**As filed with the Securities and Exchange Commission on June 30**, 2006

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 20-F**

**o**                                 REGISTRATIONSTATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIESEXCHANGE ACT OF 1934

**OR**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe fiscal year ended: December 31, 2005**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934

**OR**

**o**                                 SHELLCOMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934

Date of event requiringthis shell company report: N/A

Commission file number: **0-29860**

**SKYEPHARMA PLC**

(Exact name of Registrantas specified in its charter)

**England and Wales**

(Jurisdiction ofincorporation or organization)

**105 Piccadilly, London W1J7NJ, England**

(Address of principalexecutive offices)

Securities registered or tobe registered pursuant to Section 12(b) of the Act: **None**

Securities registered or tobe registered pursuant to Section 12(g) of the Act: 

Ordinary Shares of 10p each(‘‘Ordinary Shares’’) represented by American Depositary Shares (‘‘ADSs’’)quoted on the NASDAQ National Market System, each ADS representing ten OrdinaryShares.

Securities for which thereis a reporting obligation pursuant to Section 15(d) of the Act: **None**

Indicate the number ofoutstanding shares of each of the issuer’s classes of capital or common stockas of the close of the period covered by this Annual Report:

**Ordinary Shares, nominal value 10p each 753,764,146**

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes o  No x

If this report is an annualor transition report, indicate by check mark if the registrant is not requiredto file reports pursuant to Section 13 or 15(d) of the SecuritiesExchange Act of 1934. Yes x  No o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the Registrant was required to filesuch reports) and (2) has been subject to such filing requirements for thepast 90 days: Yes x  No o

Indicate by check markwhich financial statement item the registrant has elected to follow:

| Item 17 x | Item 18 o |
|----------------|----------------|

 

If this is an annual report, indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act): Yes o  No x

 

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**TABLEOF CONTENTS**

|                              | ** ** | ** **                                                                    | ** ** | **Page** |
|------------------------------|------------|-------------------------------------------------------------------------------|------------|----------|
| Presentation  of Information |       | 3                                                                             |
| Statistical  Data            |       | 4                                                                             |
| Forward-Looking  Statements  |       | 4                                                                             |
| Exchange  Rate Information   |       | 5                                                                             |
| **Part I**              |       |                                                                          |
| Item 1:                      |       | Identity of Directors, Senior Management and Advisers                         |       | 6        |
| Item 2:                      |       | Offer Statistics and Expected Timetable                                       |       | 6        |
| Item 3:                      |       | Key Information                                                               |       | 6        |
| Item 4:                      |       | Information on the  Company                                                   |       | 22       |
| Item 4A:                     |       | Unresolved Staff Comments                                                     |       | 47       |
| Item 5:                      |       | Operating and Financial Review and Prospects                                  |       | 48       |
| Item 6:                      |       | Directors, Senior Management and Employees                                    |       | 64       |
| Item 7:                      |       | Major Shareholders and Related Party Transactions                             |       | 75       |
| Item  8:                     |       | Financial  Information                                                        |       | 78       |
| Item  9:                     |       | The  Offer and Listing                                                        |       | 78       |
| Item 10:                     |       | Additional Information                                                        |       | 79       |
| Item 11:                     |       | Quantitative and Qualitative Disclosures about Market  Risk                   |       | 90       |
| Item 12:                     |       | Description of Securities other than Equity Securities                        |       | 93       |
| **Part II**             |       |                                                                          |
| Item 13:                     |       | Defaults, Dividend Arrearages and Delinquencies                               |       | 94       |
| Item 14:                     |       | Material Modifications to the Rights of Security  Holders and Use of Proceeds |       | 94       |
| Item 15:                     |       | Controls and Procedures                                                       |       | 94       |
| Item 16A:                    |       | Audit Committee Financial Expert                                              |       | 95       |
| Item  16B:                   |       | Code  of Ethics                                                               |       | 95       |
| Item 16C:                    |       | Principal Accountant Fees and Services                                        |       | 95       |
| Item 16D:                    |       | Exemptions from the Listing Standards for Audit  Committees                   |       | 96       |
| Item 16E:                    |       | Purchase of Equity Securities by the Issuer and  Affiliated Purchasers        |       | 96       |
| **Part III**            |       |                                                                          |
| Item 17:                     |       | Financial  Statements                                                         |       | 97       |
| Item  18:                    |       | Financial  Statements                                                         |       | 97       |

 

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**PRESENTATION OF INFORMATION**

In this Annual Report on Form 20-F(‘‘Form 20-F’’), the term ‘‘Ordinary Shares’’ refers to the OrdinaryShares, nominal value 10 pence each, of SkyePharma PLC (‘‘SkyePharma’’ or the ‘‘Company’’,and together with its consolidated subsidiaries, the ‘‘Group’’) and the term ‘‘ADSs’’refers to American Depositary Shares each representing the right to receive 10 OrdinaryShares and evidenced by American Depositary Receipts (‘‘ADRs’’).

The Company publishes its consolidatedfinancial statements expressed in pounds sterling. In this Annual Report,references to ‘‘pounds sterling’’, ‘‘£’’, ‘‘pence’’ or ‘‘p’’ are to the lawfulcurrency of the United Kingdom; references to ‘‘U.S. dollars’’ or ‘‘$’’ are tothe lawful currency of the United States; references to ‘‘Euro’’ or ‘‘e’’ are to the lawful currency of the members of the European Unionthat have adopted the single European currency; references to ‘‘$ Canadian’’ or‘‘Cdn$’’ are to the lawful currency of Canada, references to ‘‘Swiss francs’’or ‘‘Chf’’ are to the lawful currency of Switzerland and references to ‘‘SwedishKrona’’ or ‘‘SKr’’ are to the lawful currency of Sweden. Solely for theconvenience of the reader, this Annual Report contains translations of certainpound sterling amounts into U.S. dollar amounts at specified rates. Unlessotherwise stated, the translations of pounds sterling into U.S. dollars havebeen made at the noon buying rate in New York City for cable transfers inpounds sterling, as certified for customs purposes by the Federal Reserve Bankof New York (the ‘‘Noon Buying Rate’’). No representation is made that poundssterling have been, could have been or could be converted into U.S. dollars atthe rates indicated or at any other rate.

Unless otherwise indicated, historicalconsolidated financial information for the years ended December 31, 2004and 2005 included herein has been prepared in accordance with InternationalFinancial Reporting Standards as adopted by the European Union (IFRS), with areconciliation of significant differences between IFRS and generally acceptedaccounting principles in the United States (“U.S. GAAP’’) . The transition dateto IFRS for SkyePharma is January 1, 2004. For SkyePharma there are nodifferences between IFRS as adopted for use in the European Union and full IFRSas published by the International Accounting Standards Board. Prior to 2005,the Company prepared its annual consolidated financial statements under U.K.Generally Accepted Accounting Principles (U.K. GAAP). For the year ended December 31,2005, the Company has prepared its annual consolidated financial statements inaccordance with International Financial Reporting Standards and InternationalFinancial Reporting Interpretations Committee (IFRIC) interpretations asadopted by the European Union (EU) applicable to companies reporting underIFRS. The 2004 comparatives have been restated as part of the first-timeadoption requirements of IFRS. As allowed by SEC rules in relation tofirst-time adoption of IFRS, only one year of comparatives is reported in thisannual report.

IFRS differ in certain significant respectsfrom U.S. GAAP. For a description of the principal differences between IFRS andU.S. GAAP as they relate to SkyePharma and a reconciliation to U.S. GAAP of theCompany’s IFRS loss for the years ended December 31, 2005 and 2004 andshareholders’ funds at December 31, 2005 and 2004, see Note 37 of theNotes to the Consolidated Financial Statements included in Item 17 of this Form 20-F.

Amounts previously reported in this AnnualReport for the Company’s consolidated shareholders’ funds in accordance withU.S. GAAP for the fiscal years ended December 31, 2001, 2002, 2003 and 2004have been restated. This restatement reduced the Company’s shareholders’ fundsunder U.S. GAAP but did not affect our net loss under U.S. GAAP or financialstatements under IFRS. Further information is provided in “Item 5:Operating and Financial Review and Prospects’’, “Item 15: Controls and Procedures’’and Note 37 to the consolidated financial statements beginning onpage F-1 of this Annual Report.

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**STATISTICAL DATA**

Except whereotherwise indicated, figures included in this Form 20-F relating topharmaceutical market sales are obtained from the Company’s collaborativepartners.

**FORWARD-LOOKING STATEMENTS**

This Form 20-Fcontains certain forward-looking statements, as defined in Section 21E ofthe Securities Exchange Act of 1934, with respect to the financial condition,results of operations and business of the Company and certain of the plans andobjectives of the Board of Directors of the Company with respect thereto. Suchstatements may generally, but not always, be identified by the use of wordssuch as ‘‘anticipates’’, ‘‘should’’, ‘‘expects’’, ‘‘estimates’’, ‘‘believes’’or similar expressions. Such statements in this Form 20-F include,but are not limited to, statements under the following headings: (1) ‘‘Item4: Information on the Company’’; (2) ‘‘Item 5: Operating and FinancialReview and Prospects’’; (3) ‘‘Item 8: Financial Information’’; and (4) ‘‘Item11: Quantitative and Qualitative Disclosures About Market Risk’’. Specificrisks faced by the Company are described under ‘‘Item 3: Key Information—RiskFactors’’. The Company’s intention to divest its injectable business interestsis described under ‘‘Item 4: Information on the Company—Business Operations’’.Although the Company believes that the expectations reflected in theseforward-looking statements are reasonable, it can give no assurance that theseexpectations will materialize. By their nature, forward-looking statements involverisk and uncertainty, and the factors described in the context of suchforward-looking statements in this Form 20-F could cause actualresults and developments to differ materially from those expressed in orimplied by such forward-looking statements.

**STATEMENTS REGARDING COMPETITIVE POSITION**

Statements madein “Item 4: Information on the Company” referring to the Company’s competitiveposition are based on our beliefs, and in some cases rely on other publiclyavailable information.

4

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**EXCHANGE RATE INFORMATION**

The table below sets forth, for the periodsand dates indicated, certain information concerning the Noon Buying Rates forpounds sterling expressed in U.S. dollars per pound. The period average dataset forth below is the average of the Noon Buying Rates on the last day of eachfull month during the period.

Fluctuations in the exchange rate between the pound sterling and theU.S. dollar will affect, among other things, the U.S. dollar equivalent of thepound sterling price of the Company’s Ordinary Shares on the London StockExchange (‘‘LSE’’), which is likely to affect the market prices of its ADSs inthe United States. 
|      | ** ** | **High** | ** ** | **Low** | ** ** | **Period Average** | ** ** | **Period End** | ** ** |
|------|------------|----------|------------|---------|------------|-------------------------|------------|---------------------|------------|
| 2001 |       | 1.5045   |       | 1.3730  |       |                    | 1.4382     |                |       |   | 1.4543 |   |   |
| 2002 |       | 1.6095   |       | 1.4074  |       |                    | 1.5025     |                |       |   | 1.6095 |   |   |
| 2003 |       | 1.7842   |       | 1.5500  |       |                    | 1.6450     |                |       |   | 1.7842 |   |   |
| 2004 |       | 1.9482   |       | 1.7544  |       |                    | 1.8356     |                |       |   | 1.9160 |   |   |
| 2005 |       | 1.9310   |       | 1.7114  |       |                    | 1.8057     |                |       |   | 1.7188 |   |   |

 
|                                                                       | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------------------------------------------------------------|------------|----------|------------|---------|------------|
| December 2005                                                    |       | 1.7726   |       | 1.7168  |       |
| January 2006                                                     |       | 1.7873   |       | 1.7388  |       |
| February 2006                                                    |       | 1.7796   |       | 1.7290  |       |
| March 2006                                                       |       | 1.7554   |       | 1.7260  |       |
| April 2006                                                       |       | 1.8318   |       | 1.7370  |       |
| May 2006                                                         |       | 1.8906   |       | 1.8397  |       |
| On June 23,  2006 the Noon Buying Rate was 1.8204 per £1.00 |       | 1.8204   |       | 1.8204  |       |

 

For a discussion of the impact of exchangerate fluctuations on the Company’s operating results, see ‘‘Item 5: Operatingand Financial Review and Prospects—Operating Results’’.

5

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**PART I**

**Item 1:**                       Identity of Directors, Senior Management and Advisers

Not applicable

**Item 2:**                       Offer Statistics and Expected Timetable

Not applicable

**Item 3:**                       Key Information

**SelectedFinancial Data**

As part of the European Commission’s planto develop a single European capital market, the application of IFRS ismandatory for the consolidated financial statements of all listed EuropeanUnion companies for reporting periods beginning on or after January 1,2005. Under the regulation passed by the European Union, January 1, 2004is the transition date to IFRS for the Company. Under the IFRS transitionprovisions within the Securities and Exchange Commission’s (“SEC’s’’) Form 20-Frequirements, the Company is permitted to provide two years of comparablefinancial information under IFRS and reconciliations to U.S. GAAP for theperiods presented.

The transition date to IFRS for SkyePharmaPLC is January 1, 2004. Therefore, the 2005 and 2004 selected consolidatedfinancial data presented below is in accordance with IFRS and has been derivedfrom our audited consolidated financial statements, including the related Notes,contained elsewhere in this Annual Report. Additionally the selectedconsolidated financial data presented in accordance with U.S. GAAP below as ofand for each of the last five fiscal years ended December 31, 2005 havebeen derived from our audited consolidated financial statements for therelevant periods.

As noted, we report our financialinformation in accordance with IFRS. The principal differences between IFRS andU.S. GAAP that are relevant to our consolidated financial statements arediscussed in note 37 to our consolidated financial statements beginning on page F-1of this Annual Report.

The Company has prepared its auditedconsolidated financial statements assuming that it will continue as a goingconcern. However, the Company’s independent auditors, PricewaterhouseCoopersLLP, has included an emphasis of matter paragraph related to going concern intheir auditors’ report, which refers to Note 1 to the consolidatedfinancial statements beginning on page F-1 to this Annual Report stating thatthere isuncertainty as to when certain strategic initiatives may be concluded impactingthe Group’s working capital requirements. The auditopinion has not been qualified in this respect. The Company’s auditedconsolidated financial statements do not include any adjustments that mightresult from the outcome of this uncertainty. See “Report of IndependentRegistered Public Accounting Firm” and note 1 (a) to ourconsolidated financial statements beginning on page F-1 of this AnnualReport.

The selected financial data set forth belowfor the Company, for the years ended December 31, 2005, 2004, 2003, 2002and 2001, has been derived from, and should be read in conjunction with, theCompany’s audited Consolidated Financial Statements, including the Notes tothose Statements included in this report.

For exchange rate information, see ‘‘ExchangeRate Information’’ on page 5 of this Form 20-F.Solely for the convenience of the reader, the pound sterling amounts as of andfor the year ended December 31, 2005 have been translated into U.S.dollars at the Noon Buying Rate on December 31, 2005 of $1.7188 per £1.00.

For a discussion of the impact of exchangerate fluctuations on the Company’s operating results, see ‘‘Item 5: Operatingand Financial Review and Prospects—Operating Results’’.

6

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The followingtable sets forth selected consolidated financial information as of and for thefive years ended December 31, 2005.

**SkyePharmaPLC**

The followingtable presents selected consolidated financial information of SkyePharma PLC.You should read this table together with “Item 5: Operating and FinancialReview and Prospects” and our audited consolidated financial statements,including the related Notes, contained elsewhere in this annual report.

*Consolidated Income Statement Data*

| ** **                                                    | ** ** | **For the year ended December 31,**      | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                                                          | ** ** | **2005** | ** ** | **2005** | ** ** |
| ** **                                                    | ** ** | **(in millions, except per share data)** | ** ** |
| **IFRS**                                                      |       |                                                              |       |   |   |   |   |
| Revenue                                                       |       | £75.2                                                        |       | £61.3 |   | $105.4 |   |
| Cost  of sales                                                |       | (28.2                                                             | )          | (29.2 | ) | (50.2 | ) |
| Gross  profit                                                 |       | 47.0                                                              |       | 32.1 |   | 55.2 |   |
| Selling,  marketing and distribution expenses                 |       | (1.7                                                              | )          | (5.9 | ) | (10.1 | ) |
| Administration  expenses                                      | ** ** | (22.5                                                             | )(1)       | (37.3 | )(4) | (64.1 | )(4) |
| Research  and development expenses                            |       | (28.0                                                             | )          | (26.0 | ) | (44.7 | ) |
| Other  income/(expense)                                       | ** ** | 2.1                                                               | (2)        | (0.4 | ) | (0.8 | ) |
| Operating  loss                                               |       | (3.1                                                              | )          | (37.5 | ) | (64.5 | ) |
| Finance  costs                                                | ** ** | (23.9                                                             | )(3)       | (22.3 | ) | (38.3 | ) |
| Finance  income                                               |       | 8.6                                                               |       | 10.0 |   | 17.2 |   |
| Share  of loss in associate                                   |       | —                                                            |       | (0.8 | ) | (1.4 | ) |
| Loss  before income tax                                       |       | (18.4                                                             | )          | (50.6 | ) | (87.0 | ) |
| Income  tax expense                                           |       | (0.2                                                              | )          | (0.3 | ) | (0.5 | ) |
| Loss  for the year                                            |       | (18.6                                                             | )          | (50.9 | ) | (87.5 | ) |
| Basic and diluted weighted average number of shares  in issue |       | 615.2                                                             |       | 624.9 |   | 624.9 |   |
| Basic and  diluted loss per Ordinary Share                    |       | (3.0                                                              | p)         | (8.1 | p) | (14.0 | c) |

 

| ** **                            | ** ** | **For the year ended December 31,**      | ** ** |
|---------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                            | ** ** | **2001**                                                          | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2005** | ** ** |
| ** **                            | ** ** | **(in millions, except per share data)** | ** ** |
| **U.S. GAAP**                         |       |                                                              |       |   |   |   |   |   |   |   |   |   |   |
| Revenue                               |       | £44.2                                                        |       | £42.6 |   | £66.6 |   | £75.2 |   | £56.3 |   | $96.8 |   |
| Operating  loss                       |       | £(27.5                                                       | )          | £(36.2 | ) | £(22.1 | ) | £(1.3 | ) | £(33.0 | ) | $(56.7 | ) |
| Net  loss under U.S. GAAP             |       | £(44.9                                                       | )          | £(50.0 | ) | £(38.6 | ) | £(20.8 | ) | £(49.2 | ) | $(84.6 | ) |
| Basic and  diluted net loss per share |       | (8.5                                                              | p)         | (8.7 | p) | (6.3 | p) | (3.4 | p) | (7.9 | p) | (13.5 | c) |

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(1)          Administrationexpenses in 2004 include £1.2 million relating to the reorganization of someresearch and development operations and other business functions and a chargeof £3.5 million for a provision for diminution in value of fixed assetinvestments.

(2)          Otheroperating income in 2004 includes income of £2.0 million relating to the profiton disposal of the Group’s investment in Transition Therapeutics.

(3)          Financecosts in 2004 include an exceptional charge of £6.2 million relating to theexchange of convertible bonds.

7

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(4)          Administrationexpenses in 2005 include £19.4 million relating to an impairment of theinvestments in Astralis, Vital Living and Micap since following the StrategicReview and the Group’s decision to focus on its core oral and pulmonaryproducts and to divest its injectable business, the Group no longer views itscollaborations with Astralis, Vital Living and Micap as strategic, and a £2.0million charge for legal and professional fees relating to an aborted strategictransaction.

**SkyePharma PLC**

*Consolidated Balance Sheet Data*

| ** **                         | ** ** | **For the year ended December 31,**        | ** ** |
|------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                         | ** ** | **2004**                                                            | ** ** | **2005** | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **(in millions, except number of shares)** | ** ** |
| **IFRS**                           |       |                                                                |       |   |   |   |   |
| Fixed  assets                      |       | £155.8                                                         |       | £134.4 |   | $231.0 |   |
| Cash  and short term bank deposits |       | 15.3                                                                |       | 34.3 |   | 59.0 |   |
| Total  assets                      |       | 191.9                                                               |       | 186.9 |   | 321.2 |   |
| Net  Assets(1)                     |       | 36.5                                                                |       | 31.9 |   | 54.8 |   |
| Share  Capital                     |       | 63.4                                                                |       | 76.6 |   | 131.7 |   |
| Number of  shares                  |       | 622,398,743                                                         |       | 753,764,146 |   | 753,764,146 |   |

 

| ** **          | ** ** | **For the year ended December 31,** | ** ** |
|---------------------|------------|--------------------------------------------------------------|------------|
| ** **          | ** ** | **2001  (restated)**                                         | ** ** | **2002  (restated)** | ** ** | **2003  (restated)** | ** ** | **2004  (restated)** | ** ** | **2005** | ** ** | **2005** | ** ** |
| ** **          | ** ** | **(in millions)**                                       | ** ** |
| **U.S. GAAP**       | ** ** |                                                         | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |
| Total  assets(2)(3) |       |                                                         | £     | 281.4 | ** ** |   |   | £ | 302.2 | ** ** |   |   | £ | 271.4 | ** ** |   |   | £ | 216.2 | ** ** |   | £ | 222.8 |   | $ | 382.9 |   |
| Net Assets(1)(2)(3) |       |                                                         | 117.9      | ** ** |   |   | 109.8 | ** ** |   |   | 69.6 | ** ** |   |   | 58.9 | ** ** |   | 50.0 |   | 85.9 |   |
|                     |            |                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Net Assets is equivalent to shareholders’ funds.

(2)   Under U.S. GAAP totalassets and net assets have been restated to properly present changes in the Company’sgoodwill balances related to acquired subsidiaries which are outside the UnitedKingdom. In prior years the Company had made no adjustment for the differencein accounting treatment that exists between UK GAAP and U.S. GAAP in respect ofthe impact of foreign exchange translation upon consolidation of thesesubsidiaries. This restatement reduced the Company’s shareholders’ funds underU.S. GAAP but did not affect its net loss under U.S. GAAP or financial statementsunder IFRS. Further information is provided in “Item 5: Operating and FinancialReview and Prospects”, “Item 15: Controls and Procedures” and Note 37 to theconsolidated financial statements beginning on page F-1 of thisAnnual Report.

(3)   UnderU.S. GAAP total assets and net assets have been restated due to a change inaccounting principle relating to the investment in Astralis. This is caused bya change in classification from an available for sale to an equity methodinvestment due to the ability to exercise significant influence.

For a reconciliation of the Company’s IFRSshareholders’ funds to U.S. GAAP, see Note 37 of the Notes to the ConsolidatedFinancial Statements.

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**RISK FACTORS**

The Company isexposed to certain risks that arise from the activity of developing andmanufacturing drug products.

***Extensive government regulation may causeincreased costs and delays in developing and marketing products***

The Company is subject to extensivegovernment regulation. The U.S. Food and Drug Administration (‘‘FDA’’), theEuropean Medicines Evaluation Agency (‘‘EMEA’’) and other national regulatoryauthorities require rigorous pre-clinical testing, clinical trials and otherprocedures prior to approving drugs for human use. Numerous regulations alsogovern the manufacturing, safety, labeling, storage, record keeping, reportingand marketing of such drugs. These requirements vary widely from country tocountry, as does the time required to complete pre-clinical testing andclinical trials and to obtain regulatory approvals to sell drugs. The processof obtaining these approvals and complying with applicable governmentregulations is time consuming and expensive. If the FDA or other nationalregulatory authorities increase the number of clinical trials required for theapproval of drugs, the Company could face increased costs and significantdevelopment delays before the Company will be able to sell its productscommercially. In addition, changes in regulatory policy or additionalregulations adopted during product development could also result in delays orrejections in obtaining marketing approvals from regulatory authorities.

Most of the products that the Companydevelops will require a new drug application (‘‘NDA’’) filing with the FDAbefore they can be marketed in the United States. Based on current practice,the Company generally expects it to take less than two years from the date offiling for the FDA to approve an NDA for a product formulation. However, theCompany cannot predict the exact time required or the outcome of the approvalprocess for any of its product candidates with any certainty.

A number ofproducts using the Company’s technologies have not yet been approved for marketingby regulators. These product candidates are at various stages of development,ranging from pre-clinical studies to Phase III clinical trials and those thathave been filed for approval. The Company cannot be certain that its productcandidates will prove safe and effective in clinical trials or that it willobtain further regulatory approvals of any such products. These products willrequire expensive and lengthy testing and regulatory clearances before they canbe sold commercially.

***Products for which the Company obtainsregulatory approval may not succeed in the market***

Although the Company carries out commercialfeasibility assessments and extensive clinical trials on all its productsbefore they are launched, newly launched products may not achieve broad marketacceptance. The successful launch of a new pharmaceutical product involves asubstantial investment in sales and marketing costs, launch stocks and otheritems. If a new product cannot be manufactured at an acceptable cost or doesnot succeed as anticipated or its rate of sales growth is slower thananticipated, there is a risk that it could have a material adverse effect onthe Company’s financial condition and results of operations.

In addition,pre-clinical testing or clinical testing may not accurately predict safety oreffectiveness in broader human use. For a new product, it can be difficult toestablish from available data a meaningful and reliable assessment of itseventual efficacy and/or safety in the market.

***Competition and technological change mayrender the Company’s products or technologies uncompetitive or obsolete***

The drug development industry is highlycompetitive and rapidly evolving, with significant developments expected tocontinue at a rapid pace. The Company’s success will depend on maintaining a 

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competitiveposition and developing efficient and cost-effective products and technologies.The Company’s products will compete with other drugs and methods for deliveringdrugs. The Company cannot be certain that any of its products will haveadvantages that will be significant enough to cause medical professionals toprescribe or recommend them. New drugs or further development in alternativedrug delivery methods may provide greater benefits or may offer comparableperformance at lower cost than the Company’s products or technologies. TheCompany cannot be certain that developments by other companies will not renderits products or technologies uncompetitive or obsolete.

Many of the Company’s competitors havelonger operating histories and greater financial, marketing and otherresources. Such competitors may prove to be more successful in developingcompeting technologies, obtaining regulatory approvals and marketing theirproducts than the Company because of greater financial resources, strongersales and marketing teams or other factors.

The Companywill face competition with respect to the products it is developing under itscollaborative arrangements with leading pharmaceutical companies includingcompetition from other products developed and produced by the Company’scollaborative partners and branded and generic products manufactured by othercompanies.

***The Company’s business may give rise toproduct liability claims not covered by insurance or indemnification***

The design, development and manufacture ofthe Company’s products involve an inherent risk of product liability claims.

Although the Company generally relies onindemnity provisions in its agreements with its collaborative partners toprotect itself against the possibility of product liability claims, the Companyhas obtained product liability insurance in respect of pharmaceutical productsit is developing in conjunction with such partners. This product liabilityinsurance also covers liabilities associated with the commercial sale ofproducts marketed by third parties using the Company’s technology.

The Company has also obtained clinicaltrial insurance for current human clinical trials and bio-equivalence studiesinvolving its products under development and intends to obtain insurance forfuture clinical trials and bio-equivalence studies of additional products underdevelopment.

The Companybelieves that its product liability and clinical trial insurance, together withthe indemnity provisions in its collaborative agreements, is adequate forcurrent operations. However, the coverage limits of this insurance and theindemnity provisions in the Company’s collaborative agreements may not beadequate to cover all potential claims. Product liability and clinical trialinsurance is expensive and may be difficult to obtain or maintain oncommercially reasonable terms. A successful claim against the Company in excessof the Company’s insurance coverage or outside the scope of the indemnity givenby its collaborative partners could adversely affect the Company’s results ofoperations.

***The Company’s revenues may be reduced andcosts increased as a result of third-party payor cost containment measures***

The Company’sability to achieve profitability in its businesses depends in part on theextent to which appropriate levels of reimbursement for products and relatedtreatments are obtained from government authorities, private health insurersand other organizations, such as health maintenance organizations. Thesethird-party payors are increasingly challenging the pricing of pharmaceuticalproducts and seeking ways to replace more expensive pharmaceuticals withcheaper alternatives. The trend toward managed healthcare in the United Statesand the growth of organizations such as health maintenance organizations in theUnited States could significantly influence the purchase of pharmaceuticalproducts, thereby resulting in lower prices and reduced demand for the Company’sproducts under development. Such cost 

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containmentmeasures could affect the Company’s ability to sell products under developmentand may adversely affect the Company.

***Healthcare reform proposals may adverselyaffect the Company’s business***

The efforts ofgovernments to contain or reduce the cost of health care will continue to affectthe business and financial condition of drug companies. A series of health carereform proposals announced in recent years have created uncertainty that couldadversely affect the Company’s ability to raise funds and to identify and reachagreements with potential partners. Such proposals could adversely affect theCompany’s business. Furthermore, the Company’s ability to commercializepotential products may be adversely affected to the extent such proposals havean adverse effect on the business, financial condition and profitability ofother companies that are the Company’s current or prospective collaborators forsome of such products.

***The Company may not be able to divest itsinjectable business interests***

In late 2005 and early 2006, the Board of Directorsof the Company conducted a full strategic review and concluded that in the interests of achievingsustainable profitability in the near term, and inorder to improve the Company’s cash position, the Company should concentrate onoral and inhalation products, and divest its injectable business interests. Asale of these interests would include the sale of the manufacturing and otherfacilities in San Diego, California. However, there can be no assurance thatthe Company will be able to agree on suitable terms of sale with an appropriatepurchaser, or that any sale would ultimately be completed. A failure to divestthe Company’s injectable business interests could prevent the Company fromexecuting its strategy and adversely affect the Company’s results ofoperations.

Moreover, untilsuch time as the Company is able to divest its injectable business interests, itremains subject to certain risks inherent in the licensing and manufacturing ofDepoFoamTM as described elsewhere in these Risk Factors.

***The Company’s near term working capitalrequirements are uncertain and sensitive to the timing of a number ofinitiatives required to provide the financial flexibility to implement its newstrategy***

The Company’s working capital requirementscontinue to be affected by the timing and receipt of milestone payments andpayments received on the signing of new contracts. The Company’s future cashflows will also be impacted by the Company’s change in strategy, principallyits stated aim of moving to sustainable profitability in the near term and itsrefocus to concentrate on oral and pulmonary products. Consequently the Company’snear term working capital requirements are uncertain and sensitive to thetiming of a number of initiatives required to provide the financial flexibilityto implement the new strategy. These initiatives include the licensing ofFlutiformTM in Europe, the divestment of the Company’s injectable businessinterests, which is expected to require shareholder approval, or the USlicensing for DepoBupivacaine.

The Company’s independent auditors,PricewaterhouseCoopers LLP, have included an emphasis of matter paragraph relatedto going concern in their auditors’ report, which refers to Note 1 to the consolidatedfinancial statements beginning on page F-1 to this Annual Report stating thatthereis uncertainty as to when certain strategic initiatives may be concluded impactingthe Group’s working capital requirements. The auditopinion has not been qualified in this respect.

The Board of Directors has reviewed theworking capital requirements of the Group for the next twelve months and has areasonable expectation that sufficient funds will be raised from theseinitiatives and has therefore prepared the financial information contained hereinon the basis that the Company will continue in operational existence for theforeseeable future. The financial statements do not reflect any 

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adjustmentsthat would be required to be made if they were to be prepared on a basis otherthan a going concern basis.

In the event that sufficient funds are not raised by the Company’s initiativesand currentlyavailable funds and internally generated cash flow are not sufficient tosatisfy its financing needs, theCompany will be required to seek additional funding through other arrangementswith corporate collaborators, through bank borrowings or through public orprivate sales of its securities, including equity securities. Any suchcollaboration could result in limitations on the resources the Company coulddevote to research, development and commercialization of new products andproduct candidates, if any, as well as its profits therefrom. In addition, theterms of any future bank borrowings could place restrictions on the Company’sability to take certain actions, and any equity financing could result indilution to the Company’s shareholders. The Company does not currently have anycommitted sources of additional capital.

For moreinformation on the Company’s liquidity and capital resources, see ‘‘Item 5: Operatingand Financial Review and Prospects’’.

***The Company’s revenues tend to fluctuate***

The Company’srevenues principally derive from contract development. Contract developmentrevenues include milestone payments and that portion of the Company’s researchand development expenses that the Company charges to its partners pursuant tocollaborative arrangements with these partners. The amount of the Company’scontract development revenue in any given period will depend on a number ofunpredictable factors, including scientific developments, the ability of theCompany to find suitable partners, the timing of the negotiation and conclusionof agreements with such partners, whether and when the Company achievesmilestones agreed with its partners, such as the timing of regulatory approvalsand the market introduction of new products, and other factors. As a result,the Company’s revenues tend to fluctuate materially on a monthly, semi-annuallyand yearly basis. The Company believes that its revenues will continue tofluctuate in the near to medium term as a result of the factors describedabove.

***The Company may not achieve and sustainprofitability***

In 2005, SkyePharma reported a full yearnet loss of £50.9 million and in 2004 a full year net loss of £18.6 million. Asa result of these losses, the Company’s consolidated net assets at December 31,2005 declined to £31.9 million, compared with £36.5 million at December 31,2004. If and when the Company achieves profitability is dependent upon a numberof factors, including the timing and recognition of milestone payments andlicense fees received, the timing of contract development revenues and theamount of discretionary investment the Company chooses to make in furtheringits own product portfolio. As a consequence, the Company cannot assure you thatit will be able to achieve and sustain profitability. See ‘‘Item 5: Operatingand Financial Review and Prospects’’.

In late 2005 and early 2006, the Board ofDirectors of the Company conducted a full strategic review and concluded that in the interests of achievingsustainable profitability in the near term,  and in order to improve the Company’s cashflow position, the Company should concentrate on oral and inhalation products,and divest its injectable business interests. However, there can be noassurance that the Company will be able to agree on suitable terms of sale withan appropriate purchaser, or that any sale would ultimately be completed.

Otherfactors that will affect whether the Company achieves and sustainsprofitability include its ability, alone or together with its partners, to:

·       developproducts utilizing its technologies, either independently or in collaborationwith other pharmaceutical companies;

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·       receivenecessary regulatory and marketing approvals;

·       establishand expand its manufacturing;

·       achievemarket acceptance for its products;

·       receiveroyalties on products that have been approved, marketed or submitted formarketing approval with regulatory authorities in line with the Company’scurrent forecasts; and

·       maintain sufficient funds to finance its activities.

***The Company is dependent on its various technologies,as to which further successful development is uncertain***

The Company’s ability to increase revenuesand achieve profitability is largely dependent on certain of its technologies.Approximately 36% of the Company’s revenues for the year ended December 31,2005 derived from royalties, product sales, contract development and milestonepayments relating to its GeomatrixTM technologies, approximately 20% from royalties, product sales,contract development and milestone payments relating to its inhalationtechnologies and approximately 17% from royalties, product sales, contractdevelopment and milestone payments relating to its DepoFoamTM technologies. In late 2005 and early 2006, the Board of Directors ofthe Company conducted a full strategic review and concluded that in the interests of achievingsustainable profitability in the near term, and in orderto improve the Company’s cash flow position, the Company should concentrate onoral and inhalation products, and divest its injectable business interests. Inorder to increase revenues from its technologies, the Company must continue toobtain new development contracts with third parties or develop, license andmanufacture new formulations of commercially available drugs using thesetechnologies. The Company cannot assure you that it will be able to obtain suchcontracts or successfully develop new formulations internally.

There can be no assurance that the Company  will be able to develop successfully futureproducts using its various technologies. The development and formulation oforal and injectable controlled release and inhalation products is difficult andtime-consuming. Each drug compound is different, and there can be no assurancethat a drug delivery system that works with one product will work with another.

Even after aproduct incorporating the Company’s technologies has been successfullyformulated and approved, its commercial success is not assured. In order to gainmedical and commercial acceptance, a product generally must demonstrate someperformance improvements and other benefits over products incorporating thesame or similar drug compounds. In some cases, these benefits may be difficultto establish.

***Failure by the Company’s collaborativepartners to fulfil their obligations to the Company to provide funding, obtainregulatory approvals and conduct marketing activities could adversely affectthe Company’s business***

TheCompany’s ability to develop and market its present and future products dependsin large part on its ability to maintain its existing, and enter into newcollaborations with third parties. If any of the Company’s partners becomesinsolvent or terminates or otherwise fails to fulfil its obligations with theCompany, the Company’s business could be adversely affected. In particular, theCompany faces the following risks with respect to collaborative partners:

·       *Funding.*The Company hasentered into a number of collaborative arrangements with various pharmaceuticalcompanies for the development and commercialization of products using itstechnologies. Some of the Company’s collaborative partners are, however,development stage companies whose business prospects are uncertain and who facesimilar risks as the Company. If the Company becomes unable to continue toobtain funding for its development activities through its collaborativearrangements or if its collaborative partners fail to make payments due underthe 

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development andcommercialization agreements, the Company’s business would be adverselyaffected.

·       *Regulatory Approvals.*TheCompany generally depends upon its collaborative partners to secure thenecessary regulatory approvals of new pharmaceutical formulations utilizing itstechnologies. In these cases, the Company has no control over the timing of theregulatory filings and in which countries they may be filed. Its partners mayfollow a regulatory strategy that does not maximize the royalty income that theCompany may receive from its technologies. In addition, the Company’s partnersmay choose not to file for regulatory approval of a product successfullyformulated with its technologies. Even if the Company’s partners do file forregulatory approval, they may fail to devote the necessary resources andexpertise to secure approval.

·       *Marketing.*Atpresent, the Company is not involved in the direct marketing of new productsformulated with its technologies and therefore depends on its collaborativepartners for such marketing and sales from which it earns revenues includingroyalties. The Company’s future revenues largely depend on the success of suchmarketing efforts, which are beyond its control. For example, Paxil CRTM was approved by the FDA in February 1999 but was not launchedby GlaxoSmithKline PLC (‘‘GlaxoSmithKline’’) until April 2002 and in March 2005GlaxoSmithKline announced that the FDA had halted supplies of Paxil CRTM due to manufacturing issues. GlaxoSmithKline announced theresupply of Paxil CRTM on June 27, 2005.

***A failure to obtain and maintain patentsand other proprietary rights may adversely affect the Company’s business***

The Company’s success, competitive positionand the amount of milestone and royalty income it receives each depend, inpart, on its ability to obtain and maintain patent and other intellectualproperty protection, particularly for its drug delivery and formulationtechnologies. Such patent and other intellectual property protection is alsoimportant to the Company’s business and its future performance will depend inpart on its ability to obtain and maintain such protection. The Company’sperformance will also be affected by its ability to operate without infringingthe intellectual property rights of others.

While the Company intends to obtain patentscovering as many of its technologies as possible, the process of obtainingpatents is lengthy and expensive. There can be no assurance that patents willbe granted in connection with any of the Company’s currently pending or futureapplications or that they will be valid and of sufficient scope and strength toprovide the Company with meaningful legal protection or any commercialadvantage. In addition, intellectual property protection may be unavailable orlimited in some of the countries in which the Company does business. The lawsof some foreign countries do not afford the Company’s inventions the samedegree of legal protection as the laws of the United States. In addition, patentlaws may change over time. The Company cannot predict the effect that any suchchanges would have on its business and its ability to protect its current andfuture products and technologies. If the Company fails to obtain and maintainsufficient protection for its current and future products and technologies, itsability to successfully commercialize these products and technologies could beadversely affected.

The Company, from time to time, may receivenotifications of alleged infringement of patents owned by third parties. TheCompany may not, in all cases, be able to successfully defend itself in courtor resolve such allegations through licensing or settlement. Moreover, whetheror not the Company is successful in enforcing its own patents or in defendingitself against claims of alleged infringements of patents owned by thirdparties, doing so is time-consuming and costly and may result in the diversionof management resources.

The Company also relies on trade secretsand other unpatented proprietary information in its product and technologydevelopment activities. To the extent that the Company relies on trade secretsand 

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unpatentedproprietary information to maintain its competitive position, there can be noassurance that others may not independently develop the same or similarproducts or technologies. The Company seeks to protect trade secrets andproprietary information, in some cases through clauses in confidentialityagreements with its employees, consultants, advisors and collaborators. Nevertheless,these agreements may not effectively prevent disclosure of the Company’sproprietary information and may not provide the Company with an adequate remedyin the event of unauthorized disclosure of such information. If the Company’semployees, scientific consultants or collaborators develop inventions orprocesses independently that may be applicable to the Company’s products ortechnologies under development, disputes may arise about ownership ofproprietary rights to those inventions and processes. Such inventions andprocesses will not necessarily become the Company’s property, but may remainthe property of those persons or their employers. Protracted and costlylitigation could be necessary to enforce and determine the scope of the Company’sproprietary rights. Failure to protect patent or other unprotected proprietaryinformation, for any reason, would adversely affect the Company’s business.

