market demand for generic and branded therapeuticproducts. For example, in November 2004, we entered into a collaborationagreement with Perrigo Company, the largest U.S. manufacturer ofover-the-counter pharmaceutical and nutritional products for the store brandmarket, to co-develop and market in the U.S. and potentially other markets ageneric pharmaceutical product that we produce in Spain. When appropriate, wedivest products that we consider to be redundant or that have becomenon-strategic.

 

We also manufacture pharmaceuticals for other drugcompanies. In April 2004, we purchased a manufacturing facility located inSpain that specializes in the manufacture of active pharmaceutical ingredients.We are manufacturing and marketing these ingredients through our subsidiary,Bentley API. In addition, our Spanish pharmaceutical product manufacturingfacility produces pharmaceutical products that are marketed by otherpharmaceutical companies both in Spain and in other international markets,including the U.S. The facility has been approved by the FDA for themanufacture of one ingredient for marketing and sale in the U.S.

 

*Proprietary Drug Delivery Technologies and Products*

 

We develop products that incorporate our drugdelivery technologies that we have developed in the United States. We havelicensed applications of our proprietary CPE-215 drug delivery technology toAuxilium Pharmaceuticals, Inc., which launched Testim the first productincorporating our CPE-215 drug delivery technology, in the United States in February 2003.Testim is a gel indicated for testosterone replacement therapy. Testim isapproved for marketing in Belgium, Denmark, Finland, Germany, Greece, Iceland,Ireland, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden and theUnited Kingdom and has received scientific approval in Italy. We are indiscussions with other pharmaceutical and biotechnology companies to form additionalstrategic alliances to facilitate the development and commercialization ofother products using our drug delivery technologies, including delivery ofinsulin to diabetic patients intranasally, delivery of macromoleculetherapeutics using a biodegradable Nanacaplet technology and topical treatmentof nail fungus.

 

45

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**Consolidated Results of Operations**

 

***Fiscal Year Ended December 31, 2005 ComparedTo Fiscal Year Ended December 31, 2004***

 

*Revenues*

 

***(in thousands)***

 
| ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|-----------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                              | ** ** | **2005**   | ** ** | **%**      | ** ** | **2004**   | ** ** | **%**      | ** ** | **$**      | ** ** | **%** | ** ** |
| ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| *Revenues:*                             | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Net  product sales*                    | * *   | *$*        | *91,308*   | * *   | *93*       | *%*        | *$*        | *69,942*   | * *   | *95*       | *%*        | *$* | *21,366* | * * | *31* | *%* |
| *Licensing  and collaboration revenues* | * *   | *6,422*    | * *   | *7*        | *%*        | *3,451*    | * *   | *5*        | *%*        | *2,971*    | * *   | *86* | *%* |
| *Total revenues*                        | * *   | *$*        | *97,730*   | * *   | *100*      | *%*        | *$*        | *73,393*   | * *   | *100*      | *%*        | *$* | *24,337* | * * | *33* | *%* |

 

Total revenues for the year ended December 31,2005 increased 33% from the year ended December 31, 2004. Fluctuations inthe weighted average value of the Euro,in relation to the U.S. Dollar had a significant impact on operations duringthe interim periods of 2005, but did not have a material impact on operations forthe full year, as the quarterly fluctuations effectively neutralized eachother. Our current year growth was driven primarily by increased net productsales. The increase in licensing and collaboration revenues was due toincreased royalty revenues from sales of Testim and included $1,092,000resulting from a revised estimate of sell-through of prescriptions dispensedthat was recorded in the fourth quarter of 2005.

 

Our revenues are generated through our primary saleschannels of branded pharmaceuticals, generic pharmaceuticals, sales tolicensees and others and licensing and collaboration revenues. The following isa summary of our revenues by sales channel and top-selling product lines:

 

For the year ended December 31, 2005: 

 

***(in thousands)***

 
| ** **                      | ** ** | **Revenues Within Spain** | ** ** | **Revenues** | ** ** | ** ** | ** ** | ** **     | ** ** |
|---------------------------------|------------|---------------------------|------------|--------------|------------|------------|------------|----------------|------------|
| ** **                      | ** ** | **Branded**               | ** ** | **Generic**  | ** ** | ** ** | ** ** | **Outside of** | ** ** | ** ** | ** ** | **% of Total** | ** ** |
| **Product Line**                | ** ** | **Products**              | ** ** | **Products** | ** ** | **Other**  | ** ** | **Spain**      | ** ** | **Total** | ** ** | **Revenues** | ** ** |
| *Omeprazole*                    | * *   | *$*                       | *2,779*    | * *     | *$*        | *15,394*   | * *   | *$*            | *—*   | * * | *$* | *—* | * * | *$* | *18,173* | * * | *18* | *%* |
| *Simvastatin*                   | * *   | *1,666*                   | * *   | *5,080*      | * *   | *—*   | * *   | *—*       | * *   | *6,746* | * * | *7* | *%* |
| *Enalapril*                     | * *   | *4,153*                   | * *   | *1,706*      | * *   | *—*   | * *   | *—*       | * *   | *5,859* | * * | *6* | *%* |
| *Paroxetine*                    | * *   | *1,337*                   | * *   | *3,118*      | * *   | *—*   | * *   | *—*       | * *   | *4,455* | * * | *5* | *%* |
| *Codesian*                      | * *   | *3,441*                   | * *   | *—*     | * *   | *—*   | * *   | *—*       | * *   | *3,441* | * * | *4* | *%* |
| *All other products*            | * *   | *9,225*                   | * *   | *9,812*      | * *   | *271*      | * *   | *1,512*        | * *   | *20,820* | * * | *21* | *%* |
| *Sales to licensees and others* | * *   | *—*                  | * *   | *—*     | * *   | *11,589*   | * *   | *20,225*       | * *   | *31,814* | * * | *32* | *%* |
| *Licensing and collaborations*  | * *   | *—*                  | * *   | *—*     | * *   | *274*      | * *   | *6,148*        | * *   | *6,422* | * * | *7* | *%* |
| *Total Revenues*                | * *   | *$*                       | *22,601*   | * *     | *$*        | *35,110*   | * *   | *$*            | *12,134*   | * * | *$* | *27,885* | * * | *$* | *97,730* | * * | *100* | *%* |
| *% of 2005 Revenues*            | * *   | *23*                      | *%*        | *36*         | *%*        | *12*       | *%*        | *29*           | *%*        | *100* | *%* | * * | * * |

 

46

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For the year ended December 31, 2004:

 

***(in thousands)***

 
| ** **                      | ** ** | **Revenues Within Spain** | ** ** | **Revenues** | ** ** | ** ** | ** ** | ** **     | ** ** |
|---------------------------------|------------|---------------------------|------------|--------------|------------|------------|------------|----------------|------------|
| ** **                      | ** ** | **Branded**               | ** ** | **Generic**  | ** ** | ** ** | ** ** | **Outside of** | ** ** | ** ** | ** ** | **% of Total** | ** ** |
| **Product Line**                | ** ** | **Products**              | ** ** | **Products** | ** ** | **Other**  | ** ** | **Spain**      | ** ** | **Total** | ** ** | **Revenues** | ** ** |
| *Omeprazole*                    | * *   | *$*                       | *2,721*    | * *     | *$*        | *13,520*   | * *   | *$*            | *—*   | * * | *$* | *—* | * * | *$* | *16,241* | * * | *22* | *%* |
| *Simvastatin*                   | * *   | *1,392*                   | * *   | *3,638*      | * *   | *—*   | * *   | *—*       | * *   | *5,030* | * * | *7* | *%* |
| *Enalapril*                     | * *   | *3,192*                   | * *   | *1,243*      | * *   | *—*   | * *   | *—*       | * *   | *4,435* | * * | *6* | *%* |
| *Paroxetine*                    | * *   | *1,045*                   | * *   | *2,928*      | * *   | *—*   | * *   | *—*       | * *   | *3,973* | * * | *5* | *%* |
| *Codesian*                      | * *   | *3,131*                   | * *   | *—*     | * *   | *—*   | * *   | *—*       | * *   | *3,131* | * * | *4* | *%* |
| *All other products*            | * *   | *6,910*                   | * *   | *7,690*      | * *   | *576*      | * *   | *1,166*        | * *   | *16,342* | * * | *23* | *%* |
| *Sales to licensees and others* | * *   | *—*                  | * *   | *—*     | * *   | *10,502*   | * *   | *10,288*       | * *   | *20,790* | * * | *28* | *%* |
| *Licensing and collaborations*  | * *   | *—*                  | * *   | *—*     | * *   | *607*      | * *   | *2,844*        | * *   | *3,451* | * * | *5* | *%* |
| *Total Revenues*                | * *   | *$*                       | *18,391*   | * *     | *$*        | *29,019*   | * *   | *$*            | *11,685*   | * * | *$* | *14,298* | * * | *$* | *73,393* | * * | *100* | *%* |
| *% of 2004 Revenues*            | * *   | *25*                      | *%*        | *40*         | *%*        | *16*       | *%*        | *19*           | *%*        | *100* | *%* | * * | * * |

 

*Spanish Operations.*The increase in the net product sales for the year ended December 31,2005 compared to the year ended December 31, 2004 is due primarily to: (1) anincrease in sales to licensees and others totaling $11,024,000 fueled primarilyby sales outside of Spain; and (2) an aggregate increase totaling$5,072,000 in sales of our three top selling product lines (omeprazole,simvastatin and enalapril). Sales of active pharmaceutical ingredients from ourAPI manufacturing facility (included in “All other products” in the tablesabove) added $1,783,000 to consolidated revenues in 2005. Fluctuations in theweighted average value of the Euro, inrelation to the U.S. Dollar had a significant impact on operations during theinterim periods of 2005, but did not have a material impact on operations forthe year.

 

The Ministry of Health in Spain continues toencourage the substitution of generic-equivalent products in order to helpcontrol rising healthcare costs. In recent years, our business was negativelyimpacted by price reductions mandated by the Spanish government. We havefurthered our expansion into markets outside of Spain, increased the number ofdrugs in our portfolio and purchased efficient high speed manufacturingequipment to help manage our business profitability. Additionally, in April 2004,we purchased a manufacturing facility, located in Zaragoza, Spain, whichspecializes in the manufacture of active pharmaceutical ingredients. Theability to manufacture active pharmaceutical ingredients has diversified ourrevenue base. We will continue to focus on acquiring, developing and launchingnew products that will improve our product mix. Four products were launched in2005 and contributed approximately $588,000 to net product sales. We will alsocontinue our efforts to increase sales outside of Spain through additionalregistration, marketing, and supply agreements. We will also continue to makesignificant investments in renovating and increasing capacity in manufacturingfacilities and investments in new high speed, high volume equipment.

 

47

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*Branded Pharmaceutical Products*

 

***(in thousands)***

 
| ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|-------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                    | ** ** | **2005**   | ** ** | **%**      | ** ** | **2004**   | ** ** | **%**      | ** ** | **$**      | ** ** | **%** | ** ** |
| *Branded Product Sales:*      | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Enalapril*                   | * *   | *$*        | *4,153*    | * *   | *18*       | *%*        | *$*        | *3,192*    | * *   | *17*       | *%*        | *$* | *961* | * * | *30* | *%* |
| *Codesian*                    | * *   | *3,441*    | * *   | *16*       | *%*        | *3,131*    | * *   | *17*       | *%*        | *310*      | * *   | *10* | *%* |
| *Omeprazole*                  | * *   | *2,779*    | * *   | *12*       | *%*        | *2,721*    | * *   | *15*       | *%*        | *58*       | * *   | *2* | *%* |
| *Simvastatin*                 | * *   | *1,666*    | * *   | *7*        | *%*        | *1,392*    | * *   | *8*        | *%*        | *274*      | * *   | *20* | *%* |
| *Lansoprazole*                | * *   | *1,856*    | * *   | *8*        | *%*        | *31*       | * *   | *0*        | *%*        | *1,825*    | * *   | *** | * * |
| *All other  branded products* | * *   | *8,706*    | * *   | *39*       | *%*        | *7,924*    | * *   | *43*       | *%*        | *782*      | * *   | *10* | *%* |
| *Total branded sales*         | * *   | *$*        | *22,601*   | * *   | *100*      | *%*        | *$*        | *18,391*   | * *   | *100*      | *%*        | *$* | *4,210* | * * | *23* | *%* |

 

** Not meaningful*

 

Sales of our branded pharmaceutical productsaccounted for 23% of total revenues during 2005 and increased 23%, orapproximately $4,210,000 over branded sales in 2004. Enalapril, Codeisan andomeprazole remain our top-selling branded products and accounted forapproximately 46% of branded sales in 2005. In addition to our focus onmarketing existing products, we continue to develop and market new brandedproducts. Sales of lansoprazole, a branded pharmaceutical that launched in December 2004,increased to $1,856,000 in 2005 compared to approximately $31,000 in 2004.Fluctuations in the weighted average value of the Euro, in relation to the U.S. Dollar had a significant impact on brandedsales during the interim periods of 2005, but did not have a material impact onbranded sales for the full year.

 

*Generic Pharmaceutical Products*

 

***(in thousands)***

 
| ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|-------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                    | ** ** | **2005**   | ** ** | **%**      | ** ** | **2004**   | ** ** | **%**      | ** ** | **$**      | ** ** | **%** | ** ** |
| *Generic Product Sales:*      | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Omeprazole*                  | * *   | *$*        | *15,394*   | * *   | *44*       | *%*        | *$*        | *13,520*   | * *   | *47*       | *%*        | *$* | *1,874* | * * | *14* | *%* |
| *Simvastatin*                 | * *   | *5,080*    | * *   | *14*       | *%*        | *3,638*    | * *   | *12*       | *%*        | *1,442*    | * *   | *40* | *%* |
| *Paroxetine*                  | * *   | *3,118*    | * *   | *9*        | *%*        | *2,928*    | * *   | *10*       | *%*        | *190*      | * *   | *6* | *%* |
| *Pentoxifylline*              | * *   | *2,540*    | * *   | *7*        | *%*        | *2,622*    | * *   | *9*        | *%*        | *(82*      | *)*        | *-3* | *%* |
| *Trimetazidine*               | * *   | *2,214*    | * *   | *6*        | *%*        | *1,983*    | * *   | *7*        | *%*        | *231*      | * *   | *12* | *%* |
| *All other  generic products* | * *   | *6,764*    | * *   | *20*       | *%*        | *4,328*    | * *   | *15*       | *%*        | *2,436*    | * *   | *56* | *%* |
| *Total generic sales*         | * *   | *$*        | *35,110*   | * *   | *100*      | *%*        | *$*        | *29,019*   | * *   | *100*      | *%*        | *$* | *6,091* | * * | *21* | *%* |

 

Sales of our generic pharmaceutical productsaccounted for 36% of total revenues during 2005 and increased 21%, orapproximately $6,091,000 over generic sales in 2004. Omeprazole, simvastatinand paroxetine remain our top-selling generic products and accounted for 58% ofthe generic pharmaceutical product growth. Additionally, sales of our genericformulations of ibuprofen, enalapril, lansoprazole, and mirtazapine (includedin “*All other generic products*” above)accounted for approximately 26% of the growth in generic pharmaceutical productsales. Fluctuations in the weighted average value of the Euro, in relation to the U.S. Dollar had asignificant impact on branded sales during the interim periods of 2005, but didnot have a material impact on branded sales for the full year.

 

48

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*Sales to Licensees and Others*

 

***(in thousands)***

 
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|---------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **2005**   | ** ** | **2004**   | ** ** | **$**      | ** ** | **%** | ** ** |
| * *                        | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Sales to licensees and others* | * *   | *$*        | *31,814*   | * *   | *$*        | *20,790*   | * *   | *$* | *11,024* | * * | *53* | *%* |
|                                 |            |            |            |            |            |            |            |  |  |  |  |  |

 

In addition to manufacturing and selling our ownbranded and generic products, we license the right to market products to otherswithin and outside of Spain. These license agreements are usually accompaniedby long-term exclusive supply agreements, whereby our licensees purchase the licensedproducts from our manufacturing company. As of December 31, 2005, ourSpanish operations have executed 142 license agreements for productregistrations, of which 17 with customers in Spain and 64 with customersoutside of Spain, cover actively marketed products that are generatingrevenues. The remaining licenses, two with customers in Spain and 59 withcustomers outside of Spain, are for products that are awaiting regulatoryapprovals. Additionally, we have 16 contract manufacturing agreements in effectin Spain and 6 contract manufacturing agreements in effect for internationalcustomers. Our clients market these products under their own name and withtheir own labeling. Many of the products we manufacture for others use the sameactive ingredients that are used in our own marketed products. Sales underthese agreements increased by 53% over the prior year, 54% in constantcurrency. An increase in the weighted average value of the Euro, in relation tothe U.S. Dollar, had the effect of decreasing our revenues from sales tolicensees and others by approximately $223,000, or less than 1.0%.

 

*Licensing and CollaborationRevenues.*Licensingand collaboration revenues now account for approximately 7% of total revenuesand increased by approximately $2,971,000, or approximately 86%, in 2005. Theserevenues include royalties totaling $6,132,000 from the commercialization andcontinued sales of Testim, the first product incorporating our CPE-215 drugdelivery technology, which was launched by our licensee, Auxilium, in February 2003.Testim is currently reported to have captured approximately 15% of all newtestosterone replacement prescriptions in the market. *Licensingand collaboration revenues* in 2005 includes a change in our estimateof royalty revenues earned on Testim sales of approximately $1,092,000, whichwas recorded in the fourth quarter of 2005. This change in our estimate ofroyalty revenues earned is based upon publicly available data determined to bemore accurate than the source of data previously relied upon by management inrecording estimated royalty revenues on Testim sales. Also included in *licensing and collaboration revenues* in 2005 are revenues ofapproximately $274,000 related to product licensing activities in Europe.

 

*Gross Profit.**                           *Gross profit increased by approximately$13,069,000, or 34%, in 2005, when compared to 2004. Gross margins on netproduct sales decreased from 50% in 2004 to 49% in 2005, primarily due to aSpanish pharmaceutical tax of approximately $1,555,000 charged to cost ofsales.

 

*Selling and Marketing Expenses*

 

***(in thousands)***

 
| ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|-------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **              | ** ** | **2005**   | ** ** | **2004**   | ** ** | **$**      | ** ** | **%** | ** ** |
| * *                | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Selling and marketing* | * *   | *$*        | *16,347*   | * *   | *$*        | *14,808*   | * *   | *$* | *1,539* | * * | *10* | *%* |
|                         |            |            |            |            |            |            |            |  |  |  |  |  |

 

Selling and marketing expenses increased byapproximately $1,539,000, or 10%, compared to last year. We realized anincrease of $21,366,000 in net product sales in 2005 compared to 2004, or 31%,partially through the efficient use of our selling and marketing resources.Selling and marketing expenses decreased as a percentage of net product salesto 18% in 2005, compared to 21% in 2004.

 

49

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*General and AdministrativeExpenses*

 

***(in thousands)***

 
| ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **$**      | ** ** | **%** | ** ** |
| * *                     | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *General and administrative* | * *   | *$*        | *11,998*   | * *   | *$*        | *9,126*    | * *   | *$* | *2,872* | * * | *31* | *%* |
|                              |            |            |            |            |            |            |            |  |  |  |  |  |

 

General and administrative expenses for 2005increased 31% over the prior year. The $2,872,000 increase was the result ofincreased general and administrative activities required to support ourcontinuing growth and prepare for our anticipated growth in the future. Theseexpenditures include increased costs in the current year for additionalemployees, outside services, insurance and other costs to support the growth ofour organization and costs associated with our response to the requirements ofthe Sarbanes-Oxley Act of 2002. General and administrative expenses as apercent of total revenues were 12% in 2005, which is consistent with 2004.

 

*Research and Development Expenses*

 

***(in thousands)***

 
| ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|----------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                 | ** ** | **2005**   | ** ** | **2004**   | ** ** | **$**      | ** ** | **%** | ** ** |
| * *                   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Research and development* | * *   | *$*        | *5,800*    | * *   | *$*        | *4,419*    | * *   | *$* | *1,381* | * * | *31* | *%* |
|                            |            |            |            |            |            |            |            |  |  |  |  |  |

 

Research and development expenses for 2005increased  approximately 31%  compared to 2004. The increase is directlyattributable to the advancement of our research and development programs.

 

In the first quarter of 2004, we completed andreported the results of a Phase I intranasal insulin trial, which incorporatesour CPE-215 technology. Our Phase I trial demonstrated the effective deliveryof insulin intranasally in healthy human subjects. In April 2005 weannounced that we completed the data analysis stage of our Phase II study forthe intranasal delivery of insulin, which we had concluded in December 2004. We reportedthe results of that trial in an abstract titled “Intranasal Insulin Administrationin Type I Diabetic Patients Utilizing CPE-215 Technology” at the AmericanDiabetes Association 65th Scientific Sessions, June 10-14, 2005, in SanDiego, California. Additionally, we are continuing our clinical programs tosupport our strategy for the eventual distribution of certain of our Spanishgeneric pharmaceutical products in other countries, including the U.S. throughour collaboration agreement with Perrigo Company to co-develop and market ageneric pharmaceutical product in the U.S. and potentially other markets. Weexpect to continue to incur increased costs to conduct clinical trials andsupport the required regulatory submissions for our clinical programs. Weexpect to incur increased costs for product formulation and testing efforts. Wealso expect to incur costs associated with the acquisition and/or developmentof new or improved drug delivery technologies such as our May 2, 2005announcement of the discovery and synthesis of a thermodynamically stable,biodegradable Nanocaplet technology for the delivery of macromoleculetherapeutics. The expenditures in research and development reflect our focus onprojects that are necessary for expansion of our portfolio of marketed productsand clinical trials involving our drug delivery technologies. We plan toincrease our 2006 investments in research and development by 50% or more tohelp us build on the clinical progress of CPE-215 and advance the early-stageresearch on our Nanocaplet technology.

 

50

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*Other Income (Expenses)*

 

***(in thousands)***

 
| ** **                | ** ** | ** ** | ** **   | ** ** | ** ** | **Change** | ** ** |
|---------------------------|------------|------------|--------------|------------|------------|------------|------------|
| ** **                | ** ** | **2005**   | ** **   | **2004**   | ** ** | **$**      | ** ** | **%** | ** ** |
| * *                  | * *   | * *   | * *     | * *   | * *   | * *   | * *   | * * | * * |
| *Other income (expenses)* | * *   | *$*        | *  729* | * *   | *$*        | *1,800*    | * *   | *$* | *(1,071* | *)* | *-60* | *%* |
|                           |            |            |              |            |            |            |            |  |  |  |  |  |

 

Other income (expenses) in 2005 decreased by$1,071,000 compared to 2004. The other income reported in 2004 included thereversal of previously accrued tax assessments totaling $1,467,000, partiallyoffset by interest and penalties totaling $193,000 associated with thesettlement of the tax audit of our Spanish subsidiary. Other income (expenses)in 2005 included interest income of approximately $928,000 compared toapproximately $548,000 in 2004, which increase was due to rising interest rates.

 

*Provision for Income Taxes*

 

***(in thousands)***

 
| ** **                       | ** ** | **2005**   | ** ** |
|----------------------------------|------------|------------|------------|
| ** **                       | ** ** | **Europe** | ** ** | **U.S.** | ** ** | **Consolidated** | ** ** |
| * *                         | * *   | * *   | * *   | * * | * * | * * | * * |
| *Income before income taxes*     | * *   | *$*        | *15,353*   | * * | *$* | *1,042* | * * | *$* | *16,395* | * * |
| * *                         | * *   | * *   | * *   | * * | * * | * * | * * |
| *Provision for income taxes*     | * *   | *5,216*    | * *   | *198* | * * | *5,414* | * * |
| *Valuation allowance*            | * *   | *260*      | * *   | *(198* | *)* | *62* | * * |
| * *                         | * *   | * *   | * *   | * * | * * | * * | * * |
| *Net provision for income taxes* | * *   | *5,476*    | * *   | *—* | * * | *5,476* | * * |
| * *                         | * *   | * *   | * *   | * * | * * | * * | * * |
| *Net income*                     | * *   | *$*        | *9,877*    | * * | *$* | *1,042* | * * | *$* | *10,919* | * * |
| * *                         | * *   | * *   | * *   | * * | * * | * * | * * |
| *Effective tax rate*             | * *   | *36*       | *%*        | *0* | *%* | *33* | *%* |

 

We have recorded provisions for foreign income taxestotaling $5,476,000 and $4,805,000 ($4,201,000 plus a $604,000 tax auditsettlement recorded as a result of the tax audit by Spanish authorities of ourSpanish subsidiary for the tax years 1998, 1999 and 2000) for the years ended December 31,2005 and 2004, respectively.

 

Effective October 2005, we executed intercompanyagreements between Bentley Pharmaceuticals, Inc. and Bentley PharmaceuticalsIreland Limited to license non-U.S. rights of certain technologies owned byBentley Pharmaceuticals, Inc. and provide for cost-sharing of subsequentdevelopment efforts on those technologies. A net benefit of approximately$2,045,000 has been recorded to the U.S. income from operations (and acorresponding reduction to European income from operations) in 2005 as a resultof these agreements.