The Company has entered into a number ofcollaborative arrangements with leading pharmaceutical companies for thedevelopment and commercialization of products. In connection therewith, theCompany shares certain of its proprietary knowledge with such collaborativepartners. Although the Company’s patents and other proprietary rights are intendedto protect the Company from infringement by such collaborative partners, therecan be no assurance that the Company’s patents or other proprietary rights willprevent its collaborative partners from developing similar or functionallyequivalent products. In addition, the Company’s arrangements with itscollaborative partners frequently contain representations, warranties and otherassurances given by the Company regarding the scope of its own intellectualproperty and the non-infringement by the Company of intellectual property ownedby third parties. If the Company were found to be in breach of any of theseprovisions, its partners could sue the Company for damages, which could have amaterial adverse effect on the Company’s business, results of operations andfinancial condition.

The Company also engages in collaborations,sponsored research agreements and other arrangements with academic researchersand institutions, some of which have received and may receive funding fromgovernment agencies. Although the Company seeks to retain ownership of allintellectual property rights pertaining to inventions which may result fromsuch collaborations, there can be no assurance that the governments,institutions, researchers or other third parties will not also have certainrights to such inventions.

For more information on the Company’spatents and proprietary rights, see ‘‘Item 4: Information on the Company—Patentsand Proprietary Rights’’.

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***Failure to comply, or the costs of complying, withenvironmental, health and safety regulations could adversely affect the Company’sbusiness***

The Company’s business is subject to regulationrelating to the protection of the environment and health and safety, includingregulations governing air emission, effluent discharge, and the use,generation, manufacture, storage, handling and disposal of certain materials.The Company believes that it is in compliance in all material respects with allsuch laws, rules, regulations and policies applicable to the Company. However,there can be no assurance that the Company will not be required to incursignificant costs to comply with such environmental and health and safety lawsand regulations in the future.

***A failure to manage expansion effectively couldadversely affect the Company’s business***

Management of the Company’s growth, as well as thecommencement of commercial manufacturing and marketing of the Company’s productcandidates, will require continued expansion and improvement of the Company’ssystems and internal controls and an increase in the Company’s manufacturing,marketing and sales operations. Any failure to manage growth effectively and ona timely basis could adversely affect the Company’s business.

***Failure by the Company to fulfil its obligations toits collaborative partners in respect of manufacturing or to enter into new ormaintain its existing manufacturing arrangements could adversely affect theCompany’s business***

The Company has its own manufacturing sites in Lyon,France, Muttenz, Switzerland and San Diego, California. However, for themanufacture of certain of its existing products, and certain of those currentlyin development, including the Foradil® CertihalerTM and FlutiformTM, the Companywill depend on manufacturing partners who in some cases are the sole supplierof the services to the Company. If the Company loses one of its currentmanufacturing partners, fails to enter into agreements with new manufacturingpartners, experiences delays in finding such partners or if existingmanufacturing partners are unable to supply for any reason, the Company’sability to develop and manufacture products and to meet its obligations in itsexisting collaborative arrangements could be adversely affected.

***Failure by the Company to keep its manufacturingfacilities in compliance with required standards could result in delays inmanufacturing and additional costs***

The Company believes that each of its manufacturingfacilities is substantially in compliance with current good manufacturingpractices (cGMP) and the applicable regulatory standards. There can be noassurance, however, that the Company’s facilities will be found to meet or, inthose instances in which a facility has previously been approved for themanufacture of a particular drug, maintain cGMP or applicable regulatorystandards. Failure of the Company’s manufacturing facilities to meet ormaintain such standards could delay or interfere with the Company’s plans toscale-up manufacturing or manufacture commercial quantities of its productcandidates.

In those instances in which a manufacturing facilityhas previously been approved, the Company’s facilities will need to passperiodic follow-on inspections. The Company may be required to incur significantadditional expenses in order to ensure that its facilities remain compliantwith cGMP and the applicable regulatory standards.

***FlutiformTM*** may notsuccessfully complete the development process, achieve regulatory approval orsucceed in the market if approved

Due to the inherent risk in the development ofpharmaceuticals, it is possible that FlutiformTM may notsuccessfully complete development and be launched. There can be no assurancethat FlutiformTM will successfully complete clinical studies or that it will meet theregulatory requirements for commercial distribution. FlutiformTM will be thefirst product using the Company’s metered dose aerosol inhaler (‘‘MDI’’)technology to attempt to access the U.S. market where regulatory barriers toentry are particularly steep. Even if FlutiformTM is approved for marketing, there can beno assurance that the Company will not experience delays in the development orapproval process that could adversely affect the 

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commercial value of FlutiformTM.Similarly, there can be no assurance that any regulatory approvals will not bemore limited in scope than the Company currently expects. The Company currentlydoes not have its own sales and marketing capability and is currently thereforereliant on one or more marketing partners to market FlutiformTM.

In May 2006, the Company announced that it hadentered into an agreement with Kos Pharmaceuticals to jointly develop FlutiformTM.Kos will have exclusive rights to market FlutiformTM in the United States and aright of first negotiation in Canada. SkyePharma remains in negotiations withpotential partners for Europe and other markets around the world. If, however,the Company does not obtain one or more suitable partners for otherterritories, the successful marketing of FlutiformTM may be adverselyaffected. In addition, while the Company believes there is little prospect ofadditional competition in the combination market until 2012 at the earliest, FlutiformTM may notachieve the competitive position that the Company anticipates.

***The Company may not be able to maintain its exclusivetechnology rights to DepoFoamTM*** from the Research Development Foundation

The Company’s DepoFoamTM businessdepends in part on its ability to continue to use technology rights that theResearch Development Foundation (‘‘RDF’’) assigned to a subsidiary of theCompany on an exclusive basis. Under the agreement, RDF has the right toterminate the agreement or to convert the exclusive nature of the rightsgranted under the agreement into a non-exclusive right if the subsidiary doesnot satisfy its contractual obligations, including its obligation to makecertain minimum annual payments. RDF may also terminate the agreement if theCompany’s subsidiary becomes bankrupt, breaches the agreement or contests thepatents relating to this technology. The termination of the subsidiary’sagreement with RDF or its conversion to a non-exclusive agreement wouldadversely affect the Company’s DepoFoamTM business.

***Failure by the Company to ensure adequate DepoFoamTM*** manufacturingcapacity could adversely affect the Company’s business

If the Company fails to maintain adequatemanufacturing capacity in respect of its DepoFoamTM manufacturingoperations, it may be unable to supply DepoCyt® to its marketing partners, EnzonPharmaceuticals, Inc. (‘‘Enzon’’) for North America and MundipharmaInternational Holdings Limited (‘‘Mundipharma’’) for the European Union andcertain other countries in Europe. Similarly the Company may be unable tosupply DepoDurTM to its North American marketing partner, Endo Pharmaceuticals Inc. (‘‘Endo’’).DepoCyt® is currently marketed in the UnitedStates and Europe and DepoDurTM was launched in the United States in December 2004. The Companywill need to expand its current manufacturing operations significantly in orderto manufacture additional DepoFoamTM products. The Company will also need to comply with regulations in theUnited States and foreign countries relating to achieving the prescribedquality and required levels of production of its DepoFoamTM products andobtaining marketing approval.

***The Company may not be able to obtain the materialsnecessary to continue to manufacture its DepoFoamTM*** products

The Company currently relies on a limited number ofsuppliers for materials required to manufacture its DepoFoamTM products. Ifthe Company cannot obtain the materials it needs from its existing suppliers,the Company may not be able to access alternative sources of supply within areasonable period of time or at commercially reasonable rates. In addition,regulatory requirements applicable to drugs tend to make the substitution ofsuppliers costly and time-consuming. The unavailability of adequate commercialquantities, the inability to develop alternative sources, a reduction orinterruption in supply or a significant increase in the price of materialscould adversely affect the Company’s ability to manufacture and market itsDepoFoamTM products.

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***The Company’s manufacturing process may not besuitable for all of the DepoFoamTM*** products the Company desires tocommercialize

To date, SkyePharma Inc.has relied on a particular proprietary method of manufacturing its potentialDepoFoamTM products. The Company cannot be certain that this method will be equallysuitable to all DepoFoamTM products it desires to commercialize. The problems that may ariseinclude:

·       theCompany may not be able to meet manufacturing challenges that arise concerningparticular drugs to be incorporated in DepoFoamTM;

·       theCompany’s manufacturing process may not result in viable yields of DepoFoamTM products; and

·       thephysical and chemical stability of DepoFoamTM products may vary.

If the Company decides to pursue alternativemanufacturing methods for some or all of its drugs, it cannot be certain thatthese methods will prove to be commercially practical or that it will have theright to use any alternative methods.

***The Company may not be able to obtain the rights tothe drugs it desires to deliver through its DepoFoamTM*** technologies

The Company’s ability to develop and commercialize itsDepoFoamTM technologies will depend on whether it and its partners can obtain therights to the drugs, including small molecule chemical compounds andmacromolecule biologics, that it intends to deliver through DepoFoamTM technology.At times, the Company intends to rely on its partners’ ability to provide thisaccess. The Company cannot be certain, however, that its partners will haveappropriate drug candidates for its DepoFoamTM technology. In addition, the Company orits partners may be alleged or determined to be infringing on third parties’rights and may be prohibited from using such drugs or be found liable fordamages. Any restriction on access or liability for damages would adverselyaffect the Company’s growth prospects, financial condition and results ofoperations.

***The Company may expend significant time and resourcesrelating to existing and potential legal proceedings and the eventual outcomeof such proceedings may differ materially from management’s current estimatesand beliefs***

The Company is currently involved in various legalproceedings, including actions claiming alleged violations of antitrust lawsand infringement of intellectual property rights. Although the Company cannotpredict the outcome of these proceedings with certainty, the Company believesthat these actions are without merit and is vigorously contesting these claims.Contesting these claims, however, may involve the expenditure of significantmanagement time and resources of the Company. In addition, we cannot excludethe possibility that, contrary to management’s current estimates and beliefs,the eventual outcome of such matters will have a material adverse effect on theCompany’s financial position, results of operations or liquidity. For furtherinformation on pending litigation, see ‘‘Item 8: Financial Information—LegalProceedings’’.

***The Company may incur substantial costs related to itsuse of hazardous materials***

The Company’s research and development involves thecontrolled use of hazardous materials, chemicals and various radioactivecompounds. Although the Company believes that its safety procedures for thehandling and disposal of such materials comply with the standards prescribed bythe applicable regulations, the Company cannot completely eliminate the risk ofaccidental contamination or injury from these materials. If such an accidentoccurs, the Company could be held liable for any damages that result and suchliability could exceed the Company’s resources and have a material adverseeffect on its business, financial condition and results of operations.

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***If the Company is unable to retain key personnel orattract new personnel, it could have an adverse effect on the Company’sbusiness***

The Company relies upon a number of key executives andemployees and its ability to retain and attract other qualified management,scientific, technical, marketing and support personnel. Competition for suchpersonnel is intense, and there can be no assurance that the Company will beable to continue to attract and retain such personnel. The loss of the servicesof any of the Company’s key executives or employees could materially adverselyaffect its business. Associated with the Company’s divestment of its injectablebusiness interests the Company has established a retention plan for its employeeswithin the injectables business.

***The Company’sefforts to comply with new regulatory requirements, including Section 404of the Sarbanes-Oxley Act of 2002, could lead to the identification ofdeficiencies in its system of internal controls, and an inability to remedysuch deficiencies could affect the Company’s perception by investors***

As part of the Company’sefforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 forthe year ended December 31, 2006, the Company has committed substantialtime and resources to evaluating and assessing the effectiveness of theCompany’s internal controls over financial reporting. The Company’s evaluationand testing is ongoing, and the Company may identify deficiencies in its systemof internal controls over financial reporting that require remediation. Forexample, the Company has identified an error made in respect of goodwill in itsreconciliations to U.S. GAAP, where the Company inadvertently recorded the goodwill balances withoutconsidering the impact of foreign exchange translation upon consolidation ofnewly-acquired subsidiaries. As a result, the Company has restated itsnet assets and shareholders’ funds under U.S. GAAP to reflect the impact of theadjustments made to the Company’s goodwill for the years endedDecember 31, 2001, 2002, 2003 and 2004. If the Company is not able toremediate this or other identified deficiencies that either alone or togetherconstitute material weaknesses in our internal controls, senior management willnot be able to determine that internal controls over financial reporting areeffective and comply with Section 404 in a timely manner. This couldresult in a negative perception of the reliability of the Company’s financialstatements and a subsequent decline in the price of the Company’s Ordinary Sharesand ADSs.

***Potential conflicts of interests may arise fromrelated party transactions***

The Company and certain of its principal shareholdersor their affiliates and other formerly related parties have engaged in severalsignificant transactions among themselves in the past. Certain of these historictransactions provide for significant payments to certain principalshareholders, former directors and executive officers upon achievement ofspecified milestones or profit hurdles. As a result of these arrangements,conflicts of interest may arise between and among the Company, certainprincipal shareholders, former directors and executive officers. While there iscurrently no intention to enter into future related party transactions, the Companymay do so in the future.

The Company acquired Krypton Limited (‘‘Krypton’’) ina share-for-share exchange in January 1996 from a number of trusts inwhich Ian Gowrie-Smith, who was then Executive Chairman of the Company, certainformer directors and a former employee of the Company had interests. See ‘‘Item7: Major Shareholders and Related Party Transactions—Certain Arrangements inRespect of the Krypton Acquisition’’.

At June 23, 2006, the Company owned 39.8% of Astralis LTD (‘‘Astralis’’).Astralis and the Company are parties to several agreements concerning thedevelopment of Astralis’ novel injectable vaccine therapy, for the treatment ofall forms of psoriasis, a chronic skin disorder. See ‘‘Item 7: MajorShareholders and Related Party Transactions—Other Arrangements’’.

At June 23, 2006, the Company owned 23.6% of Vital Living, Inc.(‘‘Vital Living’’). The Company has entered into a contract to develop certainproducts for Vital Living that incorporate its GeomatrixTM technology.See ‘‘Item 7: Major Shareholders and Related Party Transactions—OtherArrangements’’.

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At June 23, 2006, the Company owned 9.4% of Micap PLC (‘‘Micap’’).During 2003 the Company investigated the pharmaceutical applications of Micap’smicro-encapsulation technology in the areas of oral and topical drug delivery.The Company has exercised an option granted to it under one of its agreementswith Micap to complete a technology access and license agreement with Micap andhas selected ten nominated compounds pursuant to such license. However, itbecame clear that for those drugs currently under development there werelimited applications and so in September 2005, the Company surrendered allrights under the license agreement back to Micap. See ‘‘Item 7: MajorShareholders and Related Party Transactions—Other Arrangements’’.

Although the Company anticipates that any futurerelated party transactions and agreements will be on terms no less favorable tothe Company than it could obtain in comparable contracts with unaffiliatedthird parties, there can be no assurance that conflicts of interest will notarise between the Company and the principal shareholders or their affiliateswith whom they have entered into agreements.

***Exchange rate fluctuations may adversely affect theCompany’s results of operations and financial position***

Approximately 61% of the Company’s revenues for theyear ended December 31, 2005, were derived from customers located outsidethe United Kingdom. Since the revenue and expenses of the Company’s foreignoperations are generally denominated in U.S. dollars, Euros and Swiss francs,exchange rate fluctuations between such currencies and the pound sterling willsubject the Company to foreign exchange risk with respect to the reportedresults of its foreign operations. The Company does not currently hedge againstthe effect of currency translation on its reported results, but does, whereappropriate, seek to hedge its exchange rate risk on particular transactions.Fluctuations between local currencies and the pound sterling may materiallyadversely affect the Company’s financial condition and results of operations.See ‘‘Item 5: Operating and Financial Review and Prospects’’.

The Company’s Ordinary Shares trade on the LondonStock Exchange in pound sterling and the ADSs trade on The Nasdaq NationalMarket in U.S. dollars. The value of the ADSs in U.S. dollars may fluctuate asa result of fluctuations in the U.S. dollar/pound sterling exchange rate.

***The market price of the Company’s Ordinary Shares andADSs may be adversely affected by market volatility and liquidity***

Companies like SkyePharmahave, in recent years, experienced dramatic stock price volatility. Thefollowing factors may cause the market price of the Company’s Ordinary Sharesor ADSs to fluctuate significantly:

·       announcementsof technological innovations or new products by competitors and others;

·       thestatus of submissions to the FDA or other regulatory authorities;

·       variationsin results of operations, market condition, analysts’ estimates and the stockmarket generally; and

·       stockmarket perceptions of the pharmaceutical, biotechnology and/ or drug deliveryindustries.

The value of shares can go down as well as up and themarket in the Company’s Ordinary Shares and ADSs may have limited liquidity.The market price of an investment in the Company may not reflect the underlyingvalue of the Company’s net assets.

***Issuances or sales of a substantial number of the Company’sOrdinary Shares or ADSs could adversely affect their market price***

Issuances or sales of a substantial number of OrdinaryShares or ADSs could adversely affect the market price of the Company’s OrdinaryShares and ADSs. As of June 23, 2006, certain principal shareholders and the directorsand officers of the Company, as a group, held 29.6% of the Company’soutstanding Ordinary Shares. Shares may be eligible for future sale subject tothe conditions imposed by 

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Rule 144 and RegulationS under the Securities Act of 1933. If one or more of the Company’s principalshareholders were to sell a substantial portion of the Company’s Ordinary Sharesor ADSs, the trading price of the Company’s Ordinary Shares or ADSs could beadversely affected.

***Principal shareholders may influence the outcome ofshareholder approvals and hinder a change in control that might be in othershareholders  interest’s***

As of June 23, 2006, certain principal shareholders and the directorsand officers of the Company as a group owned approximately 29.6% of the Company’soutstanding Ordinary Shares. As a result, the directors and officers of theCompany, together with such shareholders, may be in a position to influence theelection of the Company’s directors and officers and other corporate actionsthat require shareholder approval. This concentration of voting powers mayhinder changes or corporate actions that are in the interests of othershareholders.

***TheCompany’s shareholders may not receive a return on their shares other thanthrough the sale of their shares***

Undercurrent U.K. law, a company’s accumulated realized profits must exceed itsaccumulated realized losses (on a non-consolidated basis) before dividends canbe paid. The Company has not paid dividends in the past on its Ordinary Shares.The Company intends to retain earnings, if any, for use in its business anddoes not anticipate paying any cash dividends in the foreseeable future.Accordingly, other than through the sale of their shares, the Company’sshareholders are unlikely to receive a return in the foreseeable future.

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**Item 4:**                       Information on the Company

**HISTORY AND DEVELOPMENT**

**Overview**

SkyePharma PLC is a public limited company organized under the laws ofEngland and Wales with its registered office at 105 Piccadilly, London W1J 7NJ,telephone number + 44 (0) 20 7491 1777.

SkyePharma PLC, which was formerly named Black & Edgington GroupPLC, was incorporated on 18 February 1910. As Black &Edgington Group PLC, it was engaged in the provision of temporary structuresfor major events. In January 1996, the name of the Company was changed toSkyePharma PLC and the nature of its activities to pharmaceuticals. Today theCompany is a speciality pharmaceutical company, using its multiple drugdelivery technologies to create a product pipeline for out-licensing tomarketing partners.

The Company, as currently operated, wasformed substantially from the 1996 acquisition of Jago Holding AG, the 1999acquisition of DepoTech Corporation, the 2001 acquisition of RTP Pharma Inc andthe acquisition of certain other technologies as set out below.

**CorporateAcquisitions**

The Company acquired Jago, a Swiss drug delivery company whichcommenced operations in 1983, from Dr. Gonella in May 1996. The totalconsideration paid by the Company to acquire Jago was approximately £100.8million in cash (plus a prepayment of £3.9 million ($6.0 million)) andapproximately 30.7 million Ordinary Shares (valued at 75 pence per share). TheCompany agreed to pay additional consideration to Dr. Gonella pursuant toan earn-out arrangement. On March 31, 2000, a settlement agreement wassigned establishing the full and final settlement of the deferred considerationpayable to Dr. Gonella the last remaining provisions of which lapsed on 3,May 2006. See ‘‘Item 7: Major Shareholders and Related Party Transactions—CertainArrangements in Respect of the Jago Acquisition’’. Through the acquisition ofJago, SkyePharma acquired the GeomatrixTM range of oral controlled release systems and a new generation ofinhalation technologies.

In October 1998, the Company acquired 16% of the common stock ofDepoTech Corporation (‘‘Depotech’’) of San Diego. In March 1999, theCompany acquired the remaining 84% of the outstanding shares by issuing to theformer DepoTech shareholders 28.3 million SkyePharma Ordinary Shares in theform of ADSs, plus the right to receive additional shares if certain conditionswere satisfied. The conditions were satisfied in 1999 and 2000. Through thisacquisition, the Company acquired the DepoFoamTM technology. DepoTech was renamed SkyePharma Inc. SkyePharma Inc. isSkyePharma’s center for the development and manufacture of injectable,sustained-release therapeutic products.

In July 2001, the Company acquired an initial 40.2% of the votingshares of RTP Pharma Inc. (‘‘RTP’’) of Montreal, Canada in return for the issueof SkyePharma Ordinary Shares and acquired $5.0 million (£3.5 million) ofpreferred shares in RTP for cash. During the following 90 days the Companyacquired an additional $10 million (£6.9 million) of preferred shares in RTP inreturn for the issue of additional SkyePharma Ordinary Shares. In March 2002,the Company announced the completion of the acquisition of the outstandingvoting shares in RTP in return for the issue of SkyePharma Ordinary Shares plusdeferred consideration which was settled in June 2003. RTP was renamedSkyePharma Canada Inc. (‘‘SkyePharma Canada’’) and specialized in improving thesolubility of drugs using its Insoluble Drug Delivery (‘‘IDD’’) technology platform.During 2003, the Company substantially reduced the staff of SkyePharma Canadaand outsourced its activities to other SkyePharma sites.

In January 1996, the Company acquired 100% of the outstandingshare capital of Krypton, a Gibraltar-based company which holds developmentrights to certain generic drugs, in return for the issue of Ordinary Shares andwarrants to subscribe for additional Ordinary Shares. The Company agreed to payadditional consideration in respect of the Krypton acquisition. See ‘‘Item 7:Major Shareholders and Related Party Transactions—Certain Arrangements inRespect of the Krypton Acquisition’’.

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In January 1997, the Company acquired a pharmaceuticalmanufacturing and production facility near Lyon, France by acquiring 100% of theissued and outstanding share capital of Laboratories Novalis Production SAS (‘‘Novalis’’),a French company, from Wyeth-Ayerst International Inc., (‘‘Wyeth’’). After theacquisition, Novalis changed its name to Jago Production SAS and later toSkyePharma Production SAS.

In January 2004, SkyePharma convertedits 2 million series A convertible preferred shares that it had previously heldin Astralis Limited (‘‘Astralis’’), an emerging biotechnology company based andincorporated in the United States, into 25 million common shares, 12.5 millionof these being in escrow. In December 2004, SkyePharma signed conditionalstock purchase and assignment agreements with two former Astralis directors toacquire 11.2 million common shares of Astralis and appoint a further twodirectors representing SkyePharma to the Astralis Board. As a result of theseevents, the investment has been treated as an associated undertaking from December 2004.In March 2005, the conditions of the stock purchase and assignmentagreements were satisfied and the Company completed the purchase of 11.2million shares from the two former directors of Astralis in exchange forapproximately 5.5 million common shares in the Company. As at December 31,2005, the total SkyePharma holding was 36,393,900 common shares and 20,000warrants, representing approximately 40% of the common shares of Astralis.

**TechnologyAcquisitions**

In July 1999, the Company acquired intellectual property, licenseagreements, know-how and trademarks related to nano-particulate drug deliverytechnology for the delivery of poorly soluble drugs from Medac GmbH (‘‘Medac’’),a private German pharmaceutical company. As consideration for the acquisition,the Company paid cash and issued Ordinary Shares to Medac. In addition, futureroyalties will be paid to Medac on net sales of marketed products usingnano-particulate technology.

In October 1999, the Company acquired the tangible assets andintellectual property of Hyal Pharmaceutical Corporation in Canada (‘‘Hyal’’)from the court-appointed receiver and administrator of Hyal. Hyal was a drugdelivery company that developed products using its topical drug deliverytechnologies based on hyaluronan (also called hyaluronic acid or hyaluronate, ‘‘HA’’),a natural polymer, which are primarily designed to maintain efficacy andlocalize delivery of drugs to the skin for the treatment of a variety of skindisorders.

In December 2000, SkyePharma licensed rights to three topical drugdelivery technologies, Crystalip, DermaStick and the ES-Gel system, fromBioglan AB, a Swedish subsidiary of Bioglan Pharma PLC (‘‘Bioglan’’). Under theterms of the agreement, SkyePharma paid cash and obtained certain exclusivedevelopment and commercial rights in relation to new products from theCrystalip and DermaStick technologies and also the right to develop withBioglan two new products using the ES-Gel system.

In May 2002, SkyePharma acquired the entire drug delivery businessof Bioglan AB for cash, including acquisition costs, and the assumption of £0.4million of net liabilities. The acquired rights included Bioglan’s BiosphereTM injectable technology and those rights to DermaStick, Crystalip andES-Gel topical drug delivery technologies that had remained with Bioglan afterthe December 2000 licensing agreement with Bioglan. During 2004 theCompany completed the transfer of the activities of SkyePharma AB to otherSkyePharma sites.

In January 2003, SkyePharma announced a strategic investment inMicap PLC (‘‘Micap’’), a private company providing patented micro-encapsulationtechnology. Micro-encapsulation technology is a process by which tiny dropletsor particles of liquid or solid material are surrounded or coated with acontinuous film of polymeric material. During 2003, SkyePharma investigated thepharmaceutical applications of Micap’s micro-encapsulation technology in theareas of oral and topical drug delivery. In March 2004, the Companyexercised an option to enter into a technology access and license agreementwith Micap that allows the Company to use Micap’s encapsulation technology inup to ten nominated pharmaceutical products to be selected by SkyePharma.However, it became clear that for those drugs currently under development therewere limited applications and so in September 2005, the Companysurrendered all rights under the license agreement back to Micap.

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In June 2004, SkyePharma announcedthat it had entered into a strategic alliance with Vectura Limited (‘‘Vectura’’)in the area of pulmonary delivery technologies. Through this alliance,SkyePharma acquired rights to use Vectura’s Aspirair dry powder inhaler device for certain macromolecules on anon-exclusive basis. As part of the alliance, SkyePharma also made an equityinvestment in Vectura, subscribing for 800,000 ordinary shares at a price of£2.50 per share. In June 2004, Vectura undertook an initial publicoffering and the Company’s shareholding was converted into 3.2 million ordinaryshares, representing approximately 3% of Vectura’s ordinary share capital. In October 2005,SkyePharma sold 2.0 million of its shares in Vectura. The remaining 1.2 millionshares were sold in January 2006. Due to the Company’s focus on otherinhalation projects, the Company did not progress the alliance on Aspirair andthe agreement has now lapsed.

**RecentDevelopments**

*Flutiform*TM

The Company believes that its inhalation product FlutiformTM hassubstantial commercial value. However, during 2005 the Company did not completea development agreement for FlutiformTM. Faced with the prospect of a delay tothe development of this important product, which might have impaired itscommercial potential, the Company took the decision in September to raise£35 million (net of expenses) by means of a rights issue to keep FlutiformTM onits planned development timeline through Phase III. As such, the target launchdate for FlutiformTM in the United States remains 2009.

Prior to reaching the decision to ask shareholders for funding, theCompany explored a number of financing alternatives to fund the development ofFlutiformTM and also a variety of strategic options for the Company. Theseincluded discussions concerning a transaction that, had it been successful,would have created a combined company that could have marketed FlutiformTMitself in some markets. The discussions were called off by the Company due touncertainties over the other party’s prospects.

In May 2006 the Company announced that it had entered into anagreement with Kos Pharmaceuticals, to jointly develop FlutiformTM. Kos willhave exclusive rights to market FlutiformTM in the United States and a right offirst negotiation in Canada. SkyePharma remains in negotiations with potentialpartners for Europe and other markets around the world.

*StrategicReview*

In November 2005, the Company received a takeover approach fromInnovata PLC. As a result, the Board of Directors felt that it was inshareholders’ interests to explore all options and consequently undertook afull strategic review of all the options open to the Company.

The conclusion of this review in early 2006 did not lead to an offerfor the entire Company on terms that the Board of Directors felt able torecommend to shareholders. However, there were expressions of interest inindividual parts of the business. The Board announced the outcome of the strategicreview on February 2, 2006. The Board concluded that in the interests ofachieving sustainable profitability in the near term, and in order to improvethe Company’s cash flow position, the Company should concentrate on oral andinhalation products and divest its injectable business interests.

*Changes inBoard of Directors*

In January 2006, certain shareholders requisitioned anExtraordinary General Meeting (“EGM”) seeking to remove the Company’s thenChairman and to appoint a nominated director to the Company’s Board ofDirectors with the ultimate aim of having him appointed as Executive Chairman.Although this motion was defeated at the EGM in early March 2006, theBoard of Directors has since made a number of changes and introduced a processwhereby major investors are now involved in the selection of new Non-ExecutiveDirectors. Jerry Karabelas was appointed as Non-Executive Chairman in February 2006,Frank Condella was appointed as Chief Executive Officer in March 2006 and KenCunningham was appointed as Chief Operating Officer in April 2006. Thechanges to the membership of the Company’s Board of Directors are set out in “Item6:  Directors, Senior Management andEmployees—Directors and Senior Management.’’

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**BUSINESS OPERATIONS**

**Overview**

The Company isa specialty pharmaceutical company, using its multiple drug deliverytechnologies to create a product pipeline for out-licensing to marketingpartners.The Company develops novel therapeutic drugs based on its technology platformsfor delivering drugs to the human body.

The following table shows the Company’s turnover, operating loss andnet loss for the two years ending December 31, 2005.

| ** **                                                             | ** ** | **Year ended   December 31,** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                             | ** ** | **2004**                                     | ** ** | **2005** | ** ** |
| ** **                                                             | ** ** | **(in £ millions)**           | ** ** |
| *Revenue*                                                              |       |                                         |       |   |   |
| Oral, Inhalation and Other                                             |       | 49.6                                         |       | 50.8 |   |
| Injectable                                                             |       | 25.6                                         |       | 10.5 |   |
|                                                                   |       | 75.2                                         |       | 61.3 |   |
| *Operating  loss pre impairments and abortive transaction costs items* |       |                                         |       |   |   |
| Oral, Inhalation and Other                                             |       | 1.0                                          |       | 2.5 |   |
| Injectable                                                             |       | (1.4                                         | )          | (18.6 | ) |
|                                                                   |       | (0.4                                         | )          | (16.1 | ) |
| *Loss for the Year*                                                    |       | (18.6                                        | )          | (50.9 | ) |

 

**Strategy**

The Company’sstrategy is to become a leading specialty pharmaceutical company poweredthrough excellence in drug delivery. It uses multiple technologies to build aproduct pipeline for commercialization through out-licensing to co-developmentand marketing partners. The Company continually strives to acquire and developnew technologies and products to grow its position in the oral and inhalationdrug delivery areas. The Company ultimately plans to selectively market its ownproducts in targeted therapeutic areas.

In late 2005and early 2006, the Board of Directors conducted a full strategic review of allthe options open to the Company and announced the outcome on 2 February 2006.The Board concluded that in the interests of achieving sustainableprofitability in the near term, and in order to improve the Company’s cash flowposition, the Company should concentrate on oral and inhalation products, anddivest its injectable business interests.

The Company’s strategy for achieving these objectives consists of thefollowing elements:

·       *Divest the injectables business and focus on oral andinhalation products*. The proposed divestment of theinjectable business interests, which the Company expects to be subject toapproval by shareholders, would not only provide cash but also relieve theCompany of a significant cash requirement and future capital expenditure. TheCompany believes that the remaining oral and inhalation business may be able toachieve profitability in the near term. Furthermore, with a more focused use ofresources the Company would be in a better position to further develop itspipeline of oral and inhalation products. Funds raised by the divestment of theinjectables business will be available to accelerate the development of certainpipeline products whose development has had to be delayed in recent years.Several of these products are at an early stage of development but wouldaddress important therapeutic areas. Following the divestment of theinjectables business, development activities will continue to be based inMuttenz, Switzerland and manufacturing in Muttenz and Lyon, France.

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·       *Selectively Fund a Number of Key Projects to a LaterStage of Development*. The Company’s strategy inrecent years has been to self-fund certain products to a late stage ofdevelopment, prior to licensing the products to marketing partners. This hasallowed the Company to increase its share of the potential revenue streams fromthese products and gain greater control over the development process. A recent exampleof this is the Board’s decision in September 2005 to fund Phase IIIclinical trials of FlutiformTMwith the proceeds of a rights issue prior to entering into an out-licensingarrangement with Kos for the North American marketing and distribution rightsof FlutiformTM in May 2006.

·       *Develop Existing and New Collaborative Agreements*. In order to increase the market exposure of its products and tocapitalise on its collaborative partners’ market position and distributioncapabilities, the Company intends to continue to develop its projects with itsexisting collaborative partners, expand its collaborations with existing partners to include newprojects, and to seek new partners. In addition, the Company will focus itsefforts on working with partners to maximise revenues from existing and futuremarketed products. The Company has increasingly focused on undertakingadditional value added services, such as assuming responsibility fordevelopment and regulatory activities and seeking to retain manufacturing andco-marketing rights, which may allow it to increase its share of the potentialrevenue stream from these collaborations. As part of this strategy, the Companyhas also reduced its focus on up-front and milestone payments and aimed insteadto gain an increased share of royalties and longer term revenues.

·       *Seek to Retain Manufacturing Rights/and or MarketingRights on Future Collaborations*. The Companyemploys personnel who specialize in manufacturing products utilizing theCompany’s technologies in commercial quantities. Where it makes commercialsense, it will pursue long-term manufacturing and supply agreements withlicensees of the Company’s products. The Company may also seek to retainmarketing rights in respect of future products which it could co-market orultimately market itself in specific targeted therapeutic areas. Currently the Companyhas no direct marketing capability but at the appropriate time may seek todevelop or acquire its own marketing capability. This strategy should not onlygive it greater control over revenue generation but could also improve grossprofit margins.

·       *Expand the Application of the Company’s CoreTechnologies.*The Company intends to continue toexpand the application, increase the value and extend the commercial life ofits oral, inhalation and enhanced solubilization technologies, by seeking todevelop technology improvements, expand patent coverage, acquire complementarytechnologies and realise synergies between these technologies. The Company mayseek to acquire additional add-on technologies, that are complementary to itsexisting technologies. The Company intends to focus on technologies it believesare capable of commercial realisation in the near term and will also seek toacquire or license new drug delivery platforms and enabling technologies thatthe Company believes have significant commercial applicability.

**Drug Delivery Platforms**

***The Company’s business is comprised of two reportablesegments within the meaning of SFAS 131***, Oral, Inhalation and Other and Injectable.

**Oral, Inhalation and Other**

***Oral***

The originalGeomatrixTM technology was developed by a team of researchers at the Universityof Pavia in Italy in the early 1980s. The Company acquired the technologythrough its acquisition of Jago in 1996 and has subsequently pursued thedevelopment of the GeomatrixTM platform of oral controlled-release systems. GeomatrixTMis a range of technologies by which drugs taken orally in tablet form are 

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formulatedso as to control the amount, timing and location of the release of the drug inthe body. There are currently eight GeomatrixTM technologies designed to meet awide range of therapeutic objectives through different release mechanisms. Thetechnologies are flexible and can be modified to apply to a variety ofpharmaceutical products.

The Companycollaborates with large pharmaceutical companies to develop GeomatrixTMformulations of its collaborative partners’ proprietary products. The Companyfocuses its research and development efforts on the reformulation of existingdrugs using its technologies rather than the discovery of new chemicalcompounds. In reformulating an existing drug, the Company seeks to enhance thetherapeutic and commercial value of the product by creating an improved outcomeformulation that may mitigate certain side effects, reduce dosing and extendedpatent protection.

*Approved GeomatrixTM* Products

The following table summarizes certain information on the Company’s approvedproducts that utilize GeomatrixTM technologies. The major marketed products are discussed furtherbelow.
| Product                                    | ** ** | ** **                | ** ** | **Indication**                      | ** ** | **Regulatory Approvals and  Year of First Approval** | ** ** | **Collaborative Partner** |
|--------------------------------------------|------------|---------------------------|------------|-------------------------------------|------------|------------------------------------------------------|------------|---------------------------|
| Paxil CRTM                             |       | CNS                       |       | United States  (1999)               |       | GlaxoSmithKline                                      |
| Xatral® OD/Uroxatral®  |       | Genito-Urinary            |       | United  States (2003) Europe (2000) |       | Sanofi-Aventis                                       |
| Coruno                                     |       | Angina                    |       | Belgium  (2002)                     |       | Therabel                                             |
| Madopar DR                                 |       | Parkinson’s  Disease |       | Luxembourg  (2003)                  |       | Hoffmann-La  Roche                                   |
| Diclofenac-ratiopharm-uno                  |       | Arthritis                 |       | Germany  (1995)                     |       | ratiopharm                                           |

 

*Paxil CR*TM   is marketed in the United States, Canadaand certain other countries. It is a modified release version of Paxil®/Seroxat (paroxetine HCL) which uses acombination of two GeomatrixTM releasesystems. Paxil® is an FDA-approved drug that is currentlymarketed primarily in the United States and Europe and is an immediate releaseformulation prescribed for central nervous system disorders.

An applicationfor approval of Paxil CRTM was filed with the FDAby SmithKline Beecham (now part of GlaxoSmithKline) in December 1997 andapproved by the FDA in February 1999 for the 12.5 and 25mg dosage forms.In early 2001, GlaxoSmithKline, the Company’s collaborative partner in thedevelopment of Paxil CRTM, announced that it had received an approvable letterfrom the FDA for a second CR indication, panic disorder. On April 19,2002, Paxil CRTM was launched in the United States for the treatment ofcentral nervous system and panic disorders. The FDA has subsequently approvedPaxil CRTMfor the continuous treatment of premenstrual dysphoric disorder (‘‘PMDD’’)(September 2003), social anxiety disorder (October 2003) and theintermittent treatment of PMDD (February 2004). In January 2004, theTherapeutic Products Directorate of Health Canada approved Paxil CRTM for the treatment of central nervous system disorders, panicdisorder and social anxiety disorder.

On March 4,2005, GlaxoSmithKline announced that the FDA had halted supplies of Paxil CRTMdue to manufacturing issues. SkyePharma provided the formulation of Paxil CRTM,but has no involvement in its manufacturing. GlaxoSmithKline announced theresupply of Paxil CRTM on June 27, 2005.

On April 28,2005, the Company announced that it had entered into an amendment agreementwith GlaxoSmithKline in respect of Paxil CRTM. Under the terms of the amendmentagreement, GlaxoSmithKline made a one-time payment of approximately $10 millionto the Company. In addition, the Company became entitled to an increase in theroyalty rate from 3% to 4% on actual net sales of Paxil CRTM, with effect from March 4,2005. As GlaxoSmithKline was unable to supply Paxil CRTM in the United 

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Statesbetween March 4, 2005 and June 27, 2005, when GlaxoSmithklineannounced the resupply of Paxil CRTM in the United States, GlaxoSmithKline alsoagreed to pay SkyePharma the same level of royalty on GlaxoSmithKline’sbudgeted sales of Paxil CRTMfrom March 4, 2005, while the product remained off the market,subject to other terms of the agreement.

Xatral® OD**is marketed in the United States (under the name Uroxatral®), Europe, Canada and certain countries in Africa, Asia and LatinAmerica. It is a once daily GeomatrixTM formulation of alfuzosinused for the treatment of the functional symptoms of benign prostatichyperplasia, a common condition in men over the age of 50, which was developedin conjunction with Sanofi-Synthelabo (now Sanofi-Aventis). In January 2000,Sanofi-Aventis announced that it had received the first batch of Europeanmarketing approvals for Xatral® OD. Uroxatral® was launched in theUnited States in November 2003. In March 2004, Sanofi-Aventisannounced that it had begun to market Uroxatral® directly to primary care physicians in theUnited States. In addition to the United States, the product is now launchedthroughout Europe, Canada and certain countries in Africa, Asia and LatinAmerica. Xatral® OD is now approved for asecond indication, acute urinary retention, in more than 50 countries,including 24 in Europe. However Sanofi-Aventis is no longer pursuing U.S.approval for this indication.

*Coruno*® isa once per day GeomatrixTM formulation of molsidomine, currently marketed inEurope and used to treat angina pectoris, a common symptom of coronary heartdisease. The GeomatrixTM controlled release technology in Coruno® enhances patient compliance and convenience byreducing the dosing requirement to once per day. Coruno® wasdeveloped in conjunction with the Therabel Group (‘‘Therabel’’) and wasapproved by the Belgian regulatory authorities in 2002 for marketing inBelgium. In April 2003, Therabel launched Coruno® inBelgium. Subsequently, Coruno® was approvedand launched in Luxembourg.