 

In 2005, we generated U.S. income before incometaxes of approximately $1,042,000, compared to a loss before income taxes ofapproximately $2,913,000 in 2004. We utilized U.S federal net operating losscarry-forwards in order to offset the resulting income tax liability. As of December 31,2005, the remaining U.S federal net operating loss carry-forwards were approximately$53,514,000. Bentley Pharmaceuticals Ireland Limited, which is reported in ourEuropean operations, generated a net operating loss of approximately $2,080,000in 2005. As future operating profits cannot be reasonably assured, no

 

51

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taxbenefit has been recorded for these losses. Accordingly, we have established avaluation allowance equal to the full amount of the deferred tax assets inIreland.

 

Should we determine that it is more likely than notthat we will realize certain of our net deferred tax assets for which we havepreviously provided a valuation allowance, an adjustment would be required toreduce the existing valuation allowance. In addition, we operate withinmultiple taxing jurisdictions and are subject to audit in those jurisdictions.These audits can involve complex issues, which may require an extendedperiod of time for resolution. No additional potential tax contingencies wereconsidered to be probable and reasonably estimable as of December 31,2005. However, there is the possibility that the ultimate resolution of suchpotential contingencies could have an adverse effect on our ConsolidatedFinancial Statements in the future.

 

*Net Income*

 

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

 
| ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                    | ** ** | **2005**   | ** ** | **2004**   | ** ** | **Amount** | ** ** | **%** | ** ** |
| * *                                      | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Net income*                                  | * *   | *$*        | *10,919*   | * *   | *$*        | *5,690*    | * *   | *$* | *5,229* | * * | *92* | *%* |
| * *                                      | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Net income per common share:*                | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Basic*                                       | * *   | *$*        | *0.51*     | * *   | *$*        | *0.27*     | * *   | *$* | *0.24* | * * | *89* | *%* |
| *Diluted*                                     | * *   | *$*        | *0.48*     | * *   | *$*        | *0.25*     | * *   | *$* | *0.23* | * * | *92* | *%* |
| * *                                      | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Weighted average common shares outstanding:* | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Basic*                                       | * *   | *21,558*   | * *   | *20,901*   | * *   | *657*      | * *   | *3* | *%* |
| *Diluted*                                     | * *   | *22,929*   | * *   | *22,627*   | * *   | *302*      | * *   | *1* | *%* |

 

We reported2005 income from operations of $15,666,000, compared to 2004 income fromoperations of $8,695,000. In 2005, the combination of income from operations of$15,666,000 and the non-operating items, primarily the provision for incometaxes of $5,476,000, resulted in 2005 net income of $10,919,000, or $.51 perbasic common share ($.48 per diluted common share) on 21,558,000 weightedaverage basic common shares outstanding (22,929,000 weighted average dilutedcommon shares outstanding), compared to 2004 net income of $5,690,000, or $.27per basic common share ($.25 per diluted common share) on 20,901,000 weightedaverage basic common shares outstanding (22,627,000 weighted average dilutedcommon shares outstanding).

 

52

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***Fiscal Year Ended December 31, 2004 ComparedTo Fiscal Year Ended December 31, 2003***

 

*Revenues*

 

***(in thousands)***

 
| ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|-----------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                              | ** ** | **2004**   | ** ** | **%**      | ** ** | **2003**   | ** ** | **%**      | ** ** | **$**      | ** ** | **%** | ** ** |
| *Revenues:*                             | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Net  product sales*                    | * *   | *$*        | *69,942*   | * *   | *95*       | *%*        | *$*        | *62,955*   | * *   | *97*       | *%*        | *$* | *6,987* | * * | *11* | *%* |
| *Licensing  and collaboration revenues* | * *   | *3,451*    | * *   | *5*        | *%*        | *1,721*    | * *   | *3*        | *%*        | *1,730*    | * *   | *101* | *%* |
| *Total revenues*                        | * *   | *$*        | *73,393*   | * *   | *100*      | *%*        | *$*        | *64,676*   | * *   | *100*      | *%*        | *$* | *8,717* | * * | *13* | *%* |

 

Total revenues for 2004 increased 13% from2003. However, our total revenues increased approximately 3% when expressed inconstant currency. An increase in the weighted average value of the Euro, inrelation to the U.S. Dollar, had the effect of increasing revenues byapproximately $6,502,000, partially offsetting the impact of price reductionsin Spain. Sales of active pharmaceutical ingredients from our new manufacturingfacility (included in “*All other products*”in the table below) added $1,742,000 to our consolidated revenues in 2004. Theadvancement of our proprietary drug delivery programs in the U.S., evidenced bythe growing royalty stream from sales of Testim, and other licensing revenues,increased our 2004 revenues by approximately $1,730,000, when compared to theprior year.

 

Our revenues were generated through ourprimary sales channels of branded pharmaceuticals, generic pharmaceuticals,sales to licensees and others and licensing and collaboration revenues. Thefollowing is a summary of our revenues by sales channel and top-selling productlines:

 

For the year ended December 31, 2004:

 

***(in thousands)***

 
| ** **                      | ** ** | **Revenues Within Spain** | ** ** | **Revenues** | ** ** | ** ** | ** ** | ** **     | ** ** |
|---------------------------------|------------|---------------------------|------------|--------------|------------|------------|------------|----------------|------------|
| ** **                      | ** ** | **Branded**               | ** ** | **Generic**  | ** ** | ** ** | ** ** | **Outside of** | ** ** | ** ** | ** ** | **% of Total** | ** ** |
| **Product Line**                | ** ** | **Products**              | ** ** | **Products** | ** ** | **Other**  | ** ** | **Spain**      | ** ** | **Total** | ** ** | **Revenues** | ** ** |
| *Omeprazole*                    | * *   | *$*                       | *2,721*    | * *     | *$*        | *13,520*   | * *   | *$*            | *—*   | * * | *$* | *—* | * * | *$* | *16,241* | * * | *22* | *%* |
| *Simvastatin*                   | * *   | *1,392*                   | * *   | *3,638*      | * *   | *—*   | * *   | *—*       | * *   | *5,030* | * * | *7* | *%* |
| *Enalapril*                     | * *   | *3,192*                   | * *   | *1,243*      | * *   | *—*   | * *   | *—*       | * *   | *4,435* | * * | *6* | *%* |
| *Paroxetine*                    | * *   | *1,045*                   | * *   | *2,928*      | * *   | *—*   | * *   | *—*       | * *   | *3,973* | * * | *5* | *%* |
| *Codesian*                      | * *   | *3,131*                   | * *   | *—*     | * *   | *—*   | * *   | *—*       | * *   | *3,131* | * * | *4* | *%* |
| *All other products*            | * *   | *6,910*                   | * *   | *7,690*      | * *   | *576*      | * *   | *1,166*        | * *   | *16,342* | * * | *23* | *%* |
| *Sales to licensees and others* | * *   | *—*                  | * *   | *—*     | * *   | *10,502*   | * *   | *10,288*       | * *   | *20,790* | * * | *28* | *%* |
| *Licensing and collaborations*  | * *   | *—*                  | * *   | *—*     | * *   | *607*      | * *   | *2,844*        | * *   | *3,451* | * * | *5* | *%* |
| *Total Revenues*                | * *   | *$*                       | *18,391*   | * *     | *$*        | *29,019*   | * *   | *$*            | *11,685*   | * * | *$* | *14,298* | * * | *$* | *73,393* | * * | *100* | *%* |
| *% of 2004 Revenues*            | * *   | *22*                      | *%*        | *40*         | *%*        | *16*       | *%*        | *19*           | *%*        | *100* | *%* | * * | * * |

 

53

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For the year ended December 31, 2003:

 

***(in thousands)***

 
| ** **                      | ** ** | **Revenues Within Spain** | ** ** | **Revenues** | ** ** | ** ** | ** ** | ** **     | ** ** |
|---------------------------------|------------|---------------------------|------------|--------------|------------|------------|------------|----------------|------------|
| ** **                      | ** ** | **Branded**               | ** ** | **Generic**  | ** ** | ** ** | ** ** | **Outside of** | ** ** | ** ** | ** ** | **% of Total** | ** ** |
| **Product Line**                | ** ** | **Products**              | ** ** | **Products** | ** ** | **Other**  | ** ** | **Spain**      | ** ** | **Total** | ** ** | **Revenues** | ** ** |
| *Omeprazole*                    | * *   | *$*                       | *6,099*    | * *     | *$*        | *13,863*   | * *   | *$*            | *—*   | * * | *$* | *—* | * * | *$* | *19,962* | * * | *31* | *%* |
| *Simvastatin*                   | * *   | *2,176*                   | * *   | *4,412*      | * *   | *—*   | * *   | *—*       | * *   | *6,588* | * * | *10* | *%* |
| *Enalapril*                     | * *   | *2,610*                   | * *   | *1,878*      | * *   | *—*   | * *   | *—*       | * *   | *4,488* | * * | *7* | *%* |
| *Paroxetine*                    | * *   | *—*                  | * *   | *749*        | * *   | *—*   | * *   | *—*       | * *   | *749* | * * | *1* | *%* |
| *Codesian*                      | * *   | *2,713*                   | * *   | *—*     | * *   | *—*   | * *   | *—*       | * *   | *2,713* | * * | *4* | *%* |
| *All other products*            | * *   | *5,463*                   | * *   | *6,065*      | * *   | *—*   | * *   | *—*       | * *   | *11,528* | * * | *18* | *%* |
| *Sales to licensees and others* | * *   | *—*                  | * *   | *—*     | * *   | *9,536*    | * *   | *7,391*        | * *   | *16,927* | * * | *26* | *%* |
| *Licensing and collaborations*  | * *   | *—*                  | * *   | *—*     | * *   | *203*      | * *   | *1,518*        | * *   | *1,721* | * * | *3* | *%* |
| *Total Revenues*                | * *   | *$*                       | *19,061*   | * *     | *$*        | *26,967*   | * *   | *$*            | *9,739*    | * * | *$* | *8,909* | * * | *$* | *64,676* | * * | *100* | *%* |
| *% of 2003 Revenues*            | * *   | *29*                      | *%*        | *42*         | *%*        | *15*       | *%*        | *14*           | *%*        | *100* | *%* | * * | * * |

 

*Spanish Operations.*The core of our Spanishoperations has been the efficient manufacturing and domestic marketing ofbranded and generic pharmaceutical products. The 11% increase in net productsales for the year ended December 31, 2004 over the prior year wasprimarily due to an increase in the weighted average value of the Euro inrelation to the U.S. Dollar, increased sales outside of Spain, increased salesof our paroxetine product line, which was initially launched in May 2003,and increases in sales of other generic products, such as trimetazedine,pentoxifylline and increases in sales to licensees and others. Our paroxetineproduct line generated net sales of $3,973,000, representing 5% of our totalrevenues during 2004 and 37% of our total growth in 2004. These increaseshelped to offset or lessen the impact of price reductions in Spain, which arediscussed below. Revenues from our omeprazole products in 2004 declined to 22%of our total revenues, compared to 31% in the prior year, due to reducedselling prices in Spain.

 

*Branded Pharmaceutical Products*

 

***(in thousands)***

 
| ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|-------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                    | ** ** | **2004**   | ** ** | **%**      | ** ** | **2003**   | ** ** | **%**      | ** ** | **$**      | ** ** | **%** | ** ** |
| *Branded Product Sales:*      | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Enalapril*                   | * *   | *$*        | *3,192*    | * *   | *17*       | *%*        | *$*        | *2,610*    | * *   | *14*       | *%*        | *$* | *582* | * * | *22* | *%* |
| *Codeisan*                    | * *   | *3,131*    | * *   | *17*       | *%*        | *2,713*    | * *   | *14*       | *%*        | *418*      | * *   | *15* | *%* |
| *Omeprazole*                  | * *   | *2,721*    | * *   | *15*       | *%*        | *6,099*    | * *   | *32*       | *%*        | *(3,378*   | *)*        | *-55* | *%* |
| *Mio Relax*                   | * *   | *1,485*    | * *   | *8*        | *%*        | *1,114*    | * *   | *6*        | *%*        | *371*      | * *   | *33* | *%* |
| *Simvastatin*                 | * *   | *1,392*    | * *   | *8*        | *%*        | *2,176*    | * *   | *11*       | *%*        | *(784*     | *)*        | *-36* | *%* |
| *All other  branded products* | * *   | *6,470*    | * *   | *35*       | *%*        | *4,349*    | * *   | *23*       | *%*        | *2,121*    | * *   | *49* | *%* |
| *Total branded sales*         | * *   | *$*        | *18,391*   | * *   | *100*      | *%*        | *$*        | *19,061*   | * *   | *100*      | *%*        | *$* | *(670* | *)* | *-4* | *%* |

 

Sales of our branded pharmaceutical productsdecreased in 2004 by approximately 12% when expressed in constant currency. Anincrease in the weighted average value of the Euro, in relation to the U.S.Dollar, had the effect of increasing branded product sales by approximately$1,675,000, resulting in a 4% decrease in branded pharmaceutical sales in theyear ended December 31, 2004 when expressed in U.S. Dollars. Branded salesaccounted for 25% of total revenues during 2004, compared to 29% of totalrevenues during 2003. Price reductions that took effect in December 2003continued to negatively impact our branded product sales during 2004.

 

54

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Most significantly, sales of our branded omeprazole decreased byapproximately $3,378,000 from the prior year, as a result of the pricereductions, although sales increased 2% during the year in terms of number ofunits sold. Sales of our branded enalapril, which experienced a 50% increase inunit volume compared to the prior year, increased 22% from the prior year inspite of price cuts, and in 2004 accounted for 17% of our branded productsales. Strong sales of our cough and cold medicine, Codeisan, and the launch ofour branded version of paroxetine in May 2003 also helped to mitigate theimpact of the price reductions.

 

*Generic Pharmaceutical Products*

 

***(in thousands)***

 
| ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **2004**   | ** ** | **%**      | ** ** | **2003**   | ** ** | **%**      | ** ** | **$**      | ** ** | **%** | ** ** |
| *Generic Product Sales:*     | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Omeprazole*                 | * *   | *$*        | *13,520*   | * *   | *47*       | *%*        | *$*        | *13,863*   | * *   | *51*       | *%*        | *$* | * (343* | *)* | *-2* | *%* |
| *Simvastatin*                | * *   | *3,638*    | * *   | *12*       | *%*        | *4,412*    | * *   | *16*       | *%*        | *(774*     | *)*        | *-18* | *%* |
| *Paroxetine*                 | * *   | *2,928*    | * *   | *10*       | *%*        | *749*      | * *   | *3*        | *%*        | *2,179*    | * *   | *291* | *%* |
| *Pentoxifylline*             | * *   | *2,622*    | * *   | *9*        | *%*        | *2,070*    | * *   | *8*        | *%*        | *552*      | * *   | *27* | *%* |
| *Trimetazidine*              | * *   | *1,983*    | * *   | *7*        | *%*        | *532*      | * *   | *2*        | *%*        | *1451*     | * *   | *273* | *%* |
| *All other generic products* | * *   | *4,328*    | * *   | *15*       | *%*        | *5,341*    | * *   | *20*       | *%*        | *(1,013*   | *)*        | *-19* | *%* |
| *Total generic sales*        | * *   | *$*        | *29,019*   | * *   | *100*      | *%*        | *$*        | *26,967*   | * *   | *100*      | *%*        | *$* | *1,432* | * * | *8* | *%* |

 

Sales of our generic pharmaceutical productsincreased in terms of units sold, but decreased by approximately 2% in 2004when expressed in constant currency. An increase in the weighted average valueof the Euro, in relation to the U.S. Dollar, had the effect of increasinggeneric product sales by approximately $2,643,000, resulting in an 8% increasein generic pharmaceutical sales in 2004, when expressed in U.S. Dollars. Salesof our generic omeprazole, which experienced an 8% increase in unit volume,decreased by 2% when expressed in U.S. Dollars as a result of price reductionsthat took effect in December 2003. These sales accounted for 47% of ourgeneric pharmaceutical revenues in 2004, compared to 51% of generic revenues inthe prior year. Sales of our generic simvastatin, which experienced a 16%increase in unit volume, decreased by approximately 18%, when expressed in U.S.Dollars as a result of the price reductions. Our generic paroxetine, which waslaunched in May 2003, added approximately $2,179,000 to our generic salesin 2004, when compared to 2003, positioning it third behind our genericomeprazole and simvastatin products. Sales of our generic trimetazidineincreased by approximately $1,451,000 in 2004, or approximately 273% from 2003,while sales of our generic pentoxifylline increased by $552,000, orapproximately 27%.

 

*Sales to Licensees and Others*

 

***(in thousands)***

 
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|---------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$**      | ** ** | **%** | ** ** |
| * *                        | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Sales to licensees and others* | * *   | *$*        | *20,790*   | * *   | *$*        | *16,927*   | * *   | *$* | *3,863* | * * | *23* | *%* |
|                                 |            |            |            |            |            |            |            |  |  |  |  |  |

 

Sales to licensees and others increased by23% over the prior year, or 12% in constant currency. An increase in theweighted average value of the Euro, in relation to the U.S. Dollar,

 

55

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had the effect of increasing our revenues from sales to licensees andothers by approximately $1,894,000.

 

*Licensing andCollaboration Revenues.*Licensing and collaborationrevenues accounted for 5% of total revenues and increased by approximately$1,730,000, or approximately 101%, in 2004 over 2003. These revenues includeroyalties totaling $2,844,000 from the commercialization and continued sales ofTestim, the first product incorporating our CPE-215 drug delivery technology,which was launched by our licensee, Auxilium, in February 2003. Alsoincluded in *licensing and collaboration revenues* in2004 are revenues of approximately $607,000 related to product licensingactivities in Europe.

 

*Gross Profit.*Grossprofit decreased by approximately 7% in constant currency in 2004 as a directresult of the December 2003 price reductions in Spain. An increase in theweighted average value of the Euro, in relation to the U.S. Dollar, had theeffect of increasing gross profit by approximately $3,328,000. Gross margins onnet product sales decreased from 58% in 2003 to 50% in 2004 (52% gross marginson sales of pharmaceutical products, excluding sales of active pharmaceuticalingredients). Product returns, including returns related to the governmentmandated price reductions, reduced 2004 revenues by approximately $3,323,000.Product returns decreased to levels consistent with our historical experienceby June 2004.

 

*Selling and Marketing Expenses*

 

***(in thousands)***

 
| ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|-------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **              | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$**      | ** ** | **%** | ** ** |
| * *                | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Selling and marketing* | * *   | *$*        | *14,808*   | * *   | *$*        | *14,212*   | * *   | *$* | *596* | * * | *4* | *%* |
|                         |            |            |            |            |            |            |            |  |  |  |  |  |

 

Selling and marketing expenses decreased byapproximately 5% in constant currency in 2004; however, an increase in theweighted average value of the Euro, in relation to the U.S. Dollar, had theeffect of increasing selling andmarketing expenses by approximately $1,351,000, resulting in a netincrease of 4% when expressed in U.S. Dollars. Selling and marketing expensesas a percentage of net product sales decreased to 21% in 2004, compared to 23%of net product sales in 2003.

 

*General and AdministrativeExpenses*

 

***(in thousands)***

 
| ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$**      | ** ** | **%** | ** ** |
| * *                     | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *General and administrative* | * *   | *$*        | *9,126*    | * *   | *$*        | *7,001*    | * *   | *$* | *2,125* | * * | *30* | *%* |
|                              |            |            |            |            |            |            |            |  |  |  |  |  |

 

General and administrative expenses for 2004increased 30% over the prior year. The $2,125,000 increase was the result ofincreased general and administrative activities required to support ourcontinued growth and prepare for our anticipated growth in the future. Theseexpenditures included increased costs in 2004 for additional employees, outsideservices, insurance and other costs to support the growth of our organizationand costs associated with our response to

 

56

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the requirements of the Sarbanes-Oxley Act of 2002. General andadministrative expenses would have been approximately $460,000 lower, absentthe 2004 increase in the weighted average value of the Euro, in relation to theU.S. Dollar. General and administrative expenses as a percent of total revenuesincreased to approximately 12% in 2004, from approximately 11% of totalrevenues in 2003.

 

*Research and Development Expenses*

 

***(in thousands)***

 
| ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|----------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                 | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$**      | ** ** | **%** | ** ** |
| * *                   | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Research and development* | * *   | *$*        | *4,419*    | * *   | *$*        | *4,295*    | * *   | *$* | *124* | * * | *3* | *%* |
|                            |            |            |            |            |            |            |            |  |  |  |  |  |

 

Research and development expenses in 2004remained consistent with 2003 in constant currency. An increase in the weighted average value of the Euro, in relation to theU.S. Dollar, had the effect of increasing research and development expenses by approximately $114,000, representing 92% of the increase when expressed in U.S. Dollars.

 

*Otherincome (expenses)*

 

***(in thousands)***

 
| ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|---------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$**      | ** ** | **%** | ** ** |
| * *                  | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Other income (expenses)* | * *   | *$*        | *1,800*    | * *   | *$*        | *91*       | * *   | *$* | *1,709* | * * | *** | * * |
|                           |            |            |            |            |            |            |            |  |  |  |  |  |

 

**Not meaningful*

 

 

Other income (expenses) in 2004 increased by$1,709,000 over 2003. The increase was primarily due to the reversal ofpreviously accrued tax assessments totaling $1,467,000 partially offset byinterest and penalties totaling $193,000 associated with the settlement of thetax audit of our Spanish subsidiary (see *Provision for Income Taxes*)during the second quarter of 2004. We recorded a pre-tax benefit totaling$1,467,000 ($954,000 after taxes) as a component of *other income(expenses)*as the result of the reversal of previously accrued pharmaceuticaltax assessments in Spain. These assessments had been accrued to be paid to theSpanish government to help reduce the impact of the rising health care costs inSpain. Due to recent changes in the pharmaceutical industry in Spain and achange in the Spanish political environment, the basis for these liabilities nolonger existed. Accordingly, these accruals were reversed during the secondquarter of 2004.

 

57

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*Provisionfor Income Taxes*

 

***(in thousands)***

 
| ** **                                          | ** ** | **2004**   | ** ** |
|-----------------------------------------------------|------------|------------|------------|
| ** **                                          | ** ** | **Europe** | ** ** | **U.S.** | ** ** | **Consolidated** | ** ** |
| * *                                            | * *   | * *   | * *   | * * | * * | * * | * * |
| *Income (loss) before income taxes*                 | * *   | *$*        | *13,408*   | * * | *$* | *(2,913* | *)* | *$* | *10,495* | * * |
| * *                                            | * *   | * *   | * *   | * * | * * | * * | * * |
| *Provision (benefit) for income taxes*              | * *   | *4,693*    | * *   | *(990* | *)* | *3,702* | * * |
| *Tax credits, changes in deferred taxes and  other* | * *   | *(492*     | *)*        | *1,807* | * * | *1,315* | * * |
| *Tax liability, 1998 – 2000 audit*             | * *   | *604*      | * *   | *—* | * * | *604* | * * |
| * *                                            | * *   | * *   | * *   | * * | * * | * * | * * |
| *Total provision (benefit) for income taxes*        | * *   | *4,805*    | * *   | *817* | * * | *5,622* | * * |
| *Valuation allowance*                               | * *   | *—*   | * *   | *(817* | *)* | *(817* | *)* |
| * *                                            | * *   | * *   | * *   | * * | * * | * * | * * |
| *Net provision (benefit) for income taxes*          | * *   | *4,805*    | * *   | *—* | * * | *4,805* | * * |
| * *                                            | * *   | * *   | * *   | * * | * * | * * | * * |
| *Net income (loss)*                                 | * *   | *$*        | *8,603*    | * * | *$* | *(2,913* | *)* | *$* | *5,690* | * * |
| * *                                            | * *   | * *   | * *   | * * | * * | * * | * * |
| *Effective tax rate*                                | * *   | *36*       | *%*        | *0* | *%* | *46* | *%* |

 

A tax review of our Spanish subsidiary,Laboratories Belmac S.A., by the Spanish tax authorities for the tax years1998, 1999 and 2000, was completed in the quarter ended June 30, 2004. Asa result of this audit, our subsidiary was assessed an additional tax liabilityof approximately $604,000, which has been recorded as a component of*provision for income taxes* in 2004*,*and approximately $193,000 for related interest and penalties, which have beenrecorded as components of*other income andexpenses,* in the consolidated income statement in 2004.

 

We have recorded provisions for foreignincome taxes totaling $4,805,000 ($4,201,000 income tax expense on operationsplus $604,000 recorded as a result of the 1998 - 2000 tax audit of our Spanishsubsidiary) in 2004, compared to $5,423,000 in 2003. The effective tax rate inSpain in 2004 was 36%; however, when the $604,000 tax audit settlement relatedto prior years is excluded, the effective tax rate is 31%, compared to theprior year effective rate of 34%. The provision for foreign income taxes wouldhave been approximately $457,000 lower than reported, absent the increase inthe weighted average value of the Euro, in relation to the U.S. Dollar, during2004.

 

We generated additional U.S. federal netoperating loss carryforwards in 2004 and 2003 as a result of U.S. pre-taxlosses of $2,913,000 and $3,571,000, respectively. As future domestic operatingprofits could not be reasonably assured, no tax benefit was recorded for U.S.losses. Accordingly, we established a valuation allowance equal to the fullamount of the U.S. deferred tax assets.

 

We operate within multiple taxingjurisdictions and are subject to audit in those jurisdictions. These audits caninvolve complex issues, which may require an extended period of time forresolution. During 2004, we identified certain tax contingencies that wedetermined were probable and reasonably estimable. Consequently, we included acharge totaling $188,000 related to these contingencies in the*provision for income taxes* in 2004. No other potential taxcontingencies were considered probable and reasonably estimable as of December 31,2004. However, there is the possibility that the ultimate resolution of suchpotential contingencies could have an adverse effect on our ConsolidatedFinancial Statements in the future.