*GeomatrixTM* Products in Development

The following table summarizes certain information on the Company’sproducts under development that utilize GeomatrixTM technologies. The major products in development are discussedfurther below. 

| **Product**                        | ** ** | ** ** | ** ** | **Modified**              | ** ** | **Therapeutic Category** | ** ** | **Development Status** | ** ** | **Collaborative Partner** |
|------------------------------------|------------|------------|------------|---------------------------|------------|--------------------------|------------|------------------------|------------|---------------------------|
| Requip® Once-a-Day  |       | Yes        |       | Parkinson’s  Disease |       | Phase III  completed     |       | GlaxoSmithKline        |
| zileuton CR                        |       | Yes        |       | Asthma/COPD               |       | Phase  III completed     |       | Critical  Therapeutics |
| LodotraTM                      |       | Yes        |       | Inflammatory  Conditions  |       | Phase III completed      |       | Nitec                  |
| nisoldipine CR                     |       | Yes        |       | Cardiovascular            |       | Phase I completed        |       | Sciele Pharma          |

 

*Requip*® Once-a-day is a once daily dosage form of Requip® (ropinirole), which is an FDA-approved drugthat is currently marketed, primarily in the United States and Europe byGlaxoSmithKline. As it is currently marketed, Requip® isan immediate release formulation administered three times daily and isprescribed for Parkinson’s disease, a chronic progressive disease in which thedegeneration of nerve cells in the brain eventually impairs the ability tocontrol body movements. In December 2005, GlaxoSmithKline submitted Requip® Once-a-day for approval by U.S. and Europeanregulatory authorities for the treatment of Parkinson’s disease. This newonce-daily oral formulation of Requip® incorporatesthe Company’s GeomatrixTM oral controlled-release delivery technology, whichis expected to improve patient convenience. The FDA has raised someadministrative issues that were identified in the preliminary initial reviewand which led GlaxoSmithKline to withdraw the U.S. filing. The Company has beeninformed that it is the intention of GlaxoSmithKline to resubmit in late 2006.It is not expected that the European regulatory review process will be affectedby FDA issues.

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*Zileuton* is an FDA-approved drug for asthma and Chronic ObstructivePulmonary Disease (‘‘COPD’’). A four times a day immediate-release version ofzileuton was marketed by Abbott Laboratories (‘‘Abbott’’) as Zyflo® Filmtab (zileuton tablets).SkyePharma, together with Abbott, developed a controlled-release formulation ofzileuton using its GeomatrixTM technology for twice daily administration. Abbottcompleted Phase III trials to use this product to treat asthma. In January 2004,SkyePharma announced an agreement with Critical Therapeutics Inc. (‘‘CTI’’), towhom Abbott sub-licensed zileuton, to collaborate on the further development ofthis formulation for the indications of moderate to severe asthma and COPD.Because of changes in the active pharmaceutical ingredient supplier andmanufacturer, the formulation will need further in vivo (human) testing beforean application may be filed. CTI announced in January 2006 that it hadinitiated two studies designed to support an NDA for the twice-daily version ofZyflo® (zileuton). These studieswere recently completed and CTI expects to file the controlled release versionwith the FDA in the third quarter of 2006. Once approved by the FDA, CTIintends to market this product in the United States through its own specialistsales force.

*OtherOral Products in Development*

In addition tothe products in the above table, the Company has a number of other GeomatrixTM projects in earlier stages of development. For a description of thedevelopment process, including definitions for development status stages, see ‘‘Researchand Development—Development Process for Brand-Name Pharmaceuticals’’.

***Inhalation***

TheCompany is developing advanced technologies to deliver medicines via a patient’slungs without relying on chlorofluorocarbon “CFC” based propellants, which areconsidered environmentally harmful. The Company is working with two types ofsuch inhalation systems:

·       MDI Technologies—Metered dose aerosol inhalers (‘‘MDI’’), the mostwidely used systems for inhalation drug delivery, have been in existence formore than 40 years and are primarily used to deliver asthma medications andother small molecule drugs to the lung, although significant advances have beenmade in recent years in the delivery of large molecule drugs, such as peptidesand proteins, via the lung. MDI technologies rely on stable drug formulationswith non-CFC propellants, hydrofluroalkanes (‘‘HFAs’’), to deliver the requiredtherapy. In its MDI development work, the Company focuses on the formulation ofdrugs for use in MDIs manufactured by others.

·       DPI Technologies—Dry powder inhaler (“DPI”) technology has emergedas an effective means of delivering asthma medications to the pulmonary systemwithout the use of CFC propellants. Under the brand name “SkyeHalerTM”, theCompany is developing a DPI that requires no propellant but instead isbreath-actuated to deliver drugs in a fine powder suspension. In its dry powderinhaler development work, the Company focuses both on the development of thedevice and associated dry powder formulations.

In both its MDIand DPI development work, the Company’s objective is to maximize the efficiencyof the delivery system while addressing commercial requirements forreproducibility, formulation, stability, safety and convenience. The Companyhas assembled a team of researchers with substantial experience to developproprietary techniques and methods that it believes will produce stable andreproducible dry powder and aerosol formulations. To achieve this goal, theCompany is combining an understanding of lung biology, aerosol science,chemical engineering and mechanical engineering.

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*Approved Inhalation Products*

There are two approved drugs that use the Company’s Inhalation technologies
| Product                        | ** ** | ** ** | ** ** | **Indication**      | ** ** | **Regulatory Approvals and Year  of First Approval** | ** ** | **Collaborative Partner** |
|--------------------------------|------------|------------|------------|---------------------|------------|------------------------------------------------------|------------|---------------------------|
| Foradil® CertihalerTM |       | Asthma     |       | Switzerland  (2005) |       | Novartis                                             |
| Pulmicort® HFA-MDI   |       | Asthma     |       | Finland  (2006)     |       | AstraZeneca                                          |

 

*Foradil*® CertihalerTM.The Company has developed a DPI device with thecompound formoterol pursuant to a collaborative agreement with Novartis. TheForadil® CertihalerTM has now been approved in 24 countries inEurope, the Middle East and Latin America. The product was launched in Germany andSwitzerland in September 2005, but a batch recall from these markets wasinitiated in January 2006 because of concerns that accidental mishandlingof the device had resulted in inaccurate dosing in a small number of cases.SkyePharma is collaborating with Novartis and the relevant health authoritiesto investigate the matter and the actions necessary before the product can bereturned to the market. These are likely to include minor modifications of thedevice to prevent the occurrence of inaccurate dosing, while the key devicecharacteristics are expected to be left unchanged. In the United States,Novartis received an approvable letter for the Foradil®   CertihalerTM  from the FDA in October 2003, a secondapprovable letter in December 2004 and a third “approvable” letter in April 2006requiring device modification to prevent inaccurate dosing following accidentalmishandling as a prerequisite for approval, in line with the Europeanrequirements. Novartis is currently working with the FDA on the most effectiveway to address its concerns.

*Pulmicort*® HFA-MDI. The Company has entered into a collaborative agreement withAstraZeneca to develop the next generation of AstraZeneca’s Pulmicort® (budesonide) HFA—MDIs for the European market.Phase III clinical studies in Europe were completed in July 2004 and on June 28,2005 AstraZeneca announced that it had filed an application for approval ofthis product for the first country in Europe. In February 2006, the product received approvalin Finland, its first European market and other European approvals may bereceived in 2006. The currently available MDI formulation of Pulmicort® hasbeen on the market since 1981 and uses CFCs as the propellant, which will nowbe replaced by the non-ozone depleting device using HFAs as the propellant.SkyePharma developed this new HFA-MDI formulation, which employs itsproprietary formulation technology, and also conducted the clinical developmentprogramme for AstraZeneca.

*Inhalation Products in Development*

The table below summarizes inhalation products currently underdevelopment. 

| **Product**     | ** ** | ** **  | ** ** | **Therapeutic Category** | ** ** | **Development Status** | ** ** | **Inhalation System** | ** ** | **Collaborative Partner** |
|-----------------|------------|-------------|------------|--------------------------|------------|------------------------|------------|-----------------------|------------|---------------------------|
| FlutiformTM |       | Asthma/COPD |       | Phase III in  progress   |       | HFA-MDI                |       | Kos/SkyePharma        |
| QAB 149         |       | Asthma/COPD |       | Phase  II completed      |       | DPI                    |       | Novartis              |
| HFA-formoterol  |       | Asthma/COPD |       | Phase II  completed      |       | HFA-MDI                |       | SkyePharma            |

 

*Flutiform*TM. The Company isdeveloping FlutiformTM, a CFC-free metered-dose aerosol inhaler containinga fixed-dose combination of the long-acting bronchodilator formoterol with theinhaled steroid fluticasone for the treatment of asthma and COPD. A singledelivery device containing two separate agents with complementary therapeuticroles (steroids are anti-inflammatory and address the underlying causes ofasthma, whereas bronchodilators control the remaining symptoms of thoseattacks) brings convenience benefits for patients. In 2005, the Companycompleted phase II trials and a review of development activities with the FDAand European regulatory agencies and subsequently the Company initiated PhaseIII trials for FlutiformTM in February 2006. The product is on track forits target filing date 

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*with the FDA in thesecond half of 2007 with U.S. market entry expected in early 2009. In May 2006the Company announced that had entered into an agreement with KosPharmaceuticals to jointly develop*FlutiformTM. Kos will haveexclusive rights to market FlutiformTM in the United States and a right of firstnegotiation in Canada. SkyePharma could receive up to $165 million in milestonepayments on the achievement of all regulatory and revenue targets (of which $25million has been paid upfront) together with royalties on sales by Kos.SkyePharma remains in negotiations with potential partners for Europe and othermarkets around the world.

*QAB 149(indacaterol)* isNovartis’ novel inhaled long-acting bronchodilator with rapid onset of action,which has completed Phase II development for both asthma and COPD. The QAB 149development used the Company’s CertihalerTM and related formulation technology inthis second collaboration with Novartis. After the report of inaccurate dosingfollowing accidental mishandling of the device, Novartis is currently revising futureQAB 149 development plans. The Company cannot be certain that such plans willinclude the use of the Company’s CertihalerTM.

*FormoterolHFA-MDI*is a formulation ofthe long-acting bronchodilator formoterol in an HFA-MDI. This product hascompleted Phase II development. However, because of the growing use ofcombination products for asthma and COPD, there is now a correspondinglydiminishing market opportunity for single agent bronchodilators. The Company isundertaking a strategic review of the commercial viability of this product.

The Company also has a number of otherprojects at earlier stages of development utilizing its inhalation technology.

***Topical***

The Company’s topical drug deliverytechnologies are primarily designed to maintain efficacy and localise deliveryof drugs to the skin for the treatment of a variety of skin disorders. TheCompany’s portfolio of topical drug delivery technologies consist of HA-basedtechnologies, Crystalip, DermaStick and the ES-Gel system.

HA-based technologies are topical drugdelivery technologies based on HA, a natural polymer, which is designed tomaintain efficacy and localize the delivery of drugs to the skin for thetreatment of a variety of skin disorders. The properties of HA enables drugs topotentially be targeted to and held at the site where the drug is needed. As aresult, the Company believes formulations employing HA-based technologies mayresult in decreased systemic side effects or enhanced therapeutic effect.

*Approved Topical Products*

The Company hasone approved topical product:

| **Product**      | ** ** | ** **        | ** ** | **Indication**         | ** ** | **Regulatory Approvals and   Year of First Approval** | ** ** | **Marketing Partner** |
|------------------|------------|-------------------|------------|------------------------|------------|-------------------------------------------------------|------------|-----------------------|
| Solaraze*®* |       | Actinic Keratosis |       | United  Kingdom (1997) |       | Shire  Pharmaceuticals                                |
|             |       |              |       | United States (2000)   |       | Bradley Pharmaceuticals                               |

 

*Solaraze*® isa topical gel used to treat actinic keratosis, a pre-cancerous skin conditioncaused by over-exposure to the sun. It is a formulation of HA and thenon-steroidal anti-inflammatory drug diclofenac. Solaraze® has been shown to be an effective topical product foractinic keratosis. Compared with other actinic keratosis treatments, Solaraze® is non-invasive, non-scarring and is well toleratedby patients. Solaraze® is licensed to BradleyPharmaceuticals Inc. in the United States and to Shire Pharmaceuticals PLC in Europeand Australia. It is currently marketed in the United States and variouscountries in Europe. Shire filed for approval in Australia in 2005 and in June2006, Shire learned that the Australian regulatory agency has recommendedrejection of the application. Shire is currently considering whether to appealthis decision.

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*Topical Products in Development*

On April 29,2004, the Company announced that it had licensed the rights to its dermatologyassets, which account for substantially all of its topical drug deliverytechnologies, for those territories that are not covered by existing licenses,to Trigenesis Therapeutics, Inc. (‘‘Trigenesis’’). The rights relate tothree marketed drugs, including Solaraze*®* for those territories not already licensed,rights to six pipeline products, including Hyclinda and Acyclovir, and a rangeof six proprietary and complementary delivery technologies, including HA-basedtechnologies, Crystalip, Dermastick, ES-Gel, Dissocubes and Solid LipidNanoparticles. Under the agreement, Trigenesis is obligated to exploit thedermatology assets covered by the license and to continue the development ofthose drug candidates that are currently in the pipeline stage. Trigenesis hasalso assumed the majority of SkyePharma’s existing obligations to third partieswith respect to the development of these drug candidates. All rights granted bythe Company to licensees under existing licenses remain unaffected by theagreement. In addition, the Company has retained the right to use thetechnologies subject to the license for the development of a number of new chemicalentities in the dermatology area and, in certain cases, also for non-dermalapplications. In May 2004, Trigenesis was acquired by Dr Reddy’sLaboratories Limited (‘‘Dr Reddy’s’’), an Indian pharmaceutical company. Dr Reddy’sassumed all the obligations of Trigenesis.

***Solubilisation***

Solubility of drugs is an essential factorfor all drug delivery systems, independent of the route of administration. Poorsolubility may lead to a range of problems including poor bioavailability,increased toxicity, variability of absorption when taken with food and poorefficacy. The Company believes that a large number of existing marketed drugsand newly synthesised compounds have solubility problems. The Company’ssolubilisation technologies consist of two complementary technologies, thenano-particulate and the Insoluble Drug Delivery (“IDDTM”) technologies. Bothtechnologies aim to improve a drug’s solubility by reducing the size of theparticules. It has been demonstrated in laboratory testing that the saturationsolubility of many drugs can be improved by reducing particle size below onemicron in diameter. The Company is using its solubilisation technology platformto enhance the uptake and safety of water ­insoluble drugs across a broad rangeof therapeutic classes including anaesthetics, anti-cancer agents and immunesuppressants. It is intended that the solubilisation technologies will be usedto complement and enhance the Company’s other drug delivery systems.

*Approved Solubilisation Products*

The Company has one approved solubilization product.

| **Product**       | ** ** | ** **     | ** ** | **Indication**       | ** ** | **Regulatory Approvals and   Year of First Approval** | ** ** | **Marketing Partner** |
|------------------------|------------|----------------|------------|----------------------|------------|-------------------------------------------------------|------------|-----------------------|
| Triglide*®*  |       | Cardiovascular |       | United States (2005) |       | Sciele Pharma                                         |

 

***Triglide****®* is an IDDTM formulation of fenofibrate which theCompany was initially developing in partnership with an undisclosedpharmaceutical company. During 2003, the Company and its partner re-negotiatedthe terms of their agreement and the Company re-acquired rights to the productfor an unspecified amount. Triglide*®* is a lipid-lowering agent launched by Abbottunder the trade name Tricor® in the United States in 1998. The IDDTM formulation isa lower dose product providing blood levels similar to the original 200mgTricor® product and that can be taken with or withoutfood. On May 17, 2004, the Company announced an exclusive agreement withFirst Horizon Pharmaceutical Corporation, now renamed Sciele Pharma, Inc.(“Sciele Pharma”) through which the Company granted Sciele Pharma the exclusiveU.S. marketing and distribution rights for Triglide*®*. Following FDA approval in May 2005, ScielePharma launched Triglide*®* on the U.S. market in July 2005.

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*Solubilization Products in Development*

The Companygranted an exclusive license to the United States and Canadian marketing anddistribution rights for Propofol IDD-DTM to Endo. Propofol IDD-DTM is our novelformulation of propofol, a widely-used injectable anaesthetic and sedative. Ourformulation was designed to avoid the need for a preservative and to besuitable for long-term use in intensive care units. Although this productsatisfactorily completed Phase II trials in 2004, the Phase III trial has notyet commenced and in April 2006 we agreed with our North American partnerEndo to terminate the joint development of Propofol IDD-DTM as the product wasunlikely to achieve its target profile. As a result, the Company believes thisproduct has limited commercial potential.

**Injectable**

*TheCompany has two injectable technologies*

DepoFoamTM—The Company’s primary injectabletechnology is DepoFoamTM. DepoFoamTM consists of lipid-based particles composedof hundreds to thousands of discrete water-filled chambers containing theencapsulated drug, with each chamber separated from adjacent chambers by alipid membrane. The particles are suspended in saline for injection. DepoFoamTMformulations can be delivered into the body by a number of routes, includingunder the skin, within muscle tissue, into brain and spinal fluid, within eyes,within joints and within the abdominal cavity. The Company has combined manydrugs with DepoFoamTM in the laboratory and clinic and has two commercializedproducts based on this technology. Clinical studies show that DepoFoamTMtechonologies often achieve sustained controlled release of the drugs. Thisfeature allows the Company to develop new formulations of drug products aimedat treating different diseases and symptoms or allows for more convenientadministration by reducing the number or frequency of injections. The drugcandidates include drugs that have already been shown to be useful orpotentially useful in humans, as well as new drugs in development at otherpharmaceutical companies, which may potentially benefit from DepoFoamTM. TheCompany does not conduct research and development to discover new drugs to usein combination with DepoFoamTM.

BiosphereTM—The Company’s secondsustained-release injectable technology is the BiosphereTM drug delivery system.The BiosphereTM drug delivery system provides sustained-release of injectableproteins and peptides. The technology encapsulates the drug substance in highlypurified starch in microscopic spheres that are then coated with a copolymer oflactic and glycolic acid. After injection, the coating and core erode and thedrug content is released over a controlled period that can range from days tomonths. In contrast with conventional microspheres, the coating used inBiosphereTM does not contain any drug so there is a low “burst” even at highdrug loadings. In 2003, the Company announced that the BiosphereTM technologyhad been successfully used in pre-clinical studies to deliver a protein drughuman growth hormone over an extended period of time. The product has nowsuccessfully completed Phase I trials. In addition to the human growth hormone,the Company is also evaluating BiosphereTMformulations of other proteins and peptides.

*Approved Injectable Products*

The following table summarizes certain information on the Company’s twoapproved products that utilize its injectable technologies.

| **Product**     | ** ** | ** ** | ** ** | **Indication**        | ** ** | **Regulatory Approvals and   Year of First Approval** | ** ** | **Marketing Partner** |
|-----------------|------------|------------|------------|-----------------------|------------|-------------------------------------------------------|------------|-----------------------|
| DepoCyt*®* |       | Oncology   |       | United States  (1999) |       | Enzon                                                 |
|            |       |       |       | Europe (2001)         |       | Mundipharma                                           |
| DepoDurTM   |       | Acute Pain |       | United States (2004)  |       | Endo                                                  |

 

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*DepoCyt*® combines the Company’s DepoFoamTMtechnologywith cytarabine, a drug used to treat neoplastic meningitis from lymphomas andsolid tumors. It is currently marketed in North America by Enzon and in theEuropean Union and certain other countries in Europe by Mundipharma for thetreatment of lymphomatous meningitis. DepoCyt® wasdeveloped in collaboration with Chiron Corporation (“Chiron”) in the UnitedStates and, until June 2000, with Pharmacia & Upjohn S.p.A., anaffiliate of Pharmacia Corporation. We have completed a Phase IV clinical trialrequired by the FDA and have submitted the results to the FDA. We have alsofiled with the EMEA in Europe for the additional indication of the most commonform of neoplastic meningitis, associated with solid tumours. The file has beenwithdrawn as the EMEA needed additional clinical data to make a positive risk-benefitassessment.

*DepoDurTM* (previously referred to as DepoMorphine) has beendeveloped for the control of moderate to severe post-operative pain. DepoDurTMis givenas a single epidural injection in the peri-operative period and provides painrelief for up to 48 hours following surgery. The Company’s U.S. marketingpartner Endo Pharmaceuticals launched DepoDurTM in December 2004. The product is still inthe launch phase but has now been accepted on more than 400 hospitalformularies, the first gateway to routine hospital use. In the U.K., we haverecently been granted approval for DepoDurTM by the U.K. Committee on Safety ofMedicines, the CSM. This will be used as the basis for seeking approvalthroughout the European Union under the EU’s Mutual Recognition procedure.Zeneus Pharmaceuticals, SkyePharma’s European licensee for DepoDurTM, announced in December 2005that it had reached agreement to be acquired by the U.S. company Cephalon Inc.SkyePharma has regained the European rights for DepoDurTM and is now seeking a new sales and distributionpartner for the EU and other territories outside North America.

*Injectable Products in Development*

The following table summarizes certain information on the Company’sproducts under development that utilize its injectable technologies. The major products in development are discussedfurther below.

| **Product**

**(Active  Compound)**  | ** ** | ** **                      | ** ** | **Therapeutic category** | ** ** | **Development Status** | ** ** | **Collaborative Partner** |
|-------------------------------------------|------------|---------------------------------|------------|--------------------------|------------|------------------------|------------|---------------------------|
| DepoBupivacaineTM                     |       | Post  surgical/post injury pain |       | Phase II  completed      |       | SkyePharma/Maruho      |
| Psoraxine                                 |       | Psoriasis                       |       | Phase  II completed      |       | Astralis               |
| HgH                                       |       | Growth  Disorders               |       | Phase  I completed       |       | SkyePharma             |
| Interferon  alpha-2b                      |       | Anti-viral/Oncology             |       | Pre-clinical             |       | SkyePharma             |
| GCSF                                      |       | Oncology                        |       | Pre-clinical             |       | SkyePharma             |

 

*DepoBupivacaineTM*is a DepoFoamTM formulationof the local anaesthetic bupivacaine, for the treatment of regional pain. InApril 2005, the Company entered into a development and licensing agreement forDepoBupivacaineTM with MundiPharma for Europe and certain other internationalmarkets excluding the United States and Japan. In November 2005, SkyePharmaannounced that it had entered into an exclusive marketing and distributionagreement with Maruho Company Limited (“Maruho”) for Japan.

*The product successfullycompleted Phase II clinical trials in 2005. In June 2006, the Company completednegotiations with Mundipharma the result of which is that the Company willreacquire the rights for the marketing and distribution of DepoBupivacaineTM* andthe clinical data from the Phase II trials of DepoBupivacaineTM for $ 5 million. Endo Pharmaceuticals, ourNorth American partner for DepoDurTM, had a right of first negotiation forcommercial rights to DepoBupivacaineTM for North America, but has nowrelinquished this right. The reacquisition of rights from Mundipharma and the relinquishment ofrights by Endo means that the Company can now offer unrestricted global rightsto DepoBupivacaineTM (outside Japan) to parties interested in acquiring theinjectables business. Maruho will 

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*conductthe clinical development of DepoBupivacaineTM required for regulatory approvalin Japan at its own cost.*

The Company isalso evaluating, in conjunction with undisclosed corporate partners, DepoFoamTMand BiosphereTMformulations of several additional compounds, including smallmolecule chemical compounds and macromolecule biologics.

**CollaborativeArrangements**

The Company has collaborative arrangementswith each of its pharmaceutical partners, the terms of which vary considerably.Pursuant to these arrangements, the Company’s partners typically fund all or alarge part of the research and development expenses incurred in the developmentof new formulations of their products. This funding typically takes the form ofa flat fee for the Company’s research and development efforts, an agreedresearch and development budget charged at an hourly rate, or milestonepayments on signing and on the achievement of technical or commercialmilestones. Some agreements have involved equity investments in the Company bythe Company’s partners. In negotiating contracts with its partners, the Company’sstrategy generally has been to cover its costs in the research and developmentprocess. Substantially all potential profits are expected to be generated byroyalty payments or manufacturing fees for successfully developed and marketedproducts. In some cases, milestone payments may be deducted from future royaltypayments for successfully developed and marketed products.

In return the Company gives each of itspartners an exclusive license to market the products incorporating the Company’stechnologies. In some cases the licenses are worldwide. In others they arelimited to specific territories. In most cases, partners are free to sublicensethe technologies, although the Company’s consent may be required and royaltieson all sales must be paid to the Company. In addition, the majority of thecollaborative agreements do not restrict the Company from developingformulations of competitive products. In some cases, however, the Company willagree not to develop formulations of specified compounds for an agreed periodof time.

The Company’s collaborative partnersfrequently take responsibility for conducting clinical trials and for preparingand pursuing all necessary regulatory approvals, although more recently theCompany has taken responsibility for managing clinical trials in somecollaborations. The Company may assist its partners in the conduct of suchtrials and the preparation of regulatory filings. Its partners may ultimatelycontrol the process, including the selection of the jurisdictions in whichregulatory approval will be sought, if at all.

The collaborative agreements frequently donot obligate the partners to market any successfully developed and approvedproducts. The Company does not have any control over whether and to what extenta partner will elect to commercialise a product. A client may choose not tomarket a product for reasons wholly independent of the Company’s technologies.In most cases, if a client does not proceed to market the product once it hasbeen successfully formulated and approved, the Company will not receive anyadditional income in respect of the product. In some more recentcollaborations, however, contracts have included certain commitments from theCompany’s partners to use specified minimum resources to market the product orto pay a minimum royalty in lieu of sales of the product or failing that toreturn the product rights to the Company.

During the formulation and developmentstages, the Company’s partners are generally free to terminate the collaborativerelationship at any time and for any reason after providing the Company with anotice period.

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The Company’s key license, development, marketing and distributionrelationships are set out in the table below.

| **Product**                         | ** ** | ** **             | ** ** | **Collaborative Partner** | ** ** | **Technology Platform**                          | ** ** | **Territory Covered** |
|-------------------------------------|------------|------------------------|------------|---------------------------|------------|--------------------------------------------------|------------|-----------------------|
| Paxil CRTM                      |       | GlaxoSmithKline        |       | Oral                      |       | Worldwide                                        |
| Xatral® OD                |       | Sanofi-Aventis         |       | Oral                      |       | Worldwide                                        |
| Coruno                              |       | Therabel               |       | Oral                      |       | Worldwide                                        |
| Requip®                        |       | GlaxoSmithKline        |       | Oral                      |       | Worldwide                                        |
| Zileuton CR                         |       | Critical  Therapeutics |       | Oral                      |       | United States                                    |
| Foradil® CertihalerTM |       | Novartis               |       | Inhalation                |       | Worldwide                                        |
| Pulmicort® HFA-MDI        |       | AstraZeneca            |       | Inhalation                |       | Worldwide (except United States)                 |
| FlutiformTM                     |       | Kos                    |       | Inhalation                |       | United States                                    |
| DepoCyt®                       |       | Enzon                  |       | Injectable                |       | United States and Canada                         |
| DepoCyte®                      |       | Mundipharma            |       | Injectable                |       | E.U. and certain other  countries in Europe |
| DepoDurTM                       |       | Endo                   |       | Injectable                |       | United States and Canada                         |
| DepoBupivacaineTM               |       | Maruho                 |       | Injectable                |       | Japan                                            |
| Triglide®                      |       | Sciele Pharma          |       | Solubilisation            |       | United  States                                   |

 

*Other Significant CollaborativeArrangements*

In December 2000, SkyePharma enteredinto an agreement with Paul Capital Royalty Acquisition Fund (“Paul Capital”).Under the agreement, Paul Capital provided a total of $30 million between 2000and 2002, in return for the sale of a portion of potential future royalty andrevenue streams from DepoDurTM, Xatral® OD, Solaraze® and DepoCyt®. The monieswere used to fund the clinical development of DepoDurTM. Between January 2003and December 2014, Paul Capital will receive 15% of the annual royaltiesand revenues from the stated products up to an agreed ceiling. Once thepredetermined ceiling is reached, the percentage participation will fall to 3%for the remainder of the period until December 31, 2014.

In March 2002,SkyePharma entered into a second agreement with Paul Capital. Under the termsof the agreement, Paul Capital paid SkyePharma $30 million during 2002 and2003, in return for a portion of the future royalty and revenue streams fromnine products in the Company’s pipeline. The monies have been used principallyto fund the clinical development of Propofol IDD-DTM and HFA-formoterol. Thenine products referred to are Propofol IDD-DTM and HFA-formoterol, thelipid-lowering drug Triglide®, an anti-cancer agentbusulfan, an intravenous formulation of the antibiotic oxytetracycline, oralbudesonide to treat inflammatory bowel disease, HFA-budesonide and Foradil®, for the treatment of asthma, and the anti-depressant Paxil CRTM.Between January 2002 and December 2015, Paul Capital will receivebetween 4% and 20% of the annual royalties and revenues from the total of nineproducts. The 20% rate applies first. The percentage then falls, when an agreedreturn is achieved, to 12.5% until a second ceiling is reached, before fallingto 4% for the remainder of the period until December 31, 2015. During 2002and 2003, the 20% rate was reduced based on the percentage of the total $30million already funded. Also under the terms of these agreements, Paul Capitalhas been issued warrants carrying rights to subscribe for 5 millionSkyePharma Ordinary Shares at an exercise price of 73.75 pence.

**Research and Development**

The Company’sresearch and development activities are conducted in Muttenz, Switzerland andin San Diego, United States. As of December 31, 2005, the Company had 282employees at these two facilities, the majority of whom were engaged inresearch and development and manufacturing. In late 2005 and early 2006, theBoard of Directors of the Company conducted a full strategic review and 

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concludedthat inthe interests of achieving sustainable profitability in the near term, and in order to improve the Company’s cash flow position, theCompany should concentrate on oral and inhalation products, and divest itsinjectables business in San Diego.

The Companyconducts research and development both with respect to its own internallyfunded products as well as for third parties. The Company accounts for costsincurred in conducting internal research and development activities as researchand development expenses and for costs incurred on development work for thirdparty customers as cost of sales. The Company’s self-sponsored research anddevelopment costs are expensed as incurred.

The Companyrecords amounts received from third parties under the Company’s contractdevelopment arrangements within turnover, as contract development income.Contract development income represents amounts invoiced to customers forservices rendered under development contracts or for milestone payments inaccordance with the contract terms. Such amounts are only treated as revenuewhen the services have been rendered or the specified milestone has been met.Certain refundable income is treated as deferred income until the Company hasno further obligations to make refunds. The Company generally attempts to breakeven on its development work for third party customers. Therefore, productdevelopment activities do not currently have a significant impact on theCompany’s operating profit/(loss).

The Company’sdevelopment processes are described below. Specific development steps for aproduct may vary or be unnecessary depending on a number of factors, includingthe drug delivery technology used and whether the product incorporates anactive ingredient already available on the market.

*Development Process for Brand Name Pharmaceuticals*

In order toobtain approval of a new drug or a new formulation of an existing drug it isnecessary to undertake a series of tests and trials. Specific development stepsfor a product may vary or be unnecessary depending on a number of factors,including the drug delivery technology used and whether the productincorporates an existing marketed active ingredient. A typical developmentprocess may include the following series of tests and trials:

Preclinicaltests encompass the laboratory evaluation of a new pharmaceutical, itschemistry, formulation and stability, as well as animal studies to assess itspotential safety and efficacy. Following the conclusion of preclinical tests,the results of these studies, which have to demonstrate that the pharmaceuticaldelivers sufficient quantities of the drug to the bloodstream to create thedesired therapeutic results, are submitted to the relevant regulatoryauthority, which must be approved before human clinical trials may begin.

Human clinical trials are typically conducted in three sequentialphases:

·       Phase I.During this phase, the drug is initially introduced into a relatively smallnumber of healthy humans or patients and is tested for safety, dosagetolerance, absorption, metabolism, distribution and excretion.

·       Phase II.This phase involves studies in a limited patient population to identifypossible adverse effects and safety risks, to determine the efficacy of thedrug for specific targeted diseases or conditions, and to determine dosagetolerance and optimal dosage.

·       Phase III.When Phase II evaluations demonstrate that a dosage range of the drug iseffective and has an acceptable safety profile, Phase III trials are undertakento further evaluate dosage, clinical efficacy and test for safety in anexpanded patient population at geographically dispersed clinical sites.

·       *Regulatory Filing.*TheCompany alone, or in collaboration with its partner, or its partner managesregulatory activities during product development phases. These activities includedeveloping regulatory strategies, information submissions and meetings withhealth authorities and preparation 

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ofmarketing approval applications. Post-approval product development maynecessitate additional regulatory filings.

**Patents and Proprietary Rights**

The Companybelieves that patent and other intellectual property protection of its drugdelivery and formulation technologies is critical to its business and that itsfuture performance will depend in part on its ability to obtain patents,maintain confidential and trade secret information and to operate withoutinfringing the intellectual property rights of others.

*Oral Controlled Release Technology*

The Company hastwo patent families in respect of its core GeomatrixTM technologies. The firstpatent family was issued in Australia, New Zealand, Italy, Europe, Japan, theUnited States and Canada. It expired in 2002 in Australia and New Zealand, 2005in Italy, and will expire in 2006 in the rest of Europe, Japan and the UnitedStates, and in 2009 in Canada. The second patent family relating to the Company’sGeomatrixTM technologies was granted in Italy, the United States and Europe,Canada and Japan. These patents expire between 2009 and 2012.

In addition,the Company holds several other patents related to its oral controlled releasetechnology, and has applications filed in markets including Europe, the UnitedStates, Japan, Canada, Australia and New Zealand, which continue to protect thetechnology to 2018. These patents and applications cover the variety ofdifferent tablet formulations containing an active drug core and varioussurface coatings covering the core. These cores and coatings contain excipientsthat enable a variety of release profiles to be achieved. Later applicationscover recent innovations and/or improvements to the original inventions.

In total, theCompany has 175 patents protecting the GeomatrixTM technology, which represents27 patent families. The Company continues to file additional patentapplications relating to oral drug delivery technologies in order to secureprotection for its activities in this area.

*Inhalation Technology*

The Company has17 patent families in respect of its inhalation technology. One family coversSkyeHaler itself as well as several of the structural elements and featuresincorporated therein, and has been granted in the United States, Europe, Japanand certain other countries. Each of these patents expires no earlier than2015. Other patent families relate to a dry powder, for use with the Dry PowderInhalers.

The Companyhas, together with other companies working in the same area, been involved inseveral European patent oppositions related to the use of environmentallyfriendly HFA as propellants. Of these oppositions four have been settled andthe remaining four are in various stages within the European Patent Office.There are currently six oppositions in which SkyePharma is participating inrelation to various aspects of inhalation technologies. As with all contentiousproceedings, the outcome of patent oppositions is uncertain and, if negative,could have an adverse effect on the Company’s business.

*Topical Technology*

The Companyowns a wide range of intellectual property rights covering its topicaltechnology. Patents and applications covering many and varied uses ofhyaluronic acid have been filed throughout the world. Following these filings,patents have been granted in the United States, Europe, Japan and certain othercountries expiring between 2010 and 2013. On 29 April 2004, the Companyannounced that it had licensed the bulk of its Topical Technology toTrigenesis.

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*Solubilisation*

The Company hasrights to a total of 7 patent families related to its solubilisationtechnology. The Company owns two patent families covering solid lipidnanoparticles and nano-suspensions, each of which are useful for drug delivery.These two patent families, as well as applications filed, protect the Company’stechnologies in the area of solid lipid nanoparticles and nano-suspensions inthe United States, Europe, Japan and certain other countries until 2015. TheCompany also has an exclusive license under two further patent families: onerelating to solid polymer nano-particulate technology and the other to furtherdevelopments in the areas of solid lipid nano-particles and nano-suspensions.

In addition, the Company owns a large portfolio of patents and patentapplications covering three broad patent families relating to:

(i)            Lipidstabilised microparticle technology (where the drug is a solid particle);

(ii)        Lipidstabilised microdroplet technology (where the drug is a liquid); and

(iii)    Omega-3oil stabilised drug technology, which is useful for drug delivery.

The Company’ssolubilisation technology is protected by numerous patent and patent applicationsworldwide including: 15 patents in the United States and 70 correspondingpatents in countries outside the United States. In addition, the portfoliocontains many pending applications, including 23 patent applications in theUnited States, 23 regional (European and PCT) patent applications and 35applications in other countries.

*Injectable Technology*

The Companyowns a large portfolio of patents relating to the DepoFoamTM delivery technologyin the United States, Europe, Japan and certain other countries. The majorityof these patents will continue in force until 2014. Additional filings ofpatent applications have been made for improvements of the initial technologyand for innovative technology relating to this subject matter in the United States,Europe, Japan and certain other countries. In late 2005 and early 2006, theBoard of Directors of the Company conducted a full strategic review andconcluded that inthe interests of achieving sustainable profitability in the near term, and in order to improve the Company’s cash flow position, theCompany should concentrate on oral and inhalation products, and divest itsinjectables business interests.

In addition,through a prior agreement entered into by SkyePharma Inc. with the ResearchDevelopment Foundation (‘‘RDF’’), RDF granted certain rights, on an exclusivebasis, relating to the DepoFoamTM technology to SkyePharma Inc. Under theagreement SkyePharma Inc. is obliged to prosecute certain patent applicationsand maintain issued patents relating to the licensed intellectual property. RDFretains the right to terminate the agreement or to convert the exclusive natureof the rights granted under the agreement, into a non-exclusive license in theevent that SkyePharma Inc. does not satisfy its contractual obligationsincluding making certain minimum annual payments. Additional termination eventsinclude bankruptcy and a material breach of the agreement, which is notremedied within a specified period. The termination of this agreement or theconversion to a non-exclusive agreement would have a material adverse effect onthe Company. In April 2004, the Company entered into an amendmentagreement with RDF pursuant to which certain commercial terms of the RDFagreement were re-negotiated. As part of the re-negotiation of these terms,3.25 million Ordinary Shares of the Company were issued to RDF.

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The Companyowns a wide range of intellectual property rights covering its BiosphereTM technology. Patent applications have been filed and issued in theUnited States, Europe, Japan and certain other countries. The Company owns 12patent families in respect of its BiosphereTM technology. The later patent filings will offer protection out until2023.

*PatentProtection*

There can be no assurance that the Companywill be issued any additional patents or that if any patents are issued, theywill provide the Company with significant protection or will not be challengedby third parties asserting claims against the Company concerning its existingproducts or with respect to future products under development by the Company.The Company, from time to time, may receive notification of allegedinfringements. The Company may not, in all cases, be able to resolve suchallegations through licensing arrangements, settlement or otherwise.Furthermore, the Company anticipates that any attempt to enforce its patentswould be time consuming and costly. Moreover, the laws of some foreigncountries do not protect the Company’s proprietary rights in the products tothe same extent as does the law of the United States.

**Manufacturing**

*Manufacturingin Europe*

Manufacturing operations in Europe takeplace at the Company’s Lyon facility in France and Muttenz facility inSwitzerland. In Lyon the Company has an approximately 17,000 square meter(183,000 square feet) pharmaceutical manufacturing and production facility andan approximately 2,400 square metre (25,850 square feet) adjoining officecomplex. In Muttenz the Company has a 11,700 square metre (125,942 square feet)facility. The Company presently manufactures four GeomatrixTM products, MadoparDR in its Muttenz facility and Diclofenac-ratiopharm-uno, Xatral® OD and Coruno in its Lyonfacility. In addition the Company manufactures one other oral product, Triglide®, based on its solubilization technology, at its Lyon facility. TheCompany produces bio-batches for its internal development products and itscollaborative partners in both facilities.

The Lyon facility was designed and builtfor drug production in 1993 by American Cyanamid (subsequently part of AHP) butwas used instead for packaging activities. Under the terms of the Company’s 1997acquisition of the facility from AHP, the Company’s manufacturing activitieswere gradually transferred into the facility and the Company also packagedcertain pharmaceutical products and other products (‘‘Contract Products’’) onbehalf of certain subsidiaries of AHP. The facility is in compliance with cGMPwith respect to packaging operations and it has European regulatory approval topackage the Contract Products.

The Company completed its GeomatrixTMmanufacturing suite in the Lyon facility at a capital cost of approximately£7.1 million. This facility is being used to manufacture oral andsolubilisation products for collaborative partners and for the Company. Thefacility enables the Company to manufacture its own products in addition tocontracting with third parties. In 2004, the plant expanded its oralmanufacturing facilities to include two large-scale microfluidisers for theproduction of Triglide®. Scale-up to the finalcommercial scale was completed in the second half of 2004.

Manufacturing of Coruno started in April 2003,Xatral® OD in March 2004 andTriglide® in May 2005. Thecontract for manufacturing Xatral® OD is expected to terminate in December 2006.The FDA has inspected the Lyon facility in respect of four products; DilacorXR, Coruno, Xatral® OD and Triglide®. All the pre-approval inspections have been passed. There can be noassurance, however, that the Lyon facility will ultimately be found to be incompliance with cGMP or other regulatory requirements for the purposes forwhich the Company plans to use the facility. Failure to comply could result insignificant 

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delays in theCompany’s planned manufacturing efforts. The Company also could incursignificant additional expense in bringing the facility into compliance withcGMP or other regulatory requirements.

The Company expanded its operations at theLyon facility to include production activities for dry powder inhaler productspursuant to the Novartis development contract at a capital cost to date ofapproximately £8.1 million. In December 2003, the FDA approved thefacility for the commercial filling of the Foradil® CertihalerTM, which commenced in 2005 inpreparation for launch in some of the European countries where the product isapproved. The dry powder inhaler (SkyeHaler) is manufactured by a Swiss plasticcontract manufacturer, Riwisa AG. Final assembly and filling of the SkyeHalerwith the powder blend containing formoterol fumarate takes place in the Lyonfacility. The product is then released for marketing at the Lyon facility anddelivered to Novartis for final packaging and distribution. Following theForadil® CertihalerTM batch recall in January 2006,manufacturing of the product has been suspended pending device modification toprevent inaccurate dosing following accidental mishandling.

Due to EMEArequirements to retest drugs being imported into Europe, retesting andpackaging operations were established at the Lyon facility during 2003 and 2004for DepoCyt® supplies for Europe under theMundipharma marketing and distribution agreement.

*Manufacturingin North America*

DepoFoamTM manufacturing operations takeplace at the Company’s facilities in San Diego, California. The Companycurrently manufactures two DepoFoamTM products for commercial sale at itsfacilities in San Diego: DepoCyt® and DepoDurTM. In late 2005 and early 2006, theBoard of Directors of the Company conducted a full strategic review andconcluded that inthe interests of achieving sustainable profitability in the near term, and inorder to improve the Company’s cash flow position, theCompany should concentrate on oral and inhalation products, and divest itsinjectables business interests.

Manufacturing for DepoCyt® takes place in anapproximately 2,020 square metre (21,746 square feet) facility built for thispurpose. This facility complies with cGMP and is approved for commercial drugmanufacturing by the FDA and EMEA.

*Commercialmanufacturing for DepoDurTM takes place in an approximately 7,600 square metre(82,000 square feet) facility housing production, administrative and researchand development activities. This facility complies with cGMP and is approvedfor the commercial manufacture of DepoDurTM. Clinical trial materials are alsomanufactured in this facility. Prior to marketing any drugs (including DepoCyt*® andDepoDurTM) outside countries where approval has been gained, the Company willneed to meet applicable regulatory standards, achieve prescribed productquality and reach necessary levels of production of such products.

*ManufacturingPartners*

While the Company has its own manufacturingsites for GeomatrixTM inhalation (dry powderproducts) and DepoFoamTM manufacturing, for themanufacture of certain of its existing products, and certain of those currentlyin development, the Company will depend at times on manufacturing partners.

Under the terms of the development andcommercialization agreement with Endo for DepoDurTM and Propofol IDD-Dä signed in December 2002, in respect of the United States andCanada, the Company is primarily responsible for the clinical development ofthe products up to final FDA approval and for product manufacture, includingall associated costs. The Company also agreed to qualify and obtain finalregulatory approval for a second manufacturing site for DepoDurTM, eitherinternally or through a third party manufacturing partner, within a specifiedperiod from the date of first commercial sale. In April 2006 we agreedwith Endo to terminate the joint development of Propofol IDD-DTM as the productwas unlikely to achieve its target profile.

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The Companydoes not have commercial scale manufacturing capabilities for the HFA-MDIproducts, Pulmicort® , Formoterol and FlutiformTM. AstraZeneca is responsible for the manufacture ofPulmicort® . The Company has enteredinto a contract for clinical supplies of FlutiformTMwith a third party contract manufacturer and is currently in negotiation withthe same manufacturer for the production of commercial supplies.

**Supplies and Raw Materials**

The Company andits collaborative pharmaceutical company partners rely on certain suppliers ofkey raw materials. Certain of those materials are purchased from single sourcesand others may be purchased from single sources in the future. Although theCompany has no reason to believe that it and its collaborative pharmaceuticalcompany partners will be unable to procure adequate supplies of such rawmaterials on a timely basis, and at commercially reasonable rates, disruptionsin supplies, including delays due to the inability of the Company’s pharmaceuticalcompany partners, the Company or its manufacturers to procure raw materials,would have a material adverse effect on the Company’s business.

Regulatoryrequirements for pharmaceutical products tend to make the substitution ofsuppliers costly and time-consuming. The inability to develop alternativesources could have a material adverse effect on the Company’s ability tomanufacture and market its products.

One of theDepoFoamTM Injectable products, DepoDurTM, has morphine sulphate asits active ingredient. Morphine sulphate is classified as a Scheduled Drug bythe United States Drug Enforcement Agency (‘‘DEA’’). The DEA has determinedthat these drugs have a high potential for abuse and could lead to severepsychological or physical dependence. The DEA controls the national productionand distribution of certain Scheduled Drugs in the United States by allocatingproduction quotas based, in part, upon the DEA’s view of national demand.SkyePharma Inc. has a DEA license to use morphine sulphate in its research andmanufacturing of DepoDurTM. While the Company expects that adequate quantitiesof the drug will be available to it to meet future research and commercialrequirements, there can be no assurance to that effect.

**Sales and Marketing**

The Company isnot involved in the direct marketing of products formulated with itstechnologies. The Company depends on its collaborative partners for suchmarketing and sales. The majority of the Company’s partners are not obligatedto market products incorporating its technologies, even if such products aresuccessfully developed and approved. However, in some more recentcollaborations, contracts have included certain commitments by the Company’spartners to market products developed in collaboration with the Company.

**Competition**

The pharmaceuticalindustry is highly competitive and is affected by new technologies,governmental regulations, health care legislation, availability of financingand other factors. Many of the Company’s competitors have longer operatinghistories and greater financial, marketing and other resources than theCompany.

The Company isand will continue to be subject to competition from numerous other entitiesthat currently operate, or intend to operate, in the pharmaceutical industry.These include companies that are engaged in the development ofcontrolled-release technologies and products, as well as other pharmaceuticalmanufacturers that may decide to undertake in-house development of theseproducts.

As thepharmaceutical industry continues to consolidate and as pressures increase forcost-effective research and development, some pharmaceutical companies havereduced and may continue to reduce their funding of research and development.Competition for limited client financing may therefore 

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increase,and this competition could include the clients’ internal research anddevelopment programs, other drug delivery programs and other technologies andproducts of third parties.

**Government Regulation**

All drugs andmedical devices, including the Company’s products under development, aresubject to extensive regulation in the United States and Europe, the Company’stwo principal markets. In the United States, the primary regulatory body is theFDA, although to a lesser extent state and local authorities are also involvedin the regulatory process. In Europe there are two regulatory systems. There isa European Union system that is the responsibility of the EMEA. In addition,each country has its own regulatory agency. In both the United States andEurope, the applicable regulations govern or influence the development,testing, manufacture, safety, labelling, storage, record keeping, approval,advertising, promotion, sale and distribution of prescription pharmaceuticalproducts. Pharmaceutical manufacturers are also subject to certain recordkeeping and reporting requirements, establishment registration and productlisting and agency inspections.

***UnitedStates***

The federalFood, Drug and Cosmetics Act (‘‘FDCA’’), the Public Health Services Act, theControlled Substances Act and other federal statutes and regulations govern orinfluence all aspects of the Company’s business. Non-compliance with applicablelaws and regulations can result in fines and other judicially imposedsanctions, including product seizures, injunctive actions and criminalprosecutions. In addition, administrative or judicial actions can result in therecall of products, and the total or partial suspension of the manufacturing ofproducts, as well as the refusal of the government to approve pending applicationsor supplements to approved applications. The FDA also has the authority towithdraw approvals of drugs in accordance with statutory due processprocedures.

FDA approval isrequired before any dosage form of any new unapproved drug or new indication ofuse for an existing drug, including a generic equivalent of a previouslyapproved drug, can be marketed. All applications for FDA approval must containinformation relating to evidence of safety and efficacy or bio-equivalence to alisted reference drug, product formulation, stability, manufacturing processes,packaging, labelling and quality control.

*NDA Process*

A New DrugApplication (“NDA”) is submitted to the FDA to obtain approval of a new drug,new label indication of an existing drug, or a new formulation of an existingdrug and must contain complete chemistry, manufacture and control (“CMC”),pre-clinical, and clinical safety and efficacy data or a right of reference tosuch data. Before dosing an investigational drug (new chemical entity or newformulation) in healthy human subjects or patients may begin, stringentgovernment requirements for pre-clinical data must be satisfied. Thepre-clinical data, typically obtained from studies in animal species, as wellas from laboratory studies, are submitted in an Investigational New Drugapplication (“IND”), or its equivalent in countries outside the United Stateswhere the relevant clinical trials are to be conducted. The pre-clinical datamust provide an adequate basis for evaluating both the safety and thescientific rationale for the initiation of clinical trials.

Clinical trialsare typically conducted in three phases: Phase I, II and III. Adescription of each of these phases of development is included in ‘‘Researchand Development—Development Process for Brand-Name Pharmaceuticals’’. Data frompre-clinical testing and clinical trials are submitted to the FDA as an NDA formarketing approval. The process of completing clinical trials for a new drug islikely to take several years and require the expenditure of substantialresources. Preparing an NDA or marketing authorization application (“MAA”)involves considerable data collection, verification, analysis and expense, andthere can be no assurance that approval from the FDA will be granted on atimely basis, if at 

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all.The approval process is affected by a number of factors, primarily the risksand benefits demonstrated in clinical trials as well as the severity of thedisease and the availability of alternative treatments. The FDA may deny an NDAor MAA if the regulatory criteria are not satisfied, or such authorities mayrequire additional testing or information.

Even afterinitial FDA approval has been obtained, further studies, including Phase IVpost-marketing studies, may be required to provide additional safety data andwill be required to obtain approval for the use of a product as a treatment forclinical indications other than those for which the product was initiallytested. Also, the FDA or other regulatory authorities require post-marketingreporting to monitor the safety of the approved drug. Results of post-marketingprograms may limit or expand the further marketing of the products. Further, ifthere are any modifications to the drug, including changes in indication,manufacturing process or labelling or a change in manufacturing facility, anapplication seeking approval of such changes must be submitted to the FDA orother regulatory authority. Additionally, the FDA regulates post-approvalpromotional labelling and advertising activities to assure that such activitiesare being conducted in conformity with statutory and regulatory requirements.Failure to adhere to such requirements can result in regulatory actions whichcould have a material adverse effect on the Company’s business, results ofoperations and financial condition.

The FDCAprovides for NDA submissions that may rely in whole or in part on publiclyavailable clinical data on safety and efficacy under section 505(b)(2) ofthe FDCA. The Company and its collaborative partners may be able to rely onexisting publicly available safety and efficacy data in filing NDAs forextended-release products when such data exist for an approvedimmediate-release version of the same chemical entity. However, there is noguarantee that the FDA will accept such applications under section 505(b)(2),or that such existing data will be publicly available or useful. Additionally,under the Prescription Drug User Fee Act of 1992 (the ‘‘PDUFA’’), all NDAsrequire the payment of a substantial fee upon filing, and other fees must bepaid annually after approval. Under the PDUFA, there are circumstances whenwaivers may be granted to the payment of user fees. No assurances exist that,if approval of an NDA is required, such approval can be obtained in a timelymanner, if at all.

*Other Regulation*

ThePrescription Drug Marketing Act (‘‘PDMA’’), which amends various sections ofthe FDCA, imposes requirements and limitations upon drug sampling and prohibitsstates from licensing wholesale distributors of prescription drugs unless thestate licensing program meets certain federal guidelines that include, amongother things, state licensing of wholesale distributors of prescription drugsunder federal guidelines that include minimum standards for storage, handlingand record keeping. In addition, the PDMA sets forth civil and criminalpenalties for violations of these and other provisions. Nevertheless, failureby the Company’s distributors to comply with the requirements of the PDMA couldhave a material adverse effect on the Company’s business, results of operationsand financial condition.

Manufacturersof marketed drugs must comply with cGMP regulations and other applicable lawsand regulations required by the FDA, the Environmental Protection Agency, theDEA, the HPB in Canada, the EMEA in the European Union and other regulatoryagencies. Failure to do so could lead to sanctions, which may include aninjunction suspending manufacturing, the seizure of drug products and therefusal to approve additional marketing applications. The Company seeks toensure that any third party with whom it contracts for product manufacturingwill comply with cGMP. The FDA conducts periodic inspections to ensurecompliance with these rules. However, there can be no assurance that any suchthird parties will be found to be in compliance with cGMP standards. Any suchnon-compliance could result in a temporary or permanent interruption in thedevelopment and testing of the Company’s planned products or in the marketingof approved products, as well as increased costs. Such non-compliance couldhave a material adverse effect on the Company’s business, results of operationsand financial condition. SkyePharma Inc.’s 

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manufacturingfacility located in San Diego, California is regulated by the State ofCalifornia, Department of Health Services, Food and Drug Branch, and the DEA.

***EuropeanUnion Regulation***

The Europeandrug registration system is based on co-operation between the EMEA, establishedin London, and competent national authorities of the member states of theEuropean Union.

A nationalapproval process exists for each country, but this route of drug approval isused less frequently as each country negotiates separately on the merits of theinformation included in the registration dossier, the product claim orindication, and the text that appears on the product label. In 1995, twoadditional registration procedures were enacted.

The first ofthese is a centralized procedure available for new chemical entities,innovative products and delivery systems, and compulsory for biologicallymedicinal products derived from biotechnology, and available at the request ofcompanies for other innovative new products. Under this procedure MarketingAuthorization Applications (MAA’s) are submitted to the EMEA. At the conclusionof the EMEA’s internal scientific evaluation, the opinion of the EMEA’sscientific committee is transmitted to the European Commission, the approval ofwhich will form the basis of a single market authorization applying to thewhole European Union.

The secondprocedure is ‘‘mutual recognition’’ which is mandatory for most conventionalmedicinal products. It is based upon the principle of mutual recognition ofnational authorizations and it provides for the extension of an MAA granted byone member state of the European Union to one or more other member statesidentified by the applicant. Should the original national authorization not berecognized in another member state, the points in dispute are submitted to EMEA’sscientific committee for arbitration.

In both cases,the final decision is adopted by the European Commission, with the assistanceof the EMEA or, in the event of serious disagreement between the member states,by the European Council. In addition, certain European countries outside the EuropeanUnion follow the decisions of the European Commission.

In addition tothe above forms of regulation, price constraints on pharmaceutical productsexist in most countries either through governmental regulation or pressure fromhealthcare organizations. In some countries, governments or governmentalagencies are substantial purchasers of human healthcare products and this alsoimposes an indirect form of regulation on the industry.

**Environmental Matters**

The Company’soperations are subject to a number of environmental laws and regulations ineach of the jurisdictions in which it operates governing, among other things,air emissions, wastewater discharges, the use, handling and disposal ofhazardous substances and wastes, soil and groundwater contamination, as well asemployee health and safety.

The Company’sEnvironmental Policy aims to foster a positive attitude towards the environmentand to raise awareness of employees to responsible environmental practices atall sites operated by the Company. We ensure compliance with all relevantlegislation and regulatory requirements and where practical and economicallyviable we develop standards in excess of such requirements.

Although theCompany is only a small-scale manufacturer, it aims to set a high standardthrough continuous improvement in its environmental performance. The Companynow undertakes routine monitoring of various measures of its environmentalperformance at its main research and development and manufacturing sites inSwitzerland, France and the United States, the results of which are submittedto external review bodies.

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The Companybelieves that its operations are currently in material compliance with allapplicable environmental laws and regulations. In many jurisdictions,environmental requirements may be expected to become more stringent in thefuture, which could affect the Company’s ability to obtain or maintainnecessary authorizations and approvals and result in increased environmentalcompliance costs. While the Company’s management does not believe thatenvironmental compliance or remedial requirements are likely to have a materialeffect on the Company, there is no assurance that future material environmentalcompliance or remedial obligations will not arise in connection with theCompany’s operations or facilities or that such obligations will not have amaterial adverse effect on its business, financial condition or results ofoperations.

**Property,Plants and Equipment**

The Company’s principal executive officesare located in an approximately 850 square meter (9,076 square feet)facility in London, England. The premises are occupied pursuant to a leaseexpiring in December 2015 with a rent review and break option in 2010.Annual rental fees will range from £281,000 to £421,500 during the period. TheCompany is currently in negotiations to sublease approximately half of thisfacility. The Company also leases office space in New York City, New York,which expires August 31, 2011. In August 2003, the Company tookoccupation of the entire building under an eight year tenancy agreement, atwhich time the annual rent was increased from $420,000 per annum to $720,000per annum until August 2008, and $942,500 per annum from August 2008to August 2011. A portion of these premises is currently sub-let by theGroup. The Company is currently seeking to negotiate the termination of its NewYork premises lease.

In Lyon, France, the Company occupies a17,000 square meter (183,000 square feet) pharmaceutical manufacturing andproduction facility and an approximately 2,400 square meter (25,850 squarefeet) adjoining office complex.

In addition, the Company owns a 4,400square meter (47,363 square feet) facility in Muttenz, Switzerland in which itsprincipal research and development, production, small-scale manufacturing,laboratory and workshop operations are housed. In February 1999, theCompany purchased a warehousing and administration facility in Muttenz,Switzerland of approximately 7,300 square meters (78,579 square feet),including approximately 2,770 square meters (29,817 square feet) previouslyoccupied by the Company under a leasing agreement. The building, which wasextended and refitted to house additional administrative, research andlaboratory operations, was officially re-opened on April 7, 2001.

SkyePharma Inc. maintains its principaloperations in two leased buildings in San Diego, California. Its principalbuilding is an approximately 7,600 square meter (82,000 square feet) facilityhousing production, administrative and research and development activities.This facility complies with cGMP regulations and is approved for the commercialmanufacture of DepoDurTM. Clinical trial materials are also manufactured in thisfacility. The future minimum annual rental commitment for this facility willrange from $3.2 million to $4.3 million per year over the balance of theremaining lease term of approximately 10 years based upon pre-establishedannual rent increases.

The second building is an approximately2,020 square meter (21,746 square feet) facility built for the manufacture ofDepoCyt®. This facility complies with cGMP regulations and is approved forcommercial drug manufacturing by the FDA and EMEA. The lease on this facilityexpires in July 2015 and annual rental fees will range from $685,000 to$868,000 in this period.

Additionally, SkyePharma Inc. maintains athird leased facility in San Diego, California, with 427 square meter(4,576 square feet) of primarily warehouse space and an annualized rental costof $52,000. The lease for this property expires in July 2006.

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The Company expects that its obligations inrespect of the SkyePharma Inc facilities will be transferred if the Injectablesbusiness is divested.

SkyePharma Canada maintained its principaloperations in a leased 3,340 square meter (36,000 square feet) building locatedin Montreal, Quebec, Canada During 2003, the Company substantially reduced thestaff of SkyePharma Canada and outsourced its activities to other SkyePharmasites. In August 2003, the Company amended its lease agreement to extendthe lease term to expire December 31, 2013. Concurrently, the Companyentered into a sublease with a third party for the facility expiring in December 31,2013. During 2005 the sublessee went into liquidation. In January 2006 theCompany entered into a new sublease with a new tenant (sublessee). In May 2006the Company and the landlord terminated their lease agreement by the Companyassigning its new sublease directly to the landlord. The Company has no furtherobligations for the facility in Canada.

During 2004, the Company completed thetransfer of the activities of SkyePharma AB to other SkyePharma sites. Thelease on SkyePharma AB’s facility in Malmo, Sweden expired in November 2004and was not renewed. Until June 2005 the Company rented temporary officespace . The Company no longer maintains an office in Sweden.

The Companybelieves that its current facilities are adequate to meet its anticipated needsfor the foreseeable future. For further discussion of the Company’smanufacturing properties, see ‘‘Business Operations—Manufacturing’’ above.

**OrganizationalStructure**

SkyePharma PLC is an international pharmaceutical company and has anumber of wholly- owned subsidiaries.

| **Company**                 | ** ** | ** **  | ** ** | **Country of  incorporation** | ** ** | **% Held**(1) | ** ** |
|-----------------------------|------------|-------------|------------|------------------------------------|------------|--------------------|------------|
| SkyePharma  Canada Inc.*    |       | Canada      |       |                               | 100        | %                  |       |
| SkyePharma  Production SAS* |       | France      |       |                               | 100        | %                  |       |
| Krypton  Limited            |       | Gibraltar   |       |                               | 100        | %                  |       |
| SkyePharma  Holding AG*     |       | Switzerland |       |                               | 100        | %                  |       |
| Jago  Holding AG            |       | Switzerland |       |                               | 100        | %                  |       |
| SkyePharma  AG              |       | Switzerland |       |                               | 100        | %                  |       |
| Jagotec  AG                 |       | Switzerland |       |                               | 100        | %                  |       |
| SkyePharma  Holding Inc.*   |       | U.S.        |       |                               | 100        | %                  |       |
| SkyePharma  US Inc          |       | U.S.        |       |                               | 100        | %                  |       |
| SkyePharma  Inc.            |       | U.S.        |       |                               | 100        | %                  |       |
| SkyePharma  AB*             |       | Sweden      |       |                               | 100        | %                  |       |
| SkyePharma  (Jersey) Ltd*   |       | Jersey      |       |                               | 100        | %                  |       |

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*                    Directly held by SkyePharma PLC.

(1)          Portionof ownership interest equals portion of voting power held.

**Item 4A:**               UnresolvedStaff Comments

None

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**Item 5:**                       Operating and Financial Review and Prospects

Thefollowing is a discussion of the results of operations and financial conditionof SkyePharma PLC. You should read the following discussion, together with thewhole of this Annual Report, including the historical consolidated financialstatements and the related Notes included elsewhere in this Annual Report. Thehistorical consolidated financial information for the years ended December 31,2004 and 2005 included herein have been prepared in accordance withInternational Financial Reporting Standards as adopted by the European Union(IFRS), with a reconciliation of significant differences between IFRS and U.S.GAAP. Prior to 2005, the Company prepared its annual consolidated financialstatements under U.K. Generally Accepted Accounting Principles (U.K. GAAP). Forthe year ended December 31, 2005, the Company has prepared its annualconsolidated financial statements in accordance with International FinancialReporting Standards and International Financial Reporting InterpretationsCommittee (IFRIC) interpretations as adopted by the European Union (EU)applicable to companies reporting under IFRS. There are no material differencesfor the Company between IFRS and IFRS as adopted by the EU. The 2004comparatives have been restated as part of the first-time adoption requirementsof IFRS. As allowed by SEC rules in relation to first-time adoption ofIFRS, only one year of comparatives is reported in this Annual Report. IFRSdiffers in certain respects from accounting principles generally accepted inthe United States (U.S. GAAP). The material differences between IFRS and U.S.GAAP relevant to the Company are explained in Note 37 to the consolidatedfinancial statements of SkyePharma PLC included elsewhere in this AnnualReport.

IFRS 1; First-Time Adoption ofInternational Financial Reporting Standards (“IFRS 1”), sets out the transitionrules which must be applied when IFRS is adopted for the first time. As aresult, certain of the requirements and options in IFRS 1 may result in adifferent application of accounting policies in the 2004 restated informationfrom that which would apply if the 2004 financial statements were preparedusing full retrospective adoption of IFRS. The standard sets out certainmandatory exceptions to retrospective application and certain optionalexemptions. Detailed disclosure on the mandatory exemptions applicable toSkyePharma and the optional exemptions taken are provided within Note 1 to theconsolidated financial statements.

The reconciliation of the Company’s netincome for the two years ended December 31, 2005 primarily reflectsdifferences in the accounting principles under IFRS and U.S. GAAP with respectto investments in associates, convertible bonds, Paul Capital fundingliabilities and revenue recognition.

The reconciliations of the Company’sshareholders’ funds as of December 31, 2005 and 2004, as restated,primarily reflect differences in the accounting principles under IFRS and U.S.GAAP in respect of business combinations, shares issued relating to contingentconsideration, deferred shares to be issued, investments in associates,convertible bonds, Paul Capital funding liabilities and revenue recognition.

In connection with the preparation of theCompany’s Annual Report on Form 20-F, we detected an error inrespect of goodwill in our reconciliations to U.S. GAAP in our 2004 financialstatements. This restatement reduced the Company’s shareholders’ funds underU.S. GAAP but did not affect our net loss under U.S. GAAP or financialstatements under IFRS. Prior to the introduction of IFRS, under U.K. GAAP, in apurchase business combination amounts recorded in excess of assets acquired andliabilities assumed were recorded as goodwill in the accounts of the acquiringentity. Upon consolidation of the newly acquired subsidiary there was no needto translate the goodwill from the subsidiary currency to the reporting entitycurrency. Under U.S. GAAP this goodwill is recorded as an asset acquired in thepurchased entity and the goodwill is recorded in the newly acquired entity. Uponconsolidation of the acquired entity all assets and liabilities of thesubsidiary, including the goodwill amounts, are required to be translated atthe balance sheet date. In prior years we had made no adjustment for thisdifference in accounting treatment between U.K. GAAP and U.S. GAAP in our U.S.GAAP reconciliation. Consequently, we have restated our net assets andshareholders’ funds under U.S. GAAP at 

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December, 2004to reflect the impact of the adjustments made to the Company’s goodwill. As aresult, the Company’s restated U.S. GAAP shareholders’ funds reflect a decreasein net assets of £25.8 million in 2004 (from £84.7 million to £58.9 million).Further information is provided in “Item 15: Controls and Procedures” and Note 37to our consolidated financial statements beginning on page F-1 of this AnnualReport.

The Company hasprepared its audited consolidated financial statements assuming that it willcontinue as a going concern. However, the Company’s independent auditors,PricewaterhouseCoopers LLP, have included an emphasis of matter paragraph relatedto going concern in their auditors’ report, which refers to Note 1 to ourconsolidated financial statements beginning on page F-1 to the Annual Reportstating that thereis uncertainty as to when certain strategic initiatives may be concluded impactingthe Group’s working capital requirements. The auditopinion has not been qualified in this respect. The Company’s audited consolidatedfinancial statements do not include any adjustments that might result from theoutcome of this uncertainty. See “Report of Independent Registered PublicAccounting Firm” and Note1 (a) to our consolidated financial statements beginning on page F-1of this Annual Report.

**EXECUTIVESUMMARY**

The Company’s strategy is to become aleading specialty pharmaceutical company powered through excellence in drugdelivery. It uses multiple technologies to build a product pipeline forcommercialization through out-licensing to co-development and marketingpartners. The Company continually strives to acquire and develop newtechnologies and products to grow its position in the oral and inhalation drugdelivery areas. The Company ultimately plans to selectively market its ownproducts in targeted therapeutic areas. 

The following table indicates the development of the Company’s businessover the course of the two years ended December 31, 2005 in terms ofturnover and losses:

| ** **      | ** ** | **Year Ended  December 31,** | ** ** |
|-----------------|------------|----------------------------------------|------------|
| ** **      | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| ** **      | ** ** | **(in £ millions)**     | ** ** |
| Turnover        |       | 75.2                                   |       | 61.3 |   |
| Operating  loss |       | (3.1                                   | )          | (37.5 | ) |
| Net loss        |       | (18.6                                  | )          | (50.9 | ) |

 

TheCompany’s turnover principally comprises revenues from three sources:

·       contractdevelopment and licensing, including milestone payments and research anddevelopment costs recharged (£27.6 million, 2005: £39.4 million, 2004);

·       royaltiesreceivable from sales by third parties of products developed by the Company(£21.7 million, 2005: £25.9 million, 2004); and

·       manufacturingand distribution related revenue (£12.0 million, 2005: £9.9 million, 2004).

The Company is seeking to reduce itscurrent dependence on milestone payments and increase the proportion of itsrevenues arising from royalties. The amount of milestone payments, if any, thatthe Company receives in any given period is influenced by a number ofunpredictable factors, including scientific developments, the ability of theCompany to find suitable partners, the timing of the negotiation and conclusionof agreements with such partners, the timing of regulatory approvals, themarket introduction of new products and other factors.

Revenues for2005, at £61.3 million, were 18% below the £75.2 million reported in 2004. Thiswas primarily due to Paxil CRTM supply problems which theCompany understands have subsequently been 

49

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resolvedand slower overall market penetration of DepoDurTM by the marketing partner,partly offset by an increase in manufacturing and distribution revenues. Inaddition, the Company undertook a strategic shift away from license terms thatprioritize upfront payments on signature towards deal structures with higherroyalty rates and increased milestone payments tied to product revenue targets.Further, the Company did not license FlutiformTM during 2005. Excludingimpairments of £19.4 million relating to the investments in Astralis,Vital Living and Micap and abortive transaction costs of £2.0 million, theoperating loss increased by £34.4 million to £37.5 million, mainly due to the fallin revenue. The retained loss after the impairments and abortive transactioncosts described above increased by £32.3 million to £50.9 million, mainlydue to the higher one off charges and fall in revenue. Under U.S. GAAP thecompany recorded a net loss of £49.2 million, compared with a net loss of £20.8million in 2004.

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

The preparationof the Consolidated Financial Statements requires the Company to make estimatesand judgements that affect the reported amounts of assets, liabilities,revenues and expenses, and related disclosure of contingent assets andliabilities. The Company bases its estimates and judgements on historicalexperience and on various other assumptions that it considers to be reasonable.Actual results may differ from these estimates under different assumptions orconditions.

**RevenueRecognition**

The Company’srevenue comprises revenues from contract development and licensing, royaltiesand manufacturing and distribution. The Company enters a wide variety ofcollaborative arrangements with its partners from which it may earn all, orsome of, these revenue streams. The application of the Company’s revenue recognitionpolicy to its complex collaboration agreements requires significant estimatesand judgement. In particular, in arrangements with multiple deliverables, theremay be significant judgement in separating the different revenue generatingactivities.

**PaulCapital funding liabilities**

The proceedsreceived from Paul Capital are treated as a liability under IAS 39 and arerecorded within borrowings at the net present value of royalties expected to bepaid to Paul Capital at the effective interest rate at inception of theagreement. Therefore, in order to be able to record the funding liabilitysignificant estimation of certain of the Company’s future cash flows isrequired. Royalty cash flows are periodically reassessed to determine theestimated funding liability. In addition such flows are subject to foreignexchange movements.

**Impairmentof goodwill**

Under theCompany’s accounting policies tests are performed annually to determine whethergoodwill has suffered any impairment. The recoverable amounts of cash-generatingunits have been determined based on value-in-use calculations. Thesecalculations require the use of estimates.

**Impairmentof other intangible assets and property, plant and equipment**

Under theCompany’s accounting policies tests are performed annually to determine whetherother intangible assets and property, plant and equipment have suffered anyimpairment. These calculations require the use of estimates.

**DeferredConsideration**

Provisions fordeferred consideration payable by the Company comprise the fair value ofcontingent consideration arising from acquisitions. The eventual outcome issubject to the Company’s future 

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performanceand certain contractual terms. Provisions are reviewed annually by theDirectors, who make significant judgments as to the estimated fair value of thecontingent consideration. Based on these judgments, changes to the estimatedfair value of the consideration are recorded.

**ContingentLiabilities**

Provisions forcontingent liabilities are dependent upon estimates and assessments of whetherthe criteria for recognition have been met, including estimates by theDirectors as to the probable outcome and the amount of the potential cost ofresolution. Any estimate for such an accrual would be developed in consultationwith external legal advisors handling the Company’s defense in these mattersand would be based upon an analysis of potential outcomes.

**Pensions**

The Companyrecognizes actuarial gains and losses arising from experience adjustments andchanges in actuarial assumptions directly in equity, in the period they haveoccurred, in accordance to the alternative treatment allowed by the amendmentto IAS 19; Employee Benefits—Actuarial Gains and Losses, Group Plans andDisclosures. The costs are assessed in accordance with advice received fromindependent actuaries. These assumptions include inflation rate, rate ofincrease in salaries, discount rate and expected return on plan assets and aredisclosed in Note 26; Retirement benefit obligations to the Company’sConsolidated Financial Statements. The selection of different assumptions couldaffect the future results of the Company.

**Sharebased compensation**

Incentives inthe form of shares are provided to employees under share option, share purchaseand long term incentive plans. The fair value of the employee services receivedin exchange for the grant of the options and rewards is recognized as anexpense. The expense is based upon a number of assumptions. The selection ofdifferent assumptions could affect the future results of the Company.

**Amortizationlives**

Otherintangible assets are recorded at their fair value at acquisition date and areamortized on a straight line basis over their estimated useful economic livesfrom the time they are available for use. Any change in the estimated usefuleconomic lives could affect the future results of the Company.

**Taxation**

Current tax is the expected tax payable onthe taxable income for the year using the tax rates and laws that have beenenacted or substantially enacted at the balance sheet date, and any adjustmentto tax payable in respect of previous years. The Group has open tax issues witha number of revenue authorities and, on the basis of external professionaladvice, continues to believe that it has made adequate provision for anyliabilities that may arise from these open assessments. The ultimate liabilityfor such matters may vary from the amounts provided, and is dependent uponnegotiations with the relevant tax authorities.

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**OPERATINGRESULTS**

**Overview**

The following table sets forth selected items of the Company’sconsolidated income statement:

| ** **      | ** ** | **Year Ended  December 31,** | ** ** |
|-----------------|------------|----------------------------------------|------------|
| ** **      | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| ** **      | ** ** | **(in £ millions)**     | ** ** |
| Turnover        |       | 75.2                                   |       | 61.3 |   |
| Operating  loss |       | (3.1                                   | )          | (37.5 | ) |
| Net loss        |       | (18.6                                  | )          | (50.9 | ) |

 

The Directors have determined that theGroup’s primary reporting format is by business segment with geographicalreporting being the secondary format, based on the risks and returns of thevarious segments. SkyePharma is a speciality pharmaceutical Group, using itsmultiple drug delivery technologies to create a product pipeline forout-licensing to marketing partners. The business segments consist of the Oral,Inhalation and other business and the Injectable business. The geographicsegments of U.K., Europe, North America and Rest of the World reflect the Group’smost significant regional markets.

TheCompany’s revenues are principally generated from three sources:

·       contractdevelopment and licensing, including milestone payments and research anddevelopment costs recharged;

·       royaltiesreceivable from sales by third parties of products developed by the Company;and

·       manufacturingand distribution related revenue.

Historically, the revenue contribution ofeach of the Company’s revenue sources has varied from period to period. This isespecially true of contract development and licensing revenues, the level ofwhich may fluctuate, depending on a number of unpredictable factors, includingscientific developments, the ability of the Company to find suitable partners,the timing of the negotiation and conclusion of agreements with such partners,the timing of regulatory approvals, the market introduction of new products andother factors. As a result, year-to-year comparisons of the Company’s revenuesmay be materially distorted. See ‘‘Item 3: Key Information—Risk Factors—TheCompany’s results of operations tend to fluctuate’’ for more information onfactors influencing the level of the Company’s revenues.

Each of the Company’s revenue sources yieldssignificantly different gross margins. Accordingly, the comparability of grossmargins from period to period is materially affected by the revenue mix in eachperiod. For example, royalty revenues generally result in higher gross marginsthan contract development and licensing revenues. The Company pursues differentstrategies with respect to its various revenue sources. In respect of contractdevelopment and licensing revenue, the Company generally endeavors to recoverits direct costs, its objective being to generate long-term profits fromroyalties on successful product commercializations.

After cost of sales, the Company’s costsprincipally comprise research and development expenses, administrationexpenses, selling and marketing expenses, the costs of the corporate officesand interest expense. As the majority of the Company’s expenses are incurred inSwitzerland, France and the United States, whereas the Company’s revenues aresubstantially denominated in U.S. dollars, the Company’s results of operations,as reported in pounds sterling, may be materially influenced by exchange ratemovements. To minimize the impact of any fluctuations, the Company’s policy hashistorically been to maintain natural hedges. Where it has not been possible touse natural hedges, currency options, accrual 

52

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forward optionsand currency contracts are used. Foreign currency movements did not have amaterial impact on the results of operations in 2005 compared with 2004.

Inflation did not have a significant impacton the Company’s operations during any of the periods presented below.

The Company isnot aware of any other economic or political policies that could materiallyaffect the Company’s operations.

**YearEnded December 31, 2005 compared with the Year Ended December 31,2004**

The following table sets forth selected items of our consolidatedincome statement for the two years ended December 31, 2005.

| ** **                                   | ** ** | **Year to  December 31,** | ** ** |
|----------------------------------------------|------------|-------------------------------------|------------|
| ** **                                   | ** ** | **2004**                            | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **(in £ millions)**  | ** ** |
| ***Consolidated Income Statement***          |       |                                |       |   |   |
| Revenue                                      |       | 75.2                                |       | 61.3 |   |
| Cost of sales                                |       | (28.2                               | )          | (29.2 | ) |
| Gross profit                                 |       | 47.0                                |       | 32.1 |   |
| Selling, marketing and distribution expenses |       | (1.7                                | )          | (5.9 | ) |
| Administration expenses                      |       |                                |       |   |   |
| Amortization of other  intangibles           |       | (2.2                                | )          | (2.1 | ) |
| Other administration expenses                |       | (20.3                               | )          | (35.2 | ) |
|                                         |       | (22.5                               | )          | (37.3 | ) |
| Research and development expenses            |       | (28.0                               | )          | (26.0 | ) |
| Other income/(expense)                       |       | 2.1                                 |       | (0.4 | ) |
| Operating loss                               |       | (3.1                                | )          | (37.5 | ) |
| Finance costs                                |       | (23.9                               | )          | (22.3 | ) |
| Finance income                               |       | 8.6                                 |       | 10.0 |   |
| Share of loss in associate                   |       | —                              |       | (0.8 | ) |
| Loss before income tax                       |       | (18.4                               | )          | (50.6 | ) |
| Income tax expense                           |       | (0.2                                | )          | (0.3 | ) |
| Loss for the year                            |       | (18.6                               | )          | (50.9 | ) |

 

***Turnover***

Thefollowing table breaks down the Company’s turnover by revenue category for thetwo years ended December 31, 2004 and 2005: 

| ** **                          | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|
| ** **                          | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| ** **                          | ** ** | **(in £ millions)**     | ** ** |
| Contract  development and licensing |       | 39.4                                   |       | 27.6 |   |
| Royalties                           |       | 25.9                                   |       | 21.7 |   |
| Manufacturing  and distribution     |       | 9.9                                    |       | 12.0 |   |
| Total                               |       | 75.2                                   |       | 61.3 |   |

 

The Group’srevenues continue to be sensitive to the timing and receipt of milestonepayments and payments received on the signing of new contracts. Revenues for2005, at £61.3 million, were 18% below the £75.2 million reported in 2004. Thiswas primarily due to Paxil CRTM supply problems which the

53

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Companyunderstands have subsequently been resolved and slower overall marketpenetration of DepoDurTM by the marketing partner, partly offset by an increasein manufacturing and distribution revenues. In addition, the Company undertooka strategic shift away from license terms that prioritize upfront payments onsignature towards deal structures with higher royalty rates and increasedmilestone payments tied to product revenue targets. Further, the Company didnot licence FlutiformTM during 2005.

*ContractDevelopment and Licensing*

The following table breaks down the Company’s contract development andlicensing revenues for the two years ended December 31, 2004 and 2005: 

| ** **                                | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------------------------|------------|----------------------------------------|------------|
| ** **                                | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| ** **                                | ** ** | **(in £ millions)**     | ** ** |
| Milestone  payments                       |       | 33.4                                   |       | 22.1 |   |
| Research  and development costs recharged |       | 6.0                                    |       | 5.5 |   |
|                                      |       | 39.4                                   |       | 27.6 |   |

 

Total contractdevelopment and licensing revenue decreased 30% to £27.6 million, compared with£39.4 million in 2004. This was primarily due to the change in the structure ofour license agreements described above. Revenues recognized from milestonepayments and payments received on the signing of agreements amounted to £22.1million in 2005 compared with £33.4 million in 2004. The 2005 total includedrevenues from Sciele Pharma for the U.S. marketing and distribution rights forTriglide® triggered by FDA approval in May 2005,from Mundipharma for the licensing of DepoBupivacaineTM for Europe and fromMaruho for the licensing of DepoBupivacaineTM for Japan. In addition, £5.7 million of revenue was recognized fromGlaxoSmithKline on the phase III clinical trials of Requip® (ropinirole), from AstraZeneca on the phaseIII clinical trials of Pulmicort® HFA-MDI and from Novartis on the phase IIclinical trials of QAB 149. Research and development costs recharged fell by 8%to £5.5 million, compared with £6.0 million in 2004. This was mainly due to afall in the costs recharged to Micap plc in respect of the development of theirmicroencapsulation technology, which has now been completed.