 

58

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*Net Income*

 

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

 
| ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                    | ** ** | **2004**   | ** ** | **2003**   | ** ** | **Amount** | ** ** | **%** | ** ** |
| * *                                      | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Net income*                                  | * *   | *$*        | *5,690*    | * *   | *$*        | *6,097*    | * *   | *$* | *(407* | *)* | *-7* | *%* |
| * *                                      | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Net income per common share:*                | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Basic*                                       | * *   | *$*        | *0.27*     | * *   | *$*        | *0.34*     | * *   | *$* | *(0.07* | *)* | *-21* | *%* |
| *Diluted*                                     | * *   | *$*        | *0.25*     | * *   | *$*        | *0.28*     | * *   | *$* | *(0.03* | *)* | *-11* | *%* |
| * *                                      | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Weighted average common shares outstanding:* | * *   | * *   | * *   | * *   | * *   | * *   | * *   | * * | * * |
| *Basic*                                       | * *   | *20,901*   | * *   | *17,997*   | * *   | *2904*     | * *   | *16* | *%* |
| *Diluted*                                     | * *   | *22,627*   | * *   | *21,637*   | * *   | *990*      | * *   | *5* | *%* |
|                                               |            |            |            |            |            |            |            |  |  |  |  |  |  |

 

We reported2004 income from operations of $8,695,000, compared to 2003 income fromoperations of $11,429,000. In 2004, the combination of income from operationsof $8,695,000 and the non-operating items, primarily the provision for incometaxes of $4,805,000, resulted in 2004 net income of $5,690,000, or $.27 perbasic common share ($.25 per diluted common share) on 20,901,000 weightedaverage basic common shares outstanding (22,627,000 weighted average dilutedcommon shares outstanding), compared to 2003 net income of $6,097,000, or $.34per basic common share ($.28 per diluted common share) on 17,997,000 weightedaverage basic common shares outstanding (21,637,000 weighted average dilutedcommon shares outstanding).

 

59

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**Selected Quarterly Financial Data**

 

The following table sets forth certain operatingdata for our last eight quarters. We have derived this data from our unauditedquarterly financial statements. 

 
| ** **                                     | ** ** | **Fiscal 2004**                            | ** ** | **Fiscal 2005**   | ** ** |
|------------------------------------------------|------------|--------------------------------------------|------------|-------------------|------------|
| ** **                                     | ** ** | **Three Months Ended (Unaudited)**         | ** ** |
| ** **                                     | ** ** | **3/31/04(b)**                             | ** ** | **6/30/04(a)(b)** | ** ** | **9/30/04(b)** | ** ** | **12/31/04(b)** | ** ** | **3/31/05** | ** ** | **6/30/05** | ** ** | **9/30/05** | ** ** | **12/31/05(c)** | ** ** |
| ** **                                     | ** ** | **(in thousands, except per share  data)** | ** ** |
| *Total  revenues*                              | * *   | *$*                                        | *17,302*   | * *          | *$*        | *18,470* | * * | *$* | *18,103* | * * | *$* | *19,518* | * * | *$* | *24,244* | * * | *$* | *24,764* | * * | *$* | *23,512* | * * | *$* | *25,210* | * * |
| *Cost of  net product sales*                   | * *   | *8,255*                                    | * *   | *8,465*           | * *   | *8,662* | * * | *9,511* | * * | *11,452* | * * | *11,367* | * * | *11,104* | * * | *12,238* | * * |
| *Gross  profit*                                | * *   | *9,047*                                    | * *   | *10,005*          | * *   | *9,441* | * * | *10,007* | * * | *12,792* | * * | *13,397* | * * | *12,408* | * * | *12,972* | * * |
| *Operating  expenses*                          | * *   | *7,374*                                    | * *   | *7,422*           | * *   | *6,922* | * * | *8,087* | * * | *9,145* | * * | *9,408* | * * | *8,730* | * * | *8,620* | * * |
| *Income  from operations*                      | * *   | *1,673*                                    | * *   | *2,583*           | * *   | *2,519* | * * | *1,920* | * * | *3,647* | * * | *3,989* | * * | *3,678* | * * | *4,352* | * * |
| *Other  income (expenses)*                     | * *   | *57*                                       | * *   | *1,348*           | * *   | *238* | * * | *157* | * * | *113* | * * | *173* | * * | *184* | * * | *259* | * * |
| *Provision  for income taxes*                  | * *   | *921*                                      | * *   | *2,441*           | * *   | *1,344* | * * | *99* | * * | *1,590* | * * | *1,554* | * * | *1,377* | * * | *955* | * * |
| *Net  income*                                  | * *   | *$*                                        | *809*      | * *          | *$*        | *1,490* | * * | *$* | *1,413* | * * | *$* | *1,978* | * * | *$* | *2,170* | * * | *$* | *2,608* | * * | *$* | *2,485* | * * | *$* | *3,656* | * * |
| * *                                       | * *   | * *                                   | * *   | * *          | * *   | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * |
| *Net  income per  common share:*               | * *   | * *                                   | * *   | * *          | * *   | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * |
| *Basic*                                        | * *   | *$*                                        | *0.04*     | * *          | *$*        | *0.07* | * * | *$* | *0.07* | * * | *$* | *0.09* | * * | *$* | *0.10* | * * | *$* | *0.12* | * * | *$* | *0.11* | * * | *$* | *0.17* | * * |
| *Diluted*                                      | * *   | *$*                                        | *0.04*     | * *          | *$*        | *0.07* | * * | *$* | *0.06* | * * | *$* | *0.09* | * * | *$* | *0.10* | * * | *$* | *0.12* | * * | *$* | *0.11* | * * | *$* | *0.16* | * * |
| * *                                       | * *   | * *                                   | * *   | * *          | * *   | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * |
| *Weighted  average common shares outstanding:* | * *   | * *                                   | * *   | * *          | * *   | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * |
| *Basic*                                        | * *   | *20,597*                                   | * *   | *20,644*          | * *   | *21,049* | * * | *21,308* | * * | *21,316* | * * | *21,395* | * * | *21,652* | * * | *21,862* | * * |
| *Diluted*                                      | * *   | *22,784*                                   | * *   | *22,800*          | * *   | *22,746* | * * | *22,487* | * * | *22,531* | * * | *22,603* | * * | *22,970* | * * | *23,564* | * * |

 

(a)          *Other income (expenses)*for the quarter ended June 30, 2004 includes the reversal of previouslyaccrued tax assessments totaling $1,467,000. These assessments had been accruedto be paid to the Spanish government as a vehicle to help reduce the impact ofthe rising health care costs in Spain. Due to changes in the pharmaceuticalindustry in Spain and a change in the Spanish political environment, theseliabilities no longer exist. Accordingly, these accruals were reversed duringthe second quarter of 2004.

 

(b)         The interim quarters during the year ended December 31, 2004include a reclassification of $342,000 (approximately $58,000, $70,000, $94,000and $120,000 in the first, second, third and fourth quarters of 2004,respectively) between *Depreciation andamortization* and *Cost of net product sales*for depreciation on certain fixed assets to conform with the 2005presentation format throughout the year.

 

(c)          *Total revenues* forthe year ended December 31, 2005 include a change in estimate of royaltyrevenues earned of approximately $1,092,000 recorded in the fourth quarter of2005. This change in estimate of royalty revenues earned is based upon publiclyavailable data determined to be more accurate than the source of datapreviously relied upon by management in estimating the sell-through ofprescriptions dispensed.

 

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**Liquidity and Capital Resources**

 

Total assets increased 2% from $121,930,000 at December 31,2004 to $124,220,000 at December 31, 2005 and stockholders’ equityincreased 2% from $89,657,000 at December 31, 2004 to $91,589,000 at December 31,2005. The increase in stockholders’ equity primarily reflects net income of$10,919,000 offset by the effect of fluctuations in the Euro/U.S. Dollarexchange rate, which resulted in a net reduction of $7,962,000 on our balancesheet. We acquired approximately 430,000 shares of Common Stock, with a fairmarket value of approximately $5,321,000, which were tendered to us by certainemployees as consideration for the exercise of stock options and to satisfyminimum federal and statutory tax withholding requirements, the effect of whichwas offset by stock option exercises totaling $4,016,000.

 

Cash, cash equivalents and marketable securitiesdecreased 6% from $34,758,000 at December 31, 2004 to $32,846,000 at December 31,2005. Uses of cash primarily included additions to fixed assets totaling$11,018,000, additions to drug licenses and related costs of $2,045,000 and thenet effect of financing activities as discussed below. These uses of cash werepartially offset by increased cash flows from operations that totaled$12,596,000. Cash and cash equivalents at December 31, 2005 includeapproximately $11,513,000 of short-term liquid investments considered to becash equivalents.

 

Receivables decreased from $27,860,000 at December 31,2004 to $26,916,000 at December 31, 2005, despite a $2,529,000 increase inreceivables in constant currency. Changes in foreign currency exchange ratesdecreased receivables by approximately $3,473,000 in 2005. Trade receivablesincreased by approximately $802,000 in constant currency, but fluctuations inforeign currency exchange rates decreased trade receivables reported in U.S.Dollars by approximately $3,095,000. Receivables from one internationalcustomer totaled $3,059,000 at December 31, 2005; however, we owe the samecustomer approximately $1,962,000 for co-marketing expenses at December 31,2005. Revenues from this customer are recorded net of the related co-marketingcosts in the Consolidated Income Statements. We have not experienced anymaterial delinquencies on any of our receivables that have had a materialeffect on our financial position, results of operations or cash flows.

 

Inventories increased approximately $1,889,000 from$10,258,000 at December 31, 2004 to $12,147,000 at December 31, 2005.In constant currency, inventories increased by approximately $3,701,000,primarily as a result of raw material purchases and increases in finished goodsinventories in anticipation of demand in 2006. Changes in foreign currencyexchange rates reduced the amount of the increase in inventories byapproximately $1,812,000.

 

The combined total of accounts payable and accruedexpenses increased from $23,217,000 at December 31, 2004 to $24,890,000 atDecember 31, 2005. The combined total increased by approximately$4,900,000 in constant currency during 2005, but fluctuation in foreigncurrency exchange rates decreased accounts payable and accrued expenses atDecember 31, 2005 by approximately $3,227,000. The increase is primarilyattributable to increases in payables related to inventory purchases ofapproximately $1,785,000, a new pharmaceutical tax of approximately $1,555,000and accrued compensation of $1,530,000.

 

Short-term borrowings and current portion oflong-term debt increased from $2,785,000 at December 31, 2004 to$2,995,000 at December 31, 2005. The combined total increased byapproximately $652,000 in constant currency, but fluctuation in foreigncurrency exchange rates decreased short-term borrowings and current portion oflong-term debt by approximately $442,000. The weighted average interest rate onour short-term borrowings and current portion of long-term debt at December 31,2005 was 3.6%.

 

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Operating activities in 2005 provided net cash of$12,596,000 compared to $4,233,000 in 2004. Net income, which increased to$10,919,000 in 2005, and changes in working capital accounted for the majorityof the increase in cash flows from operations.

 

Investing activities, primarily capital expendituresin Spain for land, improvements and equipment to upgrade the capacity of ourmanufacturing facilities in Spain and to increase our manufacturing andpackaging capabilities with new high speed equipment, along with additions todrug licenses and related costs, used net cash of $13,063,000 in 2005.

 

Financing activities during 2005 used net cash of$1,026,000, and primarily represented the cash proceeds of approximately$2,028,000 received from the exercise of stock options, offset by thefollowing: (1) the remittance of employee tax withholding liabilities ofapproximately $2,292,000 resulting from stock option exercises, (2) therepurchase of approximately 90,000 shares of our Common Stock, with a fair marketvalue of approximately $1,041,000, which we repurchased in conjunction with theexercise of employee stock options, and (3) net borrowings totaling$279,000.

 

Long-term debt, which totaled $349,000 at December 31,2004, was classified as current at December 31, 2005 in anticipation ofrepayment during 2006.

 

*Contractual Obligations*

 

In addition to our borrowings, we have fixedcontractual obligations under various agreements. Our contractual obligationswere comprised of the following as of December 31, 2005:

 

***(in thousands)***

 
| ** **                               | ** ** | ** ** | ** ** | **Payments Due By Period** | ** ** |
|------------------------------------------|------------|------------|------------|----------------------------|------------|
| ** **                               | ** ** | ** ** | ** ** | **Less than 1**            | ** ** | **1 – 3** | ** ** | **3 – 5** | ** ** | **More than 5** | ** ** |
| ** **                               | ** ** | **Total**  | ** ** | **year**                   | ** ** | **years** | ** ** | **years** | ** ** | **years** | ** ** |
| *Long – term debt*                  | * *   | *$*        | *—*   | * *                   | *$*        | *—* | * * | *$* | *—* | * * | *$* | *—* | * * | *$* | *—* | * * |
| *Capital leases*                         | * *   | *—*   | * *   | *—*                   | * *   | *—* | * * | *—* | * * | *—* | * * |
| *Operating leases*                       | * *   | *2,572*    | * *   | *1,203*                    | * *   | *1,369* | * * | *—* | * * | *—* | * * |
| *Purchase obligations (1)*               | * *   | *9,982*    | * *   | *9,982*                    | * *   | *—* | * * | *—* | * * | *—* | * * |
| *Other long — term liabilities (2)* | * *   | *1,665*    | * *   | *333*                      | * *   | *999* | * * | *333* | * * | *—* | * * |
| * *                                 | * *   | * *   | * *   | * *                   | * *   | * * | * * | * * | * * | * * | * * |
| *Total contractual cash obligations (3)* | * *   | *$*        | *14,219*   | * *                   | *$*        | *11,518* | * * | *$* | *2,368* | * * | *$* | *333* | * * | *$* | *—* | * * |

 

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(1)          Included in purchase obligations are contractual obligations for thepurchase of machinery, construction and engineering services and a newinventory management software application. The construction and engineeringservices and new inventory management software application are associated withthe expansion of our manufacturing facilities in Zaragoza, Spain. Purchaseorders or contracts for the purchase of raw materials and other goods andservices are not included in the table above as our purchase orders representauthorizations to purchase rather than binding agreements. For the purposes ofthis table, contractual obligations for purchase of goods or services aredefined as agreements that are enforceable and legally binding and that specifyall significant terms, including: fixed or minimum quantities to be purchased;fixed, minimum or variable price provisions; and the approximate timing of thetransaction. Our purchase orders are based on our current manufacturing needsand are fulfilled by our vendors within short time frame. We do not haveagreements for the purchase of raw materials or other goods specifying minimumquantities. We also enter into contracts for outsourced services includingpayroll, information technology and maintenance; however, the obligations under

 

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these contracts are not significant and thecontracts contain clauses allowing for cancellation at will, withoutsignificant penalty.

 

(2)          There were no other contractual obligations included in other long-termliabilities in our Consolidated Balance Sheet as of December 31, 2005.These amounts represent deferred tax payments due to the Spanish Ministry ofTaxes from the sale of certain drug licenses in prior years.

 

(3)          Not included in the chart above are key executive compensationagreements that have been renewed whereby we are currently obligated to payapproximately $2,630,000 to our key executives in 2006. Such agreements renewannually unless terminated by any of the parties or amended by the CompensationCommittee of the Board of Directors.

 

The expected timing of payments of the obligationsdiscussed above are estimated based on current information. Timing of paymentsand actual amounts paid may be different depending on the time of receiptof goods or services or changes to agreed-upon amounts for obligations. Amountsdisclosed as contingent or milestone-based obligations are dependent on theachievement of the milestones or the occurrence of the contingent events andcan vary significantly.

 

In accordance with the terms of the licenseagreement whereby we granted to Auxilium an exclusive royalty-based worldwidelicense, to develop, market and sell a topical testosterone gel containing ourCPE-215 technology, we have been earning and receiving royalty payments fromAuxilium on Testim sales since the product launch in early 2003 and we expectto continue receiving royalty payments for the foreseeable future.

 

We plan to continue making improvements to ourmanufacturing facilities during 2006 that include the acquisition of additionalmanufacturing equipment and expansion of our active pharmaceutical ingredientsmanufacturing facility, in order to accommodate our expected growth. We havebudgeted approximately $22.6 for capital expenditures during 2006, includingapproximately $10.0 that was budgeted in 2005, but now planned for 2006. Weplan to finance these expenditures from a combination of cash flow fromoperations, borrowings and existing cash balances.

 

S*easonality, Effect ofInflation and Liquidity.*In the past, we have experienced lowersales in the third calendar quarter and higher sales in the fourth calendarquarter due to seasonality of our pharmaceutical business, although suchvariations are dependent upon the severity of the cough, cold and flu season.As we market more pharmaceutical products whose sales are seasonal, seasonalityof sales may become more significant. Neither inflation nor changingprices has materially impacted our revenues or income from operations for theperiods presented. We expect to have sufficient liquidity to fund operationsfor at least the next twenty-four months. We continue to search bothdomestically and internationally for opportunities that will enable us tocontinue expanding our business and explore alternative financing sources forthese activities, including the possibility of public and/or private offeringsof our securities. In appropriate situations, that will be strategicallydetermined, we may seek financial assistance from other sources, includingcontribution by others to joint ventures and other collaborative or licensingarrangements for the development, testing, manufacturing and marketing ofproducts under development.

 

*Off-Balance-Sheet Arrangements*

 

We do not have any significant off-balance-sheetarrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

 

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**Critical Accounting Policies and Estimates**

 

Certain of our accounting policies are particularlyimportant to the portrayal of our financial position, and results of operationsand cash flows and require the application of significant judgment by ourmanagement; as a result they are subject to an inherent degree of uncertainty.In applying those policies, our management uses judgment to determine theappropriate assumptions to be used in the determination of certain estimates.Those estimates are based on our historical experience, terms of existingcontracts, our observance of trends in the industry, information provided byour customers and information available from other outside sources, asappropriate. Our critical accounting policies and estimates include:

 

•                  *Revenuerecognition and accounts receivable*.

 

•                  Revenueon product sales is recognized when persuasive evidence of an arrangementexists, the price is fixed and final, delivery has occurred and there is areasonable assurance of collection of the sales proceeds. We generally obtainpurchase authorizations from our customers for a specified amount of product ata specified price and consider delivery to have occurred when the customertakes possession of the products and/or risk of loss has passed to thecustomer. We provide our customers with a limited right of return. Revenue isrecognized upon delivery of products, at which time a reserve for sales returnsis recorded limited. We have demonstrated the ability to make reasonable andreliable estimates of product returns in accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 48, *Revenue Recognition WhenRight of Return Exists*, and of allowances for doubtful accountsbased on significant historical experience.

 

•                  Revenuefrom service, research and development, and licensing and supply agreements isrecognized when the service procedures have been completed or as revenuerecognition criteria have been met for each separate unit of accounting (asdefined in Emerging Issues Task Force (“EITF”) Issue No. 00-21, *Accounting for Revenue Arrangements with Multiple Deliverables*.)

 

•                  Royaltyrevenue is recognized based on the estimated sell-through of products asdetermined from prescriptions dispensed, until such time that returns fromwholesalers and pharmacies can be reasonably estimated. Royalty revenues forthe year ended December 31, 2005 includes a change in estimate of royaltyrevenues earned of approximately $1,092,000 recorded in the fourth quarter of2005. This change in estimate of royalty revenues earned is based upon publiclyavailable data determined to be more accurate than the source of data previouslyrelied upon by management in estimating the sell-through of prescriptionsdispensed.

 

•                  *Inventories.* Inventories are stated at the lower of costor market, cost being determined on the first-in, first-out method. Reservesfor slow moving and obsolete inventories are provided based on historicalexperience and current product demand. We evaluate the adequacy of thesereserves quarterly.

 

•                  *Druglicenses and related costs.*Drug licenses and related costs incurred in connection with acquiring licenses,patents and other proprietary rights related to our commercially developedproducts are capitalized. Capitalized drug licenses and related costs are beingamortized on a straight-line basis for periods not exceeding 15 years from thedates of acquisition. Carrying values of such assets are reviewed at leastannually by comparing the carrying amounts to their estimated undiscounted cashflows and adjustments are made for any diminution in value.

 

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•                  *Provisionfor income taxes.* We haveprovided for current and deferred U.S. federal, state and foreign income taxesfor the current and all prior periods presented. Current and deferred incometaxes have been provided with respect to jurisdictions where certain of oursubsidiaries produce taxable income. We have provided a valuation allowancewith respect to the remainder of our U.S. deferred income taxes, consistingprimarily of net operating loss carryforwards in the U.S., because ofuncertainty regarding their realization.

 

Should we determine that it is more likely than notthat we will realize certain of our net deferred tax assets for which we havepreviously provided a valuation allowance, an adjustment would be required toreduce the existing valuation allowance. In addition, we operate withinmultiple taxing jurisdictions and are subject to audit in those jurisdictions.These audits can involve complex issues, which may require an extendedperiod of time for resolution. Although we believe that adequate considerationhas been made for such issues, there is the possibility that the ultimateresolution of such issues could have an adverse effect on our financialposition,  results of operations or cashflows.

 

•                  *Foreigncurrency translation*. Thefinancial position, results of operations and cash flows of our foreignsubsidiaries are measured using local currency as the functional currency.Assets and liabilities of each foreign subsidiary are translated at the rate ofexchange in effect at the end of the period. Revenues and expenses aretranslated at the average exchange rate for the period. Foreign currencytranslation gains and losses are credited to or charged against othercomprehensive income in the Consolidated Balance Sheets. Foreign currency gainsand losses arising from cash transactions are credited to or charged againstcurrent earnings.

 

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**New Accounting Standards**

 

In December 2004, the FASB issued SFAS No. 123(Revised), Share-Based Payment. This Statement is a revision of SFAS No. 123,Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees, and its related implementationguidance. SFAS No. 123 (Revised) focuses primarily on accounting for transactionsin which an entity obtains employee services in share-based paymenttransactions. The Statement requires entities to recognize stock compensationexpense for awards of equity instruments to employees based on the grant-datefair value of those awards (with limited exceptions). SFAS No. 123(Revised), as issued, was to apply to all awards granted, modified, orcancelled after June 30, 2005, and unvested portions of previously issuedgrants. On April 14, 2005, the U.S. Securities and Exchange Commissionannounced the adoption of a new rule that amended the compliance date forSFAS No. 123 (Revised), allowing companies to implement the Statement atthe beginning of their first fiscal year that begins after June 15, 2005.We adopted SFAS No. 123 (Revised) effective January 1, 2006 using themodified-prospective transition method. Consequently, we expect to record non-cashexpense of approximately $992,000, $308,000 and $68,000 in the years ending December 31,2006, 2007 and 2008, respectively, for the unvested portion of previouslyissued grants that were not previously expensed under APB Opinion No. 25.In addition, we will be required to record expense for any stock option grantssubsequent to December 31, 2005. We utilize the accelerated expense attributionmethod pursuant to FASB Interpretation No. 28 for all options accounted forunder APB Opinion No. 25. Equity-based compensation attributable to stockoptions granted subsequent to December 31, 2005 will be recognized under thestraight-line method pursuant to SFAS No. 123 (Revised). We do not expect theadoption of SFAS No. 123 (Revised) to have a material impact on theConsolidated Balance Sheets or the Consolidated Statements of Cash Flows.

 

**Item 7A.                Quantitativeand Qualitative Disclosures About Market Risk**

 

*Foreign Currency.*A substantial amount of our business is conducted in Europe and istherefore influenced to the extent to which there are fluctuations in the U.S.Dollar’s value against other currencies, specifically the Euro. The exchangerate at December 31, 2005 and 2004 was .84 Euros and .73 Euros per U.S.Dollar, respectively. The weighted average exchange rate for the years ended December 31,2005, 2004 and 2003 was .80 Euros .81 Euros and .89 Euros per U.S. Dollar,respectively. The net effect of foreign currency translation on ourConsolidated Balance Sheet during the year ended December 31, 2005 was adecrease of $7,962,000 and the cumulative historical effect was an increase of$1,760,000, as reflected in our Consolidated Balance Sheets as *accumulated other**comprehensive income*. The carrying valueof assets and liabilities can be materially impacted by foreign currency translation,as can the translated amounts of revenues and expenses. Nonetheless, we do notplan to modify our business practices.

 

We have relied primarily upon financing activitiesto fund our operations in the U.S. In the event that we are required to fundU.S. operations or cash needs with funds generated in Europe or cashrequirements in Europe with U.S. funds, currency rate fluctuations in thefuture could have a significant impact on us. However, at the present time, wedo not anticipate altering our business plans and practices to compensate forfuture currency fluctuations.

 

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*Interest Rates.*Theweighted average interest rate on our short-term borrowings and current portionof long-term debt is 3.6% and the balance outstanding is $2,995,000 as of December 31,2005. Amounts due within one year have been classified as current on theConsolidated Balance Sheets at December 31, 2005 and 2004. The effect ofan increase in the interest rate of one percentage point (one hundred basispoints) to 4.6% on short-term borrowings and current portion of long-term debt wouldhave the effect of increasing interest expense by approximately $30,000annually.

 

**Item 8.****                                                          ****Financial Statements andSupplementary Data**

 

See Item 15 of this Annual Reporton Form 10-K.