*Royalties*

Royalty incomedecreased by 16% to £21.7 million, compared with £25.9 million in 2004. Royaltyincome in 2005 was derived principally from Paxil CRTM, Xatral® OD, DepoCyt®, Solaraze®, DepoDurTM and Triglide®. Although the Company was able to negotiate an increase in theroyalty rate it receives on GlaxoSmithKline’s sales of Paxil CRTM  from 3% to 4% with effectfrom March 2005 and also received royalties based on budgeted sales whilethe product was temporarily off the U.S. market, royalties were stillnegatively impacted by the continuing supply problems experienced byGlaxoSmithKline. Excluding Paxil CRTM, royalties for SkyePharma’s other productsgrew by 38%. In addition, royalty growth was less than anticipated due toslower overall market penetration of Triglide® and DepoDurTM by marketing partners during theyear.

*Manufacturingand Distribution*

Manufacturingand distribution revenue increased by 21% to £12.0 million, compared with£9.9 million in 2004, mainly due to higher production of clinical trialmaterial and launch quantities for Novartis in respect of QAB 149 and Foradil® CertihalerTM.

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***Deferred income***

During 2005, there was a net reduction indeferred income of £3.5 million under SkyePharma’s revenue recognition policy.The movement in deferred income was:

| ** **                                  | ** ** | **December 31,  2004**        | ** ** | **Received*** | ** ** | **Recognized** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------|------------|------------------------------------|------------|---------------|------------|----------------|------------|-----------------------------|------------|
| ** **                                  | ** ** | **(in £ millions)** | ** ** |
| Contract  development and licensing revenue |       |                               | 14.1       |          |       |           | 24.1       |                        |       |   | (27.6 | ) |   |   | 10.6 |   |   |
|                                             |            |                                    |            |               |            |                |            |                             |            |  |  |  |  |  |  |  |  |

----

*                    Includes exchange adjustments.

***Expenses***

*Cost of Sales*

Cost of sales comprises research anddevelopment expenditures, including:

·       the costsof certain clinical trials incurred on behalf of the Company’s collaborativepartners,

·       the directcosts of contract manufacturing,

·       the directcosts of licensing arrangements, and

·       royaltiespayable.

Cost of sales increased by 4% to £29.2 million in 2005, compared with£28.2 million in 2004. This was mainly due to an increase in manufacturing anddistribution expenses ahead of the approval and launch of Triglide®.

The resulting gross profit decreased 32% to£32.1 million, compared with £47.0 million in 2004.

*Selling,Marketing and Distribution Expenses*

Selling, marketing and distribution expensesincreased significantly to £5.9 million, compared with £1.7 million in 2004.This mainly reflected SkyePharma’s contribution towards the initial launch andmarketing costs of DepoDurTM and Triglide®. No furthermarketing contributions are due in respect of DepoDurTM and contributions onTriglide® will terminate in 2007. TheCompany’s total costs in respect of Triglide® in 2005 amounted to approximately £4.6million.

*Amortization ofother intangibles*

Amortization of intangible assets decreasedslightly to £2.1 million, compared with £2.2 million in 2004.

*OtherAdministration Expenses*

Excluding the impairments of £19.4 millionand abortive transactions costs of £2.0 million described below, other administrationexpenses were £13.8 million in 2005, 12% lower than the £15.6 million reportedin 2004, this reflects the first full year of cost savings following therestructuring started in 2004. Following the Strategic Review and the Group’sdecision to focus on its core oral and pulmonary products and to divest itsinjectable business, the Group no longer views its collaborations withAstralis, Vital Living and Micap as strategic and these investments havetherefore been impaired. In addition, as an injectable project, SkyePharma’sentitlement to negotiate for commercial rights for Psoraxine, Astralis’ keyproduct, is being offered with the injectable business interests. The remaining£2.0 million of the one off charge relates to legal and professional feesrelating to an aborted transaction. Other administration expenses includingimpairments and abortive transaction costs increased by £14.9 million to £35.2million.

55

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*Researchand Development Expenses*

SkyePharma’sown research and development expenses in the year decreased by £2.0 millionfrom £28.0 million in 2004 to £26.0 million in 2005, mainly due to a reductionin expenditure on Pulmicort® HFA-MDI, DepoDurTM and other injectableproducts, partly off set by an increase in expenditure on FlutiformTM and DepoBupivacaineTM in advance of their commencement of phase III clinical trials.

*Otherincome/(expense)*

The otherexpense of £0.4 million comprises a £0.7 million loss due to the movement inthe fair value of the Group’s investment in GeneMedix plc, partly off set by a£0.3 million profit on disposal of part of the Group’s holding of Vectura Groupplc shares.

***Results***

Excluding the impairments of £19.4 millionand abortive transaction costs of £2.0 million described above, the operatingloss was £16.1 million in 2005, compared with £0.4 million in 2004, dueprincipally to the reduction in revenue and to increased marketingcontributions. The operating loss after impairments and abortive transactioncosts increased by £34.4 million to £37.5 million, mainly due to thehigher one off charges and fall in revenue.

The finance costs of £22.3 million (2004:£23.9 million) mainly comprise interest on the Paul Capital funding liabilitiesas well as interest on the convertible bonds. Finance income includes £9.0million (2004: £6.0 million) in respect of a change in the estimated futurepayments to Paul Capital.

The Group’s share of the losses of Astraliswas £0.8 million for 2005, compared with £10,000 in 2004.

The retained loss after impairments andabortive transaction costs  increased by£32.3 million to £50.9 million, also due to the higher one off charges andfall in revenue.

The loss per share after impairments andabortive transaction costs was 8.1 pence, which compares with 3.0 pence in2004.

Foreign currency movements did not have amaterial impact on the results of operations in 2005 compared with 2004.

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Earnings before interest, tax, depreciation amortization andimpairments showed a loss of £10.6 million in 2005, compared with a profitof £8.6 million in 2004. Management believes that earnings before interest,tax, depreciation amortization and impairments provides useful information toinvestors because it provides a clearer picture of the Company’s operatingperformance by excluding items relating to the Company’s financing andinvesting activities.
|                                                                                                                        | ** ** | **Year ended   December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                             | ** ** | **2004**                                     | ** ** | **2005** | ** ** |
| ** **                                                                                                             | ** ** | **(in £ millions)**           | ** ** |
| ***Reconciliation of loss for the year to earnings  before interest, tax, depreciation amortization and impairments*** |       |                                         |       |   |   |
| Loss  for the year                                                                                                     |       | (18.6                                        | )          | (50.9 | ) |
| Finance  costs                                                                                                         |       | 23.9                                         |       | 22.3 |   |
| Finance  income                                                                                                        |       | (8.6                                         | )          | (10.0 | ) |
| Income  tax expenses                                                                                                   |       | 0.2                                          |       | 0.3 |   |
| Depreciation                                                                                                           |       | 6.0                                          |       | 6.2 |   |
| Amortization                                                                                                           |       | 2.2                                          |       | 2.1 |   |
| Impairments                                                                                                            |       | 3.5                                          |       | 19.4 |   |
| Earnings  before interest, tax depreciation, amortization and impairments                                              |       | 8.6                                          |       | (10.6 | ) |

 

***Segmentinformation***

Segmental information on revenue, operating loss excluding the impairmentsand abortive transaction costs described above, and assets and liabilities isas follows:
|                                                                                             | ** ** | **Year ended   December 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                  | ** ** | **2004**                                     | ** ** | **2005** | ** ** |
| ** **                                                                                  | ** ** | **(in £ millions)**           | ** ** |
| *Revenue*                                                                                   |       |                                         |       | 0 |   |
| Injectable                                                                                  |       | 25.6                                         |       | 10.5 |   |
| Oral, Inhalation and other                                                                  |       | 49.6                                         |       | 50.8 |   |
|                                                                                        |       | 75.2                                         |       | 61.3 |   |
| *Operating loss excluding the  impairments and abortive transaction  costs described above* |       |                                         |       |   |   |
| Injectable                                                                                  |       | (1.4                                         | )          | (18.6 | ) |
| Oral, Inhalation and other                                                                  |       | 1.0                                          |       | 2.5 |   |
|                                                                                        |       | (0.4                                         | )          | (16.1 | ) |

 

Business segment data includes an allocation of corporate costs to eachsegment.
|                             | ** ** | **Year Ended   December 31,** | ** ** |
|-----------------------------|------------|----------------------------------------------|------------|
| ** **                  | ** ** | **2004**                                     | ** ** | **2005** | ** ** |
| ** **                  | ** ** | **(in £ millions)**           | ** ** |
| *Assets*                    |       |                                         |       |   |   |
| Injectable                  |       | 60.4                                         |       | 57.1 |   |
| Oral, Inhalation and other  |       | 95.6                                         |       | 93.3 |   |
| Total operating assets      |       | 156.0                                        |       | 150.4 |   |
| *Liabilities*               |       |                                         |       |   |   |
| Injectable                  |       | (30.5                                        | )          | (40.1 | ) |
| Oral, Inhalation and other  |       | (54.0                                        | )          | (41.4 | ) |
| Total operating liabilities |       | (84.5                                        | )          | (81.5 | ) |

 

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**LIQUIDITYAND CAPITAL RESOURCES**

The following is a summary of the Group’s contractual cash obligationsas of December 31, 2005:
|                                      | ** ** | ** **                         | ** ** | **Payments Due by Period** | ** ** |
|--------------------------------------|------------|------------------------------------|------------|-------------------------------------------|------------|
| ** **                           | ** ** | **Total**                          | ** ** | **< 1 year**                 | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **After 5 years** | ** ** |
| ** **                           | ** ** | **(in £ millions)** | ** ** |
| Bank loans                           |       | 2.9                                |       |                                      | 2.3        |   |   |   | 0.6 |   |   |   | — |   |   |   | — |   |   |
| Property mortgage                    |       | 6.9                                |       |                                      | 0.3        |   |   |   | 0.6 |   |   |   | 0.5 |   |   |   | 5.5 |   |   |
| Finance lease liabilities            |       | 0.1                                |       |                                      | 0.1        |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Operating leases                     |       | 27.3                               |       |                                      | 2.3        |   |   |   | 5.0 |   |   |   | 5.4 |   |   |   | 14.6 |   |   |
| Convertible bonds due May 2024  |       | 69.6                               |       |                                      | —     |   |   |   | — |   |   |   | — |   |   |   | 69.6 |   |   |
| Convertible bonds due June 2025 |       | 20.0                               |       |                                      | —     |   |   |   | — |   |   |   | — |   |   |   | 20.0 |   |   |
| Paul Capital funding liabilities     |       | 29.3                               |       |                                      | 3.8        |   |   |   | 7.6 |   |   |   | 7.6 |   |   |   | 10.3 |   |   |
| Provisions                           |       | 1.9                                |       |                                      | —     |   |   |   | — |   |   |   | — |   |   |   | 1.9 |   |   |
| Total Contractual Cash Obligations   |       | 158.0                              |       |                                      | 8.8        |   |   |   | 13.8 |   |   |   | 13.5 |   |   |   | 121.9 |   |   |

 

Capital commitments, contracted for but notprovided in the accounts, were £Nil at December 31, 2005 and £Nil millionat December 31, 2004.

The Group doesnot have any off-balance sheet arrangements that have or are reasonably likelyto have a material effect on the Group’s financial condition, revenues orexpenses, results of operations, liquidity, capital expenditures or capitalresources.

*Cashrequirements*

The Company’s working capital requirementscontinue to be affected by the timing and receipt of milestone payments andpayments received on the signing of new contracts. The Company’s future cashflows will also be impacted by the Company’s change in strategy, principallyits stated aim of moving to sustainable profitability in the near term and itsrefocus to concentrate on oral and pulmonary products. Consequently the Company’snear term working capital requirements are uncertain and sensitive to thetiming of a number of initiatives required to provide the financial flexibilityto implement the new strategy. The Company’s independent auditors,PricewaterhouseCoopers LLP, have included an emphasis of matter paragraphrelated to going concern in their auditors’ report, which refers to Note 1 toour consolidated financial statements beginning on page F-1 to thisAnnual Report stating that there is uncertainty as to when certain strategic initiatives may beconcluded and their effect on the Company’s working capital requirements, whichraises substantial doubt as to the Company’s ability to continue as a going concern.The audit opinion has not been qualified in thisrespect. The Company’s initiatives to improve profitability and the Company’sworking capital requirements include the licensing of FlutiformTM in Europe, the divestment of its injectable businessinterests, which is expected to require shareholder approval, or the U.S.licensing for DepoBupivacaineTM. The investment bank UBS bas been retained to manage the sale of theinjectables business. Following a marketing exercise several expressions ofinterest have been received, due diligence materials have been prepared andmanagement presentations are being made to interested parties. Management arecurrently evaluating the expressions of interest and interested parties havebeen and are continuing to undertake due diligence. Forfurther information on the Company’s new strategy see “Item 4: Information onthe Company—Business Operations—Strategy”.

The Directors have reviewed the workingcapital requirements of the Company for the next twelve months and have areasonable expectation that sufficient funds will be raised from theseinitiatives and that the Company will continue in operational existence for theforeseeable future. There can be no assurance that additional funds will be availableon a timely basis, on favorable terms or at all, or that such funds, if raised,would be sufficient to permit the Company to continue to conduct itsoperations. If 

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adequate fundsare not available, the Company may be required to curtail significantly, ordiscontinue, one or more of its research and development programs.

The Company is an emerging pharmaceuticalcompany and expects to continue to absorb cash until products are fullycommercialized. Much of the Company’s cash requirements are of an investmentnature and are to a great extent discretionary. Funds will be used for theCompany’s own product development efforts and capital expenditure. Capitalcommitments as at December 31, 2005, amounted to £Nil (2004: £Nil).

If the Company’s currently available fundsand internally generated cash flow are not sufficient to satisfy its financingneeds, the Company will be required to seek additional funding through otherarrangements with corporate collaborators, through bank borrowings, throughpublic or private sales of its securities, including equity securities. Anysuch collaboration could result in limitations on the resources the Companycould devote to research, development and commercialization of new products andproduct candidates, if any, as well as its profits therefrom. In addition, theterms of any future bank borrowings could place restrictions on the Company’sability to take certain actions, and any equity financing could result indilution to the Company’s shareholders. The Company does not currently have anycommitted sources of additional capital.

Futureacquisitions or investments, a material decrease in our cash flow fromoperations or the failure of our collaborative partners to provide funding arefactors which could affect our liquidity and working capital. The Company isreliant on collaborative partners and upon its ability to continue to obtainnew development contracts from third parties to further develop andcommercialize its drug delivery technologies. See ‘‘Item 3: Key Information—RiskFactors’’. The Company is dependent on its Geomatrix technologyTM as to which further successful development is uncertainand any failure by the Company’s collaborative partners to provide funding,obtain regulatory approvals and conduct marketing activities could adverselyaffect the Company’s business, results, financial condition and liquidity.

*Sources and uses of cash*
|                                                       | ** ** | **Year ended  December 31,** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                            | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| ** **                                            | ** ** | **(in £ millions)**     | ** ** |
| Net  cash used in operating activities                |       | (3.9                                   | )          | (7.9 | ) |
| Net  cash used in investing activities                |       | (5.3                                   | )          | (3.9 | ) |
| Net cash  generated from financing activities         |       | 2.9                                    |       | 30.6 |   |
| Effect  of exchange rate changes                      |       | (0.4                                   | )          | 0.2 |   |
| Net  (decrease)/increase in cash and cash equivalents |       | (6.7                                   | )          | 19.0 |   |
| Cash  and cash equivalents at beginning of the year   |       | 22.0                                   |       | 15.3 |   |
| Cash and cash  equivalents at end of the year         |       | 15.3                                   |       | 34.3 |   |

 

The Company finances its operationsprimarily by cash generated from the sale of equity and debt securities andfunding provided by collaborative partners and operations.

As discussedabove, a significant proportion of the Company’s cash resources comprisemilestone payments under licensing and marketing agreements between the Companyand its collaborative partners. The amount of milestone payments that theCompany receives in any given period is influenced by a number of unpredictablefactors, including scientific developments, the ability of the Company to findsuitable partners, the timing of the negotiation and conclusion of agreementswith such partners, the timing of regulatory approvals, the market introductionof new products and other factors. Although the Company is seeking to decreasethe proportion of its revenues derived from milestone payments, the 

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uncertaintyassociated with milestone payments means that there is no assurance that theCompany will be able to obtain sufficient funds to satisfy its financing needs.

*Net cashused in operating activities*

During 2005there was a net cash outflow from operating activities after tax of £7.9million, compared with £3.9 million in 2004. The Group paid £2.0 million ofcosts relating to an aborted strategic transaction during the year.

*Net cashused in investing activities*

During the yearthe Group spent £2.6 million on property, plant and equipment and expenditureon intangible assets of £2.3 million mainly relates to the purchase of licensesto intellectual property in the area of pulmonary delivery. The proceeds ondisposal of the Group’s non strategic holding of Vectura shares were £1.6million.

*Net cashgenerated from financing activities*

Cash inflowsfrom financing in 2005 were £30.6 million (2004: £2.9 million). The Group raised£34.8 million net of expenses by means of a rights issue of 125,627,357new Ordinary Shares. During the year the Group issued £20.0 million 8%convertible bonds raising £18.8 million net of expenses. In addition thecompany repaid the £9.8 million balance on the convertible bonds due June 2005.Borrowings of £7.4 million were repaid in the period (2004: £8.6 million).This primarily comprises Paul Capital’s share of the Company’s royalty income.

*Debtinstruments, guarantees and related covenants*

Bank and othernon convertible debt amounted to £9.9 million at December 31, 2005 (2004:£11.1 million), consisting principally of a £6.9 million property mortgagesecured on the assets of Jago (2004: £7.4 million). In addition, the Companyhas 6% convertible bonds due May 2024 of £69.6 million (2004: £69.6million) and 8% convertible bonds due June 2025 of £20.0 million (2004:£Nil). Net debt (excluding the Paul Capital funding liabilities) amounted to£39.2 million (2004: £55.6 million).

*Bankborrowings*

At December 31, 2005 bank borrowingsinclude two amounts due to the Basellandschaftliche Kantonalbank of £0.9million (CHF 2 million) and £0.7 million (CHF 1.5 million) (2004: £0.9 million(CHF 2 million) and £0.7 million (CHF 1.5 million)). Both loans can beterminated with six weeks notice by either party and bear interest at 6.5% and6.0% respectively. Both loans are secured on the assets of Jago and the £0.7million (CHF 1.5 million) loan is guaranteed by SkyePharma PLC.

The Group had aloan as at December 31, 2005 with GE Capital Corp of £1.4 million ($2.4million) (2004: £1.9 million ($3.7 million)). The loan is secured by certainassets of SkyePharma Inc, SkyePharma U.S. Inc and SkyePharma PLC. The loanbears interest at 8.0% and is repayable by instalments until September 2007.

*Convertiblebonds*

In June 2005, the Group issued £20.0million 8% convertible bonds, with a first put after five years by the holderof the bonds, and a final maturity of June 2025. The bonds are convertibleat the option of the holder into Ordinary Shares in the Company at an initialconversion price of 77 pence at any time prior to maturity. The bond contains aprice reset feature such that if on June 3, 2006 the Company’s averageshare price for the preceding 10 days (reset price) is less than the conversionprice, then the conversion price 

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shall beadjusted to the reset price subject to a maximum reduction of 25% in theconversion price. The conversion price was reset to 58 pence on June 3, 2006. Unlesspreviously redeemed or converted, the bonds will be redeemed by the Group attheir principal amount in June 2025. Theconvertible bonds existing at December 31, 2005, due in May 2024,were not affected by this transaction.

On June 19, 2005 £9.8 million ofconvertible bonds due June 2005 were redeemed in full by the Company attheir principal amount.

As a result ofthese transactions the Company has £69.6 million convertible bonds dueMay 2024 at a conversion price of 95 pence, and £20.0 million convertiblebonds due June 2025 at a conversion price of 58 pence.

*Propertymortgage*

AtDecember 31, 2005, the Group had a property mortgage facility with theBasellandschaftliche Kantonalbank of £6.9 million (CHF 15.5 million) (2004:£7.4 million (CHF 16.1 million)). The mortgage is in two tranches, both securedby the assets of Jago. The first tranche of £2.7 million (CHF 6.2 million)bears interest at 2.75% and is repayable by instalments over 20 yearssemi-annually. The second tranche of £4.1 million (CHF 9.3 million) bearsinterest at 2.75% and is repayable by instalments over 50 years semi-annually.

*PaulCapital funding liabilities*

The Group entered into two transactionswith Paul Capital in 2000 and 2002. Under these transactions Paul Capitalprovided a total of $60 million in return for the sale of a portion of thepotential future royalty and revenue streams on a selection of the Group’sproducts.

Whilst thecontractual arrangement with Paul Capital is a royalty agreement under whichroyalties are payable on revenues earned and payments received, the proceedsreceived from Paul Capital meet the definition of a financial liability underIAS 32, and are treated as a financial liability. Royalties paid to PaulCapital are treated as repayment of the liability and interest is charged onthe liability using the effective interest rate at inception of each agreement.The estimated future payments to Paul Capital are discounted using eachcontract’s original effective interest and any adjustment is recognized asincome or expense in the income statement.

*Financelease liabilities*

Obligationsunder hire purchase and finance leases are secured upon the assets to whichthey relate and as at December 31, 2005 £Nil (2004: £0.1 million (SKR 0.9million)) is guaranteed by the Company.

*Financialinstruments*

The Group holdsfinancial instruments to finance its operations and to manage the currencyrisks that arise from these operations. Further information on these financialinstruments is set out in Note 25 of the Notes to SkyePharma’s Consolidated Financial Statements included in Item 17 of thisForm 20-F.

**PRINCIPALDIFFERENCES BETWEEN IFRS AND U.S. GAAP**

The Company’s financial statements havebeen prepared in accordance with IFRS, which differs in certain respects fromU.S. GAAP. Included in Item 17 of this Form 20-F is a reconciliationof the Company’s net income for the years ended December 31, 2005 and 2004and shareholders’ funds as of December 31, 2005 and 2004 from IFRS to U.S.GAAP.

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The reconciliation of the Company’s net income for thetwo years ended December 31, 2005 primarily reflects differences in theaccounting principles under IFRS and U.S. GAAP with respect to investments inassociates, revenue recognition and Paul Capital funding liabilities.

The reconciliations of theCompany’s shareholders’ funds as of December 31, 2005 and 2004 primarilyreflect differences in the accounting principles under IFRS and U.S. GAAP inrespect of business combinations, shares issued relating to contingentconsideration, deferred shares to be issued, convertible bonds, Paul Capitalfunding liabilities and revenue recognition.

**TRANSITION TO IFRS**

Thefinancial information for the year ended December 31, 2005 has beenprepared for the first time in accordance with IFRS. In preparing the financialinformation certain first-time adoption provisions have been applied. The Group’saccounting policies and adjustments made on the implementation of IFRS weredisclosed in the interim results announcement issued on September 28, 2005and the IFRS restatement announcement issued on August 3, 2005 and can befound on the Group’s corporate web site (www.skyepharma.com). Since thepublication of these results the Group has changed its interpretation of theapplication of IAS 39 to the Paul Capital funding liabilities. The restatementresulted in a decrease in the 2004 net interest expense of £5.2 million and inthe liability at December 31, 2004 of £4.3 million.

**NEW ACCOUNTINGSTANDARDS NOT YET ADOPTED**

**IFRS**

SkyePharma hasdecided not to adopt early application of the following standards, amendmentsand interpretations (already adopted or in the process of being adopted by theEuropean Union):

·       IFRS7; Financial Instruments—Disclosures, which is applicable from January 1,2007; and

·       IAS39; Cash Flow Hedge Accounting of Forecast Intragroup Transactions, applicablefrom January 1, 2006.

SkyePharma is currentlyanalyzing the practical consequences of these new standards and interpretationsand the impact of their application on its financial statements. The Group isnot impacted by interpretations IFRIC 2; Members’ Shares in Co-operativeEntities and Similar Instruments, IFRIC 5; Rights to Interests Arising fromDecommissioning, Restoration and Environmental Funds,  IFRIC 6; Liabilities Arising from Participatingin a Specific Market—Waste Electrical and Electronic Equipment and IFRIC 7;Applying the Restatement Approach under IAS 29—Financial Reporting inHyperinflationary Economies,

**IFRIC 8—Scope ofIFRS 2**

In January 2006, theInternational Accounting Standards Board issued IFRIC 8; The Scope of IFRS 2 (“IFRIC8”). IFRIC 8 clarifies that the accounting standard IFRS 2; Share basedpayment, applies to arrangements where an entity makes share-based payments forapparently nil or inadequate consideration. The interpretation explains that,if the identifiable consideration given appears to be less than the fair valueof the equity instruments granted or liability incurred, this situationtypically indicates that other consideration has been or will be received.IFRIC 8 is effective for SkyePharma for the period beginning January 1,2007. SkyePharma is currently reviewing this issue to measure the potentialimpact on its consolidated results of operations, financial position, and cashflows.

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**IFRIC 9—Reassessmentof Embedded Derivatives**

In March 2006, theInternational Accounting Standards Board issued IFRIC 9; Reassessment ofEmbedded Derivatives (“IFRIC 9”). IFRIC 9 concludes that an entity must assesswhether an embedded derivative is required to be separated from the hostcontract and accounted for as a derivative when the entity first becomes aparty to the contract. Subsequent reassessment is prohibited unless there is achange in the terms of the contract that significantly modifies the cash flowsthat otherwise would be required under the contract, in which case reassessmentis required. IFRIC 9 is effective for SkyePharma for the period beginning January 1,2007. SkyePharma is currently reviewing this issue to measure the potentialimpact on its consolidated results of operations, financial position, and cashflows.

**U.S. GAAP**

SFAS 154; Accounting changes and Error Corrections, areplacement of APB Opinion No. 20 and FAS 3.

In June 2005, the Financial Accounting StandardsBoard issued SFAS 154; Accounting Changes and Error Corrections, a replacementof APB Opinion No. 20 and FAS 3 (SFAS 154). This statement replacesOpinion 20 and FAS 3, and changes the requirements for the accounting for, andreporting of, a change in accounting principle. APB Opinion No. 20previously required that most voluntary changes in accounting principle berecognized by including in net income of the period of the change thecumulative effect of changing to the new accounting principle. SFAS 154 requiresretrospective application to prior periods’ financial statements of changes inaccounting principle. SFAS 154 is effective for SkyePharma for the periodbeginning January 1, 2006. SkyePharma is currently reviewing this issue tomeasure the potential impact on the consolidated results of operations,financial position, and cash flows.

FSP No. FAS 115-1 and FSP FAS 124-1;The Meaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments.

In November 2005,the Financial Accounting Standards Board issued this FASB Staff Position (FSP)which addresses the determination as to when an investment is consideredimpaired, whether that impairment is other than temporary, and the measurementof an impairment loss. This FSP also includes accounting considerationssubsequent to the recognition of an other-than-temporary impairment andrequires certain disclosures about unrealized losses that have not beenrecognized as other-than-temporary impairments. The guidance in this FSP amendsFASB Statements No. 115, Accounting for Certain Investments in Debt andEquity Securities, and No. 124, Accounting for Certain Investments Held byNot-for-Profit Organizations, and APB Opinion No. 18, The Equity Method ofAccounting for Investments in Common Stock. FSP FAS 115-1 is effectivefor SkyePharma for the period beginning January 1, 2006. SkyePharma iscurrently reviewing this issue to measure the potential impact on theconsolidated results of operations, financial position, and cash flows.

Other recent accountingpronouncements issued by the FASB (including the Emerging Issues Task Force),the AICPA, and the SEC are not believed by management to have a material impacton SkyePharma’s present or future consolidated financial statements.

**RESEARCH ANDDEVELOPMENT, PATENTS AND LICENSES**

For a discussion of theCompany’s research and development activities, see ‘‘Item 4: Information on theCompany—Business Operations—Research and Development’’ and information onpatents and licenses, see ‘‘Item 4: Information on the Company—BusinessOperations—Patents and Proprietary Rights’’.

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**TREND INFORMATION**

The Company’s results ofoperations have fluctuated materially on a monthly, half yearly and yearlybasis, partly as a result of acquisitions and partly due to the timing ofcontract development and licensing revenues. Therefore, period-to-period andperiod-on-period comparisons are not meaningful at this stage in the Company’sdevelopment. The Company believes that it will continue to experiencefluctuations in its results of operations in the near to medium term.

**Item 6:**        Directors,Senior Management and Employees 

**Directors andSenior Management**
| Name                                   | ** ** | ** ** | ** ** | **Age**                                        | ** ** | **Position** |
|----------------------------------------|------------|------------|------------|------------------------------------------------|------------|--------------|
| Dr. Argeris (Jerry) Karabelas     |       | 53         |       | Non-Executive Chairman                         |
| Frank Condella(1)                      |       | 52         |       | Chief Executive Officer and Executive Director |
| Donald Nicholson(1)                    |       | 48         |       | Finance Director and Executive Director        |
| Dr. Kenneth Cunningham(1)         |       | 53         |       | Chief Operating Officer and Executive Director |
| Dr. David Ebsworth(2)(3) (4) |       | 51         |       | Non-Executive Director                         |
| Alan J Bray(2)(4)                      |       | 62         |       | Non-Executive Director                         |
| R. Stephen Harris(3)(4)                |       | 64         |       | Non-Executive Director                         |

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(1)          Member of ExecutiveCommittee.

(2)          Member of AuditCommittee.

(3)          Member of RemunerationCommittee.

(4)          Member of NominationCommittee.

The following information is provided as at June 23, 2006, the latest practicabledate prior to the filing of this Report.

*Dr. Argeris (Jerry)Karabelas*becameNon-Executive Chairman in February 2006, having been appointed to theBoard in November 2000. Dr Karabelas has more than 23 years’ experience inthe pharmaceutical industry, having spent the majority of his career withSmithKline Beecham. Dr Karabelas is a partner at Care Capital LLC. He waspreviously the CEO of Novartis Pharma AG where he had responsibility forpharmaceuticals, R&D, consumer products, and the generics business. He isalso an external director of the International Partnership for Microbicides andchairman of Human Genome Sciences. He is also a director of NitroMed Inc.,Acura Pharmaceuticals Inc., Inotek Pharmaceuticals Corporation, AnadysPharmaceuticals Inc., Renovo PLC and a member of the scientific advisory boardof Epigenesis Pharmaceuticals LLP and CardioKine Inc. He received a Ph.D inPharmacokinetics from the Massachusetts College of Pharmacy in 1979.

*Frank Condella* became Chief Executive Officer in March 2006and was appointed to the Board in April 2006. Mr Condella has over 25years’ commercial experience in the pharmaceutical industry, having worked forseveral major international companies. Prior to joining SkyePharma he served aspresident of european operations for IVAX Corporation, CEO of FauldingPharmaceuticals, vice-president of the Specialty Business for F. Hoffman-LaRoche Ltd, and vice-president and general manager of Lederle Standard Productsat American Home Products. He holds a BS in Pharmacy degree and an MBA fromNortheastern University in Boston, Massachusetts.

*Donald Nicholson*was named Finance Director in March 1997.He joined the Company in February 1996 as Chief Financial Officer and wasappointed to the Board in March 1997. He has over 20 years of experiencein the healthcare industry including Wellcome plc and Corange Ltd, the holdingcompany of Boehringer Mannheim and DePuy, where he was corporate strategy andfinance director. He is a member of the Institute of Chartered Accountants ofScotland and obtained a B. Com (Hons) degree from the University of Edinburghin 1980.

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*Dr. Ken Cunningham*became Chief Operating Officer in April 2006and was appointed to the Board in May 2006. Dr. Cunningham wasformerly CEO of Arakis Ltd from January 2002 to August 2005,vice-president european affairs for Alza Corporation and vice-presidentclinical development for Sequus Pharmaceuticals. Previously he held a varietyof clinical development and commercial strategy positions in GlaxoWellcome andWarner-Lambert. He is a non-executive director of Xention Discovery Ltd. Dr Cunninghamqualified from St Mary’s Medical School, London University.

*Alan Bray*wasappointedto the Board in September 2004. He is a chartered accountant, having retiredas a senior partner from Deloitte & Touche LLP’s financial servicespractice in May 2004. Mr Bray has worked with retail and investment banks,insurance companies and asset management firms and was seconded for a time tothe Department of Trade and Industry. He was responsible for Deloitte &Touche LLP’s risk management policies and procedures in its financial servicespractice and was a serving member on a DTI Supervisory Board and AuditCommittee. Mr Bray is a Fellow of the Institute of Chartered Accountants inEngland and Wales.

*Dr. David Ebsworth*was appointed to the Board in April 2002. Dr. Ebsworthhas over 25 years of pharmaceutical industry experience. He providesconsultancy services to a variety of clients including venture capitalcompanies. He was chief executive officer of Oxford GlycoSciences PLC until May 2003.Prior to this he held the position of president and general manager of thePharmaceutical Business Group for Bayer AG in Leverkusen, Germany, and has alsoworked for Bayer AG in a series of global positions in Canada, Europe and theUnited States. Dr. Ebsworth is non-executive chairman of Wilex AG, XentionDiscovery Ltd. and Curacyte AG and a non-executive director of Intercell AG,CuraGen Corporation and Renovo PLC and held the same office, until 1998, withSchein Pharmaceutical, Inc. (now known as Watson Pharmaceuticals, Inc). Heobtained a B.Sc in Chemistry and German in 1976 and a Ph.D in IndustrialRelations in 1980 from the University of Surrey.

*R Stephen Harris*was appointed to the Board in November 1995.He has 40 years of experience in the pharmaceutical industry, having worked forICI Pharmaceuticals, Merck, Eli Lilly, Boots, Reckitt & Colman andGensia; and was director of Development and Licensing with Medeva plc. He isnon-executive chairman of Proteome Sciences plc, Sinclair Pharma plc and ConvePLC and non-executive director of Advanced Medical Solutions Group plc, PremierResearch PLC and GeneMedix plc. He is a member of the Pharmaceutical Society ofGreat Britain and graduated with a B.Sc in Pharmacy from the University ofLondon in 1964.

There are no other arrangements or understandings withmajor shareholders, customers or suppliers or others pursuant to which anyperson was selected to serve as a director or senior manager.

There are no provisions within the directors’ servicecontracts that provide for any benefit to accrue to any director upontermination of employment save that salary may be paid in lieu of notice.

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**COMPENSATION**

In 2005, the Company paid £1,523,000 in aggregate toits Directors (10 persons).

Thefollowing table provides certain information regarding the compensation paid toDirectors and Senior Management in 2005. 
| Name                                 | ** ** | ** **                          | ** ** | **Salary** | ** ** | **Bonus** | ** ** | **Pension Benefits** | ** ** | **All Other  Compensation(1)** | ** ** |
|--------------------------------------|------------|-------------------------------------|------------|------------|------------|-----------|------------|---------------------------|------------|-------------------------------------|------------|
| ** **                           | ** ** | **(In £ thousands)** | ** ** |
| Ian Gowrie-Smith                     |       |                                | 140        |       |       |      | —     |                      |       |                                | —     |   |   |   | — |   |   |
| Michael Ashton(2)                    |       |                                | 440        |       |       |      | 110        |                      |       |                                | 77         |   |   |   | 48 |   |   |
| Donald Nicholson                     |       |                                | 250        |       |       |      | 63         |                      |       |                                | 44         |   |   |   | 10 |   |   |
| Air Chief Marshal Sir Michael Beavis |       |                                | 58         |       |       |      | —     |                      |       |                                | —     |   |   |   | — |   |   |
| Alan Bray                            |       |                                | 54         |       |       |      | —     |                      |       |                                | —     |   |   |   | — |   |   |
| Dr. David Ebsworth              |       |                                | 53         |       |       |      | —     |                      |       |                                | —     |   |   |   | — |   |   |
| Stephen Harris                       |       |                                | 51         |       |       |      | —     |                      |       |                                | —     |   |   |   | — |   |   |
| Dr. Argeris (Jerry) Karabelas   |       |                                | 51         |       |       |      | —     |                      |       |                                | —     |   |   |   | — |   |   |
| Dr. Keith Mansford              |       |                                | 49         |       |       |      | —     |                      |       |                                | —     |   |   |   | — |   |   |
| Torao  Yamamoto(3)                   |       |                                | 25         |       |       |      | —     |                      |       |                                | —     |   |   |   | — |   |   |

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(1)          All other compensationincludes company car allowance and medical insurance for directors, officersand their families.

(2)          All other compensationadditionally includes living allowance.

(3)          Resigned July 18,2005.

For further information on share incentives granted toDirectors, see ‘‘Share Ownership’’ below.

The Remuneration Committeeof the Board of Directors administers a bonus plan for the Company’s seniorexecutives (including Executive Directors). Such bonuses are paid at thediscretion of the Remuneration Committee, in recognition of an individual’scontribution to the success of the Company and the achievement of specifiedobjectives. In 2005 the primary performance targets were a combination ofobjective corporate, divisional and specific individual targets. A fundamentalpart of the annual bonus plan is the requirement that a stated proportion ofany cash bonus awarded under the bonus plan each year be deferred through theCompany’s Deferred Share Bonus Plan (the ‘‘Plan’’). The Plan is designed toalign the interests of senior executives with those of the shareholders byencouraging senior executives to build up and maintain shareholdings which aremeaningful in the context of their remuneration. At present, participants arerequired to defer 50% of their bonus through the Plan. The Company currentlyprovides one matching share (each a ‘‘Matching Share’’) for each share acquiredby a participant pursuant to the plan (each an ‘‘Executive Share’’). EachMatching Share will be released three years after it is issued provided thatperformance criteria have been satisfied and the senior executive remains inemployment and the corresponding Executives Shares have not been sold.

**PENSION AND SAVINGSPLANS**

The Group operates various defined contribution plansfor its employees in the U.K. and U.S. The Group’s contributions to these plansare charged to the income statement in the period to which they relate, and theassets are held in separate trustee administered funds. The income statementcharge related to defined contribution plans in detailed in Note 7 of the Notesto SkyePharma’s Consolidated Financial Statements included in Item 17 of this Form 20-F.

The Group operatesunfunded defined benefit schemes in respect of its employees in Switzerlandand France.

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**BOARD PRACTICES**

The Company’s Articles of Association provide that,except as otherwise provided in the Articles or unless otherwise determined byordinary resolution of the Company, the Board of Directors (the ‘‘Board’’)shall consist of not less than three directors. Directors of U.K. companies donot generally have fixed terms of office. At each Annual General Meeting, anumber of directors equal to as close as possible (but not exceeding) one-thirdof the directors must retire from office by rotation, based principally onlength of term of office, and are eligible for re-election. Directors may beappointed by the Company by ordinary resolution of the shareholders. Inaddition, the Board may appoint directors to fill vacancies or as additionaldirectors. Any director so appointed by the Board must retire from office atthe next Annual General Meeting but is then eligible for re-appointment by theshareholders at that meeting. 

The Board has an Executive Committee, an AuditCommittee, a Remuneration Committee and a Nominations and Governance Committee.The Executive Committee is responsible for the executive management of theCompany and is chaired by the Chief Executive. The Committee comprises the Company’sExecutive Directors and senior management and generally meets at least monthlyeither in person or by conference call.

The Audit Committee is responsible for oversight ofauditors, pre-approving all audit and non-audit services, reviewing andappraising the Company’s financial reporting practices and procedures, theadequacy of its system of internal accounting control, reviewing the auditor’sreport describing all critical accounting policies and practices, allalternative treatments within GAAP for material items discussed withmanagement, other material written communications and any matters raised by itsindependent auditors. It also is responsible for reviewing the half-year andfull-year results of the Company and its Interim and Annual Reports andAccounts prior to their submission to the full Board. The Committee reviews thecost-effectiveness, independence and objectivity of the external auditors andpre-approves all permitted non-audit expenditure incurred with the auditors. Itmeets formally at least three times a year. The Audit Committee is comprised ofthe Non-Executive Directors identified under ‘‘Directors and Senior Management’’above and is chaired by Mr. Alan Bray.

The Remuneration Committee is responsible forapproving the remuneration and other benefits, including pension contributions,bonus payments, share incentives and severance payments, of the ExecutiveDirectors and other members of senior management. The Remuneration Committee iscomprised of the Non-Executive Directors identified under “Directors and SeniorManagement”.

The Nominations andGovernance Committee is responsible for making recommendations to the Board onany appointment to the Board and for corporate governance matters. TheNominations and Governance Committee is comprised of the Non-ExecutiveDirectors identified under “Directors and Senior Management’’ and is chaired byStephen Harris.

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**EMPLOYEES**

Thefollowing table shows the distribution of the year end number of employees, byactivity and geographic location, for the last three fiscal years:
|                                                                             | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                  | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| By category of activity:                                                    |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
|    General and Administration                                     |       |                                       | 85         |   |   |   | 71 |   |   |   | 88 |   |   |
|    Marketing Operations                                           |       |                                       | 12         |   |   |   | 5 |   |   |   | 6 |   |   |
|    Research and Development                                       |       |                                       | 212        |   |   |   | 183 |   |   |   | 190 |   |   |
|    Manufacturing Operations                                       |       |                                       | 157        |   |   |   | 161 |   |   |   | 161 |   |   |
|                                                                        |       |                                       | 466        |   |   |   | 420 |   |   |   | 445 |   |   |
| By geographic location:                                                     |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
|    U.K.                                                           |       |                                       | 19         |   |   |   | 16 |   |   |   | 18 |   |   |
|    Switzerland                                                    |       |                                       | 140        |   |   |   | 135 |   |   |   | 147 |   |   |
|    France                                                         |       |                                       | 141        |   |   |   | 144 |   |   |   | 139 |   |   |
|    Sweden                                                         |       |                                       | 29         |   |   |   | 1 |   |   |   | — |   |   |
|    U.S. and Canada                                                |       |                                       | 137        |   |   |   | 124 |   |   |   | 141 |   |   |
|                                                                        |       |                                       | 466        |   |   |   | 420 |   |   |   | 445 |   |   |
| Number of employees with  scientific qualifications:                        |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
|    PhD’s, masters or medical degrees                         |       |                                       | 59         |   |   |   | 49 |   |   |   | 52 |   |   |
|    Scientists  (including PhD’s, masters or medical degrees) |       |                                       | 235        |   |   |   | 234 |   |   |   | 177 |   |   |

 

The Company believes thatit has good relations with its employees and labor unions.

**SHARE OWNERSHIP**

Thefollowing table sets out the interests of Directors and Senior Management inthe Ordinary Shares of the Company (including the interests of their immediatefamilies and persons connected with the Directors) as at June [•], 2006. 
| Name                                | ** ** | ** ** | ** ** | **Number of   Ordinary Shares** | ** ** | **Percentage of   Issued share capital** | ** ** |
|-------------------------------------|------------|------------|------------|------------------------------------------------|------------|--------------------------------------------------------------|------------|
| Dr. Argeris  (Jerry) Karabelas |       |       | 206,667    |                                           |       |                                                         | 0.027      | % |   |
| Frank Condella                      |       |       | 400,342    |                                           |       |                                                         | 0.053      | % |   |
| Donald Nicholson                    |       |       | 955,139    |                                           |       |                                                         | 0.127      | % |   |
| Dr. Kenneth  Cunningham        |       |       | 179,300    |                                           |       |                                                         | 0.024      | % |   |
| Dr. David  Ebsworth            |       |       | 133,000    |                                           |       |                                                         | 0.018      | % |   |
| Alan Bray                           |       |       | 170,000    |                                           |       |                                                         | 0.023      | % |   |
| Stephen Harris                      |       |       | 257,299    |                                           |       |                                                         | 0.034      | % |   |

 

The aggregate number of OrdinaryShares held by the Directors listed in the table above at June 23, 2005 was 2,301,747,representing 0.3% of the total Ordinary Shares outstanding.

The aggregate number of OrdinaryShares underlying the Company’s outstanding options and long-term incentiveplan awards as of June 23, 2006 was 48,983,890.

**Share Option Plans**

The Company has five share option schemes (together,the ‘‘Option Schemes’’). Grants between 1996 and 1998 were made under the 1988Executive Share Option Scheme and the European and North American Scheme andgrants from April 1999 were made under the SkyePharma PLC 1999 ShareOption 

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Scheme, the European andNorth American 1999 Scheme and the SkyePharma Holding Inc. 1999 Stock OptionPlan for SkyePharma Inc. Employees.

Executive Directors and senior executives participatein the SkyePharma PLC 1999 Share Option Scheme, the European and North AmericanScheme and the SkyePharma Holdings Inc. 1999 Share Option Plan as appropriate.Exercise of options granted under these plans is dependent upon totalshareholder return performance measured against a peer group of companies. Alloptions granted to Executive Directors and senior executives during 2003 weremade on this basis and vest after three years on a scale between 0% and 100%depending on the Company’s performance relative to that comparator group ofcompanies. Options granted in 2001 and subsequent years will not be re-testedfollowing vesting. If the stringent performance requirements are not met at theend of the performance period, all options will lapse.

There are two types of options under each scheme:options and Super Options. With respect to options, prior to 2001 individualparticipation limits under the schemes were set at four times individualremuneration. Options granted under the schemes are granted at the market priceruling at the date of grant, are exercisable after three years and up to amaximum of 10 years from date of grant. Options granted under each of theschemes may be exercised only if, over a period of three consecutive years, theshareholder return of the Company exceeds the growth in FTSE All Share Indexover the same period. Prior to 2001, individual participation limits for SuperOptions were set at eight times remuneration. Super Options, which are alsogranted at the market price ruling at the date of grant, are exercisable afterfive years and subject to more challenging performance conditions based upontop quartile performance in the FTSE 250 Index.

***SkyePharma PLC 1999 Share Option Scheme***

The SkyePharma PLC 1999 Share Option Scheme (the ‘‘Scheme’’)is divided into two parts, the first of which is approved by the Inland Revenueand the second of which is unapproved. The unapproved part is designed for thegrant of options to employees, the value of which may exceed the approved limitof £30,000. Except to the extent required to obtain Inland Revenue approval,the two parts of the Scheme are similar in all material respects.

The Scheme is governed by the Rules of the Schemeand is administered by the Board. Eligibility for participation in the Schemeis limited to employees of SkyePharma, including Directors, who work forSkyePharma at least 25 hours per week and are invited to participate by theBoard. No Director or employee is entitled as of right to participate in theScheme.

Options may be granted under the Scheme within sixweeks of the day on which the Company first announces its annual or interimresults in any year in which the Scheme is in operation or any date on whichthe Directors determine that exceptional circumstances exist which justify thegrant of options at that date. No consideration is payable on the grant of anoption. An option may not be granted to an individual selected to participateif the total subscription price thereunder would exceed 200% of the participant’sremuneration in that year. Remuneration includes salary, commission andbonuses, but excludes benefits in kind. In the case of the approved part of theScheme, participants may only be granted options up to a value of £30,000. TheBoard will only grant options to replace those already exercised if they aresatisfied that there has been sustained improvement in the performance of theCompany over not less than a two to three year period prior to such grant.Benefits under the Scheme are not pensionable.

The price per Ordinary Share at which a participantmay acquire Ordinary Shares (the ‘‘Option Price’’) on the exercise of an optionwill be at the discretion of the Board, but shall not be less than the marketvalue (as defined in the Rules) of an Ordinary Share at the date of grant andshall not in any event be less than the nominal value of an Ordinary Share.

Options granted pursuant to the Scheme may not beexercised prior to the third anniversary of their grant and must be exercisedbefore the expiry of ten years from the date of grant. Super Options may not beexercised prior to the fifth anniversary of their grant and must be exercisedbefore the expiry of ten years from the date of grant. Options may be exercisedin whole or in part in respect of any number of 

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Ordinary Shares subject toa minimum of 1,000 Ordinary Shares. An option granted under the Scheme may notbe exercised unless the relevant conditions, as specified by the Directors or acommittee thereof and notified to the participant no later than the date of grant,is satisfied. The performance conditions for Super Options are more challengingand in accordance with criteria recommended by the Association of BritishInsurers.

If a participant leaves the service of the Company byreason of injury, disability, redundancy or normal retirement, or because thecompany by which such participant is employed ceases to be a member of theCompany, such participant will be entitled to exercise any options inaccordance with the rules of the Scheme. If a participant leaves theservice of the Company by reason of death, such participant’s personalrepresentative will be entitled to exercise any options within 12 monthsfollowing the date of such participant’s death. If a participant leaves theservice of the Company for any reason other than the foregoing, in respect ofoption grants prior to 2001 such participant will be entitled to exercise anyoptions within six months of leaving the service of the Company. For optionsgranted during 2001 and subsequently, the options would normally lapse.

If an offeror obtains control of the Company on theoccurrence of (i) a general offer to acquire the whole of the Ordinary Sharecapital of the Company, (ii) pursuant to an offer, an offeror becomingentitled to acquire the shares under Sections 428-430 of the CompaniesAct 1985 (the ‘‘Act’’) or (iii) a compromise or arrangement beingsanctioned by the Court under Section 425 of the Act, then an optionholder and the offeror may agree that the options held can be exchanged forequivalent options in the offeror. Alternatively, if an offeror gains controlpursuant to either a general offer or a compromise or arrangement pursuant to Section 425of the Act, then the option holder may, in the case of a general offer,exercise his or her options within six months following the later of the dateof the acquisition or the date upon which the offer becomes unconditional, or,in the case of a court order sanctioning a compromise or arrangement, withinsix months of that date.

Employees who receive options in excess of the £30,000approved limit are responsible for any National Insurance contributionsrequired in connection with the exercise of the options.

***The European and North American Scheme***

The European and North American Scheme is in allmaterial aspects identical to the SkyePharma PLC 1999 Share Option Scheme,except that eligibility is restricted to employees in Europe and North America.No further grants will be made under this Scheme.

***The SkyePharma Holdings Inc. 1999 Stock Option Planfor SkyePharma Inc. Employees***

The SkyePharma Holdings Inc. 1999 Stock Option Plan(the ‘‘Plan’’) is governed by the rules of the Plan and is administered bythe Board of Directors of the Company acting through the RemunerationCommittee. The Plan is available to all officers and key employees ofSkyePharma Holdings Inc. and its subsidiaries who render services whichcontribute to its management, growth or financial success. Options are grantedat the discretion of the Remuneration Committee. No Director or employee isentitled as of right to participate in the Plan.

Options may be granted under the Plan within six weeksof the day on which the Company first announces its annual or interim resultsin the year which the Plan is in operation or any date on which theRemuneration Committee determines that exceptional circumstances exist whichjustify the grant of options at that date. An option may not be granted to anindividual selected to participate if the total subscription price thereunderwould exceed 200% of his remuneration in that year. Remuneration includessalary, commission and bonuses, but excludes benefits in kind. Benefits underthe Plan are not pensionable.

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If an option is to qualify for tax benefitsunder certain provisions of the U.S. Internal Revenue Code of 1986 as amended(‘‘Incentive Options’’), the aggregate exercise price of options first becomingexercisable in any one calendar year may not exceed U.S.$100,000.

The price per Ordinary Share at which aparticipant may acquire Ordinary Shares (the ‘‘Option Price’’) on the exerciseof an option will be at the discretion of the Remuneration Committee, but shallnot (in the case of Incentive Options) be less than the market value (asdefined in the rules of the Plan), or (in the case of options which arenot Incentive Options) 85% of the market value (as so defined) of an Ordinary Shareat the date of grant and shall not in any event be less than the nominal valueof an Ordinary Share.

Options must be exercised before the expiryof ten years from the date of grant. The earliest date at which an option maybe exercised is at the discretion, in each case, of the Remuneration Committee.The Remuneration Committee may, but is not obliged to, impose conditions on theexercise of an option. In exercising its discretion in these respects, theRemuneration Committee will seek to act in the best interests of the Company,having regard to the conflicting requirements of, on the one hand, the customand practice in the United States with regard to the grant of share options andthe expectations of U.S.-based employees and, on the other hand, the need tooperate the Plan in such a way as complies with best U.K. practice.

The lapsingprovisions and those relating to change of control under the Plan are in allmaterial respects similar to the provisions of the SkyePharma PLC 1999 ShareOption Scheme, as described on page 88.

**OutstandingOptions**

The table belowsets forth certain information concerning the options issued to Directors andofficers of the Company pursuant to the Company’s share option plans as of June 23, 2006. No otherDirectors or officers of the Company have outstanding ordinary options or SuperOptions.

***OrdinaryOptions***
| Name                 | ** ** | ** ** | ** ** | **Number of Ordinary   Shares underlying  Options Outstanding**(1) | ** ** | **Exercise Price** | ** ** | **First Exercise Date** | ** ** | **Last Exercise Date** | ** **           |
|----------------------|------------|------------|------------|---------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------------|------------|----------------------------------|----------------------|
| Donald  Nicholson(2) |       |       | 89,614     |                                                                                        |       |                    | 89.3       | p                                 |       |                             | March 31,  2001 |   |   | March 31, 2008 |   |
|                 |       |       | 179,872    |                                                                                        |       |                    | 66.7       | p                                 |       |                             | April 19,  2002 |   |   | April 19, 2009 |   |
|                 |       |       | 465,301    |                                                                                        |       |                    | 77.4       | p                                 |       |                             | June 12,  2004  |   |   | June 12, 2011 |   |
|                 |       |       | 483,274    |                                                                                        |       |                    | 69.4       | p                                 |       |                             | April,  12, 2005     |   |   | April 12, 2012 |   |

----

(1)          Following completion of the Company’s rights issue announced on September 28,2005 the number and exercise prices applicable to options were adjusted to takeaccount of the dilution in the value of options caused by the rights issue.

(2)          Optionsgranted under the SkyePharma PLC 1999 Share Option Scheme.

***SuperOptions***
| Name             | ** ** | ** ** | ** ** | **Number of Ordinary   Shares Underlying  Options Outstanding** | ** ** | **Exercise Price** | ** ** | **First Exercise Date** | ** ** | **Last Exercise Date** | ** **        |
|------------------|------------|------------|------------|------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------------|------------|----------------------------------|-------------------|
| Donald Nicholson |       |       | 1,064,830  |                                                                                     |       |                    | 54.4       | p                                 |       |                             | May 25, 2004 |   |   |   | May 25, 2009   |   |   |
|                  |            |            |            |                                                                                          |            |                         |            |                                   |            |                                  |                   |  |  |  |  |  |  |  |  |

 

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The aggregatenumber of Ordinary Shares underlying all of the outstanding options as of June 23, 2006 was 34,860,927.Such options have exercise prices ranging between 43.0 pence and 89.3 pence andexpire between April 7, 2007 and September 26,2013. It is the current intention of the Company that it will no longer grantoptions under any of the above option schemes in view of the dilution caused byissuing such shares and the impact of the charge to the Company’s profit andloss account.

**DeferredShare Bonus Plan**

Approximately 25 members of SeniorManagement (including Executive Directors) participate in the Deferred ShareBonus Plan. Eligible participants are any employees of the Company selected bythe Remuneration Committee (‘‘Eligible Employees’’), or a trustee acting onbehalf of such employees. The plan, which is operated by the RemunerationCommittee, is designed to align the interests of participants with those of theshareholders by encouraging executives to build up and maintain shareholdingswhich are meaningful in the context of their remuneration.

Under the Deferred Share Bonus Plan, anEligible Employee is required to defer no less than 50% of his or her bonus andto use the deferred portion to acquire shares in the Company (‘‘ExecutiveShares’’). The Company, in turn, issues to each Eligible Employee one matchingshare (a ‘‘Matching Share’’) for each Executive Share so acquired. In additionto Matching Shares, the Remuneration Committee may award additional deferredshares to Eligible Employees (‘‘Long-Term Incentive Plan Awards’’, or ‘‘LTIPAwards’’).

The maximum value of an Eligible Employee’sLTIP Award will not exceed 100% of an employee’s salary. The first LTIP Awardswere made on May 5, 2004 to 21 participants at a share price of 59.92pence, including awards of 700,534 shares to Michael Ashton and 392,857 sharesto Donald Nicholson. LTIP awards were made on September 20, 2004 to 48participants at a share price of 57.17 pence, on June 3, 2005 to 18 participantsat a share price of 53.92 pence, including awards of 816,024 shares to MichaelAshton and 463,650 shares to Donald Nicholson, and on June 9, 2005 to 48participants at a share price of 53.58 pence. A further LTIP Award was made on April 24,2006 to 49 participants at a share price of 38p, including awards of 1,184,210shares to Frank Condella, 697,368 shares to Donald Nicholson and 657,894 sharesto Ken Cunningham. The maximum value which was awarded was 100% of the relevantparticipant’s salary.

Matching Shares and LTIP Awards grantedunder the Deferred Share Bonus Plan are released to the relevant employee afterthree years provided certain conditions have been satisfied.

For Matching Shares granted prior to 2005,the relevant employee must remain in employment with the Company and theunderlying Executive Shares must not have been sold. For Matching Sharesgranted thereafter, there is an additional requirement that shares be releasedonly if certain performance conditions have been satisfied. Matching Sharesgranted in 2006 will only be released if the total shareholder return of theCompany is at or above the median of a specified comparator group of theCompany’s competitors. In addition, the Remuneration Committee will be requiredto ensure that the underlying financial performance of the Company isconsistent with its total shareholder return performance, by considering the Company’sperformance against financial measures such as turnover, profitability and cashflow. For example, no Matching Shares will be provided at the end of theholding period unless the Company is in profit.

For LTIP Awards, the relevant employee mustremain in employment with the Company and certain performance conditions mustbe satisfied. The principal performance condition for the release of an LTIPAward is measured in terms of the total shareholder return of the Companyrelative to a comparator group. 30% of the LTIP award will be released wherethe Company is at the median of the comparator group rising to full vesting atthe upper quartile. LTIP awards will be released on a straight line basisbetween these two points. In addition, the Remuneration Committee will berequired to ensure that the 

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underlyingfinancial performance of the Company is consistent with its total shareholderreturn performance, by considering the Company’s performance against financialmeasures such as turnover, profitability and cash flow.

Participants have no rights to vote orreceive dividends in respect of shares awarded under the Deferred Share BonusPlan prior to release.

The Company may issue 10% of its shareswithin a ten year period to satisfy share awards to employees under theDeferred Share Bonus Plan and any other share scheme operated by the Companyunder which shares are issued. No more than 5% of the Company’s shares will beissued under the Deferred Share Bonus Plan or any other share scheme operatedby the Company where shares are issued for executives provided that this limitmay be exceeded if the executives are required to satisfy more stretchingperformance requirements. The Remuneration Committee will be monitoring theissue of shares during the ten-year period.

Matching Share awards are not transferableand will lapse if the participant attempts to effect a transfer. If aparticipant disposes of his Executive Shares during the holding period orleaves employment prior to the expiration of the holding period the MatchingShare award will lapse unless the Remuneration Committee in its absolutediscretion determines otherwise. In the event of a takeover, reconstruction,amalgamation or winding up of the Company, all Matching Shares will be releasedunless they are exchanged for matching shares in the acquiring company. In theevent of a merger or demerger of the Company, the Committee may determine thatall Matching Share awards will be released or the number of shares comprised ina Matching Share award may be adjusted.

LTIP Awards are not transferable and willlapse if the participant attempts to effect a transfer. If a participant leavesemployment prior to the expiration of the vesting period, then the LTIP Awardwill lapse. However, on cessation for injury, disability, redundancy,retirement, death or other reasons at the absolute discretion of theRemuneration Committee, there may be proportionate release of LTIP Awardsdepending upon the lapse of time and the satisfaction of the attachedperformance conditions. In the event of a takeover, reconstruction,amalgamation, winding up, merger or de-merger of the Company, there may beproportionate release of LTIP Awards depending upon the satisfaction of theperformance conditions at the time of the transaction. In addition, theRemuneration Committee shall take into account the amount of time elapsed sincethe date of grant of the LTIP Award in determining the proportion of the LTIPAward that shall be released.

On a variation of the capital of theCompany, the number of shares awarded to an employee under the Deferred ShareBonus Plan may be adjusted in such manner as the Remuneration Committeedetermines and a professional advisor of the Company confirms to be fair andreasonable. Following completion of the Company’s rights issue announced on September 28,2005, the number of shares awarded was adjusted to take account of the dilutionin the value of shares awarded under the Deferred Share Bonus Plan caused bythe rights issue. The number of shares awarded prior to 2006 was increased by 4.2%.

The Committee may not grant Matching Sharesor LTIP Awards under the Deferred Share Bonus Plan more than five years afterits adoption unless the Deferred Share Bonus Plan is extended pursuant toshareholder authority for a further period of up to five years.

Subject to the limitations described below,amendments to the rules of the plan may be made at the discretion of theRemuneration Committee. However, the provisions governing eligibilityrequirements, equity dilution, share utilization and individual participationlimits and the adjustments that may be made following a rights issue or anyother variation of capital and the limitations on the number of shares that maybe issued cannot be altered to the advantage of participants without priorshareholder approval, except for minor amendments to benefit the administrationof the Deferred Share Bonus Plan, to take 

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account of achange in legislation or to obtain or maintain favorable tax, exchange controlor regulatory treatment for participants or for the Company and any subsidiary.

Shares acquired, awards and any otherrights granted pursuant to the Deferred Share Bonus Plan are non-pensionable.

The Company hasthe ability to use new issue shares under the Deferred Share Bonus Plan. Anyshares issued under this Deferred Share Bonus Plan are subject to the dilutionlimits set out above for the Option Schemes (i.e., the shares issued under thisDeferred Share Bonus Plan would be aggregated with the shares issued under theOption Schemes when calculating the number of shares issued against thelimits).

**SharePurchase Plan**

It is the Company’s policy to encourageshare ownership at all levels of the business, thereby aligning all employees’interests with those of the shareholders. Accordingly, the Company introducedthe SkyePharma International Share Purchase Plan (‘‘the Employee Plan’’) andthe Employee Stock Purchase Plan in February 2002 to encourage employeesto acquire shares of the Company. All employees (including Executive Directors)are eligible to participate in the Employee Plan under the arrangementsintroduced in their respective countries.

The Employee Plan enables the sameremuneration policy applied to executives under the Deferred Share Bonus Planto be applied to all employee levels, i.e., awarding matching shares on thebasis of the number of employee purchased shares.

Under the rules of the Plan theCompany may award free shares to specific employees, subject to a holdingperiod of three years and continued employment. An award of a total of 33,755shares was made to 13 participants on September 20, 2004 at a share priceof 57.17 pence.

Under the Employee Plan, employees aregiven the opportunity to purchase up to a maximum of £1,500 of Company sharesper year (or local currency equivalent). The Company will then match each sharepurchased with an award of one Ordinary Share (each a ‘‘Matching Share’’). Themaximum ratio of Matching Shares to employee purchased shares is two to onealthough the current ratio adopted by the Company is one Matching Share foreach share purchased. The Matching Shares are subject to a three-year holdingperiod. Normally, the Matching Shares will only be released at the end of thisholding period if the corresponding employee purchased shares have not beensold and the employee is still in employment at that time. Awards under theEmployee Plan lapse if the holder is adjudicated bankrupt, sells his or hershares or ceases to be in the Company’s employment during the restricted perioddetermined by the Directors. Matching Shares cannot be released later than tenyears after the date of the purchase.

The sharesrequired for the Employee Plan are currently being purchased in the marketrather than being issued by the Company. The Company may, however, issue newshares for the purposes of the Employee Plan if it becomes necessary ordesirable in the future.

**Warrants**

*‘D’ and ‘E’Warrants*

In March 2002,the Company issued warrants granting Paul Capital the right, under an agreementto fund new product development, to subscribe for 5 million SkyePharma OrdinaryShares at an exercise price of 73.75 pence, representing a 25% premium to theaverage trading price for the five trading days immediately prior to theclosing date. At June 23, 2006, should the warrants be converted, they represented0.7% of the Company’s Ordinary Share capital. Thewarrants are divided into 2,500,000 

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Series Dand 2,500,000 Series E warrants. The terms are identical save for theexercise dates. The Series D Warrants can be exercised at any time fromthe date of creation of the warrants until December 31, 2008 and the Series EWarrants can be exercised at any time from June 30, 2002 until December 31,2008. There are standard provisions in the deed polls creating the warrantsrelating to provision for adjustment of the warrant rights in certaincircumstances such as a capital reorganization and relating to certainrestrictions on the Company, such as capital distributions. There are a numberof other provisions in the deed polls designed to comply with the SecuritiesAct of 1933.

*‘F’Warrants*

The Companyissued ‘F’ Warrants in December 2003 as part of the $5 million loan withGE Capital Corp. The ‘F’ Warrants entitle GE Capital to subscribe for a totalof 300,000 Ordinary Shares at any time until the repayment date of the loan atan exercise price of £1.20 per Ordinary Share.

*OtherWarrants*

Warrants wereissued to former DepoTech shareholders by the Company in December 1999 aspart of the acquisition of DepoTech. These warrants entitled their holders tosubscribe for 371,353 Ordinary Shares at any time during the period beginning December 31,1999 and ending on February 25, 2005 at an exercise price of $1.142 per OrdinaryShare. All of these warrants lapsed unexercised on February 25, 2005.

**Item 7:**                       Major Shareholders and Related Party Transactions 

**MAJORSHAREHOLDERS**

As far as the Company is aware, it isneither directly nor indirectly owned or controlled by another corporation orany government, and there are no arrangements in place the operation of whichmay result in a change in its control.

As of June 23, 2006, the Company had notice or was aware that thefollowing persons owned more than 3% of the outstanding Ordinary Shares:

| **Ordinary Shares**       | ** ** | ** ** | ** ** | **Number** | ** ** | **% Holding** | ** ** |
|--------------------------------|------------|------------|------------|------------|------------|--------------------|------------|
| HBM  BioVentures (Cayman) Ltd. |       | 77,000,000 |       |       | 10.2       |               |       |
| UBS AG  and Subsidiaries       |       | 45,673,766 |       |       | 6.1        |               |       |
| Dr  Jacques Gonella            |       | 37,412,291 |       |       | 5.0        |               |       |
| HBOS  plc and subsidiaries     |       | 30,680,577 |       |       | 4.1        |               |       |
| Kowa Company  Limited          |       | 30,000,000 |       |       | 4.0        |               |       |

 

The interest of HBM BioVentures (Cayman)Ltd was substantially acquired in 2005 and the interest of UBS AG andSubsidiaries was substantially acquired in 2006.

As of June 23, 2006, there were 16,327 holders of record of Ordinary Shares, of which 23 were U.S. beneficial holders representing 3% of the Ordinary Shares. In addition, at June 23, 2006 there were 115 holders of record of American DepositaryShares (‘‘ADSs’’) representing 5% of the Ordinary Shares.

 

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**RELATEDPARTY TRANSACTIONS**

**CertainArrangements in Respect of the Jago Acquisition**

On July 20,2000, the following shares were issued to Dr. Jacques Gonella, the vendorof Jago, under the Settlement Agreement that established full and finalsettlement of the deferred consideration payable on the acquisition of Jago:

(i)             6 million Ordinary Shares;

(ii)         12 million ‘A’ Deferred Shares which automatically converted into 12million Ordinary Shares in April 2003, following the first commercial saleby GlaxoSmithKline of Paxil CRTM; and

(iii)     12 million ‘B’ Deferred Shares which automatically convert into 12million Ordinary Shares on the Company’s receipt of a royalty statement underthe current License Agreement with GlaxoSmithKline stating that reported salesof Paxil CRTM have exceeded

(a)          $1,000 million during any calendar year prior to January 1,2006 or

(b)         exceeded $337 million between January 1, 2006 and May 3,2006.

The third condition set out above was notsatisfied prior to May 3, 2006 and the Deferred ‘B’ Shares have beentransferred to the Company Secretary for no consideration for him to hold ascustodian.

On issue, the OrdinaryShares were recorded as share capital and share premium at a price of 94.25 pence.The Deferred Shares were recorded within non-equity share capital andnon-equity share premium at a price of 94.25 pence, the fair value of thoseshares, on July 20, 2000.

**CertainArrangements in Respect of the Krypton Acquisition**

On January 8,1996 the Company acquired Krypton from a series of trusts in which IanGowrie-Smith had an interest. The deferred consideration on the acquisition ofKrypton provides that a maximum of 37.5 million Ordinary Shares would beissued contingent on a change in control of the Company at a share price of notless than 80 pence compounded at an annual rate of 10% (£2.08 as at December 31,2005), or satisfaction of various conditions and hurdles which lapsed on December 31,2003. To date, no payments have been made under the Krypton earn-out arrangements.No provision for deferred consideration had been recognized as at December 31,2005.

**OtherArrangements**

At the end of December 1998, IanGowrie-Smith (through a family-owned trust) acquired a 51% interest in 10 East63rd Street Inc., the company whichowns 10 East 63rd Street, a property in NewYork. In December 2002, Mr. Gowrie-Smith acquired a further 49%interest. SkyePharma PLC has been in occupation of approximately half of thatproperty since January 1997, subject to tenancy agreements based uponindependent valuation. In August 2003, the Company took occupation of theentire building under an eight year tenancy agreement, at which time the annualrent was increased from $420,000 per annum to $720,000 per annum until August 2008,and $942,500 per annum from August 2008 to August 2011. A portion ofthese premises is currently sub-let by the Group for $270,000 per annum to August 2006.The Company is currently seeking to negotiate the termination of this lease.

In December 2001, the Company enteredinto several agreements with Astralis Limited concerning the development of anovel injectable vaccine therapy for the treatment of all forms of psoriasis, achronic skin disorder. In a separate transaction, the Company made a totalequity investment in Astralis of $20 million in convertible preferredshares. In January 2004 SkyePharma converted all of its convertiblepreferred shares of Astralis into common stock of Astralis.

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In December 2004 SkyePharma signedconditional stock purchase and assignment agreements with two former Astralisdirectors to acquire 11,160,000 common shares and appoint a further twodirectors representing SkyePharma to the Astralis Board. In March 2005,the conditions of the stock purchase and assignment agreements were satisfiedand the Company completed the purchase of 11,160,000 million shares from thetwo former directors of Astralis in exchange for 5.5 million common shares inthe Company. The Group also acquired 33,900 common shares of Astralis forapproximately £12,000. As at December, 31 2005, the total SkyePharma holdingwas 36,393,900 common shares and 20,000 warrants, representing approximately 39.8%of the common shares. As a result of these events the investment has beentreated as an associated undertaking from December 2004.

Michael Ashton was appointed to theAstralis Board in January 2002. Dr. Gordon Schooley, SkyePharma’sChief Scientific Officer, has also been appointed to the board of Astralis. Forfurther details of the Astralis transactions see ‘‘Item 4: Information on theCompany—Business Operations—Collaborative Arrangements—Other SignificantCollaborative Arrangements’’.

In December 2001, the Company enteredinto several agreements with e-nutriceuticals inc, as a result of which theCompany acquired 1 million convertible preference shares in e-nutriceuticals.In August 2003, e-nutriceuticals merged with Vital Living Inc. and as aresult of the merger SkyePharma acquired 14,204,548 common shares in VitalLiving. In December 2003, the Group acquired 1 million series Dconvertible preferred shares, $1 million of 12% senior secured convertiblenotes due 2008 and 1 million warrants expiring 2008 of Vital Living for £1.2million ($2.0 million).

During 2004 the Group received 687,629 VitalLiving common shares with a value of £42,000 ($80,000) in lieu of interest dueon the 12% senior secured convertible notes. Michael Ashton was appointed tothe Vital Living Board in January 2004. In 2005 the Group received afurther 2,101,422 Vital Living common shares with a value of £68,000 ($120,000)in lieu of interest due on the 12% senior secured convertible notes. In June 2006,the Company entered into an agreement with Vital Living and VTLV LLC, anaffiliate of Vital Living, whereby the Company sold 1 million Series D ConvertiblePreferred Shares and $1 million of 12% Senior Secured Convertible Notes to VTLVLLC for $416,666. Vital Living also issued to the Company an additional 12.5million common shares in Vital Living in settlement of an outstandingreceivable due from Vital Living to the Company. As at June 23, 2006 the totalSkyePharma holding was estimated at 29,493,599 common shares and 1 millionwarrants expiring 2008, representing approximately 23.6% of the common shares.

In 2003, the Company entered into severalagreements with Micap plc concerning the application of micro-encapsulationtechnology to drug delivery. The Company subscribed for 2,500,000 ordinaryshares at a price of 80 pence as part of a fundraising of 3,125,000 ordinaryshares approved by Micap’s shareholders at an Extraordinary General Meeting on January 13,2003. The remaining 625,000 ordinary shares were subscribed for by the SigmaTechnology Venture Fund, an existing shareholder. In 2003 Micap undertook aninitial public offering and as part of the renegotiation of Micap inconjunction with the offering, the Company’s shareholding was converted into5,238,334 ordinary shares, representing approximately 18.2% of the ordinaryshare capital as at December 31, 2003, and 1,830,000 convertible shares.Ian Gowrie-Smith was appointed to the Micap Board in January 2003 andresigned in September 2005.

During 2003,SkyePharma investigated the pharmaceutical applications of Micap’s micro­encapsulationtechnology, in the areas of oral and topical drug delivery. The Company waspaid for its services. In March 2004, the Company exercised an optiongranted to it under one of its agreements with Micap to complete a technologyaccess and license agreement with Micap that allows the Company to use Micap’sencapsulation technology in up to ten nominated pharmaceutical products to beselected by SkyePharma. In March 2005, the Company completed the selectionof its ten nominated compounds. However, it became clear that for those drugscurrently under development there were limited applications and so in September 2005,the Company surrendered all rights under the license agreement back to Micap.

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**Item 8:**                       Financial Information

**CONSOLIDATEDSTATEMENTS AND OTHER FINANCIAL INFORMATION**

See ‘‘Item 17:Financial Statements’’.

**LEGALPROCEEDINGS**

Save as disclosed below, the Company andits subsidiaries are not involved in any legal or arbitration proceedings whichare expected to have, or have had in the past twelve months preceeding the dateof this document, a significant impact on the Company.

On April 12, 2002, a class actioncomplaint was filed by the Action Alliance of Senior Citizens of GreaterPhiladelphia, a non-profit Pennsylvania corporation against Elan CorporationPLC and SkyePharma Inc. On May 15, 2002, a second class action complaintwas filed in the same court by Jeanine Weber, and on June 12, 2002, athird class action complaint was filed in the same court by Charles Frederick.On October 14, 2002, a consolidated class action complaint was filed,covering all three cases, and on the same date the plaintiffs filed a motionrequesting class certification. The consolidated complaint, which is broughtunder the Sherman Anti-trust Act and various state statutes alleges a contractin restraint of trade as well as an attempt to monopolize the market forNaprelan in violation of those laws. The consolidated complaint seeksinjunctive relief and damages, multiple damages, and restitution in unspecifiedamounts. On November 22, 2002, the case was stayed by agreement of theparties pending final resolution of certain patent litigation between Elan andAndrx Pharmaceuticals, Inc. that relates to Elan’s patents coveringNaprelan. The case remains stayed at the present time. The Company believesthat the claims asserted in the consolidated complaint are without merit andwill vigorously defend the action.

In late December 2002,SkyePharma, Inc. was served with a subpoena by the U.S. Federal TradeCommission (‘‘FTC’’), requesting documents relating to the same agreementbetween Elan and SkyePharma at issue in the Andrx lawsuit and the Pennsylvaniaclass action litigation described above. SkyePharma, Inc. has cooperatedwith the FTC’s request and produced documents and provided other information inresponse to the subpoena.

**DIVIDENDPOLICY**

The Company hasnot paid dividends in the last 11 years on its Ordinary Shares and does notintend to pay dividends in the foreseeable future. The Company currentlyintends to retain all of its earnings to finance its operations and futuregrowth. Moreover, under current U.K. law, the Company’s accumulated realizedprofits must exceed its accumulated realized losses (on a nonconsolidatedbasis) before dividends can be paid.

**SIGNIFICANTCHANGES**

There have beenno significant changes since the date of the Consolidated Financial Statementsincluded in this Form 20-F.

**Item 9:**                       The Offer and Listing

**STOCK PRICE HISTORY**

The principal trading market for the OrdinaryShares is the London Stock Exchange (the ‘‘LSE’’).

The table below sets forth, for the periods indicated, the highest andlowest closing market quotations for the Company’s Ordinary Shares as derivedfrom the Daily Official List of the LSE and the highest and lowest sales pricesof the Company’s ADSs on The Nasdaq National Market. The mid-closing price forthe Ordinary Shares on the LSE and the last sale price for the ADSs on TheNasdaq National Market on 

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June 23, 2006 was 32.00pence per Ordinary Share and $5.80 per ADS. See ‘‘Exchange Rate Information’’ with respect to theexchange rates applicable to the periods set forth below.
|                                              | ** ** | **SkyePharma Ordinary Shares**                        | ** ** | **SkyePharma ADSs**          | ** ** |
|----------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                   | ** ** | **High**                                                   | ** ** | **Low**                           | ** ** | **High** | ** ** | **Low** | ** ** |
| ** **                                   | ** ** | **(Pence per Company Ordinary Share)** | ** ** | **($ per Company ADS)** | ** ** |
| **Year ended  December 31, 2001**       |       | 108.00                                                     |       | 49.00                             |       | 15.50 |   | 7.01 |   |
| **Year ended  December 31, 2002**       |       | 80.25                                                      |       | 39.00                             |       | 11.90 |   | 6.25 |   |
| **Year ended  December 31, 2003**       |       | 79.25                                                      |       | 41.50                             |       | 14.00 |   | 6.60 |   |
| **Year ended  December 31, 2004**       |       | 75.25                                                      |       | 50.00                             |       | 13.66 |   | 9.09 |   |
| **Year ended  December 31, 2005**       |       | 66.75                                                      |       | 34.25                             |       | 12.84 |   | 6.24 |   |
| **Year ended  December 31, 2004**       |       |                                                       |       |                              |       |   |   |   |   |
| First Quarter                                |       | 75.25                                                      |       | 58.75                             |       | 13.66 |   | 11.24 |   |
| Second  Quarter                              |       | 69.75                                                      |       | 50.50                             |       | 13.30 |   | 9.09 |   |
| Third Quarter                                |       | 63.00                                                      |       | 50.00                             |       | 11.64 |   | 9.12 |   |
| Fourth  Quarter                              |       | 70.25                                                      |       | 53.00                             |       | 13.60 |   | 9.52 |   |
| **Year ended  December 31, 2005**       |       |                                                       |       |                              |       |   |   |   |   |
| First Quarter                                |       | 66.75                                                      |       | 51.50                             |       | 12.84 |   | 9.40 |   |
| Second  Quarter                              |       | 56.75                                                      |       | 50.25                             |       | 10.77 |   | 9.14 |   |
| Third Quarter                                |       | 60.25                                                      |       | 39.25                             |       | 11.19 |   | 6.70 |   |
| Fourth  Quarter                              |       | 56.00                                                      |       | 34.25                             |       | 9.91 |   | 6.24 |   |
| **Year ended  December 31, 2006**       |       |                                                       |       |                              |       |   |   |   |   |
| First Quarter                                |       | 49.50                                                      |       | 38.00                             |       | 9.52 |   | 6.31 |   |
| Second Quarter (through June 23,  2006) |       | 41.00                                                      |       | 29.50                             |       | 7.48 |   | 5.17 |   |
| **Monthly Data**                             |       |                                                       |       |                              |       |   |   |   |   |
| December 2005                           |       | 53.25                                                      |       | 49.75                             |       | 9.91 |   | 8.42 |   |
| January 2006                            |       | 49.50                                                      |       | 43.00                             |       | 9.52 |   | 7.52 |   |
| February 2006                           |       | 44.25                                                      |       | 39.75                             |       | 8.01 |   | 6.96 |   |
| March 2006                              |       | 43.00                                                      |       | 38.00                             |       | 7.66 |   | 6.31 |   |
| April 2006                              |       | 41.00                                                      |       | 36.50                             |       | 7.37 |   | 6.31 |   |
| May 2006                                |       | 39.75                                                      |       | 35.00                             |       | 7.48 |   | 6.43 |   |
| June 2006  (through June 23, 2006) |       | 36.75                                                      |       | 29.50                             |       | 6.80 |   | 5.17 |   |

 

**STOCK EXCHANGES ON WHICH THE COMPANY’SSHARES ARE LISTED**

The Company’s OrdinaryShares were admitted to the Official List of the LSE on May 3, 1996 andare quoted under the symbol ‘‘SKP’’.

The Company’sADSs are quoted on The Nasdaq National Market under the symbol ‘‘SKYE’’. ADSsare issued by the Bank of New York as depositary under the Deposit Agreement datedas of July 8, 1998. Each ADS represents ten Ordinary Shares.