 

**Item 9.****                                                          ****Changes in and Disagreements WithAccountants on Accounting and Financial Disclosure**

 

Not applicable**.**

 

**Item 9A.             Controlsand Procedures**

 

**Disclosure Controls and Procedures**

 

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in our reportsthat are filed or submitted under the under the Securities Exchange Act of1934, as amended (the “Exchange Act”) with the Securities and ExchangeCommission is recorded, processed, summarized and reported within the timeperiods required for each report and that such information is reported to ourmanagement, including our principal executive officer and principal financialofficer, as appropriate, to allow timely decisions regarding requireddisclosure.

 

Our management, with the participation of ourprincipal executive officer and principal financial officer, carried out anevaluation of the effectiveness of our disclosure controls and procedures (assuch term is defined in Rules 13a-15(e) and 15d-15(e) under theExchange Act as of the end of the period covered by this report. Based on thatevaluation, our principal executive officer and principal financial officerconcluded that our disclosure controls and procedures were effective as of December 31,2005.

 

**Internal Control over Financial Reporting**

 

*Management’s Report on Internal Control over Financial Reporting*

 

Our management is responsible for establishing andmaintaining adequate internal control over financial reporting, as such term isdefined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Ourmanagement assessed the effectiveness of our internal control over financialreporting as of December 31, 2005. In making this assessment, ourmanagement used the criteria set forth by the Committee of SponsoringOrganizations of the Treadway Commission (COSO) in *InternalControl—Integrated Framework*. Based on its assessment under theframework in *Internal Control—Integrated Framework*,our management has concluded that, as of December 31, 2005, our internalcontrol over financial reporting was effective.

 

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*Attestation Report of the Independent Registered Public Accounting Firm*

 

Management’s assessment of the effectiveness of ourinternal control over financial reporting as of December 31, 2005, hasbeen audited by Deloitte & Touche LLP, an independent registeredpublic accounting firm, as stated in their report which appears below.

 

*Changes in Internal Control Over Financial Reporting*

 

There was no change in our internal control overfinancial reporting (as defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act) identified in connection with the evaluation of our internalcontrols that occurred during our last fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Stockholders ofBentley Pharmaceuticals, Inc.Exeter, New Hampshire

 

We have audited management’s assessment, included inthe accompanying “Management’s Report on Internal Controls over FinancialReporting”, that Bentley Pharmaceuticals, Inc. and subsidiaries (the “Company”)maintained effective internal control over financial reporting as of December 31,2005, based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express an opinion on management’sassessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.

 

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtainreasonable assurance about whether effective internal control over financialreporting was maintained in all material respects. Our audit included obtainingan understanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinions.

 

A company’s internal control over financialreporting is a process designed by, or under the supervision of, the company’sprincipal executive and principal financial officers, or persons performingsimilar functions, and effected by the company’s board of directors,management, and other personnel to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples. A company’s internal control over financial reporting includesthose policies and procedures that (1) pertain to the maintenance ofrecords that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable

 

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assuranceregarding prevention or timely detection of unauthorized acquisition, use, ordisposition of the company’s assets that could have a material effect on thefinancial statements.

 

Because of the inherent limitations of internalcontrol over financial reporting, including the possibility of collusion orimproper management override of controls, material misstatements due to erroror fraud may not be prevented or detected on a timely basis. Also,projections of any evaluation of the effectiveness of the internal control overfinancial reporting to future periods are subject to the risk that the controlsmay become inadequate because of changes in conditions, or that the degreeof compliance with the policies or procedures may deteriorate.

 

In our opinion, management’s assessment that theCompany maintained effective internal control over financial reporting as of December 31,2005, is fairly stated, in all material respects, based on the criteriaestablished in *Internal Control— IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission. Also in our opinion, the Company maintained, in allmaterial respects, effective internal control over financial reporting as of December 31,2005, based on the criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission.

 

We have also audited, in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theCompany’s consolidated balance sheets as of December 31, 2005 and 2004,and the related consolidated income statements, statements of changes instockholders’ equity and statements of cash flows for each of the three yearsin the period ended December 31, 2005, and our report dated March 16,2006, expressed an unqualified opinion on those financial statements.

 

 
| /s/ Deloitte & Touche LLP |   |
|------------------------------------|--------|
| Boston, Massachusetts              |
| March 16, 2006                     |

 

**Item 9B.               OtherInformation**

 

Not applicable**.**

 

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**Part III**

 

**Item 10.              Directorsand Executive Officers of the Registrant**

 
| **Name**           | ** ** | **Age** | ** ** | **Position**                                                     |
|--------------------|------------|---------|------------|------------------------------------------------------------------|
|               |       |    |       |                                                             |
| James R. Murphy    |       | 56      |       | Chairman, Chief Executive Officer and Director                   |
|               |       |    |       |                                                             |
| Michael McGovern   |       | 62      |       | Vice Chairman and Director                                       |
|               |       |    |       |                                                             |
| John A. Sedor      |       | 61      |       | President                                                        |
|               |       |    |       |                                                             |
| Michael D. Price   |       | 48      |       | Vice President, Chief Financial Officer, Treasurer and Secretary |
|               |       |    |       |                                                             |
| Adolfo Herrera     |       | 46      |       | Managing Director of European Subsidiaries                       |
|               |       |    |       |                                                             |
| Miguel Fernandez   |       | 75      |       | Director                                                         |
|               |       |    |       |                                                             |
| F. Ross Johnson    |       | 74      |       | Director                                                         |
|               |       |    |       |                                                             |
| Edward J. Robinson |       | 65      |       | Director                                                         |
|               |       |    |       |                                                             |
| John W. Spiegel    |       | 65      |       | Lead Director                                                    |

 

**James R. Murphy**hasserved as one of our directors since 1993. Mr. Murphy was President ofBentley from September 1994 until August 2005, was named ChiefExecutive Officer effective January 1995 and became Chairman of the Boardin June 1995. Prior to rejoining Bentley, Mr. Murphy served as VicePresident of Business Development at MacroChem Corporation, a publicly ownedpharmaceutical and drug delivery company, from March 1993 through September 1994.From September 1992 until March 1993, Mr. Murphy served as aconsultant in the pharmaceutical industry with his primary efforts directedtoward product licensing. Prior thereto, Mr. Murphy served as Director - Worldwide Business Development and StrategicPlanning of Bentley from December 1991 to September 1992. Mr. Murphypreviously spent 14 years in pharmaceutical research and productdevelopment with SmithKline Corporation and in international businessdevelopment with contract research and consulting laboratories. Mr. Murphyreceived a B.A. in Biology from Millersville University.

 

**Michael McGovern**has served as one of our directors since 1997 and was named ViceChairman of Bentley in October 1999. Mr. McGovern serves as Presidentof McGovern Enterprises, a provider of corporate and financial consultingservices, which he founded in 1975. Mr. McGovern is Chairman of the Boardof Training Solutions Interactive, Inc. and Vice Chairman of the Board ofEmployment Technologies, Inc. and is a Director on the corporate board ofthe Reynolds Development Company. Mr. McGovern received a B.S. and M.S. inaccounting and his Juris Doctor from the University of Illinois. Mr. McGovernis a Certified Public Accountant.

 

**John A. Sedor**joined Bentley as President in August 2005. From 2001 toMay 2005, he served as President and Chief Executive Officer for SandozInc., based in Princeton, N.J. In this role, Mr. Sedor oversaw all aspectsof Sandoz, the North American arm of Novartis Generics where hisresponsibilities included Sales and Marketing, Research and Development,Operations and Product Manufacturing, Business Development and Strategy. From1998-2001, he served as President and Chief Executive

 

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Officer of Verion, Inc., a technology company,where he was responsible for the creation, launch and direction of the jointventure. Prior thereto, Mr. Sedor served as President and Chief ExecutiveOfficer of Centeon, a joint venture between two major multinationalcorporations, Rhône-Poulenc Rorer and Hoechst AG. Prior thereto, Mr. Sedorserved as Executive Vice President at Rhône-Poulenc Rorer, Revlon Healthcareand Parke Davis. Mr. Sedor received his BS, Pharmacy/Chemistry fromDuquesne University in 1970.

 

**Michael D. Price**became Chief Financial Officer, Vice President/Treasurer and Secretaryof Bentley in October 1993, April 1993 and November 1992,respectively. He has served Bentley in other capacities since March 1992.Prior to joining Bentley, he was employed as a financial and managementconsultant with Carr Financial Group from March 1990 to March 1992.Prior thereto, he was employed as Vice President of Finance with Premiere Group, Inc.from June 1988 to February 1990. Prior thereto, Mr. Price wasemployed by Price Waterhouse (now PricewaterhouseCoopers) from January 1982to June 1988 where his last position was Audit Manager. Mr. Pricereceived a B.S. in Business Administration with a concentration in Accountingfrom Auburn University and an M.B.A. from Florida State University. Mr. Priceis a Certified Public Accountant licensed by the State of Florida.

 

**Adolfo Herrera**serves as Managing Director of our European Subsidiaries, and has been employedas General Manager of Bentley’s Spanish subsidiaries since 1999. Prior tojoining Bentley in 1997, Mr. Herrera served as General Manager ofLaboratorios Llorente-Juventus Group from 1993 to 1997, where he was employedsince 1990. Prior thereto, Mr. Herrera was employed by the Public HealthMinistry in Spain. Mr. Herrera received his degree in Veterinary Medicinefrom Complutense University in Madrid, Spain in 1982 and his MBA degree fromInstituto de Empresas in Madrid, Spain in 1994.

 

**Miguel Fernandez**has served as one of our directors since 1999. Mr. Fernandezserved from 1980 to 1996 as President of the International Division andcorporate Vice President at Carter-Wallace, Inc., where he was responsiblefor all product lines outside of the United States. Prior thereto, Mr. Fernandezwas employed for approximately eight years by SmithKline & French,where his last position was President of the division that included France,Portugal and Switzerland. Mr. Fernandez attended the University of BritishColumbia in Canada and received an M.B.A. from the Ivey School of Business atthe University of Western Ontario in London, Ontario, Canada. Mr. Fernandezhas been retired since 1996.

 

**F. Ross Johnson**has served as one of our directors since 2004. Mr. Johnson has been theChairman and Chief Executive Officer of RJM Group, a management advisory andinvestment firm, since 1989. Prior to 1989, Mr. Johnson was the Chairmanof RJR/Nabisco, Inc., a public diversified holding company, having heldvarious senior executive positions in RJR/Nabisco, Inc. and its predecessors,Standard Brands and Nabisco Brands since 1971. He received a Bachelor ofCommerce from the University of Manitoba, Canada and a Master of Commerce fromthe University of Toronto, Canada. Mr. Johnson serves on the boards ofdirectors of AuthentiDate Holding Corporation and EdgeStone Capital Partnersand serves on the advisory boards of Power Corporation of Canada and WachoviaBank-Florida, Bennett Advisory Group – Palm Beach and Black & McDonaldLtd.

 

**Edward J. Robinson** has served as one of our directors since 2004. Mr. Robinsonserved as Chief Operating Officer of Meditrust Operating Company, a healthcareREIT, in 1998, President and Chief Operating Officer of Avon Products, Inc.,a public beauty products company, from 1993 to 1997, and Executive VicePresident and Chief Financial Officer of Avon Products, Inc. from 1989 to1992. Previously, he held various positions with RJR Nabisco and itspredecessor companies, Standard Brands and Nabisco Brands, including ExecutiveVice President, Chief Financial Officer, Vice President – Treasurer and SeniorVice President – Controller. He received a B.A. in Business Administration fromIona College.  Mr. Robinson is aCertified Public Accountant licensed by the State of New York. Mr. Robinsonhas been retired since 1998.

 

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**John W. Spiegel**hasserved as one of our directors since June 2002. Mr. Spiegel served asVice Chairman and Chief Financial Officer of SunTrust Banks, Inc. from August 2000until August 2004. Prior to August 2000, Mr. Spiegel was anExecutive Vice President and Chief Financial Officer of SunTrust Banks since1985. Mr. Spiegel also serves on the Board of Directors of the BankAdministration Institute, HomeBank Corp., Rock-Tenn Company, S1 Corporation andColonial Properties Trust. Mr. Spiegel is also a trustee of the WoodruffArts Center and Children’s Healthcare of Atlanta, and is a member of the Dean’sAdvisory Council of the Goizueta Business School at Emory University. Mr. Spiegelreceived an MBA from Emory University.

 

**Audit Committee**

 

The information called for by this item regardingBentley’s Audit Committee, including the Committee’s financial expert, isincorporated by reference to our Proxy Statement for the 2006 Annual Meeting ofStockholders.

 

**Section 16(a) Beneficial Ownership Reporting Compliance**

 

Section 16(a) of the Securities ExchangeAct of 1934, as amended, requires our executive officers and directors, and anypersons who own more than 10% of any class of our equity securities, to filecertain reports relating to their ownership of such securities and changes insuch ownership with the Securities and Exchange Commission and the New YorkStock Exchange and to furnish us with copies of such reports. To the best ofour knowledge during the year ended December 31, 2005, all Section 16(a) filingrequirements have been satisfied.

 

**Other Information**

 

As required by Section 303A.12 (a) of theNew York Stock Exchange Listed Company Manual, on June 17, 2005, (amendedin August 2005), our Chief Executive Officer submitted the Annual CEOCertification to the New York Stock Exchange, certifying that he was not awareof any violation by Bentley of the New York Stock Exchange’s corporategovernance listing standards, with the following qualifications. The availabilityof our Corporate Governance Guidelines and Code of Business Conduct and Ethicsand the determination by our Board of Directors that John W. Spiegel’s serviceon three public company audit committees in addition to ours does not impair hisability to serve on our Audit Committee were inadvertently omitted form ourProxy Statement for the 2005 Annual Meeting of Stockholders. The Proxy Statementalso did not clearly describe Mr. Spiegel’s role as the Presiding Director atexecutive sessions of meetings of non-management and independent directors anddid not reference Mr. Spiegel directly as the contact for interested partieswho wish to send communications on any topic to the Presiding Director or the Boardof Directors. Additionally, we did not have an internal audit function for ashort period beginning in May 2005 between the time that the person performingthat function was promoted to controller and his internal audit functionreplacement was hired. We subsequently addressed each of these qualificationsin satisfaction of the New York Stock Exchange’s corporate governance listingstandards.

 

We filed with the SEC as exhibits to this AnnualReport on Form 10-K for the year ended December 31, 2005 (whichexhibits are identified as Exhibit 31.1 and Exhibit 31.2)certifications by our Chief Executive Officer and Chief Financial Officerregarding the quality of our public disclosures in accordance with Section 302of the Sarbanes-Oxley Act of 2002.

 

Our Corporate Governance Guidelines, Code of BusinessConduct and Ethics, Audit Committee Procedures for Handling Complaints,Nominating and Governance Committee Charter, Audit Committee Charter andCompensation Committee Charter are available on our website atwww.bentleypharm.com. The information is also available in print to anyshareholder who requests it. Additionally, copies of reports filed by uspursuant to Section 13(a) or 15(d) of the Securities ExchangeAct of 1934, including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Qand Current Reports on Form 8-K may be accessed from the our website,free of charge, as soon as reasonably practicable after we electronically filesuch reports with, or furnish such reports to, the Securities and ExchangeCommission. Alternatively, these reports can be accessed through a query at thewebsite of the Securities and Exchange Commission at www.sec.gov.

 

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Our Board of Directors consists of six directors,four of whom (Messrs. John W. Spiegel, Miguel Fernandez, F. Ross Johnsonand Edward J. Robinson) are considered to be “independent” in accordance withthe listing standards of the New York Stock Exchange and Rule 10A-3 underthe Securities Exchange Act of 1934, as amended. All four of the independentdirectors serve on our Audit Committee. Since his retirement in 2004 as theChief Financial Officer of SunTrust Banks, Inc., John W. Spiegel hasagreed to serve on a fourth public company audit committee, in addition to hisservice for Bentley and two others. The Board of Directors has determined thatin Mr. Spiegel’s current circumstances this simultaneous service does notimpair his ability to serve on the Audit Committee of Bentley.

 

John W. Spiegel has been selected as the LeadDirector (or Presiding Director) of our Board of Directors. Mr. Spiegelpresides at executive sessions of meetings of our non-management andindependent directors. Interested parties who wish to send communications onany topic to Mr. Spiegel, the presiding director and the Chairperson ofthe Nominating and Governance Committee or to Bentley’s Board of Directors as agroup, should address such communications to the Chairman of the Nominating andGovernance Committee, c/o the Corporate Secretary, Bentley Pharmaceuticals, Inc.,Bentley Park, 2 Holland Way, Exeter, New Hampshire, 03833.

 

**Code of Business Conduct and Ethics**

 

We have adopted a Code of Business Conduct andEthics which applies to all of our employees and directors, including ourprincipal executive officer and our principal financial and accounting officer.The Code of Business Conduct and Ethics is available on our website atwww.bentleypharm.com and is also available in print to any shareholder whorequests it.

 

**Item 11.              ExecutiveCompensation**

 

The information called for by this item isincorporated by reference to our Proxy Statement for the 2006 Annual Meeting ofStockholders.

 

**Item 12.              SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters**

 

The information called for by this item isincorporated by reference to our Proxy Statement for the 2006 Annual Meeting ofStockholders.

 

**Item 13.              CertainRelationships and Related Transactions**

 

The information called for by this item isincorporated by reference to our Proxy Statement for the 2006 Annual Meeting ofStockholders.

 

**Item 14.              PrincipalAccounting Fees and Services**

 

The information called for by this item isincorporated by reference to our Proxy Statement for the 2006 Annual Meeting ofStockholders.

 

73

----

 

**Part IV**

 

**Item 15.              Exhibits,Financial Statement Schedules**

 
| (a)                                                                          | The following documents are filed as a part of this report:                                                                          |                                                                                      |   |
|------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------|--------|
|                                                                         |                                                                                                                                      |                                                                                      |   |   |
|                                                                         | (1)                                                                                                                                  | Financial Statements:                                                                     |   |   |
|                                                                         |                                                                                                                                      |                                                                                      |   |   |
|                                                                         |                                                                                                                                      | Consolidated Financial Statements of Bentley Pharmaceuticals, Inc.  and Subsidiaries |   |   |
|                                                                         |                                                                                                                                      |                                                                                      |   |   |
|                                                                         | (2)                                                                                                                                       | Financial Statement Schedules:                                                            |   |   |
|                                                                         |                                                                                                                                      |                                                                                      |   |   |
|                                                                         |                                                                                                                                      | None                                                                                      |   |   |
|                                                                         |                                                                                                                                      |                                                                                      |   |   |
|                                                                         | (3)                                                                                                                                       | Exhibits – See index beginning on page 75                                       |   |   |
|                                                                         |                                                                                                                                      |                                                                                      |   |   |
| (b)                                                                          | The exhibits filed as a part of this annual report on Form 10-K  are listed on the Exhibit Index immediately preceding the |
| signature page. The Exhibit Index is incorporated herein by  reference. |

 

74

----

 

**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3.1         |       | Articles of Incorporation of the Registrant, as amended and restated.  (Reference is made to Appendix B to the Registrant’s Definitive Proxy  Statement for the Annual Meeting of Stockholders filed on May 18, 1999,  Commission File No. 1-10581, which exhibit is incorporated herein  by reference.)                                                                                                                                                                                                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3.2         |       | Amendment of Restated Articles of Incorporation of the Registrant.  (Reference is made to Exhibit 3.1 to the Registrant’s Form 10-Q for  the quarter ended June 30, 2004, Commission File No. 1-10581, which  exhibit is incorporated herein by reference.)                                                                                                                                                                                                                                                                                                   |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3.3         |       | Bylaws of the Registrant, as amended and restated. (Reference is made  to Exhibit 3.1 to the Registrant’s Form 10-Q for the quarter ended March 31,  2004, Commission File No. 1-10581, which exhibit is incorporated  herein by reference.)                                                                                                                                                                                                                                                                                                                  |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.1         |       | Renewed Rights Agreement dated as of December 21, 2004 between  Bentley Pharmaceuticals, Inc. and American Stock Transfer &  Trust Company, as Rights Agent, including the form of Rights certificate  as Exhibit B thereto and the Summary of Rights to Purchase Series A  Junior Participating Preferred Stock as Exhibit C thereto. (Reference is  made to Exhibit 4.1 to the Registrant’s Form 8-K, filed on December 21,  2004, Commission File No. 1-10581, which exhibit is incorporated  herein by reference.) |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.1*       |       | Registrant’s  Amended and Restated 1991 Stock Option Plan. (Reference is made to Appendix D  to the Registrant’s Definitive Proxy Statement for the Annual Meeting of  Stockholders filed on May 18, 1999, Commission File No. 1-10581,  which exhibit is incorporated herein by reference.)                                                                                                                                                                                                                                                                       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.2*       |       | Form of Non-qualified Stock Option Agreement under the  Registrant’s 1991 Stock Option Plan. (Reference is made to Exhibit 4.25  to the Registrant’s Form 10-K for the year ended June 30, 1992,  Commission File No. 1-10581, which exhibit is incorporated herein  by reference.)                                                                                                                                                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.3*       |       | Nonqualified Performance Vesting Stock Option Contract dated as of December 19,  1996 between the Registrant and James R. Murphy. (Reference is made to Exhibit 4.5  to the Registrant’s Form S-8 filed on July 15, 2005, Commission  File No. 333-126651, which exhibit is incorporated herein by  reference.)                                                                                                                                                                                                                                          |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.4*       |       | Nonqualified Performance Vesting Stock Option Contract dated as of December 19,  1996 between the Registrant and Michael D. Price. (Reference is made to Exhibit 4.6  to the Registrant’s Form S-8 filed on July 15, 2005, Commission  File No. 333-126651, which exhibit is incorporated herein by  reference.)                                                                                                                                                                                                                                         |

 

75

----

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                         |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                                                                                               |
| 10.5*       |       | Nonqualified Performance Vesting Stock Option Contract dated as of December 19,  1996 between the Registrant and Robert M. Stote. (Reference is made to Exhibit 4.7  to the Registrant’s Form S-8 filed on July 15, 2005, Commission  File No. 333-126651, which exhibit is incorporated herein by  reference.) |
|        |       |                                                                                                                                                                                                                                                                                                                                               |
| 10.6*       |       | Registrant’s 2001 Employee Stock Option Plan. (Reference is made to  Appendix B to the Registrant’s Definitive Proxy Statement for the Annual  Meeting of Stockholders filed on April 9, 2001, Commission File No. 1-10581,  which exhibit is incorporated herein by reference.)                                          |
|        |       |                                                                                                                                                                                                                                                                                                                                               |
| 10.7*       |       | Registrant’s 2001 Directors’ Stock Option Plan. (Reference is made to  Appendix C to the Registrant’s Definitive Proxy Statement for the Annual  Meeting of Stockholders filed on April 9, 2001, Commission File No. 1-10581,  which exhibit is incorporated herein by reference.)                                   |
|        |       |                                                                                                                                                                                                                                                                                                                                               |
| 10.8*       |       | Form of Stock Option contract under the Registrant’s 2001  Employee Stock Option Plan. (Reference is made to Exhibit 4.8 to the  Registrant’s Form 10-K for the year ended December 31, 2001,  Commission File No. 1-10581, which exhibit is incorporated herein  by reference.)                           |
|        |       |                                                                                                                                                                                                                                                                                                                                               |
| 10.9*       |       | Form of Stock Option contract under the Registrant’s 2001  Directors’ Stock Option Plan. (Reference is made to Exhibit 4.9 to the  Registrant’s Form 10-K for the year ended December 31, 2001,  Commission File No. 1-10581, which exhibit is incorporated herein  by reference.)                    |
|        |       |                                                                                                                                                                                                                                                                                                                                               |
| 10.10*      |       | Amendment No. 1 to the Registrant’s 2001 Employee Stock Option  Plan. (Reference is made to Exhibit 4.10 to the Registrant’s Form 10-K  for the year ended December 31, 2003, Commission File No. 1-10581,  which exhibit is incorporated herein by reference.)                                            |
|        |       |                                                                                                                                                                                                                                                                                                                                               |
| 10.11*      |       | Amendment No. 2 to the Registrant’s 2001 Employee Stock Option  Plan. (Reference is made to Exhibit 4.11 to the Registrant’s Form 10-K  for the year ended December 31, 2003, Commission File No. 1-10581,  which exhibit is incorporated herein by reference.)                                            |
|        |       |                                                                                                                                                                                                                                                                                                                                               |
| 10.12*      |       | Amendment No. 1 to the Registrant’s 2001 Directors’ Stock Option  Plan. (Reference is made to Exhibit 4.12 to the Registrant’s Form 10-K  for the year ended December 31, 2003, Commission File No. 1-10581,  which exhibit is incorporated herein by reference.)                                     |
|        |       |                                                                                                                                                                                                                                                                                                                                               |
| 10.13*      |       | Amendment No. 2 to the Registrant’s 2001 Directors’ Stock Option  Plan. (Reference is made to Exhibit 4.13 to the Registrant’s Form 10-K  for the year ended December 31, 2003, Commission File No. 1-10581,  which exhibit is incorporated herein by reference.)                                     |
|        |       |                                                                                                                                                                                                                                                                                                                                               |
| 10.14*      |       | Registrant’s 2005 Equity and Incentive Plan. (Reference is made to Exhibit 10.1  to the Registrant’s Form 8-K filed on May 31, 2005, Commission File  No. 1-10581, which exhibit is incorporated herein by reference.)                                                                                          |

 