**Item 10:**                AdditionalInformation

**MEMORANDUM AND ARTICLES OF ASSOCIATION**

The followingsummarizes certain provisions of SkyePharma PLC’s Memorandum and Articles ofAssociation and applicable English law. The summary is qualified in itsentirety by reference to the UK Companies Act and SkyePharma’s Memorandum andArticles of Association. Investors can obtain copies 

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ofthe Memorandum and Articles of Association by contacting the Company Secretaryat the registered office of the Company. On May 30, 2002, the Companyadopted new Articles of Association.

**Objects and Purposes**

The Company wasincorporated in England and Wales on February 18, 1910 under the CompaniesAct 1908 as a Company limited by shares and was re-registered in 1982 as apublic limited company under the Companies Act 1948 to 1980. The Company isregistered under company number 107582. The Company was re-registered asSkyePharma PLC on January 8, 1996.

The objects ofthe Company are set out in full in clause 4 of its memorandum of associationwhich provides, among other things, that the Company’s objects are to carry onin any part of the world any business which, in the opinion of the directors,may seem conveniently carried on in connection with or ancillary to any ofseveral diverse businesses, including applying for, purchasing or otherwiseacquiring and holding, using, developing, selling, licensing or otherwisedisposing of or dealing with patents, copyrights, designs, trade marks, secretprocesses, know-how and inventions and any interest therein.

**Directors**

The businessand affairs of the Company shall be managed by the directors.

A director may not vote or count towards the quorum on any resolutionconcerning any proposal in which he (or any connected person) to his knowledgehas a material interest (other than by virtue of his interest in securities ofthe Company), which includes the voting of compensation awards to themselves.This prohibition does not apply to any of the following matters:

(i)            acontract or arrangement for giving to the director security or as guarantee orindemnity in respect of

a)                moneylent by him or obligations undertaken by him or by any other person at therequest of or for the benefit of the Company or any of its subsidiaries; or

b)               adebt or obligation of the Company or any of its subsidiaries for which hehimself has assumed responsibility in whole or part under a guarantee orindemnity or by the giving of security.

(ii)   where the Company or any of its subsidiaryundertakings is offering securities in which offer the director is, or may be,entitled to participate as a holder of securities or in the underwriting or subunderwriting of which the director is to participate;

(iii) relating to another company in which he and anypersons connected to him do not to his knowledge hold an interest in sharesrepresenting 1 per cent or more of any class of the equity share capital or ofthe voting rights in that company;

(iv)  relating to a pension, superannuation orsimilar scheme or retirement, death or disability benefits scheme or employees’share scheme which has been approved by the inland revenue or is conditionalupon that approval or does not award him any privilege or benefit not awardedto the employees to whom the scheme relates; or

(v)          concerninginsurance which the Company proposes to maintain or purchase for the benefit ofpersons including directors.

A director maynot vote or be counted in the quorum on any resolution which concerns his orher own appointment with the Company or any other company in which the Companyis interested.

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The UKCompanies Act requires a director of a company who is in any way interested ina contract or proposed contract with the Company to declare the nature of hisinterest at a meeting of the directors of the Company.

The directorsmay exercise all the powers of the Company to borrow money. The borrowingpowers contained in the articles of association may only be varied by amendingthe articles of association.

A director mustretire at the conclusion of the first annual general meeting after he reachesthe age of 70 and thereafter annually, and being eligible, may stand forre-election.

A director isnot required to hold an interest in the shares of the Company.

At each annualgeneral meeting of the Company one-third of the directors for the time being(rounded down if necessary) are required to resign from office.

**Classes of Shares**

The authorizedshare capital of the Company is £111,400,000 divided into 1,090,000,000 OrdinaryShares of 10p each, 12,000,000 ‘A’ Deferred Shares of 10p each (which have beenconverted into Ordinary Shares) and 12,000,000 ‘B’ Deferred Shares of 10p each.

***Provisionsset out applying to the Ordinary Shares of 10p each***

(a)           Dividends

Under Englishlaw, dividends are payable on the Company’s Ordinary Shares only out of profitsavailable for distribution, as determined in accordance with accountingprinciples generally accepted in the U.K. and by the Companies Act 1985. TheCompany in general meeting may declare dividends by ordinary resolution, butsuch dividend may not exceed the amount recommended by the directors. Thedirectors may pay interim dividends if it appears they are justified by theCompany’s financial position.

Dividends unclaimed for 12 years after they become due for paymentshall, unless the directors resolve otherwise, be forfeited and revert to theCompany.

(b)          VotingRights

Every memberwho is present in person or represented at any general meeting of the Companyand who is entitled to vote has one vote on a show of hands. On a poll everymember who is present or represented has one vote for every share held.

Holders of OrdinaryShares may appoint a proxy, including a beneficial owner of those shares, toattend, speak and vote on their behalf at any shareholders’ meeting.

If any sum remains unpaid in relation to a member’s shareholding, thatmember is not entitled to vote that share unless the board otherwisedetermines.

(c)           Rightsto share in the Company’s profits

The profits ofthe Company available for dividend and resolved to be distributed shall beapplied in the payment of dividends (if any are declared) to members in accordancewith their respective rights and priorities.

(d)          Rightsto share in any surplus in the event of liquidation

On a winding upof the Company, the balance of the assets available for distribution, afterdeduction of any provision made under the Companies Act 1985 and subject to anyspecial rights attaching to any class of share, shall be applied in repaying tothe members of the Company the amounts paid up on the shares held by them. Anysurplus assets will belong to the holders of any Ordinary Shares then in issueaccording to the numbers of shares held by them.

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(e)           Redemptionand sinking provisions

The Company mayby special resolution create and sanction the issue of shares which are, or atthe option of the Company or the holder are to be liable, to be redeemed,subject to and in accordance with the provisions of the Companies Act 1985. Thespecial resolution sanctioning the issue shall also make such alterations tothe articles of the Company as are necessary to specify the terms on which andthe manner in which the shares are to be redeemed. The Company has noredeemable shares in issue and there are no provisions relating to sinkingfunds in the articles of the Company. The Company has not established a sinkingfund.

(f)             Liabilityto further capital calls by the Company

The directorsmay make calls upon the members in respect of any monies unpaid on theirshares. Each member shall pay to the Company at the time and place specifiedthe amount called on his shares. A call may be revoked or postponed as thedirectors determine.

(g)           Substantialshareholders

There are noprovisions contained in the articles of the Company which discriminate againstany existing or prospective holder of securities as a result of suchshareholder owning a substantial number of shares.

***Provisionsset out applying to the ‘‘B’’ Deferred Shares***

The ‘‘B’’Deferred Shares do not confer any right to participate in any profits of theCompany or to receive notice of or attend any general meeting of the Company.Each ‘‘B’’ Deferred Share would have been redesignated as an Ordinary Share onthe first occasion that total reported sales of GeomatrixTM versions of Paroxetine/Paxil® exceed $1 billion in any calendar year ending prior to January 1,2006 or if such sales exceed $337 million in the period January 1, 2006 toMay 3, 2006.

This conditionwas not satisfied and the ‘B’ Deferred Shares have been transferred to theCompany Secretary for him to hold as custodian.

**Variation of Rights**

Whenever thecapital of the Company is divided into different classes of shares, the specialrights attached to any class of shares may be modified either with the consentin writing of the holders of three quarters of the issued shares of the classor with the sanction of an extraordinary resolution passed at a separategeneral meeting of the holders.

**Shareholders’ Meetings and Notices**

The Company isrequired to hold a general meeting each year as its annual general meeting inaddition to other meetings (called extraordinary general meetings) as thedirectors think fit. The type of meeting will be specified in the noticecalling it. Not more than 15 months may elapse between the date of one annualgeneral meeting and the next.

In the case ofan annual general meeting or the meeting for the passing of a specialresolution (requiring the consent of a 75% majority), 21 clear days’ notice isrequired. In other cases, 14 clear days’ notice is required. The notice mustspecify the place, the date, and the hour of the meeting, and the generalnature of the business to be transacted.

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**Limitations on foreign shareholders**

There are nolimitations imposed by English law or the Company’s Memorandum or Articles ofAssociation on the right of non-residents or foreign persons to hold or votethe Company’s Ordinary Shares other than the limitations that would generallyapply to all of the Company’s shareholders.

**Change of Control**

There are noprovisions in the Articles of Association that would have an effect ofdelaying, deferring or preventing a change in control of the Company and thatwould operate only with respect to a merger, acquisition or corporaterestructuring involving the Company or any of its subsidiaries.

**Disclosure of Interests in Shares**

The UKCompanies Act gives the Company the power to require persons whom it believesto have, or to have acquired in the previous three years, an interest in itsvoting shares to disclose certain information with respect to those interests.Failure to supply the information required may lead to disenfranchisement ofthe relevant shares and a prohibition on their transfer and receipt ofdividends and other payments in respect of those shares. In this context theterm ‘‘interest’’ is widely defined and will generally include an interest ofany kind whatsoever in voting shares, including an interest of a holder ofSkyePharma ADSs. Disclosure of ownership is covered by the London StockExchange Regulations and the Companies Act. Shareholders holding beneficialinterests in excess of 3% are required to disclose this interest.

**MATERIAL CONTRACTS**

At March 31,2000, a Settlement Agreement was signed establishing the full and finalsettlement of the deferred consideration payable to the vendor of Jago, Dr. Gonella.The settlement was approved by shareholders at the Company’s Annual GeneralMeeting held on July 11, 2000 to be made entirely in shares. On July 20,2000, 6 million Ordinary Shares were issued to Dr. Gonella at a price of94.25 pence. Also on July 20, 2000, 12 million ‘‘A’’ and 12 million ‘‘B’’non-equity Deferred Shares were issued. The contingencies determining theconversion of the Deferred Shares into Ordinary Shares are set out in ‘‘Item 7:Major Shareholders and Related Party Transactions–Certain Arrangements inrespect of the Jago Acquisition”. Following the April 2002 U.S. launch ofPaxil CRTM by GlaxoSmithKline and thefirst commercial sale of Paxil CRTM, Dr. Gonella’s 12 million ‘‘A’’Deferred Shares have been converted into 12 million Ordinary Shares. Theconditions for the conversion of the “B” Deferred Shares have not been met andthe “B” Deferred Shares have been transferred to the Company Secretary for noconsideration for him to hold as custodian.

In December 2002,the Company entered into a development and commercialization agreement underwhich Endo Pharmaceuticals Inc. received an exclusive license to the U.S. andCanadian marketing and distribution rights for two of the Company’s patenteddevelopment products, DepoDurTM, an injectable product, and Propofol IDD-Dä, aproduct using the Company’s IDDTM solubilization technology, with options tonegotiate for other development products in the area of pain management. Inreturn, the Company received a $25 million payment on signing in respect ofDepoDurTM. In addition, the Company may receive further milestone paymentstotaling $95 million of which $15 million has been received to date. The totalfurther comprises a $15 million milestone payment when net sales of DepoDurTM reach $125 million in a calendar year, and a $20 million milestonepayment when net sales of DepoDurTM reach $175 million in acalendar year. In addition, the amount comprises total milestone payments of$50 million for Propofol IDD-Dä. The Propofol IDD-Dä milestone payments are payable when the product successfullyachieves certain regulatory milestones, including FDA approval, except that, inthe event the FDA-approved labeling fails to meet the parties’ target labeling,only $10 million becomes payable upon FDA approval, with the remaining $40million being due upon the achievement of certain sales targets. The Companywill also receive a share of each product’s sales revenue that will increasefrom 

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20%to a maximum of 60% of net sales as the products’ combined sales achievecertain thresholds in any given year. The agreement provides for the parties towork together and complete the necessary clinical, regulatory and manufacturingwork for regulatory approval of DepoDurTM and Propofol IDD-Dä in the United Statesand Canada. The Company will be primarily responsible for clinical developmentup to final FDA approval and for product manufacture, including all associatedcosts. Upon approval, Endo will market each product in the United States andCanada with the Company as supplier. In respect of the first product launchedunder the agreement, the Company will pay Endo a fixed contribution in relationto marketing activities undertaken by Endo in respect of the first and secondyear of commercialization. Endo will be responsible for funding and conductingany post-marketing studies and for selling and marketing expenses. Theagreement expires with respect to each product upon the later of the expiry ofall relevant patents and the 15th anniversary of the date of firstcommercialization. The agreement may be terminated in various cases, includingby Endo in the event the Company experiences delays in obtaining regulatoryapproval for the products or fails to achieve the target labeling and, withoutcause, upon sixty days’ notice provided that, in such an event, Endo shall payan undisclosed termination fee to the Company. Although Propofol satisfactorilycompleted Phase II trials in 2004, the Phase III trial has not yet commencedand in April 2006 we agreed with our North American partner Endo toterminate the joint development of Propofol IDD-DTM as the product was unlikelyto achieve its target profile. As a result, the Company believes this producthas limited commercial potential.

In March 2000,the Company entered into an agreement with Bioglan for the manufacture,marketing and distribution of Solaraze® in Europe for anupfront licensing fee and royalty payments. In December 2000, the Companyentered into a further agreement with Bioglan for the license of marketingrights to the United States, Canada and Mexico for Solaraze® , for which Bioglan paid a $14 million fee andagreed to pay further significant milestone payments upon the commercializationof Solaraze®. On May 13, 2000, the Company announced that it had agreed totransfer all rights to market Solaraze® in Europe to Shire for total consideration of up to £15 million. Ofthis amount, £2.1 million is contingent on various conditions, includingSolaraze®’s launch in certain European countries. In addition, SkyePharmawill receive royalties on all European sales from Shire. In addition, theCompany agreed to pay the administrators an amount of £0.7 million. On June 9,2004, Quintiles announced that it had reached agreement to sell assets relatingto its specialty dermatology products company, to Bradley Pharmaceuticals, Inc.The assets sold to Bradley included the marketing rights for the United States,Canada and Mexico with respect to Solaraze®. In August 2004,the Company announcedthat it had received a payment of $5 million from Quintiles for consenting tothe transfer of the U.S., Canadian, and Mexican marketing rights for Solaraze® to Bradley.

In March 1996,the Company entered into a License Agreement with SmithKline Beecham (now partof GlaxoSmithKline) for the development, manufacture and marketing of amodified release version of Paxil®/Seroxat (paroxetine HCL)using a combination of GeomatrixTM systems, known as PaxilCRTM. Paxil® is an FDA-approveddrug that is currently marketed primarily in the United States and Europe andis an immediate release formulation prescribed for central nervous systemdisorders. Paxil CRTM was filed with the FDAby SmithKline Beecham in December 1997 and approved by the FDA in February 1999for the 12.5 and 25mg dosage forms. Subsequently Paxil CRTM has been approved forfour additional indications: panic disorder, the continuous treatment of PMDD,social anxiety disorder and the intermittent treatment of PMDD.

Under the termsof the License Agreement with SmithKlineBeecham, the Company will receiveroyalty payments on net sales of Paxil CRTM until certain patentshave expired. The Company has received such payments since its launch in April 2002.The Company is entitled to an increased royalty rate in any country orterritory in which certain GlaxoSmithKline patents have expired and in whichJagotec AG owns a patent which contains an existing, valid and enforceableclaim that prevents a third party from commercializing a delivery system forparoxetine based on or using the GeomatrixTM technologies. In 

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January 2004,the Company announced that it was in discussion with GlaxoSmithKline over theroyalty rate received on sales of Paxil CRTM. SkyePharma believes, based on thecontract and external legal advice, that it has been entitled to the increasedroyalty rate from September 8, 2003, the date of entry of genericparoxetine in the U.S. market.

On March 4,2005, GlaxoSmithKline announced that the FDA had halted supplies of Paxil CRTM due to manufacturing issues. SkyePharma provided the formulation ofPaxil CRTM, but has no involvement in its manufacturing. GlaxoSmithKline announcedthe resupply of Paxil CRTM on June 27, 2005.

On April 28,2005, the Company announced that it had entered into an amendment agreementwith GlaxoSmithKline in respect of Paxil CRTM. Under the terms of the amendmentagreement, GlaxoSmithKline made a one-time payment of approximately $10 millionto the Company. In addition, the Company will also be entitled to an increasein the royalty rate from 3% to 4% on actual net sales of Paxil CRTM, with effectfrom March 4, 2005. As GlaxoSmithKline was unable to supply Paxil CRTM in the United States between March 4, 2005 and June 27,2005 when GlaxoSmithKline announced the resupply of  Paxil CRTM in theUnited States,GlaxoSmithKline also agreed to pay SkyePharma the same level of royalty onGlaxoSmithKline’s budgeted sales of Paxil CRTM from March 4,2005 while the product remained off the market, subject to other terms of theagreement.

For adescription of transactions with related parties, see ‘‘Item 7: MajorShareholders and Related Party Transactions’’.

**EXCHANGE CONTROLS**

There arecurrently no limitations, either under the laws of the United Kingdom or in theArticles of Association of the Company, on the rights of non-residents to hold,or to vote on Ordinary Shares. Additionally, there are currently no UnitedKingdom foreign exchange control restrictions on the conduct of the Company’soperations or affecting the remittance of dividends on unrestrictedshareholders’ equity.

**TAXATION**

The followingis a summary of the material U.S. federal income and the United Kingdom taxconsequences of owning and disposing of Ordinary Shares or ADSs of the Companyby a U.S. Holder (as defined below) that holds the Ordinary Shares or ADSs ascapital assets.

This summary is not exhaustive of all possible tax considerations anddoes not take into account the specific circumstances of any particularinvestors (such as tax-exempt organizations, life insurance companies, dealersin securities and currencies, traders in securities that elect to use amark-to-market method of accounting, investors liable for alternative minimumtax, investors that actually or constructively own 10% or more of the votingstock of the Company, investors that hold Ordinary Shares or ADSs as part of astraddle or a hedging or conversion transaction, holders who acquired the stockunits or ADS as compensation, or investors whose functional currency is not theU.S. dollar) that may be subject to special rules. In addition to these classesof holders, for United Kingdom tax purposes, special rules may apply alsoto holders that are banks, regulated investment companies or other financialinstitutions.

This summary isbased on the tax laws of the United States (including the Internal Revenue Codeof 1986, as amended, its legislative history, existing effective regulations,published rulings and court decisions) and on the tax laws of the UnitedKingdom all as in effect on the date hereof, as well as on the ConventionBetween the Government of the United States of America and the Government ofthe United Kingdom of Great Britain and Northern Ireland for the Avoidance ofDouble Taxation and the Prevention of Fiscal Evasion with respect to Taxes onIncome and Capital Gains (the ‘‘Treaty’’), as well as the Convention betweenthe Government of the United States and the Government of the United Kingdom ofGreat Britain and Northern Ireland for the Avoidance of Double Taxation andPrevention of Fiscal Evasion with respect to Taxes on Estates of DeceasedPersons and on Gifts (the ‘‘Estate Tax Treaty’’), 

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bothas in effect on the date hereof. These laws are subject to change (or changesin interpretation), possibly with retroactive effect.

In addition,this summary is based in part upon the representations of the Depositary andthe assumption that each obligation in the Deposit Agreement and any relatedagreement will be performed in accordance with their respective terms.

For purposes of this discussion, a ‘‘U.S. Holder’’ is any beneficialowner of Ordinary Shares or ADSs that is for United States federal income taxpurposes:

(1)          acitizen or resident of the United States;

(2)          aUnited States domestic corporation;

(3)          anestate the income of which is subject to United States federal income taxwithout regard to its source; or

(4)          a trustif a court within the United States is able to exercise primary supervision overthe administration of the trust and one or more United States persons have theauthority to control all substantial decisions of the trust.

The discussiondoes not address any aspects of United States taxation other than federalincome taxation. In addition, the following summary of certain U.K. taxconsiderations does not address the tax consequences of owning and disposingthe Company’s Ordinary Shares or ADSs by a U.S. Holder:

(1)          that isresident (or, in the case of an individual, ordinarily resident) in the UnitedKingdom for U.K. tax purposes,

(2)          whoseholding of Ordinary Shares or ADSs is effectively connected with a permanentestablishment in the United Kingdom through which such U.S. Holder carries onbusiness activities or, in the case of an individual who performs independentpersonal services, with a fixed base situated therein,

(3)          who isnot otherwise eligible for benefits under the Treaty with respect to income andgain from the Ordinary Shares or ADSs.

***Prospectiveinvestors are urged to consult their own tax advisors regarding the UnitedStates federal, state and local and the United Kingdom and other taxconsequences of owning and disposing of Ordinary Shares and ADSs. Inparticular, a U.S. Holder should confirm with its advisor whether it iseligible for the benefits of the Treaty and should discuss the consequences offailing to be so eligible.***

In general, andtaking into account the earlier assumptions, for United States federal incomeand United Kingdom income tax purposes, holders of ADRs evidencing ADSs will betreated as the beneficial owners of the Ordinary Shares represented by thoseADSs. Exchange of Ordinary Shares for ADRs, and ADRs for Ordinary Shares,generally will not be subject to United States federal income tax or to UnitedKingdom income tax.

**Taxation of Dividends**

***UnitedKingdom Taxation***

The taxation ofdividends paid in respect of the Ordinary Shares depends upon the law andpractice in force at the time dividends are paid. The following summary isbased upon current law and practice, which may change by the time that anydividends become payable.

Withholding tax is not levied by the United Kingdom on payment ofdividends.

U.S. Holderswho are not resident or ordinarily resident for tax purposes in the UnitedKingdom and have no other source of U.K. income are not required to file a U.K.income tax return.

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***United StatesTaxation***

Under the United Statesfederal income tax laws, and subject to the passive foreign investment companyrules discussed below, the gross amount of any dividend paid to a U.S.Holder by the Company out of its current or accumulated earnings and profits(as determined for United States federal income tax purposes) is subject toUnited States federal income taxation. Dividends paid to a non-corporate U.S.holder in taxable years before January 1, 2011 that constitute qualifieddividend income will be taxable to the holder at a maximum tax rate of 15%provided that the Ordinary Shares or ADSs are held for more than 60 days duringthe 121-day period beginning 60 days before the ex-dividend date and theholder meets other holding period requirements. Dividends paid by the Companywith respect to its Ordinary Shares or ADSs generally will be qualifieddividend income.

The dividend is taxable tothe U.S. Holder when the holder, in the case of Ordinary Shares, or theDepositary, in the case of ADSs, receives the dividend, actually orconstructively. The dividend will not be eligible for the dividends-receiveddeduction generally allowed to United States corporations in respect ofdividends received from other United States corporations. The amount of thedividend distribution includible in income of a U.S. Holder will be the U.S.dollar value of the British pounds sterling payments made, determined at thespot British pound sterling/U.S. dollar rate on the date such dividenddistribution is includible in the income of the U.S. Holder, regardless ofwhether the payment is in fact converted into U.S. dollars. Generally, any gainor loss resulting from currency exchange fluctuations during the period fromthe date the dividend payment is includible in income to the date such paymentis converted into U.S. dollars will be treated as ordinary income or loss andwill not be eligible for the special tax rate applicable to qualified dividendincome. Such gain or loss will generally be from sources within the UnitedStates for foreign tax credit limitation purposes. Distributions in excess ofcurrent and accumulated earnings and profits, as determined for United Statesfederal income tax purposes, will be treated as a return of capital to theextent of the U.S. Holder’s basis in the Ordinary Shares or ADSs and thereafteras capital gain.

Dividends will be incomefrom sources outside the United States, but generally will be ‘‘passiveincome’’ or, in the case of certain holders, ‘‘financial services income’’which is treated separately from other types of income for foreign tax creditlimitation purposes. Because a U.S. Holder will not be subject to UnitedKingdom withholding tax, receipt of a dividend will not entitle the U.S. Holderto a foreign tax credit.

**Taxation of CapitalGains**

***United Kingdom Taxation***

U.S. Holders who are notresident or (in the case of individuals only) ordinarily resident for taxpurposes in the United Kingdom will not be liable for U.K. tax on capital gainsrealized on the disposal of their ADSs or Ordinary Shares unless such ADSs or OrdinaryShares are used, held or acquired for the purposes of a trade, profession orvocation carried on in the United Kingdom through a branch or agency.

***United States Taxation***

Under the United States federal income tax laws, andsubject to the passive foreign investment company rules discussed below,upon a sale or other disposition of Ordinary Shares or ADSs, a U.S. Holder willrecognize gain or loss for United States federal income tax purposes in anamount equal to the difference between the U.S. dollar value of the amountrealized and the U.S. Holder’s tax basis (determined in U.S. dollars) in such OrdinaryShares or ADSs. Generally, such gain or loss will be long-term capital gain orloss if the U.S. Holder’s holding period for such Ordinary Shares or ADSsexceeds one year, and will be from sources within the United States for foreigntax credit limitation purposes. Long-term capital gain of a non-corporate U.S.Holder that is recognized before January 1, 2011 is taxed at a maximumrate of 15%.

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**Passive ForeignInvestment Company Rules**

The Company believes that its Ordinary Shares and ADSsshould not be treated as the stock of a passive foreign investment company, orPFIC, for United States federal income tax purposes. However, this conclusionis a factual determination made annually and thus may be subject to change.

In general, we willbe a PFIC with respect to a U.S. Holder if, for any taxable year in which the U.S.Holder holds the Company’s Ordinary Shares or ADSs:

(1)   75% or moreof the gross income of the Company for the taxable year is passive income; or

(2)   50% or moreof the value (determined on the basis of quarterly averages) of the Company’sassets is attributable to assets that produce or are held for the production ofpassive income.

Passive income generally includes dividends, interest,royalties, rents (other than certain rents and royalties derived in the activeconduct of a trade or business) annuities and gains from assets that producepassive income of this nature. If a foreign corporation owns at least 25% byvalue of the stock of another corporation, the foreign corporation is treatedfor purposes of the PFIC tests as owning its proportionate share of the assetsof the other corporation, and as receiving directly its proportionate share ofthe other corporation’s income.

If the Company weretreated as a PFIC, a U.S. Holder that did not make a qualified electing fund (‘‘QEF’’)or mark-to-market election, each as described below, would be subject tospecial rules with respect to (a) any gain realized on the sale orother disposition of Ordinary Shares or ADSs and (b) any excessdistribution by the Company to the U.S. Holder (generally, any distributions tothe U.S. Holder in respect of the Ordinary Shares or ADSs during a singletaxable year that are greater than 125% of the average annual distributionsreceived by the U.S. Holder in respect of the Ordinary Shares or ADSs duringthe three preceding taxable years or, if shorter, the U.S. Holder’s holdingperiod for the Ordinary Shares or ADSs). Under these rules:

(1)         the gain or excessdistribution would be allocated ratably over the U.S. Holder’s holding periodfor the Ordinary Shares or ADSs;

(2)         the amount allocated tothe taxable year in which the gain or excess distribution was realized would betaxable as ordinary income;

(3)         the amount allocated toeach prior year, with certain exceptions, would be subject to tax at thehighest tax rate in effect for that year; and

(4)         the interest chargegenerally applicable to underpayments of tax would be imposed in respect of thetax attributable to each such year.

A U.S. Holder that makes a QEF election would becurrently taxable on its pro rata share of the Company’s ordinary earnings andnet capital gain (at ordinary income and capital gain rates, respectively) foreach taxable year of the Company, regardless of whether distributions wereactually received. The U.S. Holder’s basis in the Ordinary Shares or ADSs wouldbe increased to reflect taxed but undistributed income. Distributions of incomethat had previously been taxed would result in a corresponding reduction ofbasis in the Ordinary Shares or ADSs and would not be taxed again as adistribution to the U.S. Holder.

Special rules apply with respect to thecalculation of the amount of the foreign tax credit with respect to excessdistributions by a PFIC or, in certain cases, QEF inclusions.

A U.S. Holder would not be subject to the PFIC tax rules describedabove if the U.S. Holder makes a mark-to-market election with respect to its OrdinaryShares or ADSs. Instead, in general, an electing U.S. Holder would include ineach year, as ordinary income, the excess, if any, of the fair market value ofthe Ordinary Shares or ADSs at the end of the taxable year over their adjustedbasis. These amounts of 

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ordinary income would notbe eligible for the favorable tax rates applicable to qualified dividend incomeor long term capital gains and would be permitted an ordinary loss in respectof the excess, if any, of the adjusted basis of the Ordinary Shares of ADSsover their fair market value at the end of the taxable year (but only to theextent of the net amount of previously included income as a result of themark-to-market election). The electing U.S. Holder’s basis in the Ordinary Sharesor ADSs would be adjusted to reflect any such income or loss amounts.

In addition, notwithstanding any election by a U.S.Holder with regard to the Ordinary Shares or ADSs, dividends received by theU.S. Holder from the Company would not constitute qualified dividend income tothe U.S. Holder, if the Company were a PFIC either in the taxable year of thedistribution or the preceding taxable year. Dividends received that do not constitutequalified dividend income would not be eligible for taxation at the 15% maximumrate applicable to qualified dividend income. Instead, the gross amount of anysuch dividend paid by the Company out of its accumulated earnings and profits(as determined for United States federal income tax purposes) would beincludible in the U.S. Holder’s gross income and would be subject to tax atrates applicable to ordinary income.

A U.S. Holder who owns OrdinaryShares or ADSs during any year that the Company is a PFIC must file InternalRevenue Service Form 8621.

**Additional UnitedKingdom Tax Considerations**

***Gift and Inheritance Taxes***

An individual who is domiciled in the United Statesand who is not a national of the United Kingdom for the purposes of the EstateTax Treaty will normally not be subject to U.K. inheritance tax in respect ofthe Ordinary Shares or ADSs on the individual’s death or on a gift of the OrdinaryShares or ADSs during the individual’s lifetime, provided that any applicableU.S. federal gift or estate tax liability is paid, unless the Ordinary Sharesor ADSs are part of the business property of a permanent establishment of anenterprise of the individual in the United Kingdom or pertain to a fixed basein the United Kingdom of the individual used for the performance of independentpersonal services.

Where the ADSs or OrdinaryShares have been placed in trust by a settlor who, at time of settlement, was aU.S. Holder, the ADSs or Ordinary Shares will normally not be subject to U.K.inheritance tax unless the settlor, at the time of settlement, was notdomiciled in the United States and was a U.K. national. In the exceptional casewhere the ADSs or Ordinary Shares are subject both to U.K. inheritance tax andto U.S. federal gift or estate tax, the Estate Tax Treaty generally providesfor the tax paid in the United Kingdom to be credited against tax paid in theUnited States or for tax paid in the United States to be credited against taxpayable in the United Kingdom based on priority rules set out in thatTreaty.

***Stamp Duty and Stamp Duty Reserve Tax***

A transfer for value of the Ordinary Shares willgenerally be subject to U.K. ad valorem stamp duty, normally at the rate of0.5% of the amount or value of the consideration given for the transfer,rounded up to the nearest £5. Stamp duty is normally a payable by thePurchaser.

An agreement to transfer Ordinary Shares for money ormoney’s worth will normally give rise to a charge to stamp duty reserve tax (‘‘SDRT’’)at the rate of 0.5% of the amount or value of the consideration unless aninstrument of transfer of the Ordinary Shares has been executed in pursuance ofthe agreement and duly stamped. SDRT is a liability of the Purchaser.

Stamp duty is charged at the higher rate of 1.5%, roundedup to the nearest £5, or SDRT at the rate of 1.5%, of the amount or value ofthe consideration, or in some circumstances the value of the Ordinary Shares,on a transfer or issue of the ordinary shares (a) to, or to a nominee for,a person whose business is or includes the provision of clearance services or (b) to,or to a nominee for, a person whose business is or 

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includes issuingdepositary receipts. An election is available whereby clearance services may,under certain conditions, elect for the 0.5% rate of SDRT to apply to atransfer of shares into, and to transactions within, the service.

In accordance with the terms of the Deposit Agreement,any tax or duty payable by the Depositary or the Custodian of the Depositary onthe deposit of Ordinary Shares will be charged by the Depositary to the holderof the ADS.

No U.K. stamp duty will be payable on the acquisitionor transfer of an ADS evidenced by an ADR or beneficial ownership of an ADR,provided that any instrument of transfer or written agreement to transferremains at all times outside the United Kingdom. An agreement for the transferof an ADR or beneficial ownership of an ADR will not give rise to a liabilityto SDRT.

Any transfer for value ofthe underlying Ordinary Shares represented by ADSs evidenced by ADRs, may giverise to a liability to U.K. stamp duty or SDRT at the rate of 0.5% as indicatedabove. However, on a transfer from the Custodian of the Depositary to a holderof an ADS upon cancellation of the ADS a fixed U.K. stamp duty of £5 perinstrument of transfer only will be payable.

**DOCUMENTS ONDISPLAY**

It is possible to read andcopy documents referred to in this Annual Report on Form 20-F thathave been filed with the SEC at the SEC’s public reference room located at 100F Street, NE, Washington D.C. 20549. Please call the SEC at 1(800) SEC 0330 forfurther information on the public reference rooms and their copy charges. TheCompany’s SEC filings made after November 4, 2002 are also available overthe Internet at the SEC’s website at http://www.sec.gov.

**DIFFERENCES IN OURCORPORATE GOVERNANCE AND NASDAQ CORPORATE GOVERNANCE REQUIREMENTS**

Under the NasdaqMarketplace Rules, as a foreign private issuer we are required to disclose anysignificant ways in which our corporate governance practices differ from thosefollowed by U.S. companies under the Nasdaq Marketplace Rules. Rule 4350(f) requireseach issuer to provide for a quorum in its by-laws for any meeting of theholders of common stock, which shall in no case be less than 33 1/3% of theoutstanding shares of the issuer’s common voting stock. The Company’s articlesof association do not provide any quorum requirement for general meetings ofits shareholders. This absence of a quorum requirement is in accordance withU.K. law and generally accepted business practices in the United Kingdom.

**Item 11:**                Quantitativeand Qualitative Disclosures About Market Risk

The Company holdsfinancial instruments to finance its operations and to manage the currency,interest rate and liquidity risks that arise from those operations. Adiscussion of the Company’s treasury policies employed to manage these risks isset out below. In the numerical disclosures that follow, short-term debtors andcreditors that arise directly as a result of the Company’s operations areexcluded from all disclosures.

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**LIQUIDITY RISK**

The Company’s policy is tomaintain continuity of funding through a mixture of long-term debt and bankloans, raised to cover specific projects, and through the issue of shares tocollaborative partners, where necessary, to obtain development contracts.Short-term flexibility is provided through the use of overdrafts. The maturityprofile of the Company’s debt at December 31, 2004 and 2005 is set outbelow.

**Maturity analysis of non-current borrowings**
|                                   | ** ** | **As at December 31, 2005** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **1 to 2 Years**                 | ** ** | **2 to 5 Years** | ** ** | **Over 5 Years** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | **(in £ millions)**              | ** ** |
| Convertible bonds                 |       |                                            | —     |   |   |   | — |   |   |   | 63.6 |   |   | 63.6 |   |
| Bank borrowings                   |       |                                            | 0.6        |   |   |   | — |   |   |   | — |   |   | 0.6 |   |
| Property mortgage                 |       |                                            | 0.3        |   |   |   | 0.8 |   |   |   | 5.5 |   |   | 6.6 |   |
| Paul Capital  funding liabilities |       |                                            | 4.9        |   |   |   | 22.1 |   |   |   | 16.9 |   |   | 43.9 |   |
| **Non-current borrowings**        | ** ** | ** **                                      | **5.8**    |   | ** ** | ** ** | **22.9** |   | ** ** | ** ** | **86.0** |   | ** ** | **114.7** | ** ** |

 
|                                   | ** ** | **As at December 31, 2004** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **1 to 2 Years**                 | ** ** | **2 to 5 Years** | ** ** | **Over 5 Years** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | **(in £ millions)**              | ** ** |
| Convertible bonds                 |       |                                            | —     |   |   |   | — |   |   |   | 50.4 |   |   | 50.4 |   |
| Property mortgage                 |       |                                            | 0.3        |   |   |   | 0.8 |   |   |   | 6.0 |   |   | 7.1 |   |
| Paul Capital  funding liabilities |       |                                            | 10.6       |   |   |   | 21.5 |   |   |   | 12.6 |   |   | 44.7 |   |
| Finance lease  liabilities        |       |                                            | 0.1        |   |   |   | — |   |   |   | — |   |   | 0.1 |   |
| **Non-current borrowings**        | ** ** | ** **                                      | **11.0**   |   | ** ** | ** ** | **22.3** |   | ** ** | ** ** | **69.0** |   | ** ** | **102.3** | ** ** |

 

**Foreign CurrencyRisk**

All of the Company’s operations other than itscorporate offices are based overseas in Europe and North America giving rise toexposures to changes in foreign exchange rates, notably the Swiss Franc, Euroand U.S. Dollar. Beginning in June 1996, and where natural hedges have notbeen sufficient or possible, the Company has selectively entered into forwardcurrency contracts to fix certain of the non-sterling funding requirements ofits principal subsidiaries. The contracts generally have maturities notexceeding twelve months.

At December 31, 2004, the Group had anunrecognized gain of approximately £2,000 arising from a Swedish Krona swap ofSKr 7.2 million.

At December 31, 2005, the Group had a short termdual currency deposit of sterling versus U.S. dollars, which earns an effectiveinterest rate of 10.5%. If the sterling/ U.S. dollar spot rate is at or above1.75 at expiry, the £7.5 million deposit will be returned in U.S. dollars at1.75 ($13.1 million), otherwise it will be returned in sterling.

The currency analysis of borrowingsat December 31, 2004 and 2005 is set out below.

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**Currency analysis of borrowings**
|                                   | ** ** | **As at December 31, 2005** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **Sterling**                                    | ** ** | **$US** | ** ** | **Swiss francs** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | **(in £ millions)**              | ** ** |
| Convertible bonds                 |       |                                            | 63.6       |   |   | — |   |   | — |   |   | 63.6 |   |
| Bank borrowings                   |       |                                            | —     |   |   | 0.6 |   |   | — |   |   | 0.6 |   |
| Property mortgage                 |       |                                            | —     |   |   | — |   |   | 6.6 |   |   | 6.6 |   |
| Paul Capital  funding liabilities |       |                                            | —     |   |   | 43.9 |   |   | — |   |   | 43.9 |   |
| **Total borrowings**              |       |                                            | **63.6**   | ** ** | ** ** | **44.5** | ** ** | ** ** | **6.6** | ** ** | ** ** | **114.7** |   |

 
|                                   | ** ** | **As at December 31, 2004** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **Sterling**                                    | ** ** | **$US** | ** ** | **Swiss francs** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | **(in £ millions)**              | ** ** |
| Convertible bonds                 |       |                                            | 50.4       |   |   | — |   |   | — |   |   | 50.4 |   |
| Property mortgage                 |       |                                            | —     |   |   | — |   |   | 7.1 |   |   | 7.1 |   |
| Paul Capital  funding liabilities |       |                                            | —     |   |   | 44.7 |   |   | — |   |   | 44.7 |   |
| Finance lease  liabilities        |       |                                            | —     |   |   | — |   |   | 0.1 |   |   | 0.1 |   |
| **Total borrowings**              |       |                                            | 50.4       |   |   | 44.7 |   |   | 7.2 |   |   | 102.3 |   |

 

**Interest Rate Risk**

The Company borrows atfixed and floating rates of interest as deemed appropriate for itscircumstances. Where necessary, the Company uses interest rate swaps to achievethe desired interest rate profile. The Company’s management have assessedremaining interest rate exposures and deemed then not to be material. Theinterest rate analysis at December 31, 2004 and 2005 is set out below.

**Interest rate analysis**
|                                   | ** ** | **As at December 31, 2005** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **Sterling  %**                                 | ** ** | **$US  %** | ** ** | **Swiss francs  %** | ** ** |
| Convertible bonds                 |       | 8.9/9.5/13.3                                    |       | — |   |   | — |   |   |
| Bank borrowings                   |       | —                                          |       | 8.0 |   |   | — |   |   |
| Property mortgage                 |       | —                                          |       | — |   |   | 2.8 |   |   |
| Paul Capital funding  liabilities |       | —                                          |       | 24.0/ 30.0 |   |   | — |   |   |

 

| ** **                        | ** ** | **As at December 31, 2004** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **Sterling  %**                                 | ** ** | **$US  %** | ** ** | **Swiss francs  %** | ** ** |
| Convertible bonds                 |       | 8.9/9.5                                         |       | — |   |   | — |   |   |
| Property mortgage                 |       | —                                          |       | — |   |   | 2.8 |   |   |
| Paul Capital  funding liabilities |       | —                                          |       | 24.0/30.0 |   |   | — |   |   |
| Finance lease  liabilities        |       | —                                          |       | — |   |   | 6.5 |   |   |

 

**Credit Risk**

The Company is exposed tocredit-related losses in the event of non-performance by third parties tofinancial instruments. The Company does not expect any third parties to fail tomeet their obligations given the policy of selecting only parties with highcredit ratings and minimizing its exposure to any one institution.