76

----

 
| **Exhibit**  | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|--------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**   | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.15*       |       | Form of Incentive Stock Option Certificate under the Registrant’s  2005 Equity and Incentive Plan. (Reference is made to Exhibit 10.2 to  the Registrant’s Form 10-Q for the quarter ended June 30, 2005,  Commission File No. 1-10581, which exhibit is incorporated herein  by reference.)                                                                                                                                 |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.16*       |       | Form of Non-Statutory Stock Option Certificate under the  Registrant’s 2005 Equity and Incentive Plan. (Reference is made to Exhibit 10.3  to the Registrant’s Form 10-Q for the quarter ended June 30, 2005,  Commission File No. 1-10581, which exhibit is incorporated herein  by reference.)                                                                                                                             |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.17*† |       | Ordinary Labor Contract  dated as of February 12, 1998 between the Registrant’s wholly-owned  subsidiary, Laboratorios Belmac, S.A. and Adolfo Herrera.                                                                                                                                                                                                                                                                                                    |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.18*       |       | Employment Agreement dated  as of January 1, 2002 between the Registrant and James R. Murphy.  (Reference is made to Exhibit 10.1 to Amendment No. 1 to the  Registrant’s Form 10-K for the year ended December 31, 2001,  Commission File No. 1-10581, which exhibit is incorporated herein  by reference.)                                                                                                                 |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.19*       |       | Employment Agreement dated  as of January 1, 2002 between the Registrant and Michael D. Price.  (Reference is made to Exhibit 10.3 to Amendment No. 1 to the Registrant’s  Form 10-K for the year ended December 31, 2001, Commission File No. 1-10581,  which exhibit is incorporated herein by reference.)                                                                                                                 |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.20*       |       | Employment Agreement dated  as of August 27, 2005 between the Registrant and John A. Sedor.  (Reference is made to Exhibit 10.1 to the Registrant’s Form 10-Q  for the quarter ended September 30, 2005, Commission File No. 1-10581,  which exhibit is incorporated herein by reference.)                                                                                                                                        |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.21*       |       | 2005  base salaries, target bonuses and annual stock option awards for the  Registrant’s executive officers. (Reference is made to Exhibit 10.1 to  the Registrant’s Form 8-K filed on April 5, 2005, Commission File No. 1-10581,  which exhibit is incorporated herein by reference.)                                                                                                                                                |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.22        |       | Asset  Purchase Agreement between the Registrant and Yungtai Hsu dated February 1,  1999, effective as of December 31, 1998. (Reference is made to Exhibit 7.1  to the Registrant’s Form 8-K filed on February 26, 1999, Commission File  No. 1-10581, which exhibit is incorporated herein by reference.)                                                                                                                        |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.23        |       | License  Agreement between the Registrant and Auxilium A(2), Inc. dated May 31,  2000, including Amendment No. 1 thereto dated October 2000 and  Amendment No. 2 dated May 31, 2001. (Reference is made to Exhibit 10.10  to Amendment No. 2 to the Registrant’s Form 10-K for the year ended  December 31, 2001, Commission File No. 1-10581, which exhibit is  incorporated herein by reference.) |

 

77

----

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.24       |       | Supply Agreement, License Agreement and Rights Agreement between  Laboratorios Belmac, S.A., Laboratorios Davur, S.L. and Teva Pharmaceutical  Industries Ltd. dated July 18, 2000. (Reference is made to Exhibit 10.12  to Amendment No. 2 to the Registrant’s Form 10-K for the year ended  December 31, 2001, Commission File No. 1-10581, which exhibit is  incorporated herein by reference.) |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.25       |       | Amendment No. 3 dated  September 6, 2002 to License Agreement between the Registrant and  Auxilium Pharmaceuticals, Inc. dated May 31, 2000. (Reference is  made to Exhibit 10.10 to the Registrant’s Form 10-K for the year  ended December 31, 2002, Commission File No. 1-10581, which exhibit is  incorporated herein by reference.)                                                 |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.26† |       | Amendment No. 4 dated  March 25, 2004 to License Agreement between the Registrant and Auxilium  Pharmaceuticals, Inc. dated May 31, 2000.                                                                                                                                                                                                                                                                              |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.27       |       | License Agreement between  the Registrant and Auxilium Pharmaceuticals, Inc. dated May 31,  2001 relating to products using Dihydrotestosterone. (Reference is made to Exhibit 10.12  to the Registrant’s Form 10-K for the year ended December 31, 2002,  Commission File No. 1-10581, which exhibit is incorporated herein  by reference.)                                                       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.28       |       | Amendment No. 1 dated  September 6, 2002 to License Agreement between the Registrant and  Auxilium Pharmaceuticals, Inc. dated May 31, 2001 related to  products using Dihydrotestosterone. (Reference is made to Exhibit 10.13  to the Registrant’s Form 10-K for the year ended December 31, 2002,  Commission File No. 1-10581, which exhibit is incorporated herein  by reference.)  |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 21.1†  |       | Subsidiaries of the Registrant.                                                                                                                                                                                                                                                                                                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 23.1†  |       | Consent of Independent Registered Public Accounting Firm.                                                                                                                                                                                                                                                                                                                                                                                  |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 31.1†  |       | Certification of the Chief Executive Officer Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                              |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 31.2†  |       | Certification of the Chief Financial Officer Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                              |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 32.1†  |       | Certification of the Chief Executive Officer Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                              |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 32.2†  |       | Certification of the Chief Financial Officer Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                              |

 

----

| *      |   | Indicates a management contract or compensatory plan or arrangement. |
|--------|--------|----------------------------------------------------------------------|
|   |   |                                                                 |
| † |   | Filed herewith.                                                      |

 

78

----

 

**SIGNATURES**

 

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

 
|   | BENTLEY PHARMACEUTICALS, INC. |
|--------|------------------------------------|
|   | By:                                | /s/ James R. Murphy |   |
|   |                               | James R. Murphy |
|   |                               | Chairman and Chief |
|   |                               | Executive Officer |
|   |                               | Date: March 16, 2006 |

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, this report has been signed below by thefollowing persons on behalf of the Registrant and in the capacities and on thedates indicated.

 
| **Signature**          | ** ** | **Title** | ** **                 | **Date** |
|------------------------|------------|-----------|----------------------------|----------|
| /s/ James R. Murphy    |       |      | Chairman, Chief            |     | March 16, 2006 |
| James R. Murphy        |       |      | Executive Officer          |     |   |
|                   |       |      | and Director (principal    |     |   |
|                   |       |      | executive officer)         |     |   |
|                   |       |      |                       |     |   |
| /s/ Michael McGovern   |       |      | Vice Chairman and Director |     | March 16, 2006 |
| Michael McGovern       |       |      |                       |     |   |
|                   |       |      |                       |     |   |
| /s/ Michael D. Price   |       |      | Vice-President,            |     | March 16, 2006 |
| Michael D. Price       |       |      | Chief Financial Officer,   |     |   |
|                   |       |      | Treasurer and Secretary    |     |   |
|                   |       |      | (principal financial and   |     |   |
|                   |       |      | accounting officer)        |     |   |
|                   |       |      |                       |     |   |
| /s/ Miguel Fernandez   |       |      | Director                   |     | March 16, 2006 |
| Miguel Fernandez       |       |      |                       |     |   |
|                   |       |      |                       |     |   |
| /s/ F. Ross Johnson    |       |      | Director                   |     | March 16, 2006 |
| F. Ross Johnson        |       |      |                       |     |   |
|                   |       |      |                       |     |   |
| /s/ Edward J. Robinson |       |      | Director                   |     | March 16, 2006 |
| Edward J. Robinson     |       |      |                       |     |   |
|                   |       |      |                       |     |   |
| /s/ John W. Spiegel    |       |      | Lead Director              |     | March 16, 2006 |
| John W. Spiegel        |       |      |                       |     |   |

 

----

 

**Index toConsolidated Financial Statements of**

**BentleyPharmaceuticals, Inc. and Subsidiaries**

 
| ** **                                                                                                                 | ** ** | **Page** |
|----------------------------------------------------------------------------------------------------------------------------|------------|----------|
|                                                                                                                       |       |     |
| Report of Independent Registered Public Accounting Firm                                                                    |       | F-2      |
|                                                                                                                       |       |     |
| Consolidated Balance Sheets as of December 31, 2005 and 2004                                                          |       | F-3      |
|                                                                                                                       |       |     |
| Consolidated Income Statements for the years ended December 31,  2005, 2004 and 2003                                  |       | F-4      |
|                                                                                                                       |       |     |
| Consolidated Statements of Changes in Stockholders’ Equity for the  years ended December 31, 2005, 2004 and 2003 |       | F-5      |
|                                                                                                                       |       |     |
| Consolidated Statements of Cash Flows for the years ended  December 31, 2005, 2004 and 2003                           |       | F-6      |
|                                                                                                                       |       |     |
| Notes to Consolidated Financial Statements                                                                                 |       | F-8      |

 

F-1

----

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Stockholders of

BentleyPharmaceuticals, Inc.

Exeter, New Hampshire

 

Wehave audited the accompanying consolidated balance sheets of BentleyPharmaceuticals, Inc. and subsidiaries (the “Company”) as of December 31,2005 and 2004, and the related consolidated income statements, statements ofchanges in stockholders’ equity, and statements of cash flows for each of thethree years in the period ended December 31, 2005. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

Inour opinion, such consolidated financial statements present fairly, in allmaterial respects, the financial position of the Company as of December 31,2005 and 2004, and the results of its operations and its cash flows for each ofthe three years in the period ended December 31, 2005, in conformity withaccounting principles generally accepted in the United States of America.

 

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of the Company’sinternal control over financial reporting as of December 31, 2005, basedon the criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated March 16,2006 expressed an unqualified opinion on management’s assessment of theeffectiveness of the Company’s internal control over financial reporting and anunqualified opinion on the effectiveness of the Company’s internal control overfinancial reporting.

 

 
| /s/ Deloitte & Touche LLP |   |
|------------------------------------|--------|
|                               |
| Boston, Massachusetts              |
| March 16, 2006                |

 

F-2

----

 

**BentleyPharmaceuticals, Inc. and Subsidiaries**

**Consolidated Balance Sheets**

 
| **(in thousands, except per share data)**                                                                   | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                  |       |                        |       |                        |       |
|                                                                                                        |       |                        |       |                        |       |
| Current assets:                                                                                             |       |                        |       |                        |       |
| Cash and  cash equivalents                                                                                  |       | $                           | 32,384     |                        | $          | 34,230 |   |
| Marketable  securities                                                                                      |       | 462                         |       | 528                         |       |
| Receivables,  net                                                                                           |       | 26,916                      |       | 27,860                      |       |
| Inventories,  net                                                                                           |       | 12,147                      |       | 10,258                      |       |
| Deferred  taxes                                                                                             |       | 1,099                       |       | 479                         |       |
| Prepaid  expenses and other                                                                                 |       | 2,069                       |       | 1,355                       |       |
| Total  current assets                                                                                       |       | 75,077                      |       | 74,710                      |       |
|                                                                                                        |       |                        |       |                        |       |
| Non-current assets:                                                                                         |       |                        |       |                        |       |
| Fixed  assets, net                                                                                          |       | 33,366                      |       | 30,849                      |       |
| Drug  licenses and related costs, net                                                                       |       | 13,858                      |       | 14,863                      |       |
| Restricted  cash                                                                                            |       | 1,000                       |       | 1,000                       |       |
| Other                                                                                                       |       | 919                         |       | 508                         |       |
| Total  non-current assets                                                                                   |       | 49,143                      |       | 47,220                      |       |
|                                                                                                        |       | $                           | 124,220    |                        | $          | 121,930 |   |
|                                                                                                        |       |                        |       |                        |       |
| **Liabilities and Stockholders’ Equity**                                                               |       |                        |       |                        |       |
|                                                                                                        |       |                        |       |                        |       |
| Current liabilities:                                                                                        |       |                        |       |                        |       |
| Accounts  payable                                                                                           |       | $                           | 15,462     |                        | $          | 17,048 |   |
| Accrued expenses                                                                                            |       | 9,428                       |       | 6,169                       |       |
| Short-term  borrowings                                                                                      |       | 2,608                       |       | 2,754                       |       |
| Current  portion of long-term debt                                                                          |       | 387                         |       | 31                          |       |
| Deferred  income                                                                                            |       | 795                         |       | 1,594                       |       |
| Total  current liabilities                                                                                  |       | 28,680                      |       | 27,596                      |       |
|                                                                                                        |       |                        |       |                        |       |
| Non-current liabilities:                                                                                    |       |                        |       |                        |       |
| Deferred  taxes                                                                                             |       | 1,665                       |       | 2,319                       |       |
| Long-term  debt                                                                                             |       | —                      |       | 349                         |       |
| Deferred  income                                                                                            |       | 2,286                       |       | 1,944                       |       |
| Other                                                                                                       |       | —                      |       | 65                          |       |
| Total  non-current liabilities                                                                              |       | 3,951                       |       | 4,677                       |       |
|                                                                                                        |       |                        |       |                        |       |
| Commitments and contingencies                                                                               |       |                        |       |                        |       |
|                                                                                                        |       |                        |       |                        |       |
| Stockholders’ equity:                                                                                  |       |                        |       |                        |       |
| Preferred  stock, $1.00 par value, authorized 2,000 shares, issued and outstanding, none                    |       | —                      |       | —                      |       |
| Common  stock, $.02 par value, authorized 100,000 shares, issued and outstanding,  21,923 and 21,312 shares |       | 438                         |       | 426                         |       |
| Additional  paid-in capital                                                                                 |       | 139,381                     |       | 140,418                     |       |
| Accumulated  deficit                                                                                        |       | (49,990                     | )          | (60,909                     | )          |
| Accumulated  other comprehensive income                                                                     |       | 1,760                       |       | 9,722                       |       |
| Total  stockholders’ equity                                                                            |       | 91,589                      |       | 89,657                      |       |
|                                                                                                        |       | $                           | 124,220    |                        | $          | 121,930 |   |

 

*Theaccompanying Notes to Consolidated Financial Statements are an integral part ofthese financial statements.*

 

F-3

----

 

**BentleyPharmaceuticals, Inc. and Subsidiaries**

**Consolidated Income Statements**

 
| ** **                                  | ** ** | **For the Year Ended December 31,** | ** ** |
|---------------------------------------------|------------|------------------------------------------|------------|
| **(in thousands, except per share data)**   | ** ** | **2005**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                   | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net product  sales                          |       | $                                        | 91,308     |   | $ | 69,942 |   | $ | 62,955 |   |
| Licensing  and collaboration revenues       |       | 6,422                                    |       | 3,451 |   | 1,721 |   |
| Total  revenues                             |       | 97,730                                   |       | 73,393 |   | 64,676 |   |
|                                        |       |                                     |       |   |   |   |   |
| Cost of net product sales                   |       | 46,161                                   |       | 34,893 |   | 26,399 |   |
|                                        |       |                                     |       |   |   |   |   |
| Gross profit                                |       | 51,569                                   |       | 38,500 |   | 38,277 |   |
|                                        |       |                                     |       |   |   |   |   |
| Operating expenses:                         |       |                                     |       |   |   |   |   |
| Selling and  marketing                      |       | 16,347                                   |       | 14,808 |   | 14,212 |   |
| General and  administrative                 |       | 11,998                                   |       | 9,126 |   | 7,001 |   |
| Research and  development                   |       | 5,800                                    |       | 4,419 |   | 4,295 |   |
| Depreciation  and amortization              |       | 1,758                                    |       | 1,452 |   | 1,340 |   |
| Total  operating expenses                   |       | 35,903                                   |       | 29,805 |   | 26,848 |   |
|                                        |       |                                     |       |   |   |   |   |
| Income from operations                      |       | 15,666                                   |       | 8,695 |   | 11,429 |   |
|                                        |       |                                     |       |   |   |   |   |
| Other income (expenses):                    |       |                                     |       |   |   |   |   |
| Interest  income                            |       | 928                                      |       | 548 |   | 332 |   |
| Interest  expense                           |       | (211                                     | )          | (226 | ) | (228 | ) |
| Other, net                                  |       | 12                                       |       | 1,478 |   | (13 | ) |
|                                        |       |                                     |       |   |   |   |   |
| Income before income taxes                  |       | 16,395                                   |       | 10,495 |   | 11,520 |   |
|                                        |       |                                     |       |   |   |   |   |
| Provision for income taxes                  |       | 5,476                                    |       | 4,805 |   | 5,423 |   |
|                                        |       |                                     |       |   |   |   |   |
| Net income                                  |       | $                                        | 10,919     |   | $ | 5,690 |   | $ | 6,097 |   |
|                                        |       |                                     |       |   |   |   |   |
| Net income per common share:                |       |                                     |       |   |   |   |   |
| Basic                                       |       | $                                        | 0.51       |   | $ | 0.27 |   | $ | 0.34 |   |
| Diluted                                     |       | $                                        | 0.48       |   | $ | 0.25 |   | $ | 0.28 |   |
|                                        |       |                                     |       |   |   |   |   |
| Weighted average common shares outstanding: |       |                                     |       |   |   |   |   |
| Basic                                       |       | 21,558                                   |       | 20,901 |   | 17,997 |   |
| Diluted                                     |       | 22,929                                   |       | 22,627 |   | 21,637 |   |

 

*Theaccompanying Notes to Consolidated Financial Statements are an integral part ofthese financial statements.*

 

F-4

----

 

**BentleyPharmaceuticals, Inc. and Subsidiaries**

**Consolidated Statements of Changes inStockholders’ Equity**

 
| ** **                              | ** ** | **$.02 Par Value  Common Stock** | ** ** | **Stock  Purchase** | ** ** | **Additional  Paid-In** | ** ** | **Accumulated** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|---------------------|------------|-------------------------|------------|-----------------|------------|---------------------------------------|------------|------------|------------|
| **(in thousands)**                      | ** ** | **Shares**                       | ** ** | **Amount**          | ** ** | **Warrants**            | ** ** | **Capital**     | ** ** | **Deficit**                           | ** ** | **Income** | ** ** | **Total** | ** ** |
|                                    |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Balance at January 1, 2003         |       | 17,404                           |       | $                   | 348        |                    | $          | 431             |       | $                                     | 121,084    |       | $          | (72,696 | ) | $ | (416 | ) | $ | 48,751 |   |
| Comprehensive income:                   |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Net income                              |       | —                           |       | —              |       | —                  |       | —          |       | 6,097                                 |       | —     |       | 6,097 |   |
| Other comprehensive income:             |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Foreign currency translation adjustment |       | —                           |       | —              |       | —                  |       | —          |       | —                                |       | 5,585      |       | 5,585 |   |
| Comprehensive income                    |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       | 11,682 |   |
|                                    |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Exercise of stock options / warrants    |       | 3,111                            |       | 62                  |       | (98                     | )          | 15,258          |       | —                                |       | —     |       | 15,222 |   |
| Equity-based compensation               |       | 58                               |       | 2                   |       | —                  |       | 508             |       | —                                |       | —     |       | 510 |   |
|                                    |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Balance at December 31, 2003       |       | 20,573                           |       | 412                 |       | 333                     |       | 136,850         |       | (66,599                               | )          | 5,169      |       | 76,165 |   |
|                                    |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Comprehensive income:                   |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Net income                              |       | —                           |       | —              |       | —                  |       | —          |       | 5,690                                 |       | —     |       | 5,690 |   |
| Other comprehensive income:             |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Foreign currency translation adjustment |       | —                           |       | —              |       | —                  |       | —          |       | —                                |       | 4,553      |       | 4,553 |   |
| Comprehensive income                    |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       | 10,243 |   |
|                                    |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Exercise of stock options / warrants    |       | 725                              |       | 14                  |       | (333                    | )          | 3,393           |       | —                                |       | —     |       | 3,074 |   |
| Equity-based compensation               |       | 14                               |       | —              |       | —                  |       | 175             |       | —                                |       | —     |       | 175 |   |
|                                    |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Balance at December 31, 2004       |       | 21,312                           |       | 426                 |       | —                  |       | 140,418         |       | (60,909                               | )          | 9,722      |       | 89,657 |   |
|                                    |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Comprehensive income:                   |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Net income                              |       | —                           |       | —              |       | —                  |       | —          |       | 10,919                                |       | —     |       | 10,919 |   |
| Other comprehensive loss:               |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Foreign currency translation adjustment |       | —                           |       | —              |       | —                  |       | —          |       | —                                |       | (7,962     | )          | (7,962 | ) |
| Comprehensive income                    |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       | 2,957 |   |
|                                    |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Exercise of stock options               |       | 1,021                            |       | 20                  |       | —                  |       | 4,055           |       | —                                |       | —     |       | 4,075 |   |
| Purchase of treasury shares             |       | (430                             | )          | (8                  | )          | —                  |       | (5,313          | )          | —                                |       | —     |       | (5,321 | ) |
| Equity-based compensation               |       | 20                               |       | —              |       | —                  |       | 221             |       | —                                |       | —     |       | 221 |   |
|                                    |       |                             |       |                |       |                    |       |            |       |                                  |       |       |       |   |   |
| Balance at December 31, 2005       |       | 21,923                           |       | $                   | 438        |                    | $          | —          |       | $                                     | 139,381    |       | $          | (49,990 | ) | $ | 1,760 |   | $ | 91,589 |   |

 

*Theaccompanying Notes to Consolidated Financial Statements are an integral part ofthese financial statements.*

 

F-5

----

 

**BentleyPharmaceuticals, Inc. and Subsidiaries**

**Consolidated Statements of Cash Flows**

 
| ** **                                                                         | ** ** | **For the Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| **(in thousands)**                                                                 | ** ** | **2005**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                               |       |                                     |       |   |   |   |   |
| Cash flows  from operating activities:                                             |       |                                     |       |   |   |   |   |
| Net income                                                                         |       | $                                        | 10,919     |   | $ | 5,690 |   | $ | 6,097 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                     |       |   |   |   |   |
| Depreciation  and amortization                                                     |       | 5,096                                    |       | 3,918 |   | 2,479 |   |
| Forgiveness  of related party notes                                                |       | —                                   |       | — |   | 302 |   |
| Equity-based  compensation expense                                                 |       | 280                                      |       | 195 |   | 510 |   |
| Loss on  disposal of assets                                                        |       | 481                                      |       | — |   | — |   |
| Other  non-cash items                                                              |       | 38                                       |       | (103 | ) | (163 | ) |
| (Increase)  decrease in assets and increase (decrease) in liabilities:             |       |                                     |       |   |   |   |   |
| Receivables                                                                        |       | (2,529                                   | )          | (7,715 | ) | (3,673 | ) |
| Inventories                                                                        |       | (3,701                                   | )          | (2,083 | ) | (801 | ) |
| Deferred  income taxes                                                             |       | (1,160                                   | )          | (271 | ) | (55 | ) |
| Prepaid  expenses and other current assets                                         |       | (809                                     | )          | (398 | ) | (362 | ) |
| Other assets                                                                       |       | (681                                     | )          | (153 | ) | (123 | ) |
| Accounts  payable and accrued expenses                                             |       | 4,900                                    |       | 4,022 |   | 2,682 |   |
| Deferred  income                                                                   |       | (173                                     | )          | 1,305 |   | 1,180 |   |
| Other  liabilities                                                                 |       | (65                                      | )          | (174 | ) | (10 | ) |
| Net cash  provided by operating activities                                         |       | 12,596                                   |       | 4,233 |   | 8,063 |   |
|                                                                               |       |                                     |       |   |   |   |   |
| Cash flows  from investing activities:                                             |       |                                     |       |   |   |   |   |
| Additions to  fixed assets                                                         |       | (11,018                                  | )          | (10,049 | ) | (8,076 | ) |
| Additions to  drug licenses and related costs                                      |       | (2,045                                   | )          | (1,204 | ) | (2,193 | ) |
| Proceeds  from maturity of investments                                             |       | 461                                      |       | 150,352 |   | 225,750 |   |
| Purchase of  investments                                                           |       | (461                                     | )          | (149,477 | ) | (226,219 | ) |
| Purchase of  API manufacturing assets                                              |       | —                                   |       | (3,309 | ) | — |   |
| Net cash  used in investing activities                                             |       | (13,063                                  | )          | (13,687 | ) | (10,738 | ) |
|                                                                                    |            |                                          |            |  |  |  |  |  |  |  |

 

*Theaccompanying Notes to Consolidated Financial Statements are an integral part ofthese financial statements.*

 

F-6

----

 

**BentleyPharmaceuticals, Inc. and Subsidiaries**

**ConsolidatedStatements of Cash Flows (concluded)**

 
| ** **                                                                                                     | ** ** | **For the Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| **(in thousands)**                                                                                             | ** ** | **2005**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                           |       |                                     |       |   |   |   |   |
| Cash flows  from financing activities:                                                                         |       |                                     |       |   |   |   |   |
| Proceeds  from the exercise of stock options/warrants                                                          |       | $                                        | 2,028      |   | $ | 3,083 |   | $ | 15,222 |   |
| Remittance  of employee tax liabilities in exchange for common stock tendered to the  Company                  |       | (2,292                                   | )          | — |   | — |   |
| Purchases of  treasury stock                                                                                   |       | (1,041                                   | )          | — |   | — |   |
| Proceeds  from borrowings                                                                                      |       | 1,938                                    |       | 5,759 |   | 3,556 |   |
| Repayment of  borrowings                                                                                       |       | (1,659                                   | )          | (5,164 | ) | (3,577 | ) |
| Increase in  restricted cash                                                                                   |       | —                                   |       | — |   | (1,000 | ) |
| Net cash  (used in) provided by financing activities                                                           |       | (1,026                                   | )          | 3,678 |   | 14,201 |   |
|                                                                                                           |       |                                     |       |   |   |   |   |
| Effect of  exchange rate changes on cash                                                                       |       | (353                                     | )          | 613 |   | 1,286 |   |
|                                                                                                           |       |                                     |       |   |   |   |   |
| Net  (decrease) increase in cash and cash equivalents                                                          |       | (1,846                                   | )          | (5,163 | ) | 12,812 |   |
|                                                                                                           |       |                                     |       |   |   |   |   |
| Cash and  cash equivalents at beginning of year                                                                |       | 34,230                                   |       | 39,393 |   | 26,581 |   |
|                                                                                                           |       |                                     |       |   |   |   |   |
| Cash and  cash equivalents at end of year                                                                      |       | $                                        | 32,384     |   | $ | 34,230 |   | $ | 39,393 |   |
|                                                                                                           |       |                                     |       |   |   |   |   |
| **Supplemental  Disclosures of Cash Flow Information**                                                         |       |                                     |       |   |   |   |   |
| The Company  paid cash during the year for:                                                                    |       |                                     |       |   |   |   |   |
| Interest                                                                                                       |       | $                                        | 204        |   | $ | 339 |   | $ | 203 |   |
| Foreign  income taxes                                                                                          |       | $                                        | 4,231      |   | $ | 4,283 |   | $ | 4,862 |   |
|                                                                                                           |       |                                     |       |   |   |   |   |
| **Supplemental  Disclosures of Non-Cash Financing and Investing Activities**                                   |       |                                     |       |   |   |   |   |
| The Company  has issued Common Stock as equity-based compensation in lieu of cash during  the year as follows: |       |                                     |       |   |   |   |   |
| Shares                                                                                                         |       | 20                                       |       | 14 |   | 58 |   |
| Amount                                                                                                         |       | $                                        | 221        |   | $ | 175 |   | $ | 505 |   |
|                                                                                                           |       |                                     |       |   |   |   |   |
| Amounts  included in accounts payable at end of year for fixed asset and drug license  purchases               |       | $                                        | 2,675      |   | $ | 3,986 |   | $ | 1,721 |   |

 

*Theaccompanying Notes to Consolidated Financial Statements are an integral part ofthese financial statements.*

 

F-7

----

** **

**BENTLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 – HISTORY AND OPERATIONS**

 

Bentley Pharmaceuticals, Inc.and Subsidiaries (which may be referred to as Bentley Pharmaceuticals,Bentley, or the Company), headquartered in the U.S., is an internationalspecialty pharmaceutical company, incorporated in the State of Delaware,focused on:

 

•                  development,licensing and sales of generic and branded pharmaceutical products and activepharmaceutical ingredients (API) and the manufacturing of pharmaceuticals forothers; and

 

•                  research,development and licensing/commercialization of advanced drug deliverytechnologies and pharmaceutical products.

 

Bentley’s pharmaceutical product sales and licensingactivities are based primarily in Spain, where it has a significant commercialpresence and manufactures and markets approximately 100 products of variousdosages and strengths through three wholly-owned Spanish subsidiaries:Laboratorios Belmac, Laboratorios Davur and Laboratorios Rimafar. Bentley’sproducts include approximately 151 product presentations in four primarytherapeutic areas: cardiovascular, gastrointestinal, central nervous system andinfectious diseases. The Company continually adds to its product portfolio inresponse to increasing market demand for generic and branded therapeutic agentsand, when appropriate, divests portfolio products considered to be redundant orthat have become non-strategic. Although most of the Company’s sales of theseproducts are currently in the Spanish market, it has recently focused onincreasing sales in other European countries and other geographic regionsthrough strategic alliances with companies in these territories. In April 2004,the Company purchased a manufacturing facility located in Zaragoza, Spain thatspecializes in the manufacture of active pharmaceutical ingredients. Thefacility has been approved by the U.S. Food and Drug Administration for themanufacture of one ingredient for marketing and sale in the U.S. The Companymanufactures and markets active pharmaceutical ingredients through its subsidiary,Bentley A.P.I. In November 2005, the Company announced a newly formedIrish subsidiary, Bentley Pharmaceuticals Ireland Limited, and its firstmarketing approval by the Irish Medicines Board.

 

The Company has U.S. and international patents andother proprietary rights to technologies that facilitate the absorption ofdrugs. Bentley is developing products that incorporate its drug deliverytechnologies and has licensed applications of its proprietary CPE-215® drugdelivery technology to Auxilium Pharmaceuticals, Inc., which launchedTestim® in the U.S. market in February 2003. Testim, which incorporatesBentley’s CPE-215 drug delivery technology, is a gel indicated for testosteronereplacement therapy. Bentley continues to seek other pharmaceutical and biotechnologycompanies to form additional strategic alliances to facilitate thedevelopment and commercialization of other products using its drug deliverytechnologies, including product candidates that deliver insulin to diabeticpatients intranasally, deliver macromolecule therapeutics using a biodegradableNanacapletTM technology and treat nail fungus infections topically.

 

**NOTE 2** – **SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**Principles of consolidation and foreign currency translation**

 

The consolidated financial statements include theaccounts of Bentley Pharmaceuticals, Inc. and its wholly-ownedsubsidiaries: Pharma de Espana, Inc. and its wholly-owned subsidiaries,Bentley A.P.I. S.L. and Laboratorios Belmac S.A. and its wholly-ownedsubsidiaries, Laboratorios Davur S.L. and Laboratorios Rimafar S.L.; BentleyPark, LLC; Bentley Healthcare Corporation and its wholly-owned

 

F-8

----

 

subsidiary,Belmac Hygiene, Inc.; Belmac Health Corporation; Belmac Holdings, Inc.and its wholly-owned subsidiary, Belmac A.I., Inc.; B.O.G. InternationalFinance, Inc.; Belmac Jamaica, Ltd.; and Bentley PharmaceuticalsIreland Limited. All inter-company balances have been eliminated inconsolidation. The financial position and results of operations of the Company’sforeign subsidiaries are measured using local currency as the functionalcurrency. Assets and liabilities of each foreign subsidiary are translated atthe rate of exchange in effect at the end of the period. Revenues and expensesare translated at the average exchange rate for the period. Foreign currencytranslation gains and losses are credited to or charged against othercomprehensive income in the Consolidated Balance Sheets. Foreign currency gainsand losses arising from cash transactions are credited to or charged againstcurrent earnings. The weighted average exchange rate for the years ended December 31,2005, 2004 and 2003 was .80 Euros, .81 Euros and .89 Euros per U.S. Dollar,respectively. The exchange rate as of December 31, 2005, 2004 and 2003 was .84Euros, .73 Euros and .80 Euros per U.S. Dollar, respectively. The net effect offoreign currency translation on the Company’s net assets during the years endedDecember 31, 2005, 2004 and 2003 was a decrease of $7,962,000, an increaseof $4,553,000 and an increase of $5,585,000, respectively, which has beenincluded in *other**comprehensive income.* The cumulativehistorical effect of foreign currency translation as of December 31, 2005and 2004 was an increase of $1,760,000 and $9,722,000, respectively, asreflected in *accumulated other**comprehensive income*.

 

**Use of estimates**

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates.

 

**Cash and cash equivalents and restricted cash**

 

The Company considers all highly liquid investmentswith remaining maturities of three months or less when purchased to be cashequivalents for purposes of classification in the Consolidated Balance Sheetsand the Consolidated Statements of Cash Flows. Investments in securities thatdo not meet the definition of cash equivalents are classified as *marketable securities* in the ConsolidatedBalance Sheets.

 

Included in cash and cash equivalents at December 31,2005 and 2004 are approximately $11,513,000 and $3,684,000, respectively, ofshort-term investments considered to be cash equivalents, as the originalmaturity dates of such investments were three months or less when purchased.

 

The Company acquired intellectual property duringthe year ended December 31, 2003 for $1,000,000 plus future royalties onsales and licensing income. In connection with the acquisition, the Companyobtained a renewable, irrevocable letter of credit in the amount of $1,000,000in favor of the assignor to guarantee future royalty payments. The $1,000,000used to secure the letter of credit has been classified as *restrictedcash* in the Consolidated Balance Sheets as of December 31, 2005and 2004.

 

**Marketable securities**

 

The Company has investments in Spanish governmenttreasury bills, with maturities of greater than three months when purchased,totaling $462,000 and $528,000 as of December 31, 2005 and 2004,respectively, which are classified as available-for-sale. The Company’s investments are carried atamortized cost, which approximates fair value due to the short-term nature ofthese investments. Accordingly, no unrealized gains or losses have beenrecognized with respect to these investments. Should the fair values differsignificantly from the amortized costs, changes in fair market value resultingin unrealized gains or losses would be included as a component of *other comprehensive income*.

 

F-9

----

 

**Inventories**

 

Inventories are stated at the lower of cost ormarket, cost being determined on the first-in, first-out (*FIFO*)method. Reserves for slow moving and obsolete inventories are provided based onhistorical experience and current product demand.

 

**Fixed assets**

 

Fixed assets are stated at cost. Depreciation iscomputed using the straight-line method over the following estimated economiclives of the assets: 

 
| ** **                 | ** ** | **Years** | ** ** |
|----------------------------|------------|-----------|------------|
| Buildings and improvements |       | 30        |       |
| Equipment                  |       | 3-7       |       |
| Furniture and fixtures     |       | 5-7       |       |
| Other                      |       | 5         |       |

 

Expenditures for replacements and improvements thatsignificantly add to productive capacity or extend the useful life of an assetare capitalized, while expenditures for maintenance and repairs are charged tooperations as incurred. Leasehold improvements are amortized over the life ofthe respective lease. When assets are sold or retired, the cost of the assetand the related accumulated depreciation are removed from the accounts and anygain or loss is recognized currently.

 

**Drug licenses and related costs**

 

Drug licenses and related costs incurred inconnection with acquiring licenses, patents, and other proprietary rightsrelated to the Company’s commercially developed products are capitalized.Capitalized drug licenses and related costs are amortized on a straight-linebasis for periods not exceeding fifteen years from the dates of acquisition. Inaccordance with the guidelines in Statement of Financial Accounting Standards (“SFAS”)No. 142, *Goodwill and Other Intangible Assets*,the Company has reviewed its intangible assets for impairment inaccordance with the recognition and measurement provisions of SFAS No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*. Values of suchassets are reviewed at least annually by the Company, by comparing the carryingamounts to their estimated future undiscounted cash flows, and adjustments aremade for any diminution in value. The Company performed its annual review fordiminution in value and has concluded that no diminution in value has occurred.The Company has also reassessed the useful lives of its drug licenses andrelated costs and has determined that the estimated useful lives areappropriate for determining amortization expense.

 

**Fair value of financial instruments**

 

The carrying amounts of cash, cash equivalents,marketable securities, receivables, accounts payable, accrued expenses andshort-term borrowings approximate fair value because of their short-termnature. The carrying amounts of the Company’s long-term obligations approximatefair value, when considering the amounts outstanding at December 31, 2005and 2004. The fair value information presented herein is based on informationavailable to management as of December 31, 2005. 

 

F-10

----

 

**Revenue recognition**

 

Revenue on product sales is recognized whenpersuasive evidence of an arrangement exists, the price is fixed and final,delivery has occurred and there is a reasonable assurance of collection of thesales proceeds. The Company generally obtains purchase authorizations from itscustomers for a specified amount of product at a specified price and considersdelivery to have occurred when the customer takes possession of the product.The Company provides its customers with a limited right of return. Revenue isrecognized upon delivery and a reserve for sales returns is recorded whenconsidered appropriate. The Company has demonstrated the ability to makereasonable and reliable estimates of product returns in accordance with SFAS No. 48,*Revenue Recognition When Right of Return Exists,*and of allowances for doubtful accounts based on significant historicalexperience.

 

Revenue from service, research and development, andlicensing agreements is recognized when the service procedures have beencompleted or as revenue recognition criteria have been met for each separateunit of accounting as defined in Emerging Issues Task Force (EITF) Issue No. 00-21,*Accounting for Revenue Arrangements withMultiple Deliverables*. The Company has deferred the recognition ofapproximately $2,594,000 and $2,147,000 of licensing revenues as of December 31,2005 and 2004, respectively, for which the earnings process has not beencompleted.

 

Royalty revenues on Testim product sales are currentlyrecognized based on an estimate of Auxilium’s sell-through of the Testimproduct based on prescriptions dispensed. The Company recognized royaltyrevenues of $6,132,000 and $2,842,000 for the years ended December 31,2005 and 2004, respectively. Under SFAS No. 48, the Company cannotrecognize all of the royalty revenues earned on product shipments of Testimuntil product returns related to those shipments can be reasonably estimated.The difference between the total amount earned from Auxilium under the royaltyarrangement and the amount recognized as a component of *licensingand collaboration revenues* is recorded as a component of current *deferred income* in the Consolidated Balance Sheets. Oncereturns can be reasonably estimated, the Company expects to record a one-timeincrease in *licensing and collaboration revenues*related to the recognition of previously deferred royalty revenues. As of yearend 2005 and 2004, deferred income from Testim royalties totaled $348,000 and$1,233,000, respectively.

 

**Research and development**

 

Research and development costs are expensed asincurred.

 

**Income taxes**

 

The Company accounts for income taxes in accordancewith SFAS No. 109, *Accounting for IncomeTaxes*, which requires the recognition of deferred tax assets andliabilities relating to the expected future tax consequences of events thathave been recognized in the Company’s consolidated financial statements and taxreturns. As permitted by Accounting Principles Board (“APB”) Opinion No. 23,*Accounting for Income Taxes – Special Areas*,provisions for income taxes on undistributed earnings of foreign subsidiariesthat are considered permanently invested are not recognized in the Company’sconsolidated financial statements. The cummulative amount of foreignearnings that have been permanently reinvested are approximately $38,980,000.

 

**Basic and diluted net income per common share**

 

Basic and diluted net income per common share isbased on the weighted average number of shares of Common Stock outstandingduring each period. The effect of the Company’s outstanding stock options andstock purchase warrants were considered in the diluted net income per sharecalculation for the years ended December 31, 2005, 2004 and 2003.

 

F-11

----

 

The following is a reconciliation between basic anddiluted net income per common share for the years ended December 31, 2005,2004 and 2003. Dilutive securities issuable for the years ended December 31,2005, 2004 and 2003 include approximately zero, zero and 1,441,000 incrementalshares, respectively, issuable as a result of Class B Warrants, andapproximately 1,371,000, 1,726,000 and 2,199,000 incremental shares,respectively, issuable as a result of various stock options and/or warrantsoutstanding.

 

**For The Year Ended December 31,2005**

 
| ** **                                 | ** ** | **Basic  EPS**                             | ** ** | **Effect of  Dilutive  Securities** | ** ** | **Diluted  EPS** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------|------------|------------------|------------|
| ** **                                 | ** ** | **(In Thousands, Except Per Share  Data)** | ** ** |
| Net income                                 |       | $                                          | 10,919     |                                | $          | —           |       | $ | 10,919 |   |
| Weighted average common shares outstanding |       | 21,558                                     |       | 1,371                               |       | 22,929           |       |
| Net income per common share                |       | $                                          | 0.51       |                                | $          | (0.03            | )          | $ | 0.48 |   |

 

**For The Year Ended December 31,2004**

 
| ** **                                 | ** ** | **Basic  EPS**                             | ** ** | **Effect of  Dilutive  Securities** | ** ** | **Diluted  EPS** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------|------------|------------------|------------|
| ** **                                 | ** ** | **(In Thousands, Except Per Share  Data)** | ** ** |
| Net income                                 |       | $                                          | 5,690      |                                | $          | —           |       | $ | 5,690 |   |
| Weighted average common shares outstanding |       | 20,901                                     |       | 1,726                               |       | 22,627           |       |
| Net income per common share                |       | $                                          | 0.27       |                                | $          | (0.02            | )          | $ | 0.25 |   |

 

**For The Year Ended December 31,2003**

 
| ** **                                 | ** ** | **Basic  EPS**                             | ** ** | **Effect of  Dilutive  Securities** | ** ** | **Diluted  EPS** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------|------------|------------------|------------|
| ** **                                 | ** ** | **(In Thousands, Except Per Share  Data)** | ** ** |
| Net income                                 |       | $                                          | 6,097      |                                | $          | —           |       | $ | 6,097 |   |
| Weighted average common shares outstanding |       | 17,997                                     |       | 3,640                               |       | 21,637           |       |
| Net income per common share                |       | $                                          | 0.34       |                                | $          | (0.06            | )          | $ | 0.28 |   |

 

For the years ended December 31, 2005,2004 and 2003, warrants and/or options to purchase 736,000, 672,000 and 237,000shares of Common Stock, respectively, were excluded from the diluted EPSpresentation as determined under the treasury stock method, because theirexercise prices were greater than the average market value of the Common Stock.

 

**Comprehensive income**

 

The Company applies SFAS No. 130, *Reporting Comprehensive Income*, which requires disclosure ofall components of comprehensive income on an annual and interim basis.Comprehensive income is defined as the change in equity of a business enterpriseduring a period from transactions and other events and circumstances fromnon-owner sources. The Company’s comprehensive income includes foreign currencytranslation gains (losses). Should the fair values of the Company’smarketable equity securities differ significantly from their amortized costs,unrealized gains or losses resulting from the change in fair market value wouldbe included as a component of *othercomprehensive income*.

 

F-12

----

 

**Equity-based compensation plans**

 

The Company has equity-based employeecompensation plans that are described more fully in Note 11. The Companyaccounted for these plans under the recognition and measurement principles ofAPB Opinion No. 25, *Accounting for StockIssued to Employees*, and related Interpretations through December 31,2005. However, the Company adopted SFAS No. 123 (Revised), *Share-Based Payment* effective January 1, 2006, which will change themethod the Company uses to account for its equity-based compensation in thefuture. SFAS No. 123 (Revised) is explained in more detail in *Recently issued accounting pronouncements* below. Stockoptions granted under these plans have exercise prices equal to or greater thanthe market value of the underlying common stock on the dates of grant, which isgenerally the date on which compensation is measured. The Company uses theaccelerated expense attribution method pursuant to Financial AccountingStandards Board (“FASB”) Interpretation No. 28 for all options accounted forunder APB Opinion No. 25. In addition to these plans, the Company also sponsorsa 401(k) Plan for eligible employees and matches eligible contributions withshares of the Company’s Common Stock. At the discretion of the CompensationCommittee of the Board of Directors, the Company may grant shares of itsCommon Stock to employees in lieu of cash compensation. The Company recordedequity-based compensation expense of approximately $280,000, $195,000 and$510,000, in 2005, 2004 and 2003, respectively, as a result of such grants.Related equity-based employee compensation costs are reflected in theaccompanying Consolidated Income Statements and Statements of Cash Flows.

 

The following table illustrates the effect onnet income and earnings per share as if the Company had applied the fair valuerecognition provisions of SFAS No. 123, *Accountingfor Stock-Based Compensation*, to equity-based employee compensation:

 
| ** **                                                                                                  | ** ** | **Year Ended December 31,**           | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                  | ** ** | **(In Thousands, Except Per Share  Data)** | ** ** |
| Net income,  as reported                                                                                    |       | $                                          | 10,919     |   | $ | 5,690 |   | $ | 6,097 |   |
|                                                                                                        |       |                                       |       |   |   |   |   |
| Add:  Stock-based employee compensation expense included in reported net income                             |       | 280                                        |       | 195 |   | 510 |   |
|                                                                                                        |       |                                       |       |   |   |   |   |
| Deduct:  Total stock-based employee compensation expense determined under fair value method  for all awards |       | (3,452                                     | )          | (2,978 | ) | (3,232 | ) |
|                                                                                                        |       |                                       |       |   |   |   |   |
| Pro forma  net income                                                                                       |       | $                                          | 7,747      |   | $ | 2,907 |   | $ | 3,375 |   |
|                                                                                                        |       |                                       |       |   |   |   |   |
| Net income  per share:                                                                                      |       |                                       |       |   |   |   |   |
| Basic - as  reported                                                                                        |       | $                                          | 0.51       |   | $ | 0.27 |   | $ | 0.34 |   |
| Basic - pro  forma                                                                                          |       | $                                          | 0.36       |   | $ | 0.14 |   | $ | 0.19 |   |
|                                                                                                        |       |                                       |       |   |   |   |   |
| Diluted - as  reported                                                                                      |       | $                                          | 0.48       |   | $ | 0.25 |   | $ | 0.28 |   |
| Diluted -  pro forma                                                                                        |       | $                                          | 0.34       |   | $ | 0.13 |   | $ | 0.16 |   |

 

F-13

----

 

The preceding pro forma results were calculated using the Black-Scholesoption pricing model with the following weighted average assumptions andresulting fair value applied (results may vary depending on theassumptions applied within the model):

 
| ** **                    | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------|------------|----------------------------------|------------|
| ** **                    | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| Risk free interest rate       |       | 3.90                             | %          | 2.94 | % | 3.86 | % |
| Dividend yield                |       | 0.00                             | %          | 0.00 | % | 0.00 | % |
| Expected life                 |       | 5 years                          |       | 5 years |   | 5 years |   |
| Volatility                    |       | 45.28                            | %          | 48.63 | % | 54.12 | % |
| Fair value of options granted |       | $                                | 4.04       |   | $ | 5.77 |   | $ | 5.03 |   |
|                               |            |                                  |            |  |  |  |  |  |  |  |

 

Stock or other equity-based compensation fornon-employees is accounted for under the fair value method as required by SFAS No. 123and EITF Issue No. 96-18, *Accountingfor Equity Instruments That Are Issued to Other Than Employees for Acquiring,or in Conjunction with Selling, Goods or Services* and other relatedinterpretations.

 

**Segments of an enterprise and related information**

 

SFAS No. 131, *Disclosures About Segments of an Enterprise and Related Information,*redefines how operating segments are determined and requires disclosure ofcertain financial and descriptive information about a company’s operatingsegments. The Company operates in two business segments that are in twogeographical locations. See Note 14 for the disclosures required by SFAS No. 131.

 

**Recently issued accounting pronouncements**

 

In December 2004, the FASB issued SFAS No. 123(Revised). This Statement is a revision of SFAS No. 123, *Accounting for Stock-Based Compensation*, and supersedes APBOpinion No. 25, *Accounting for StockIssued to Employees*, and its related implementation guidance. SFAS No. 123(Revised) focuses primarily on accounting for transactions in which an entityobtains employee services in share-based payment transactions. The Statementrequires entities to recognize stock compensation expense for awards of equityinstruments to employees based on the grant-date fair value of those awards(with limited exceptions). SFAS No. 123 (Revised), as issued, was to applyto all awards granted, modified, or cancelled after December 31, 2005, andunvested portions of previously issued grants. The Company adopted SFAS No. 123(Revised) effective January 1, 2006 using the modified-prospectivetransition method. Consequently, the Company expects to record expense ofapproximately $992,000, $308,000 and $68,000 in the years ending December 31,2006, 2007 and 2008, respectively, for the unvested portion of previouslyissued grants that were not previously expensed under APB Opinion No. 25.In addition, the Company will be required to record expense for any stockoption grants subsequent to December 31, 2005. The Company uses theaccelerated expense attribution method pursuant to FASB Interpretation No. 28for all options accounted for under APB Opinion No. 25. Equity-based compensationattributable to stock options granted subsequent to December 31, 2005 will berecognized under the straight-line method pursuant to SFAS No. 123 (Revised). TheCompany does not expect the adoption of SFAS No. 123 (Revised) to have amaterial impact on its *Consolidated Balance Sheets*or the *Consolidated Statements of Cash Flows*.

 

**Reclassifications**

 

Certain prior period depreciation amountshave been reclassified from *operating expenses*to *cost of net product sales* to conform withthe current period’s presentation. Such reclassifications did not have amaterial effect on the Company’s financial position, results of operations orcash flows.

 

F-14

----

 

**NOTE 3** – **RECEIVABLES**

 

Receivables consist of the following: 

 
| ** **                                                                                                                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                              | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                                                                                                                              | ** ** | **(In Thousands)**    | ** ** |
| Trade  receivables (of which $2,595 and $2,754, respectively, collateralize  short-term borrowings with Spanish financial institutions) |       | $                     | 21,293     |   | $ | 23,586 |   |
| VAT, income  and social security taxes receivable                                                                                       |       | 2,270                 |       | 2,428 |   |
| Royalties  receivable                                                                                                                   |       | 2,861                 |       | 1,882 |   |
| Other                                                                                                                                   |       | 694                   |       | 339 |   |
|                                                                                                                                    |       | 27,118                |       | 28,235 |   |
| Less-allowance  for doubtful accounts                                                                                                   |       | (202                  | )          | (375 | ) |
|                                                                                                                                    |       | $                     | 26,916     |   | $ | 27,860 |   |

 

The following is a summary of the activityrelated to the allowance for doubtful accounts:

 
| ** **                                    | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                    | ** ** | **(In Thousands)**               | ** ** |
| Balance at beginning of year                  |       | $                                | 375        |   | $ | 160 |   | $ | 100 |   |
| Net provisions charged to costs and  expenses |       | (122                             | )          | 184 |   | 102 |   |
| Write-offs reducing allowance                 |       | (9                               | )          | (1 | ) | (64 | ) |
| Effect of foreign currency                    |       | (42                              | )          | 32 |   | 22 |   |
| Balance at end of year                        |       | $                                | 202        |   | $ | 375 |   | $ | 160 |   |

 

**NOTE 4** – **INVENTORIES**

 

Inventories consist of the following: 

 
| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **(In Thousands)**    | ** ** |
| Raw materials                            |       | $                     | 6,414      |   | $ | 5,953 |   |
| Finished goods                           |       | 5,869                 |       | 4,380 |   |
|                                     |       | 12,283                |       | 10,333 |   |
| Less-allowance for slow moving inventory |       | (136                  | )          | (75 | ) |
|                                     |       | $                     | 12,147     |   | $ | 10,258 |   |

 

The following is a summary of the activity related to the allowance forslow moving inventory:

 
| ** **                               | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                               | ** ** | **(In Thousands)**               | ** ** |
| Balance at beginning of year             |       | $                                | 75         |   | $ | 74 |   | $ | 62 |   |
| Provisions charged to costs and expenses |       | 70                               |       | — |   | — |   |
| Write-offs reducing allowance            |       | —                           |       | (5 | ) | — |   |
| Effect of foreign currency               |       | (9                               | )          | 6 |   | 12 |   |
| Balance at end of year                   |       | $                                | 136        |   | $ | 75 |   | $ | 74 |   |

 

F-15

----

 

**NOTE 5** – **FIXED ASSETS**

 

Fixed assets consist of the following: 

 
| ** **                    | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                    | ** ** | **(In Thousands)**    | ** ** |
| Land                          |       | $                     | 2,673      |   | $ | 2,573 |   |
| Buildings and improvements    |       | 14,151                |       | 11,985 |   |
| Equipment                     |       | 16,742                |       | 16,026 |   |
| Furniture and fixtures        |       | 1,974                 |       | 1,813 |   |
| Other                         |       | 148                   |       | 102 |   |
|                          |       | 35,688                |       | 32,499 |   |
| Capital in-progress           |       | 7,748                 |       | 6,550 |   |
|                          |       | 43,436                |       | 39,049 |   |
| Less-accumulated depreciation |       | (10,070               | )          | (8,200 | ) |
|                          |       | $                     | 33,366     |   | $ | 30,849 |   |

 

In order to support the Company’s growth inEurope, management is adding additional capacity to its manufacturing facilitiesthrough a series of improvements. During the year ended December 31,2005, the Company invested approximately $5,654,000 renovating and expandingthe Company’s manufacturing and warehouse facilities and approximately$4,530,000 for related machinery and equipment.

 

In April 2004, the Company purchased aSpanish manufacturing facility and related machinery, equipment and inventoryused to manufacture active pharmaceutical ingredients, for approximately$3,309,000. The Company is manufacturing and marketing some of these productsthrough its subsidiary, Bentley API. The 11,000 square foot facility iscurrently FDA approved for one product, which the Company sells to severalcustomers, including customers in the United States.

 

Depreciation expense of approximately$309,000, $288,000 and $368,000 has been charged to operations as a componentof *depreciation and amortization expense*in the Consolidated Income Statements for the years ended December 31,2005, 2004 and 2003, respectively. The Company has included depreciationtotaling approximately $3,338,000, $2,466,000 and $1,139,000 in *cost of net product sales* during the yearsended December 31, 2005, 2004 and 2003, respectively.

 

**NOTE 6** – **DRUG LICENSES AND RELATED COSTS**

 

Drug licenses and related costs consist ofthe following: 

 
| ** **                      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In Thousands)**    | ** ** |
| Drug licenses and related costs |       | $                     | 19,443     |   | $ | 20,389 |   |
| Less-accumulated amortization   |       | (5,585                | )          | (5,526 | ) |
|                            |       | $                     | 13,858     |   | $ | 14,863 |   |

 

F-16

----

 

Amortization expense for drug licenses andrelated costs was approximately $1,403,000, $1,140,000 and $959,000 for theyears ended December 31, 2005, 2004 and 2003, respectively, and has beenrecorded in *depreciation and amortizationexpense*in the accompanying Consolidated Income Statements.

 

Amortization expense for existing druglicenses and related costs for each of the five years ending December 31,2010 and for all remaining years thereafter is estimated to be as follows:

 
| **Year Ending December 31,** | ** ** | **Future Amortization Expense** | ** ** |
|-----------------------------------|------------|---------------------------------|------------|
| ** **                        | ** ** | **(In Thousands)**              | ** ** |
| 2006                              |       | $                               | 1,337      |   |   |
| 2007                              |       | 1,389                           |       |   |
| 2008                              |       | 1,312                           |       |   |
| 2009                              |       | 1,314                           |       |   |
| 2010                              |       | 1,314                           |       |   |
| 2011 and beyond                   |       | 7,192                           |       |   |

 

**NOTE 7** – **RELATED PARTY AND SUPPLEMENTAL CASH FLOW DISCLOSURES**

 

During the year ended December 31, 2005,the Chief Executive Officer (“CEO”), the Chief Financial Officer (“CFO”) andthe Chief Medical Officer (“CMO”) of the Company exercised stock options topurchase an aggregate of 925,700 shares of the Company’s Common Stock. Insatisfaction of the option exercise prices, the Company received approximately$1,218,000 in cash proceeds and an aggregate of approximately 159,000 shares ofpreviously acquired Bentley Common Stock, with a fair market value ofapproximately $1,988,000. The Company also received a total of approximately181,500 shares of Common Stock, with a fair market value of approximately$2,292,000 from the three employees in order to satisfy minimum federal andstatutory tax withholding requirements. The Company repurchased approximately89,500 shares of Common Stock with a fair market value of approximately$1,041,000 from the CEO and CMO in connection with these options exercises. Theshares of Common Stock acquired by the Company in connection with these stockoption exercises were recorded at fair market value and are held by the Companyas treasury shares.

 

In March 2003, the CompensationCommittee agreed to amend loan agreements with certain executive officers ofthe Company, resulting in the forgiveness of aggregate principal and accruedinterest totaling approximately $302,000.These amounts were recorded as compensation expense during the year ended December 31,2003.

 

**NOTE 8** – **ACCRUED EXPENSES**

 

Accrued expenses consist of the following: 

 
| ** **                           | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                           | ** ** | **(In Thousands)**    | ** ** |
| Foreign income taxes payable         |       | $                     | 2,107      |   | $ | 2,218 |   |
| Allowance for sales returns          |       | 887                   |       | 597 |   |
| Accrued payroll and related taxes    |       | 2,268                 |       | 2,211 |   |
| Spanish pharmaceutical taxes payable |       | 1,471                 |       | — |   |
| Other accrued expenses               |       | 2,695                 |       | 1,143 |   |
|                                 |       | $                     | 9,428      |   | $ | 6,169 |   |

 

F-17

----

 

The following is a summary of the activityrelated to the allowance for sales returns:

 
| ** **                                  | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|
| ** **                                  | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                  | ** ** | **(In Thousands)**               | ** ** |
| Balance at beginning of year                |       | $                                | 597        |   | $ | 446 |   | $ | 349 |   |
| Provisions charged to costs and expenses(a) |       | 898                              |       | 721 |   | 640 |   |
| Write-offs reducing allowance(a)            |       | (652                             | )          | (618 | ) | (615 | ) |
| Effect of foreign currency                  |       | 44                               |       | 48 |   | 72 |   |
| Balance at end of year                      |       | $                                | 887        |   | $ | 597 |   | $ | 446 |   |

 

----

(a)          The Company experiencedan unforeseen level of product returns in 2004 as a result of governmentimposed price reductions in Spain. The product returns exceeded the Company’sallowance for estimated sales returns, and were accounted for as a reduction inrevenues of approximately $2,705,000 in the year ended December 31, 2004.

 

**NOTE 9** – **DEBT**

 

Short-term borrowings consists of thefollowing: 

 
| ** **                                                                                                                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                                                                                                                                | ** ** | **(In Thousands)**    | ** ** |
| Trade  receivables discounted with Spanish financial institutions, with recourse,  effective interest rate is 3.3% and 5.0%, respectively |       | $                     | 2,595      |   | $ | 2,754 |   |
| Revolving  line of credit facilities payable to Spanish financial institutions, weighted  average interest rate is 3.2%                   |       | 13                    |       | — |   |
|                                                                                                                                      |       | $                     | 2,608      |   | $ | 2,754 |   |

 

The weighted average stated interest rate onshort-term borrowings outstanding at December 31, 2005 and 2004 was 3.3%and 5.0%, respectively.

 

The revolving line of credit facilities withSpanish financial institutions, entitle the Company to borrow up to $5,912,000as of December 31, 2005 at interest rates ranging from 2.8% to 3.3%. Thefacilities are scheduled to mature on various dates through December 15,2006 and are renewable.

 

Long-term debt consists of the following: 

 
| ** **                                                                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                           | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                                                                                           | ** ** | **(In Thousands)**    | ** ** |
| Loans payable to Spanish government, net of  unamortized discount of $0  and $65,  respectively |       | $                     | 387        |   | $ | 380 |   |
| Less-current portion of long-term debt                                                               |       | (387                  | )          | (31 | ) |
| Total  long-term debt                                                                                |       | $                     | —     |   | $ | 349 |   |

 

The weighted average interest rate onlong-term debt outstanding at December 31, 2004 was 5.7%.

 

In November 2002, the Company enteredinto a loan agreement with the Spanish government as part of aresearch-funding program. The loan is non-interest bearing and payable in sevenequal annual installments of approximately $17,000 beginning in 2006.Accordingly, the Company imputed interest at the

 

F-18

----

 

market rate in Spain (5.2%) at the time of the borrowing, and recordeda discount on the obligation of $33,000. The obligation was classified ascurrent at December 31, 2005 in anticipation of repayment during the yearending December 31, 2006.

 

In December 2001, the Company enteredinto a loan agreement with the Spanish government as part of aresearch-funding program. The loan is non-interest bearing and payable in sevenequal annual installments of approximately $31,000 which began in 2005.Accordingly, the Company imputed interest at the market rate in Spain (6%) atthe time of the borrowing, and recorded a discount on the obligation of$72,000. The obligation was classified as current at December 31, 2005 inanticipation of repayment during the year ending December 31, 2006.

 

**NOTE 10** – **PREFERRED STOCK**

 

The Company has 2,000,000 shares of PreferredStock, $1.00 par value, authorized for issuance. As of December 31, 2005and 2004, no shares of Preferred Stock were outstanding.

 

**NOTE 11** – **STOCKHOLDERS’ EQUITY**

 

At December 31, 2005 the Company had thefollowing Common Stock reserved for issuance under various plans andagreements: 

 
| ** **                                | ** ** | **Common Shares**  | ** ** |
|-------------------------------------------|------------|--------------------|------------|
| ** **                                | ** ** | **(In Thousands)** | ** ** |
| For exercise of outstanding stock options |       | 3,916              |       |
| For future stock option grants            |       | 438                |       |
|                                      |       | 4,354              |       |

 

The Company has never paid any cash dividendson its Common Stock. The current policy of the Board of Directors is to retainearnings to finance the operation and growth of the Company’s business.Accordingly, it is anticipated that no cash dividends will be paid to theholders of the Common Stock in the foreseeable future.

 

**Common stock transactions**

 

During the year ended December 31, 2005,the Company issued approximately 1,020,700 shares of Common Stock upon exerciseof stock purchase options and approximately 20,100 shares of Common Stock asequity-based compensation in lieu of cash. The Company also received approximately430,000 shares of treasury stock in connection with the exercise ofstock purchase options during the yearended December 31, 2005 (See Note 7).

 

During the year ended December 31, 2004,the Company issued approximately 400,000 shares of Common Stock upon exerciseof stock purchase warrants, approximately 325,600 shares of Common Stock uponexercise of stock purchase options, and approximately 14,400 shares of CommonStock as equity-based compensation in lieu of cash.

 

During the year ended December 31, 2003,the Company issued approximately 2,870,000 shares of Common Stock upon exerciseof Class B Warrants, approximately 240,000 shares of Common Stock uponexercise of stock purchase options, and approximately 58,000 shares of CommonStock as equity-based compensation in lieu of cash.

 

F-19

----

 

General and administrative expenses for theyears ended December 31, 2005, 2004 and 2003 include approximately$113,000, $73,000 and $248,000, respectively, of non-cash equity-basedcompensation. Research and development expenses for the years ended December 31,2005, 2004 and 2003 include approximately $167,000, $122,000 and $262,000,respectively, of non-cash equity-based compensation.

 

**Stock purchase warrants**

 

During the year ended December 31, 2004,approximately 400,000 stock purchase warrants were exercised to acquire anaggregate of 400,000 shares of Common Stock. The Company received net cashproceeds of approximately $600,000 from such exercises during the year ended December 31,2004. Approximately 20,000 stock purchase warrants expired unexercised duringthe year ended December 31, 2004. There were no stock purchase warrantsissued during the years ended December 2005 or 2004, nor outstanding at December 31,2005 or 2004.

 

During the year ended December 31, 2003,approximately 5,740,000 Class B Warrants were exercised to acquire an aggregateof 2,870,000 shares of Common Stock. The Company received net cash proceeds ofapproximately $14,349,000 from all such exercises during the year ended December 31,2003. Approximately 3,600 Class B Warrants that were not exercised by December 31,2003 expired unexercised.

 

The table below summarizes warrant activityfor the three years ended December 31, 2005:

 
| ** **                                      | ** ** | **Number of  Common Shares**               | ** ** | **Weighted  Average Exercise  Price Per Share** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                      | ** ** | **(In Thousands, Except Per Share  Data)** | ** ** |
| Outstanding at December 31, 2002           |       | 3,292                                      |       | $                                               | 4.67       |   |
| Exercised                                       |       | (2,870                                     | )          | 5.00                                            |       |
| Expired                                         |       | (2                                         | )          | 5.00                                            |       |
| Outstanding at December 31, 2003           |       | 420                                        |       | 2.38                                            |       |
| Exercised                                       |       | (400                                       | )          | 1.50                                            |       |
| Expired                                         |       | (20                                        | )          | 20.00                                           |       |
| Outstanding at December 31, 2004 and  2005 |       | —                                     |       | $                                               | —     |   |

 

**Stock option plans**

 

The Company has in effect Stock Option Plans(the “Plans”), pursuant to which directors, officers, employees and consultantsof the Company have been awarded grants of options to purchase the Company’sCommon Stock. Approximately 4,354,400 shares of Common Stock have been reservedfor issuance under the Plans, of which approximately 361,200 are outstandingunder the 1991 Plan, approximately 2,631,900 are outstanding under the 2001Employee and Director Plans, 533,300 are outstanding under the Executive Planand 390,000 are outstanding under the 2005 Equity and Incentive Plan as of December 31,2005. Options are granted for terms not exceeding ten years from the date ofgrant. Options may not be granted at a price that is less than 100% of thefair market value on the date the options are granted. Options granted underthe Plans generally vest over one to three years. Options to purchaseapproximately 1,020,700, 325,600, and 240,500 shares of Common Stock wereexercised during the years ended December 31, 2005, 2004 and 2003,respectively, resulting in net cash proceeds to the Company of approximately$2,028,000, $2,483,000 and $962,000, respectively (See Note 7).

 

F-20

----

 

The table below summarizes activity in theCompany’s Plans for the years ended December 31, 2003, 2004 and 2005.

 
| ** **                            | ** ** | **Number of  Common Shares**               | ** ** | **Weighted Average  Exercise Price** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|--------------------------------------|------------|
| ** **                            | ** ** | **(In Thousands, Except Per Share  Data)** | ** ** |
| Outstanding at January 1, 2003   |       | 3,459                                      |       | $                                    | 6.07       |   |
| Granted                               |       | 731                                        |       | 9.62                                 |       |
| Exercised                             |       | (240                                       | )          | 4.00                                 |       |
| Canceled                              |       | (30                                        | )          | 20.08                                |       |
| Outstanding at December 31, 2003 |       | 3,920                                      |       | 6.75                                 |       |
| Granted                               |       | 612                                        |       | 12.60                                |       |
| Exercised                             |       | (326                                       | )          | 7.66                                 |       |
| Canceled                              |       | (119                                       | )          | 10.80                                |       |
| Outstanding at December 31, 2004 |       | 4,087                                      |       | 7.44                                 |       |
| Granted                               |       | 870                                        |       | 9.11                                 |       |
| Exercised                             |       | (1,021                                     | )          | 3.93                                 |       |
| Canceled                              |       | (20                                        | )          | 8.87                                 |       |
| Outstanding at December 31, 2005 |       | 3,916                                      |       | $                                    | 8.72       |   |

 

The table below summarizes optionsoutstanding and exercisable at December 31, 2005 (number of options inthousands): 

 
| ** **                          | ** ** | **Options Outstanding** | ** ** | **Options Currently Exercisable**      | ** ** |
|-------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|
| **Range of  Exercise  Prices**      | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining Life  (Years)** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $2.00 -  $3.68                 |       | 238                     |       | $                                      | 3.40       |   | 1.1 |   | 238 |   | $ | 3.40 |   |
| 4.73                                |       | 367                     |       | 4.73                                   |       | 0.3 |   | 367 |   | 4.73 |   |
| 5.70 -     5.88 |       | 142                     |       | 5.84                                   |       | 4.4 |   | 142 |   | 5.84 |   |
| 6.00 -     6.33 |       | 317                     |       | 6.01                                   |       | 5.4 |   | 317 |   | 6.01 |   |
| 7.10 -     7.39 |       | 182                     |       | 7.31                                   |       | 7.3 |   | 80 |   | 7.20 |   |
| 7.50                                |       | 370                     |       | 7.50                                   |       | 9.3 |   | — |   | — |   |
| 8.00 -     8.93 |       | 334                     |       | 8.26                                   |       | 7.0 |   | 334 |   | 8.26 |   |
| 9.00 -     9.80 |       | 499                     |       | 9.70                                   |       | 6.0 |   | 499 |   | 9.70 |   |
| 10.04                               |       | 298                     |       | 10.04                                  |       | 7.4 |   | 298 |   | 10.04 |   |
| 10.38 -   10.79           |       | 200                     |       | 10.76                                  |       | 8.7 |   | 115 |   | 10.75 |   |
| 11.00 -   11.98           |       | 400                     |       | 11.36                                  |       | 7.9 |   | 349 |   | 11.28 |   |
| 12.01 -   12.55           |       | 153                     |       | 12.39                                  |       | 8.6 |   | 112 |   | 12.49 |   |
| 13.30                               |       | 373                     |       | 13.30                                  |       | 8.0 |   | 183 |   | 13.30 |   |
| 13.48 -   15.83           |       | 43                      |       | 14.07                                  |       | 7.9 |   | 42 |   | 14.08 |   |
| $2.00 -  $15.83                     |       | 3,916                   |       | $                                      | 8.72       |   | 6.3 |   | 3,076 |   | $ | 8.47 |   |

 

Approximately 3,076,300 of the 3,916,400options outstanding at December 31, 2005 are vested and exercisable at December 31,2005.  Approximately 3,338,000 of the4,087,100 options outstanding at December 31, 2004 were vested and exercisableat December 31, 2004. Options and warrants outstanding at December 31, 2003included aproximately 420,000 warrants, all of which were exercisable, and approximately3,920,000 options, of which approximately 2,839,000 were vested and exercisableat December 31, 2003.

 

F-21

----

 

**401(k) Retirement Plan**

 

The Company sponsors a 401(k) retirementsavings plan (the “401(k) Plan”) under which eligible employees may contribute,on a pre-tax basis, up to a maximum aggregate annual contribution imposed bythe Internal Revenue Code of 1986, as amended. All employees who work for theCompany in the U.S. are eligible to participate in the 401(k) Plan. Allemployee contributions are allocated to the employee’s individual account andare invested in various investment options as directed by the employee.Employees’ cash contributions are fully vested and nonforfeitable. The Companymade matching contributions to the 401(k) Plan during the years ended December 31,2005, 2004 and 2003 in the form of approximately 20,100, 14,400 and 11,500shares, respectively, of the Company’s Common Stock valued at approximately$221,000, $175,000 and $117,000, respectively. All Company matchingcontributions vest 25% each year for the first four years of each employee’semployment in which the employee works for the Company at least 1,000 hours.

 

**Stockholder Rights Plan**

 

Effective December 21, 2004, the Boardof Directors of the Company adopted a new Stockholder Rights Plan that replacedthe Company’s previous Stockholder Rights Agreement that expired on December 21,2004. Pursuant to the Renewed Rights Agreement, the Board of Directors declareda dividend of one Preferred Stock Purchase Right for each outstanding share ofthe Company’s Common Stock, payable to stockholders of record at the close ofbusiness on December 21, 2004. Each right, when exercisable, entitles theregistered holder to purchase from the Company one one-thousandth of a share ofSeries A Junior Participating Preferred Stock, par value $1.00 per share,at a purchase price of $72.55 per one one-thousandth of a share of Series APreferred Stock, subject to adjustment. The plan is designed to prevent apotential acquirer from gaining control of the Company without fairlycompensating all of the Company’s stockholders and to protect the Company fromcoercive takeover attempts. The rights will become exercisable only if a personor group of affiliated persons beneficially acquire(s) 15% or more of theCompany’s Common Stock.

 

In the event that an acquiring person becomesthe beneficial owner of 15% or more of the then outstanding shares of CommonStock (except pursuant to a qualifying offer), each holder of a right willthereafter have the right to receive, upon payment of the purchase price,shares of Common Stock (or, in certain circumstances, cash, property or othersecurities of the Company) having a value (based on a formula set forth in theRenewed Rights Agreement) equal to two times the purchase price of the right.The rights are not exercisable until the distribution date and will expire atthe close of business on December 19, 2014, unless earlier redeemed orexchanged by the Company.

 

F-22

----

 

**NOTE 12** – **PROVISION FOR INCOME TAXES**

 

See Note 14 for information regarding thecomponents of *income before income taxes*.

 

The provision for income taxes consists ofthe following: 

 
| ** **                                  | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|
| ** **                                  | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                  | ** ** | **(In Thousands)**               | ** ** |
| Current:                                    |       |                             |       |   |   |   |   |
| Foreign                                     |       | $                                | 6,515      |   | $ | 5,466 |   | $ | 5,417 |   |
|                                        |       |                             |       |   |   |   |   |
| Deferred:                                   |       |                             |       |   |   |   |   |
| State                                       |       | 120                              |       | (60 | ) | (54 | ) |
| Federal                                     |       | 134                              |       | (251 | ) | (329 | ) |
| Foreign                                     |       | (1,039                           | )          | (661 | ) | 6 |   |
|                                        |       |                             |       |   |   |   |   |
| Tax effect of operating loss carryforwards: |       |                             |       |   |   |   |   |
| State                                       |       | (56                              | )          | 2,169 |   | (219 | ) |
| Federal                                     |       | —                           |       | (1,041 | ) | (1,348 | ) |
| Foreign                                     |       | (260                             | )          | — |   | — |   |
| Change in valuation allowance               |       | 62                               |       | (817 | ) | 1,950 |   |
| Total provision for income taxes            |       | $                                | 5,476      |   | $ | 4,805 |   | $ | 5,423 |   |

 

A reconciliation between the federalstatutory rate and the Company’s effective income tax rate is as follows: 

 
| ** **                                     | ** ** | **Year Ended December 31,** |
|------------------------------------------------|------------|----------------------------------|
| ** **                                     | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                     | ** ** | **(In Thousands)**               | ** ** |
| Statutory federal income taxes                 |       | $                                | 6,198 |   | $ | 3,695 |   | $ | 3,917 |   |
| Permanent differences from foreign  subsidiary |       | 311                              |   | 492 |   | 489 |   |
| Foreign taxes                                  |       | —                           |   | 604 |   | (331 | ) |
| State income taxes                             |       | 63                               |   | (90 | ) | — |   |
| Expiration/Reduction of loss carryforwards     |       | —                           |   | 2,199 |   | — |   |
| Tax credits                                    |       | (1,124                           | ) | (971 | ) | — |   |
| Other                                          |       | (34                              | ) | (307 | ) | (602 | ) |
| Change in valuation allowance                  |       | 62                               |   | (817 | ) | 1,950 |   |
|                                           |       | $                                | 5,476 |   | $ | 4,805 |   | $ | 5,423 |   |

 

F-23

----

 

The components of the Company’s deferredtaxes are as follows: 

 
| ** **                      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(In Thousands)**    | ** ** |
| Deferred tax assets:            |       |                  |       |   |   |
| NOL  carryforwards              |       | $                     | 18,665     |   | $ | 15,560 |   |
| Disposition  of subsidiary      |       | 6,848                 |       | 6,920 |   |
| Foreign tax  on deferred income |       | 1,099                 |       | 479 |   |
| Tax credit  carryforwards       |       | 744                   |       | 543 |   |
| Other, net                      |       | 956                   |       | 1,272 |   |
| Total  deferred tax assets      |       | 28,312                |       | 24,774 |   |
| Foreign deferred tax liability  |       | (1,665                | )          | (2,319 | ) |
| Other deferred tax liabilities  |       | (215                  | )          | (217 | ) |
| Valuation allowance             |       | (26,998               | )          | (24,078 | ) |
| Deferred tax liability, net     |       | $                     | (566       | ) | $ | (1,840 | ) |

 

The Company recorded provisions for foreign income taxestotaling $5,476,000, $4,805,000 ($4,201,000 plus a $604,000 tax auditsettlement recorded as a result of the 1998 - 2000 tax audit of its Spanishsubsidiary), and $5,423,000 for the years ended December 31, 2005, 2004,and 2003 respectively. The effective tax rate in Europe for 2005 is 36%compared to 36% (31% excluding the $604,000 tax audit settlement) in 2004 and34% in 2003.

 

The Company generated U.S. federal net operatingincome of approximately $1,042,000 in 2005, compared to net operating losses ofapproximately $2,913,000 and $3,571,000 in the years ended December 31,2004 and 2003, respectively. Bentley Pharmaceuticals Ireland Limited generateda net operating loss of approximately $2,080,000 in 2005. As future operatingprofits cannot be reasonably assured, no tax benefit has been recorded forthese losses. Accordingly, the Company has established a valuation allowanceequal to the full amount of the deferred tax assets in Ireland. TheCompany has a current deferred tax asset of $1,099,000 and a non-currentdeferred tax liability of $1,665,000 due to temporary differences arising as aresult of the Company’s Spanish subsidiary recording the gain on the sale ofdrug licenses and the corresponding taxes for Spanish statutory purposes.

 

Should the Company determine that it is more likelythan not that it will realize certain of its net deferred tax assets for whichwe have previously provided a valuation allowance, an adjustment would berequired to reduce the existing valuation allowance. In addition, the Companyoperates within multiple taxing jurisdictions and is subject to audit in thosejurisdictions. These audits can involve complex issues, which may requirean extended period of time for resolution. During 2004, we identified certaintax contingencies that we determined are probable and reasonably estimable.Consequently, we have included a charge totaling $188,000 related to thesecontingencies in the*provision for incometaxes* for the year ended December 31,2005. No other potential tax contingencies were considered to beprobable and reasonably estimable as of December 31, 2005. However, thereis the possibility that the ultimate resolution of such potential contingenciescould have an adverse effect on our Consolidated Financial Statements in thefuture.

 

Under the provisions of the Internal Revenue Code,certain substantial changes in the Company’s ownership may have limited,or may limit in the future, the amount of net operating loss (the “NOL”)carryforwards that could be utilized annually to offset future taxable incomeand income tax liabilities. The amount of any annual limitation is determinedbased upon the Company’s value prior to an ownership change.

 

F-24

----

 

At December 31, 2005, the Company has NOLcarryforwards of approximately $53,514,000 available to offset U.S. taxableincome. In October 2005,intercompany agreements were executed between Bentley Pharmaceuticals, Inc.and Bentley Pharmaceuticals Ireland Limited to license non-U.S. rights of certaintechnologies owned by Bentley Pharmaceuticals, Inc. and provide forcost-sharing of subsequent development efforts on those technologies. A netbenefit of approximately $2,045,000 has been recorded to the U.S. income fromoperations, which contributed to U.S. income before income taxes of $1,042,000in 2005. The Company utilized U.S federal net operating loss carry-forwards inorder to offset the resulting U.S. income tax liability. The NOL carryforwardsinclude the benefit of 2005 compensation expense from nonqualified stock optiondispositions and disqualifying dispositions of incentive stock options ofapproximately $8,402,000, the tax effect of which $(2,857,000) will be creditedto additional paid-in capital if and when realized. The Company calculates thatuse of its NOL carryforwards may be limited each year as a result of stockoption exercises resulting in an ownership change of more than 50% of theCompany’s outstanding equity. If not offset against future taxable income, theNOL carryforwards will expire in tax years 2006 through 2025. During the yearended December 31, 2004, the Company determined that a portion of itsState NOL carryforwards, generated during prior periods, were no longeravailable in the state jurisdictions in which the Company conducts business.The Company therefore reduced the deferred tax benefit related to its State NOLcarryforwards by $2,199,000.

 

The valuation allowance increased (decreased)by approximately $2,920,000, $(817,000), and $1,950,000 in 2005, 2004, and 2003,respectively.  The 2005 increase consistsof approximately $2,858,000 related to the loss carryforward attributable tothe deduction for stock options and approximately $62,000 related to changesresulting from operating items.  The losscarryforwards attributable to the deductions for stock options in 2004 and 2003were $375,000 and $235,000, respectively. The effect of the stock option deductions in 2004 and 2003 were morethan offset by other book to tax differences in those years, resulting in valuationallowance changes that are only attributable to operating activities.

 

**NOTE 13** – **SELECTED QUARTERLY FINANCIAL INFORMATION (Unaudited)**

 

The following tables contain condensedinformation from the Company’s Consolidated Income Statements for each quarterof the years ended December 31, 2005, 2004 and 2003. The Company hasderived this data from its unaudited quarterly financial statements. TheCompany believes that the following information reflects all normal recurringadjustments necessary for a fair presentation of the information for theperiods presented. The operating results for any quarter are not necessarilyindicative of results for any future period.

 

 
| ** **                                  | ** ** | **For the Three Months Ended**             | ** ** |
|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                  | ** ** | **3/31/05**                                | ** ** | **6/30/05** | ** ** | **9/30/05** | ** ** | **12/31/05 (a)** | ** ** |
| ** **                                  | ** ** | **(In Thousands, Except Per Share  Data)** | ** ** |
| Total revenues                              |       | $                                          | 24,244     |   | $ | 24,764 |   | $ | 23,512 |   | $ | 25,210 |   |
| Cost of net product sales                   |       | 11,452                                     |       | 11,367 |   | 11,104 |   | 12,238 |   |
| Gross profit                                |       | 12,792                                     |       | 13,397 |   | 12,408 |   | 12,972 |   |
| Operating expenses                          |       | 9,145                                      |       | 9,408 |   | 8,730 |   | 8,620 |   |
| Income from operations                      |       | 3,647                                      |       | 3,989 |   | 3,678 |   | 4,352 |   |
| Other income (expenses)                     |       | 113                                        |       | 173 |   | 184 |   | 259 |   |
| Provision for income taxes                  |       | 1,590                                      |       | 1,554 |   | 1,377 |   | 955 |   |
| Net income                                  |       | $                                          | 2,170      |   | $ | 2,608 |   | $ | 2,485 |   | $ | 3,656 |   |
| Net income per common share:                |       |                                       |       |   |   |   |   |   |   |
| Basic                                       |       | $                                          | 0.10       |   | $ | 0.12 |   | $ | 0.11 |   | $ | 0.17 |   |
| Diluted                                     |       | $                                          | 0.10       |   | $ | 0.12 |   | $ | 0.11 |   | $ | 0.16 |   |
| Weighted average common shares outstanding: |       |                                       |       |   |   |   |   |   |   |
| Basic                                       |       | 21,316                                     |       | 21,395 |   | 21,652 |   | 21,862 |   |
| Diluted                                     |       | 22,531                                     |       | 22,603 |   | 22,970 |   | 23,564 |   |

 

F-25

----

 
| ** **                                  | ** ** | **For the Three Months Ended**             | ** ** |
|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                  | ** ** | **3/31/04 (c)**                            | ** ** | **6/30/04 (b)(c)** | ** ** | **9/30/04 (c)** | ** ** | **12/31/04 (c)** | ** ** |
| ** **                                  | ** ** | **(In Thousands, Except Per Share  Data)** | ** ** |
| Total revenues                              |       | $                                          | 17,302     |   | $ | 18,470 |   | $ | 18,103 |   | $ | 19,518 |   |
| Cost of net product sales                   |       | 8,255                                      |       | 8,465 |   | 8,662 |   | 9,511 |   |
| Gross profit                                |       | 9,047                                      |       | 10,005 |   | 9,441 |   | 10,007 |   |
| Operating expenses                          |       | 7,374                                      |       | 7,422 |   | 6,922 |   | 8,087 |   |
| Income from operations                      |       | 1,673                                      |       | 2,583 |   | 2,519 |   | 1,920 |   |
| Other income (expenses)                     |       | 57                                         |       | 1,348 |   | 238 |   | 157 |   |
| Provision for income taxes                  |       | 921                                        |       | 2,441 |   | 1,344 |   | 99 |   |
| Net income                                  |       | $                                          | 809        |   | $ | 1,490 |   | $ | 1,413 |   | $ | 1,978 |   |
| Net income per common share:                |       |                                       |       |   |   |   |   |   |   |
| Basic                                       |       | $                                          | 0.04       |   | $ | 0.07 |   | $ | 0.07 |   | $ | 0.09 |   |
| Diluted                                     |       | $                                          | 0.04       |   | $ | 0.07 |   | $ | 0.06 |   | $ | 0.09 |   |
| Weighted average common shares outstanding: |       |                                       |       |   |   |   |   |   |   |
| Basic                                       |       | 20,597                                     |       | 20,644 |   | 21,049 |   | 21,308 |   |
| Diluted                                     |       | 22,784                                     |       | 22,800 |   | 22,746 |   | 22,487 |   |

 
| ** **                                  | ** ** | **For the Three Months Ended**             | ** ** |
|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                  | ** ** | **3/31/03**                                | ** ** | **6/30/03** | ** ** | **9/30/03** | ** ** | **12/31/03** | ** ** |
| ** **                                  | ** ** | **(In Thousands, Except Per Share  Data)** | ** ** |
| Total revenues                              |       | $                                          | 14,988     |   | $ | 16,754 |   | $ | 14,875 |   | $ | 18,059 |   |
| Cost of net product sales                   |       | 6,121                                      |       | 6,819 |   | 5,744 |   | 7,715 |   |
| Gross profit                                |       | 8,867                                      |       | 9,935 |   | 9,131 |   | 10,344 |   |
| Operating expenses                          |       | 6,213                                      |       | 6,619 |   | 6,290 |   | 7,726 |   |
| Income from operations                      |       | 2,654                                      |       | 3,316 |   | 2,841 |   | 2,618 |   |
| Other income (expenses)                     |       | 29                                         |       | 18 |   | 20 |   | 24 |   |
| Provision for income taxes                  |       | 1,151                                      |       | 1,805 |   | 1,513 |   | 954 |   |
| Net income                                  |       | $                                          | 1,532      |   | $ | 1,529 |   | $ | 1,348 |   | $ | 1,688 |   |
| Net income per common share:                |       |                                       |       |   |   |   |   |   |   |
| Basic                                       |       | $                                          | 0.09       |   | $ | 0.09 |   | $ | 0.08 |   | $ | 0.09 |   |
| Diluted                                     |       | $                                          | 0.08       |   | $ | 0.07 |   | $ | 0.06 |   | $ | 0.08 |   |
| Weighted average common shares outstanding: |       |                                       |       |   |   |   |   |   |   |
| Basic                                       |       | 17,455                                     |       | 17,534 |   | 17,911 |   | 19,071 |   |
| Diluted                                     |       | 20,350                                     |       | 20,878 |   | 22,228 |   | 22,418 |   |

 

----

(a)          *Totalrevenues* for the quarter ended December 31, 2005 includes achange in estimate of royalty revenues earned of approximately $1,092,000recorded in the fourth quarter of 2005. This change in estimate of royaltyrevenues earned is based upon publicly available data determined to be moreaccurate than the source of data previously relied upon by management inestimating the sell-through of prescriptions dispensed.

 

(b)         *Other income(expenses)* for the quarter ended June 30, 2004 includes thereversal of previously accrued tax assessments totaling $1,467,000. These assessmentshad been accrued to be paid to the Spanish government as a vehicle to helpreduce the impact of the rising health care costs in Spain. Due to changes inthe pharmaceutical industry in Spain and a change in the Spanish politicalenvironment, these liabilities no longer exist. Accordingly, these accrualswere reversed during the second quarter of 2004.

 

F-26

----

 

(c)          For the interim quarterspresented during the year ended December 31, 2004, a reclassification of$342,000 (approximately $58,000, $70,000, $94,000 and $120,000 in the first,second, third and fourth quarters of 2004, respectively) has been made between *Depreciation and amortization* and *Cost of netproduct sales* for depreciation on certain fixed assets to conform withthe 2005 presentation format throughout the year.

 

**NOTE 14** – **BUSINESS SEGMENT INFORMATION**

 

The Company, headquartered in the U.S., is aninternational specialty pharmaceutical company focused on advanced drugdelivery technologies and pharmaceutical products. Bentley’s proprietary drugtechnologies enhance or facilitate the absorption of pharmaceutical compoundsacross various membranes. The Company manufactures a growing portfolio ofgeneric and branded pharmaceuticals in Europe for the treatment ofcardiovascular, gastrointestinal, infectious and central nervous systemdiseases through its subsidiary, Laboratorios Belmac, and markets thesepharmaceutical products through its subsidiaries, Laboratorios Belmac,Laboratorios Davur, Laboratorios Rimafar and Bentley Pharmaceuticals Ireland.In the U.S., the Company’s activities consist primarily of licensing, productresearch and development, business development activities, corporate managementand administration.

 

Set forth in the tables below is certainfinancial information with respect to the Company’s business and geographicalsegments for the years ended December 31, 2005, 2004 and 2003. Thesegments use the same accounting policies as those described in the summary ofsignificant accounting policies in Note 2.

 
| ** **                                        | ** ** | **As of and for the Year Ended December 31,  2005** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                        | ** ** | **(In Thousands)**                                       | ** ** |
| ** **                                        | ** ** | **Product  Sales  Europe**                               | ** ** | **R&D/  Collaborations/  U.S.** | ** ** | **Consolidated** | ** ** |
| Total revenues                                    |       | $                                                        | 91,581     |   | $ | 6,149 |   | $ | 97,730 |   |
| Interest income                                   |       | 182                                                      |       | 746 |   | 928 |   |
| Interest expense                                  |       | 211                                                      |       | — |   | 211 |   |
| Depreciation and amortization expense             |       | 1,068                                                    |       | 690 |   | 1,758 |   |
| Income before income taxes                        |       | 15,353                                                   |       | 1,042 |   | 16,395 |   |
| Provision for income taxes                        |       | 5,476                                                    |       | — |   | 5,476 |   |
| Net income                                        |       | 9,877                                                    |       | 1,042 |   | 10,919 |   |
| Fixed assets                                      |       | 31,189                                                   |       | 2,177 |   | 33,366 |   |
| Drug licenses and related costs                   |       | 8,931                                                    |       | 4,927 |   | 13,858 |   |
| Total assets                                      |       | 90,647                                                   |       | 33,573 |   | 124,220 |   |
| Total liabilities                                 |       | 29,583                                                   |       | 3,048 |   | 32,631 |   |
| Expenditures for drug licenses and related  costs |       | 945                                                      |       | 1,100 |   | 2,045 |   |
| Expenditures for fixed assets                     |       | 10,821                                                   |       | 197 |   | 11,018 |   |
|                                                   |            |                                                          |            |  |  |  |  |  |  |  |

 

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| ** **                                        | ** ** | **As of and for the Year Ended December 31,  2004** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                        | ** ** | **(In Thousands)**                                       | ** ** |
| ** **                                        | ** ** | **Product  Sales  Europe**                               | ** ** | **R&D/  Collaborations/  U.S.** | ** ** | **Consolidated** | ** ** |
| Total revenues                                    |       | $                                                        | 70,549     |   | $ | 2,844 |   | $ | 73,393 |   |
| Interest income                                   |       | 120                                                      |       | 428 |   | 548 |   |
| Interest expense                                  |       | 226                                                      |       | — |   | 226 |   |
| Depreciation and amortization expense             |       | 844                                                      |       | 608 |   | 1,452 |   |
| Income (loss) before income taxes                 |       | 13,408                                                   |       | (2,913 | ) | 10,495 |   |
| Provision for income taxes                        |       | 4,805                                                    |       | — |   | 4,805 |   |
| Net income (loss)                                 |       | 8,603                                                    |       | (2,913 | ) | 5,690 |   |
| Fixed assets                                      |       | 28,679                                                   |       | 2,170 |   | 30,849 |   |
| Drug licenses and related costs                   |       | 10,481                                                   |       | 4,382 |   | 14,863 |   |
| Total assets                                      |       | 89,733                                                   |       | 32,197 |   | 121,930 |   |
| Total liabilities                                 |       | 30,222                                                   |       | 2,051 |   | 32,273 |   |
| Expenditures for drug licenses and related  costs |       | 745                                                      |       | 459 |   | 1,204 |   |
| Expenditures for fixed assets                     |       | 12,536                                                   |       | 210 |   | 12,746 |   |
|                                                   |            |                                                          |            |  |  |  |  |  |  |  |

 
| ** **                                        | ** ** | **As of and for the Year Ended December 31,  2003** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                        | ** ** | **(In Thousands)**                                       | ** ** |
| ** **                                        | ** ** | **Product  Sales  Europe**                               | ** ** | **R&D/  Collaborations/  U.S.** | ** ** | **Consolidated** | ** ** |
| Total revenues                                    |       | $                                                        | 63,158     |   | $ | 1,518 |   | $ | 64,676 |   |
| Interest income                                   |       | 136                                                      |       | 196 |   | 332 |   |
| Interest expense                                  |       | 215                                                      |       | 13 |   | 228 |   |
| Depreciation and amortization expense             |       | 863                                                      |       | 477 |   | 1,340 |   |
| Income (loss) before income taxes                 |       | 15,091                                                   |       | (3,571 | ) | 11,520 |   |
| Provision for income taxes                        |       | 5,092                                                    |       | 331 |   | 5,423 |   |
| Net income (loss)                                 |       | 9,999                                                    |       | (3,902 | ) | 6,097 |   |
| Fixed assets                                      |       | 16,428                                                   |       | 2,138 |   | 18,566 |   |
| Drug licenses and related costs                   |       | 9,269                                                    |       | 4,377 |   | 13,646 |   |
| Total assets                                      |       | 62,564                                                   |       | 37,899 |   | 100,463 |   |
| Total liabilities                                 |       | 22,619                                                   |       | 1,679 |   | 24,298 |   |
| Expenditures for drug licenses and related  costs |       | 970                                                      |       | 1,223 |   | 2,193 |   |
| Expenditures for fixed assets                     |       | 5,970                                                    |       | 2,106 |   | 8,076 |   |
|                                                   |            |                                                          |            |  |  |  |  |  |  |  |

 

Interest income and interest expense arebased upon the actual results of each operating segment’s assets andborrowings.

 

Revenues from one customer exceeded 10% ofconsolidated total revenues during the year ended December 31, 2005,accounting for 12% of 2005 consolidated total revenues and 4% of theconsolidated receivables balance at December 31, 2005. Revenues from onecustomer exceeded 10% of consolidated total revenues during the year ended December 31,2004, accounting for 13% of 2004 consolidated total revenues and 4% of theconsolidated receivables balance at December 31, 2004. Revenues from onecustomer exceeded 10% of consolidated total revenues during the year ended December 31,2003, accounting for 14% of 2003 consolidated total revenues and 7% of theconsolidated receivables balance at December 31, 2003.

 

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**NOTE 15** – **COMMITMENTS AND CONTINGENCIES**

 

The Company is obligated to pay certain royaltypayments upon commercialization of products using its CPE-215 technologyacquired in 1999 and its intellectual property acquired in 2003 (See Note 2).

 

The Company has entered into renewable employmentagreements with key executives and certain other personnel. These employmentagreements provide for salaries, potential bonuses and other benefits inexchange for services provided. The employment agreements also provide forcertain compensation in the event of termination or change in control of theCompany. The Company is currently obligated to pay approximately $2,630,000 in2006 under such agreements, which are scheduled to expire on December 31,2006. In addition, the Company is obligated to grant an aggregate of 250,000stock options to executive officers in 2006.

 

During the year ended December 31, 2005,management of the Company identified certain tax contingencies that weredetermined to be probable and reasonably estimable. Consequently, the Companyhas included a charge totaling $180,000 related to these contingencies in the *provision for income taxes* in the accompanying ConsolidatedIncome Statements. No other potential tax contingencies were considered probableand reasonably estimable by the Company at December 31, 2005. However,there is the possibility that the ultimate resolution of such potentialcontingencies could have an adverse effect on the Company’s ConsolidatedFinancial Statements.

 

The Company leases certain equipment andfacilities under non-cancelable operating leases, which expire through the year2008. Total charges to operations under operating leases were approximately$1,059,000, $991,000 and $911,000 for the years ended December 31, 2005,2004 and 2003, respectively. Future minimum lease payments under operatingleases are as follows (in thousands): 

 
| **Year Ending December 31,** | ** ** | **Future Minimum Lease Payments** | ** ** |
|-----------------------------------|------------|-----------------------------------|------------|
| 2006                              |       | $                                 | 1,203      |   |   |
| 2007                              |       | 872                               |       |   |
| 2008                              |       | 497                               |       |   |
| 2009 and  beyond                  |       | —                            |       |   |

 

The Company has committed approximately$10,000,000 for capital expenditures as of December 31, 2005 for continued improvements to its manufacturingfacilities, including the acquisition of additional manufacturing equipment andthe expansion of its active pharmaceutical ingredients manufacturing facility. 

 

On February 4, 2002, the Company was notifiedthat a legal proceeding had been commenced against it by Merck &Co. Inc. and its Spanish subsidiary, Merck Sharp & Dohme deEspaña, S.A., alleging that the Company violated their patents in theCompany’s production of simvastatin products and requested an injunctionordering the Company to not manufacture or market the products. The case wasbrought against the Company’s Spanish subsidiaries in the 39th First Instance Court of the Cityof Madrid. After a hearing on February 18, 2002, the court refused togrant the requested injunction and dismissed the case on February 25,2002, awarding court costs and legal fees to the Company. Merck appealed theaward of fees, but the Madrid Court of Appeal rejected its allegations andupheld the First Instance decision in the Company’s favor.

 

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Merck filed an infringement action against theCompany in another proceeding brought in the 19th First Instance Court of the City of Madrid, ofwhich the Company received notice on January 23, 2003. In this case, Merckalso alleged violation of its patents in the production of simvastatinproducts, requested an order that the Company cease manufacturing the productsand demanded damages during the period of manufacture. After a trial withrespect to this matter held on February 19 and 20, 2004, the court, on April 8,2004, ruled in the Company’s favor, again awarding court costs and legal feesto the Company. Merck appealed this ruling, but the Madrid Court of Appealupheld the First Instance judgment on all grounds, rejecting Merck’s appeal(judgment rendered on February 21, 2006, served to the parties on March 6,2006). Merck has the ability to appeal this judgment before the Spanish SupremeCourt.

 

On January 10, 2004, the Company was notifiedthat a legal proceeding had been commenced against it by Smith Kline BeechamPLC, Smith Kline Beecham, S.A. and GlaxoSmithKline S.A. alleging that theCompany violated their patents in its production of paroxetine products andrequesting an order requiring the Company to not manufacture or market theproducts. The case was brought against the Company’s Spanish subsidiaries inthe 50th FirstInstance Court of the City of Madrid. This proceeding followed a preliminaryinjunction that the same plaintiffs attempted to bring against the Company in2003, which was dismissed. The Company filed a response to this suit in February 2004that included a counterclaim requesting that the court declare the assertedpatent invalid. On May 11, 2005, the Spanish Court terminated thesejudicial proceedings upon agreement among the parties to dismiss, withoutrecourse, all paroxetine-related patent infringement claims in Spain.

 

On September 27, 2004, the Company was servedwith a complaint in an action captioned Ethypharm S.A. France &Ethypharm S.A. Spain v. Bentley Pharmaceuticals, Inc., U.S. DistrictCourt for the District of Delaware, Civil Action No. 04-1300 (SLR). Inthis action, Ethypharm S.A., a French-based drug delivery company, and itsSpanish affiliate (collectively, “Ethypharm”), allege that since March 2002the Company and its Spanish subsidiary Laboratorios Belmac, S.A. (“Belmac”)misappropriated unspecified Ethypharm trade secrets and confidentialinformation and used that information in the manufacture of omeprazole, one ofBelmac’s pharmaceutical products. Based on Ethypharm’s primary allegation ofmisappropriation of trade secrets, the complaint also asserted counts of fraud,unjust enrichment, and intentional interference with actual and prospectivebusiness relationships. Ethypharm’s complaint seeks injunctive relief as wellas damages. On September 26, 2005, the Court granted the Company’s motionto dismiss two counts, Count 1 (Fraud) and Count 3 (Unjust Enrichment), ofEthypharm’s complaint but denied the Company’s motion to dismiss the complaintin its entirety without prejudice to its being renewed after the completion ofdiscovery on the issue of agency. We intend to contest the case vigorously.

 

On April 11, 2005, Ethypharm’s Spanishaffiliate, Ethypharm S.A., filed suit against Belmac S.A. in the CommercialCourt No. 5 of Madrid, Spain. The complaint alleges that Belmac refused torenew its contract with Ethypharm for the manufacture of omeprazole whichexpired on March 22, 2002, and that after that date Belmac’s continuedmanufacture of omeprazole pursuant to its own patented technology has infringedEthypharm’s Spanish Patent No. ES9301319. In its complaint, Ethypharmseeks an order from the court declaring Belmac to be in violation of Ethypharm’spatent, preventing further sales of omeprazole by Belmac using processes theallegedly infringe Ethypharm’s patent, and awarding monetary damages. On July 5,2005, Belmac filed an answer and counterclaim which denies Ethypharm’s materialallegations and seeks a declaration that Ethypharm’s patent is invalid.Ethypharm has responded to Belmac’s counterclaim. No trial date has been set.Belmac intends to defend the case vigorously.

 

In January 2005, the Company was notified thata legal proceeding had been commenced against it by Pfizer Inc and its Spanishsubsidiary Pfizer, S.A. requesting an order requiring the Company to notmanufacture or market its amlodipine products. The case was brought againstLaboratorios Davur S.L. in

 

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the3rd Commercial Court of the City ofBarcelona. After an initial hearing the court imposed an injunction,preventing the Company from launching its amlodipine products. However, uponappeal, the court lifted the requested injunction and awarded the Company withcourt costs and legal fees.

 

The Company is party to various other legal actionsthat arise in the ordinary course of business. The Company does not expect thatresolution of these matters will have, individually or in the aggregate, amaterial adverse effect on its financial position, results of operations orcash flows.

 

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