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**Fair Values**

Thecomparison of carrying amount and fair value of all the Company’s financialinstruments as at December 31, 2004 and 2005 is set out below.
|                                   | ** ** | **As at December 31, 2005** | ** ** |
|-----------------------------------|------------|--------------------------------------------|------------|
| ** **                        | ** ** | **Carrying  Amount**                       | ** ** | **Fair Value** | ** ** |
| ** **                        | ** ** | **(in £ millions)**         | ** ** |
| Convertible bonds                 |       |                                       | 63.6       |   |   |   | 83.5 |   |   |
| Bank borrowings                   |       |                                       | 0.6        |   |   |   | 0.6 |   |   |
| Property mortgage                 |       |                                       | 6.6        |   |   |   | 6.6 |   |   |
| Paul Capital  funding liabilities |       |                                       | 43.9       |   |   |   | 43.9 |   |   |
|                              | ** ** | ** **                                 | **114.7**  |   | ** ** | ** ** | **134.6** |   |   |

 

| ** **                        | ** ** | **As at December 31, 2004** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **Carrying  Amount**                            | ** ** | **Fair Value** | ** ** |
| ** **                        | ** ** | **(in £ millions)**              | ** ** |
| Convertible bonds                 |       |                                            | 50.4       |   |   |   | 75.9 |   |   |
| Property mortgage                 |       |                                            | 7.1        |   |   |   | 7.1 |   |   |
| Paul Capital  funding liabilities |       |                                            | 44.7       |   |   |   | 44.7 |   |   |
| Finance lease  liabilities        |       |                                            | 0.1        |   |   |   | 0.1 |   |   |
|                              | ** ** | ** **                                      | **102.3**  |   | ** ** | ** ** | **127.8** |   |   |

 

**Undrawn facility**

At December 31, 2005the Group had an overdraft facility of £1.3 million (CHF 3 million) (2004:£1.4 million, CHF 3 million) with the Basellandschaftliche Kantonalbanksecured on the assets of Jago.

**Item 12:**                Descriptionof Securities other than Equity Securities

Not applicable.

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**PART II**

**Item 13:**                Defaults,Dividend Arrearages and Delinquencies

None.

**Item 14:**                MaterialModifications to the Rights of Security Holders and Use of Proceeds

None.

**Item 15:**                Controlsand Procedures

The Company maintainsdisclosure controls and procedures (as defined in Rule 13(a)-15(e))that are designed to ensure that information required to be disclosed in thereports the Company files or submits under the Securities Exchange Act of 1934is recorded, processed, summarized and reported within the time periodsspecified in the SEC rules and forms, and that such information isaccumulated and communicated to management, including the Chief ExecutiveOfficer and Finance Director, as appropriate, to allow timely decisionsregarding required disclosure.

In designing and evaluating the Company’s disclosurecontrols and procedures, the Company’s management, including the ChiefExecutive Officer and the Finance Director, recognize that any controls andprocedures, no matter how well designed or operated, can only providereasonable, not absolute, assurance of achieving their control objectives, andthe Company’s management necessarily is required to apply its judgment inevaluating the cost-benefit relationship of possible controls and procedures.Because of the inherent limitations in all control systems, no evaluation ofcontrols can provide absolute assurance that all control issues and instancesof fraud, if any, within the Company have been detected. The Company’sdisclosure controls and procedures have been designed to meet, and managementbelieve that they meet, reasonable assurance standards.

In connection with the preparation of the Company’sAnnual Report on Form 20-F, we detected an error in respect ofgoodwill in our reconciliations to U.S. GAAP in our 2004 financial statements. Thisrestatement reduced the Company’s shareholders’ funds under U.S. GAAP but didnot affect its net loss under U.S. GAAP or financial statements under IFRS. Priorto the introduction of IFRS, under UK GAAP, in a purchase business combinationamounts recorded in excess of assets acquired and liabilities assumed wererecorded as goodwill in the accounts of the acquiring entity. Uponconsolidation of the newly acquired subsidiary there was no need to translatethe goodwill from the subsidiary currency to the reporting entity currency. UnderU.S. GAAP this goodwill is recorded as an asset acquired in the purchasedentity and the goodwill is recorded in the newly acquired entity. Uponconsolidation of the acquired entity all assets and liabilities of thesubsidiary, including the goodwill amounts, are required to be translated atthe balance sheet date. In prior years we had made no adjustment for thisdifference in accounting treatment between UK GAAP and U.S. GAAP in ourU.S. GAAP reconciliation. Consequently, we have restated our net assetsand shareholders’ funds under U.S. GAAP for the years ended December 31,2001, 2002, 2003 and 2004 to reflect the impact of the adjustments made to theCompany’s goodwill. As a result, the Company’s restated U.S. GAAP shareholders’funds reflect a decrease in net assets of £23.7 million in 2001, £23.0 millionin 2002, £24.8 million in 2003 and £25.8 million in 2004.

In light of thisrestatement, the Company’s management, including the Chief Executive Officerand the Finance Director, have evaluated the Company’s disclosure controls andprocedures and concluded that, as at December 31, 2005, the Company’sdisclosure controls and procedures were not effective to provide reasonableassurance that information required to be disclosed in the Company’s reportsfiled or submitted under the Securities Exchange Act of 1934 was recorded,processed, summarized and reported within the time period specified in therules and forms of the SEC.

94

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With the exception of the matter described above,there have been no significant changes during 2005 in the Company’s internalcontrol over financial reporting, including any corrective actions with regardto significant deficiencies and material weaknesses, or in other factors thathave materially affected, or are reasonably likely to materially affect, ourinternal controls over financial reporting. The Company is not currentlyrequired to report on management’s assessment of the effectiveness of theGroup’s internal controls over financial reporting and, as such, the Companyhas not undertaken the kind of review of such controls that would be requiredin order to make such a report.

Prior to the detection ofthis error, the Company had previously begun to implement procedures to reviewour controls related to our reporting of U.S. GAAP information, includingconsolidations and subsidiary accounting related to initial purchase accountingand the recording of goodwill. Following the review of the treatment of goodwillin the reconciliation to U.S. GAAP, the Company has begun to expand the Company’scontrol procedures to include additional analysis and other post closingprocedures to ensure that the Company’s disclosure controls and procedures areadequate in relation to the preparation of the Company’s financial statements.In this regard, the Company is improving documentation of U.S. GAAP adjustmentsas at December 31, 2004 and 2005 as part of our preparation for compliancewith the requirements of Section 404 of the Sarbanes Oxley Act of 2002. 

**Item 16A:**        AuditCommittee Financial Expert

The Board has determinedthat Mr Alan Bray, Chairman of the Company’s Audit Committee, is independentpursuant to Rule 10A-3 and qualifies as an Audit Committee FinancialExpert for the purposes of this Item.

**Item 16B:**       Codeof Ethics

On April 28, 2004 theCompany adopted a Code of Business Conduct and Ethics which is applicable toall directors, officers and employees. A copy of the Code is posted on theCompany’s internet website at www.skyepharma.com.

**Item 16C:**       PrincipalAccountant Fees and Services

During2004 and 2005 the Company (including its overseas subsidiaries) obtained thefollowing services from its auditor for the fees set forth below:
|                     | ** ** | **Year toDecember 31,**  | ** ** |
|---------------------|------------|------------------------------------|------------|
| ** **          | ** ** | **2004**                           | ** ** | **2005** | ** ** |
| ** **          | ** ** | **(in £ millions)** | ** ** |
| Audit fees          |       |                               | 0.3        |   |   |   | 0.4 |   |   |
| Audit-related  fees |       |                               | 0.2        |   |   |   | 0.2 |   |   |
| Tax fees            |       |                               | 0.7        |   |   |   | 0.2 |   |   |
| All other fees      |       |                               | 1.0        |   |   |   | 1.2 |   |   |
|                | ** ** | ** **                         | **2.2**    |   | ** ** | ** ** | **2.0** |   |   |

 

Audit-related fees include fees paid for assurance andrelated services, such as the review of the Company’s interim report. Tax feesinclude fees paid for compliance, advisory and planning services. All otherfees include fees paid for due diligence, accounting advice and assistance inconnection with the preparation of regulatory returns.

The Audit Committee has in place pre-approval policiesand procedures, which were adopted on March 26, 2003. The pre-approvedengagements are specified in reasonable detail in the pre-approval policies andprocedures and generally include all services requiring an independent,objective assessment 

95

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of information orprocedures and advice on areas core to the financial statements and audit. Inparticular, pre-approved engagements include services relating to externalreporting, acquisitions, disposals, taxation and general accounting.

All engagements not covered by the pre-approvalpolicies and procedures are subject to pre-approval on a case-by-case basis.

The Audit Committee is informed of each engagemententered into pursuant to the pre-approved policies and procedures at its nextscheduled meeting.

All services for whichPricewaterhouseCoopers LLP was engaged during the year have been pre-approved.

**Item 16D:**      Exemptionfrom the Listing Standards for Audit Committees

Not applicable.

**Item 16E:**       Purchasesof Equity Securities by the Issuer and Affiliated Purchasers

None.

96

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**PART III**

**Item 17:**                FinancialStatements

Thefollowing financial statements, together with the report thereon, byPricewaterhouseCoopers LLP, are filed as part of this Form 20-F:
| Report of Independent  Registered Public Accounting Firm                              |   | F-1    |
|---------------------------------------------------------------------------------------|--------|--------|
| SkyePharma PLC  Consolidated Financial Statements                                     |   |   |
| Consolidated Income Statements for the years ended  December 31, 2004 and 2005   |   | F-2    |
| Consolidated  Balance Sheet at December 31, 2004 and 2005                        |   | F-3    |
| Consolidated  Statement of Recognized Income and Expense                              |   | F-4    |
| Consolidated  Cash Flow Statement for the years ended December 31, 2004 and 2005 |   | F-5    |
| Notes to the Consolidated Cash Flow Statement                                         |   | F-6    |
| Notes to the Consolidated Financial Statements                                        |   | F-7    |

 

**Item 18:**                FinancialStatements

The Company is furnishing financial statementspursuant to the instructions of Item 17 of Form 20-F. See ‘‘Item 17:Financial Statements’’.

97

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**SIGNATURES**

The registrant hereby certifies that itmeets all of the requirements for filing on Form 20-F and that ithas duly caused and authorized the undersigned to sign this Annual Report onits behalf.

Date: June 30, 2006

|        | SKYEPHARMA PLC  (REGISTRANT) |
|--------|------------------------------|
|   | By:                          | /s/ DONALD NICHOLSON |
|   | Name:                        | Donald Nicholson |
|   | Title:                       | *Finance Director* |

 

98

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**SKYEPHARMA PLCREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

**To theBoard of Directors and Shareholders of SkyePharma PLC**

In our opinion, the accompanyingconsolidated balance sheets, the related consolidated  statements of income, consolidated statementof recognized income and expense and consolidated statement of cash flowspresent fairly, in all material respects, the financial position of SkyePharmaPLC and its subsidiaries at December 31, 2005 and 2004, and the results oftheir operations and their cash flows for each of the two years in the periodended December 31, 2005, in conformity with International FinancialReporting Standards as adopted by the EU. These financial statements are theresponsibility of the Company’s management; our responsibility is to express anopinion on these financial statements based on our audits. We conducted ouraudits of these statements in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), which require that we planand perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

The accompanying financial statements havebeen prepared assuming that the Company will continue as a going concern. Asdiscussed in Note 1 to the financial statements, there is uncertainty as towhen certain strategic initiatives may be concluded and their effect on theGroup’s working capital requirements which raises substantial doubt about theCompany’s ability to continue as a going concern. Management plans with regardsto these matters are also described in Note 1. The financial statements do notinclude any adjustments that might result from the outcome of the uncertainty.

International Financial Reporting Standardsadopted by the EU vary in certain significant respects from accountingprinciples generally accepted in the United States of America. Informationrelating to the nature and effect of such differences is presented in Note 37,as restated, to the consolidated financial statements.

**PricewaterhouseCoopers LLP**LondonUnited KingdomJune 30, 2006

F-1

----

**SKYEPHARMA PLCCONSOLIDATED INCOME STATEMENTfor the year ended December 31, 2005**

| ** **                                    | ** ** | **Notes**  | ** ** | **Before  Exceptional  Items** | ** ** | **Exceptional  Items  (Note 5)** | ** ** | **Year to  December 31,  2004** | ** ** | **Before  Exceptional  Items** | ** ** | **Exceptional  Items  (Note 5)** | ** ** | **Year to  December 31,  2005** | ** ** |
|-----------------------------------------------|------------|------------|------------|--------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|--------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|
| ** **                                    | ** ** | ** ** | ** ** | **£m**                    | ** ** | **£m**                           | ** ** | **£m**                               | ** ** | **£m**                    | ** ** | **£m**                           | ** ** | **£m**                               | ** ** |
| Revenue                                       |       |       | 4          |                           |       |                                  | 75.2       |                                      |       |                           | —     |                                  |       |                                      | 75.2       |   |   |   | 61.3 |   |   |   | — |   |   |   | 61.3 |   |   |
| Cost  of sales                                |       |       |       |                           |       |                                  | (28.2      | )                                         |       |                           | —     |                                  |       |                                      | (28.2      | ) |   |   | (29.2 | ) |   |   | — |   |   |   | (29.2 | ) |   |
| **Gross profit**                              |       |       |       |                           | ** ** | ** **                            | **47.0**   | ** **                                | ** ** | ** **                     | **—** | ** **                            | ** ** | ** **                                | **47.0**   | ** ** | ** ** | ** ** | **32.1** | ** ** | ** ** | ** ** | **—** | ** ** | ** ** | ** ** | **32.1** | ** ** | ** ** |
| Selling,  marketing and distribution expenses |       |       |       |                           |       |                                  | (1.7       | )                                         |       |                           | —     |                                  |       |                                      | (1.7       | ) |   |   | (5.9 | ) |   |   | — |   |   |   | (5.9 | ) |   |
| Administration  expenses                      |       |       |       |                           |       |                                  |       |                                      |       |                           |       |                                  |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Amortization of other intangibles             |       |       |       |                           |       |                                  | (2.2       | )                                         |       |                           | —     |                                  |       |                                      | (2.2       | ) |   |   | (2.1 | ) |   |   | — |   |   |   | (2.1 | ) |   |
| Other administration expenses                 |       |       |       |                           |       |                                  | (15.6      | )                                         |       |                           | (4.7       | )                                     |       |                                      | (20.3      | ) |   |   | (13.8 | ) |   |   | (21.4 | ) |   |   | (35.2 | ) |   |
|                                          |       |       |       |                           |       |                                  | (17.8      | )                                         |       |                           | (4.7       | )                                     |       |                                      | (22.5      | ) |   |   | (15.9 | ) |   |   | (21.4 | ) |   |   | (37.3 | ) |   |
| Research  and development expenses            |       |       |       |                           |       |                                  | (28.0      | )                                         |       |                           | —     |                                  |       |                                      | (28.0      | ) |   |   | (26.0 | ) |   |   | — |   |   |   | (26.0 | ) |   |
| Other  expense                                |       |       | 8          |                           |       |                                  | 0.1        |                                      |       |                           | 2.0        |                                  |       |                                      | 2.1        |   |   |   | (0.4 | ) |   |   | — |   |   |   | (0.4 | ) |   |
| **Operating loss**                            |       |       |       |                           | ** ** | ** **                            | **(0.4**   | **)**                                     | ** ** | ** **                     | **(2.7**   | **)**                                 | ** ** | ** **                                | **(3.1**   | **)** | ** ** | ** ** | **(16.1** | **)** | ** ** | ** ** | **(21.4** | **)** | ** ** | ** ** | **(37.5** | **)** | ** ** |
| Finance  costs                                |       |       | 9          |                           |       |                                  | (17.7      | )                                         |       |                           | (6.2       | )                                     |       |                                      | (23.9      | ) |   |   | (22.3 | ) |   |   | — |   |   |   | (22.3 | ) |   |
| Finance  income                               |       |       | 9          |                           |       |                                  | 8.6        |                                      |       |                           | —     |                                  |       |                                      | 8.6        |   |   |   | 10.0 |   |   |   | — |   |   |   | 10.0 |   |   |
| Share  of loss in associate                   |       |       | 15         |                           |       |                                  | —     |                                      |       |                           | —     |                                  |       |                                      | —     |   |   |   | (0.8 | ) |   |   | — |   |   |   | (0.8 | ) |   |
| **Loss before income tax**                    |       |       |       |                           | ** ** | ** **                            | **(9.5**   | **)**                                     | ** ** | ** **                     | **(8.9**   | **)**                                 | ** ** | ** **                                | **(18.4**  | **)** | ** ** | ** ** | **(29.2** | **)** | ** ** | ** ** | **(21.4** | **)** | ** ** | ** ** | **(50.6** | **)** | ** ** |
| Income  tax expense                           |       |       | 10         |                           |       |                                  | (0.2       | )                                         |       |                           | —     |                                  |       |                                      | (0.2       | ) |   |   | (0.3 | ) |   |   | — |   |   |   | (0.3 | ) |   |
| **Loss for the year**                         |       |       |       |                           | ** ** | ** **                            | **(9.7**   | **)**                                     | ** ** | ** **                     | **(8.9**   | **)**                                 | ** ** | ** **                                | **(18.6**  | **)** | ** ** | ** ** | **(29.5** | **)** | ** ** | ** ** | **(21.4** | **)** | ** ** | ** ** | **(50.9** | **)** | ** ** |
| **Basic and diluted  earnings per share**     |       |       | 11         |                           |       |                                  | (1.6p)     |                                      |       |                           | (1.4p)     |                                  |       |                                      | (3.0p)     |   |   |   | (4.7p) |   |   |   | (3.4p) |   |   |   | (8.1p) |   |   |

 

All results represent continuingactivities.

See Notes to the Financial Statements.

F-2

----

**SKYEPHARMA PLCCONSOLIDATED BALANCE SHEETas at December 31, 2005**

| ** **                                             | ** ** | **Notes**  | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                             | ** ** | ** ** | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| **ASSETS**                                             | ** ** | ** ** | ** ** |                        | ** ** | ** **                  |       |   | ** ** | ** ** |   |
| **Non-current assets**                                 | ** ** | ** ** | ** ** |                        | ** ** | ** **                  |       |   | ** ** | ** ** |   |
| Goodwill                                               |       | 12         |       |                        | 68.7       |                        |       |   | 68.7 |   |   |
| Other  intangible assets                               |       | 13         |       |                        | 26.7       |                        |       |   | 26.8 |   |   |
| Property,  plant and equipment                         |       | 14         |       |                        | 40.9       |                        |       |   | 37.1 |   |   |
| Investments  in associates                             |       | 15         |       |                        | 14.3       |                        |       |   | 0.2 |   |   |
| Available-for-sale  financial assets                   |       | 16         |       |                        | 5.2        |                        |       |   | 1.6 |   |   |
|                                                   |       |       | ** ** |                        | **155.8**  | ** **                  |       |   | **134.4** | ** ** |   |
| **Current assets**                                     | ** ** | ** ** | ** ** |                        | ** ** | ** **                  |       |   | ** ** | ** ** |   |
| Inventories                                            |       | 17         |       |                        | 1.5        |                        |       |   | 3.6 |   |   |
| Trade and  other receivables                           |       | 18         |       |                        | 18.2       |                        |       |   | 14.2 |   |   |
| Financial  assets at fair value through profit or loss |       | 19         |       |                        | 1.1        |                        |       |   | 0.4 |   |   |
| Cash and cash  equivalents                             |       | 20         |       |                        | 15.3       |                        |       |   | 34.3 |   |   |
|                                                   |       |       | ** ** |                        | **36.1**   | ** **                  |       |   | **52.5** | ** ** |   |
| **Total Assets**                                       |       |       | ** ** |                        | **191.9**  | ** **                  |       |   | **186.9** | ** ** |   |
| **LIABILITIES**                                        |       |       |       |                        |       |                        |       |   |   |   |   |
| **Current liabilities**                                |       |       |       |                        |       |                        |       |   |   |   |   |
| Trade and  other payables                              |       | 21         |       |                        | (20.6      | )                           |       |   | (21.0 | ) |   |
| Convertible  bonds                                     |       | 22,23      |       |                        | (9.4       | )                           |       |   | — |   |   |
| Other  borrowings                                      |       | 22         |       |                        | (3.9       | )                           |       |   | (3.4 | ) |   |
| Derivative  financial instruments                      |       | 24         |       |                        | (0.2       | )                           |       |   | — |   |   |
| Deferred  income                                       |       |       |       |                        | (11.8      | )                           |       |   | (7.7 | ) |   |
| Provisions                                             |       | 25         |       |                        | (0.3       | )                           |       |   | — |   |   |
|                                                   |       |       | ** ** |                        | **(46.2**  | **)**                       |       |   | **(32.1** | **)** |   |
| **Non current liabilities**                            |       |       |       |                        |       |                        |       |   |   |   |   |
| Convertible  bonds                                     |       | 22,23      |       |                        | (50.4      | )                           |       |   | (63.6 | ) |   |
| Other  borrowings                                      |       | 22         |       |                        | (51.9      | )                           |       |   | (51.1 | ) |   |
| Deferred  income                                       |       |       |       |                        | (2.3       | )                           |       |   | (2.9 | ) |   |
| Other non  current liabilities                         |       |       |       |                        | (2.9       | )                           |       |   | (3.4 | ) |   |
| Provisions                                             |       | 25         |       |                        | (1.7       | )                           |       |   | (1.9 | ) |   |
|                                                   |       |       | ** ** |                        | **(109.2** | **)**                       |       |   | **(122.9** | **)** |   |
| **Total Liabilities**                                  |       |       | ** ** |                        | **(155.4** | **)**                       |       |   | **(155.0** | **)** |   |
| **Net Assets**                                         | ** ** | ** ** | ** ** |                        | **36.5**   | ** **                  |       |   | **31.9** | ** ** |   |
| **SHAREHOLDERS’ EQUITY**                          |       |       |       |                        |       |                        |       |   |   |   |   |
| Share capital                                          |       | 27         |       |                        | 63.4       |                        |       |   | 76.6 |   |   |
| Share premium                                          |       | 29         |       |                        | 321.0      |                        |       |   | 345.6 |   |   |
| Translation  reserve                                   |       | 29         |       |                        | (0.9       | )                           |       |   | (1.2 | ) |   |
| Fair value  reserve                                    |       | 29         |       |                        | (0.5       | )                           |       |   | 0.2 |   |   |
| Retained  losses                                       |       | 29         |       |                        | (378.9     | )                           |       |   | (427.1 | ) |   |
| Other  reserves                                        |       | 30         |       |                        | 32.4       |                        |       |   | 37.8 |   |   |
| **Total Shareholders’ Equity**                    |       |       | ** ** |                        | **36.5**   | ** **                  |       |   | **31.9** | ** ** |   |

 

See Notes to the Financial Statements.

F-3

----

**SKYEPHARMA PLCCONSOLIDATED STATEMENT OF RECOGNIZED INCOME AND EXPENSEfor the year ended December 31, 2005**

| ** **                                              | ** ** | **Year to  December 31,  2004** | ** ** | **Year to  December 31,  2005** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                              | ** ** | **£m**                               | ** ** | **£m**                               | ** ** |
| Net  currency translation effect                        |       |                                      | (2.5       | )                                         |       |   | (0.3 | ) |   |
| Fair  value movements on available for sale investments |       |                                      | (0.5       | )                                         |       |   | 0.2 |   |   |
| Actuarial  losses on defined benefit plans              |       |                                      | (0.1       | )                                         |       |   | — |   |   |
| Net  losses recognized directly in equity               |       |                                      | (3.1       | )                                         |       |   | (0.1 | ) |   |
| Loss  for the year                                      |       |                                      | (18.6      | )                                         |       |   | (50.9 | ) |   |
| **Total recognized income  and expense for the year**   | ** ** | ** **                                | **(21.7**  | **)**                                     | ** ** | ** ** | **(51.0** | **)** | ** ** |

 

F-4

----

**SKYEPHARMA PLCCONSOLIDATED CASH FLOW STATEMENTfor the year ended December 31, 2005**

| ** **                                                             | ** ** | **Note**   | ** ** | **Year to  December 31,  2004** | ** ** | **Year to  December 31,  2005** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                             | ** ** | ** ** | ** ** | **£m**                               | ** ** | **£m**                               | ** ** |
| **Cash flow from operating  activities**                               |       |       |       |                                      |       |                                      |       |   |   |   |   |   |   |
| Cash  used in operations                                               |       |       | (a)        |                                      | ** ** | ** **                                | **(3.7**   | **)** | ** ** | ** ** | **(7.6** | **)** | ** ** |
| Income  tax paid                                                       |       |       |       |                                      |       |                                      | (0.2       | ) |   |   | (0.3 | ) |   |
| **Net cash used in operating activities**                              |       |       |       |                                      | ** ** | ** **                                | **(3.9**   | **)** | ** ** | ** ** | **(7.9** | **)** | ** ** |
| **Cash flows from investing activities**                               | ** ** |       |       |                                      | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchases  of property, plant and equipment                            |       |       |       |                                      |       |                                      | (4.4       | ) |   |   | (2.6 | ) |   |
| Purchases  of intangible assets                                        |       |       |       |                                      |       |                                      | (1.4       | ) |   |   | (2.3 | ) |   |
| Purchase  of shares in associates                                      |       |       |       |                                      |       |                                      | —     |   |   |   | (0.2 | ) |   |
| Purchase  of available for sale investments                            |       |       |       |                                      |       |                                      | (2.2       | ) |   |   | — |   |   |
| Purchase  of own shares                                                |       |       |       |                                      |       |                                      | —     |   |   |   | (0.4 | ) |   |
| Proceeds  from disposal of available for sale investments              |       |       |       |                                      |       |                                      | 2.7        |   |   |   | 1.6 |   |   |
| **Net cash used in investing activities**                              | ** ** |       |       |                                      | ** ** | ** **                                | **(5.3**   | **)** | ** ** | ** ** | **(3.9** | **)** | ** ** |
| **Cash flows from financing activities**                               | ** ** |       |       |                                      | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Gross  proceeds from rights issue                                      |       |       |       |                                      |       |                                      | —     |   |   |   | 37.7 |   |   |
| Expenses  of rights issue                                              |       |       |       |                                      |       |                                      | —     |   |   |   | (2.9 | ) |   |
| Proceeds  from issue of Ordinary Share capital                         |       |       |       |                                      |       |                                      | 0.3        |   |   |   | 0.1 |   |   |
| Proceeds  from issue of convertible bonds due June 2025           |       |       |       |                                      |       |                                      | —     |   |   |   | 20.0 |   |   |
| Proceeds  from issue of convertible bonds due May 2024            |       |       |       |                                      |       |                                      | 20.0       |   |   |   | — |   |   |
| Expenses  of issue of convertible bonds due June 2025             |       |       |       |                                      |       |                                      | —     |   |   |   | (1.2 | ) |   |
| Expenses  of issue and exchange of convertible bonds due May 2024 |       |       |       |                                      |       |                                      | (3.4       | ) |   |   | — |   |   |
| Repayment  of convertible bonds due June 2005                     |       |       |       |                                      |       |                                      | —     |   |   |   | (9.8 | ) |   |
| Repayments  of borrowings                                              |       |       |       |                                      |       |                                      | (8.6       | ) |   |   | (7.4 | ) |   |
| Repayment  of finance lease principal                                  |       |       |       |                                      |       |                                      | (0.2       | ) |   |   | — |   |   |
| Interest  paid                                                         |       |       |       |                                      |       |                                      | (5.9       | ) |   |   | (6.7 | ) |   |
| Interest  received                                                     |       |       |       |                                      |       |                                      | 0.7        |   |   |   | 0.8 |   |   |
| **Net cash generated from financing activities**                       |       |       |       |                                      | ** ** | ** **                                | **2.9**    | ** ** | ** ** | ** ** | **30.6** | ** ** | ** ** |
| **Effect of exchange rate changes**                                    | ** ** |       |       |                                      | ** ** | ** **                                | **(0.4**   | **)** | ** ** | ** ** | **0.2** | ** ** | ** ** |
| **Net (decrease)/increase in cash and cash equivalents**               | ** ** |       |       |                                      | ** ** | ** **                                | **(6.7**   | **)** | ** ** | ** ** | **19.0** | ** ** | ** ** |
| Cash and cash equivalents at beginning of the year                     |       |       |       |                                      |       |                                      | 22.0       |   |   |   | 15.3 |   |   |
| **Cash and cash  equivalents at end of the year**                      |       |       |       |                                      | ** ** | ** **                                | **15.3**   | ** ** | ** ** | ** ** | **34.3** | ** ** | ** ** |

 

See Notes to the Financial Statements.

F-5

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**SKYEPHARMA PLCNOTES TO THE CONSOLIDATED CASH FLOW STATEMENT**

****(a)********         ********Cash flow fromoperating activities****

| ** **                                                   | ** ** | **Year to  December 31,  2004** | ** ** | **Year to  December 31,  2005** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                   | ** ** | **£m**                               | ** ** | **£m**                               | ** ** |
| **Loss for the year**                                        |       |                                      | (18.6      | )                                         |       |   | (50.9 | ) |   |
| Adjustments  for:                                            |       |                                      |       |                                      |       |   |   |   |   |
| Tax                                                          |       |                                      | 0.2        |                                      |       |   | 0.3 |   |   |
| Depreciation                                                 |       |                                      | 6.0        |                                      |       |   | 6.2 |   |   |
| Amortization                                                 |       |                                      | 2.2        |                                      |       |   | 2.1 |   |   |
| Impairments                                                  |       |                                      | 3.5        |                                      |       |   | 19.4 |   |   |
| Fair value loss/(gain) on derivative financial  instruments  |       |                                      | 0.5        |                                      |       |   | (0.3 | ) |   |
| Finance costs                                                |       |                                      | 23.9       |                                      |       |   | 22.3 |   |   |
| Finance income                                               |       |                                      | (6.8       | )                                         |       |   | (10.0 | ) |   |
| Share of loss in associate                                   |       |                                      | —     |                                      |       |   | 0.8 |   |   |
| Profit on disposal of available for sale financial  assets   |       |                                      | (2.0       | )                                         |       |   | (0.3 | ) |   |
| Other non-cash changes                                       |       |                                      | 4.0        |                                      |       |   | 3.2 |   |   |
| **Operating cash flows before movements in working capital** |       |                                      | 12.9       |                                      |       |   | (7.2 | ) |   |
| **Changes in working capital**                               |       |                                      |       |                                      |       |   |   |   |   |
| Increase in inventories                                      |       |                                      | (0.2       | )                                         |       |   | (2.1 | ) |   |
| (Increase)/decrease in trade and other receivables           |       |                                      | (5.9       | )                                         |       |   | 4.2 |   |   |
| Increase in trade and other payables                         |       |                                      | 4.0        |                                      |       |   | 1.2 |   |   |
| Decrease in deferred income                                  |       |                                      | (13.0      | )                                         |       |   | (3.4 | ) |   |
| Decrease in provisions                                       |       |                                      | (1.5       | )                                         |       |   | (0.3 | ) |   |
| **Cash used in operations**                                  |       |                                      | (3.7       | )                                         |       |   | (7.6 | ) |   |

 

F-6

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**SKYEPHARMA PLCNotes to the Financial Statements**

**1**                    Accounting policies

**Generalinformation**

SkyePharma PLC (the “Company”) and itssubsidiaries (together the “Group”) is a speciality pharmaceutical Group whichuses its multiple drug delivery technologies to create a product pipeline forout-licensing to marketing partners.

The Company is incorporated and domiciledin United Kingdom, with its registered office at 105 Piccadilly, LondonW1J 7NJ.

The principalaccounting policies adopted in the preparation of these consolidated financialstatements are set out below.

***(a) Basis of preparation***

In accordance with EU regulations,SkyePharma is required to prepare statutory financial statements which complywith the International Financial Reporting Standards adopted for use in theEuropean Union (“IFRS”) starting from the financial year ended December 31,2005, being the first financial year commencing after January 1, 2005.

The International Financial ReportingStandards adopted for use in the European Union are similar with theInternational Financial Reporting Standards as issued by the IASB, except forcertain provisions concerning fair value accounting for financial liabilitiesand hedge accounting, which have no impact on the financial statements of theGroup. Consequently, the consolidated IFRS financial statements for the yearended December 31, 2005 are compliant with both the InternationalFinancial Reporting Standards as issued by IASB and the version adopted for usein the European Union.

These consolidated financial statementshave been prepared in accordance with IFRS and the interpretations issued bythe International Financial Reporting Interpretations Committee (“IFRIC”) andwith those parts of the Companies Act 1985 applicable to companies reporting underIFRS. The financial statements have been prepared under the historical costconvention, as modified by the revaluation of financial assets and financialliabilities.

The Company’s working capital requirementscontinue to be affected by the timing and receipt of milestone payments andpayments received on the signing of new contracts. The Company’s future cashflows will also be impacted by the Company’s change in strategy, principallyits stated aim of moving to sustainable profitability in the near term and itsrefocus to concentrate on oral and pulmonary products. Consequently the Group’snear term working capital requirements are uncertain and sensitive to thetiming of a number of initiatives required to provide the financial flexibilityto implement the new strategy. These initiatives include the licensing ofFlutiformTM in Europe, the divestment of its injectable business interests,which is expected to require shareholder approval, or the US licensing forDepoBupivacaineTM. Uncertainty as to when these initiatives may be concluded andtheir effect on the Group’s working capital requirements raises substantialdoubt about the Company’s ability to continue as a Going Concern.

However, the Directors have reviewed theworking capital requirements of the Group for the next twelve months and have areasonable expectation that sufficient funds will be raised from theseinitiatives and have therefore prepared the financial information containedherein on a going concern basis which assumes that the Company will continue inoperational existence for the foreseeable future. The financial 

F-7

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statements donot reflect any adjustments that would be required to be made if they were tobe prepared on a basis other than the going concern basis.

In the event that sufficient funds are not raised by these initiativesand currently available funds and internally generatedcash flow are not sufficient to satisfy its financing needs, the Company will be required to seekadditional funding through other arrangements with corporate collaborators,through bank borrowings or through public or private sales of its securities,including equity securities. Any such collaboration could result in limitationson the resources the Company could devote to research, development andcommercialization of new products and product candidates, if any, as well asits profits therefrom. In addition, the terms of any future bank borrowingscould place restrictions on the Company’s ability to take certain actions, andany equity financing could result in dilution to the Company’s shareholders.The Company does not currently have any committed sources of additionalcapital.

*Use ofestimates*

The preparationof the financial statements, in conformity with IFRS, requires the use ofestimates and assumptions that affect the reported amounts of assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Although these estimates arebased on management’s best knowledge of the amount, event or actions, actualresults may ultimately differ from those estimates. The areas involving higherdegree of judgement or complexity, or areas where assumptions and estimates aresignificant to the consolidated financial statements are disclosed in Note 3;Critical accounting estimates and judgements.

***(b) IFRS 1 exemptions***

IFRS 1; First-time Adoption ofInternational Financial Reporting Standards has been applied in preparing thesefinancial statements. IFRS 1 sets out the procedures that the Group must followwhen it adopts IFRS for the first time.

The Group has established its IFRSaccounting policies for the year ending December 31, 2005 and appliedthese standards retrospectively to determine the IFRS opening balance sheet atits date of transition, January 1, 2004, except where permitted orrequired by IFRS 1 or other applicable standards.

Except as noted below, at the date oftransition to IFRS, the Group recognized all assets and liabilities as requiredby IFRS and derecognized all assets and liabilities not permitted by IFRS.Assets and liabilities were all measured in accordance with IFRS.

The impact of transition from UK GAAP toIFRS on the Group’s shareholders’ funds as at January 1, 2004 and December 31,2004, and on the Group’s income statement for the year ended December 31,2004 is discussed in Note 37; Transition from accounting practices generallyaccepted in the UK to International Financial Reporting Standards.

Theadoption of the provisions set out in IFRS 1 are outlined below.

·       **Businesscombinations:  **A first-time adopter may electnot to apply IFRS 3; Business Combinations retrospectively to businesscombinations that occurred before the date of transition to IFRS. The Companyelected to take advantage of this exemption, not applying IFRS 3 to thebusiness combinations that occurred before the date of transition. Anyunamortized goodwill at January 1, 2004, calculated in accordance with UKGAAP, has been recognized in the IFRS accounts at depreciated cost after takinginto account potential adjustments required to comply with IFRS measurementprinciples.

·       **Share-basedpayments:  **A first-time adopter is encouraged,but not required, to apply IFRS 2; Share-Based Payments to equityinstruments that were granted on or before November 7, 2002 and 

F-8

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not vested at January 1,2005. The Company elected to adopt full retrospective application of IFRS 2,not taking advantage of the IFRS 1 exemption.

·       **Cumulativetranslation differences:  **A first-time adopterneed not comply retrospectively with the requirements in IAS 21; TheEffects of Changes in Foreign Exchange Rates to classify translationdifferences as a separate component of equity related to foreign operations andrecycle them through the income statement on disposal of the foreignoperations. The Group elected not to take advantage of this exemption.

·       **Financial instruments:  **In its first IFRS financial statements a first time adopter need notrestate the comparative information  incompliance with IAS 32; Financial Instruments: Disclosure and presentationand IAS 39; Financial Instruments: Recognition and Measurement. The Companyelected not to take advantage of this exemption.

***(c) Consolidation***

The underlyingfinancial statements comprise a consolidation of the accounts of the Companyand all its subsidiaries and includes the Group’s share of the results and netassets of its associates. The accounts of the Group’s subsidiaries andassociates are made up to December 31.

*Subsidiaries*

Subsidiaries are all entities over whichthe Group has control. Control is achieved where the Company has the power togovern the financial and operating policies of an entity so as to obtainbenefits from its activities. Subsidiaries are fully consolidated from the dateon which control is transferred to the Group. They are de-consolidated from thedate on which control ceases. The results of subsidiaries acquired or disposedduring the year are included in the consolidated income statement from theeffective date of acquisition or up to the effective date of disposal, asappropriate.

The Group uses the purchase method toaccount for the acquisition of subsidiaries. The cost of an acquisition ismeasured as the fair value of the assets given, equity instruments issued andliabilities incurred or assumed at the date of exchange, plus costs directlyattributable to the acquisition. Identifiable assets acquired and liabilitiesand contingent liabilities assumed in a business combination are measuredinitially at their fair values at the acquisition date, irrespective of theextent of any minority interest. The excess of the cost of acquisition over thefair value of the Group’s share of the identifiable net assets acquired isrecorded as goodwill. If the cost of acquisition is less than the fair value ofthe group’s share of the net assets of the subsidiary acquired, the differenceis recognized directly in the income statement.

Inter-companytransactions, balances and unrealized gains on transactions between Groupcompanies are eliminated. Unrealized losses are also eliminated unless thetransaction provides evidence of an impairment of the asset transferred.Subsidiaries’ accounting policies have been changed where necessary to ensureconsistency with the policies adopted by the Group.

*Associates*

Associates are all entities over which theGroup has the power to exercise significant influence but not control generallyaccompanying a shareholding of between 20% and 50% of the voting rights.Investments in associates are accounted for by the equity method of accountingand are initially recognized at cost. The Group’s investment in associatesincludes goodwill identified on acquisition.

The Group’s share of its associates’post-acquisition profits or losses is recognized in the income statement, andits share of post-acquisition movements in reserves is recognized in reserves.The cumulative post-acquisition movements are adjusted against the carryingamount of the investment. When the Group’s share of losses in an associate orjoint venture equals or exceeds its interest or participation, 

F-9

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including anyother unsecured long-term receivables, the Group does not recognize furtherlosses, unless it has incurred obligations or made payments on behalf of theassociate or joint venture.

Unrealizedgains on transactions between the Group and its associates are eliminated tothe extent of the Group’s interest in the associates. Unrealized losses arealso eliminated unless the transaction provides evidence of an impairment ofthe asset transferred. Associates’ accounting policies have been changed wherenecessary to ensure consistency with the policies adopted by the Group.

***(d) Foreign currency translation***

*Functionaland presentation currency*

Items includedin the financial statements of each of the Group’s entities are measured usingthe currency of the primary economic environment in which the entity operates (‘thefunctional currency’). The consolidated financial statements are presented inpound sterling, which is the Company’s functional and presentation currency.

*Transactionsand balances*

Foreigncurrency transactions by Group companies are translated in the functionalcurrency at the exchange rate prevailing at the date of the transaction.Foreign exchange gains and losses resulting from the settlement of suchtransactions and from the translation at year-end exchange rates of monetaryassets and liabilities denominated in foreign currencies are recognized in theincome statement, except when it relates to items recognized directly in equitye.g. equities classified as available for sale, the exchange component of thatgain or loss will be recognized directly in equity.

*Groupcompanies*

The resultsand financial position of all the Group entities that have a functionalcurrency different from the presentation currency are translated into thepresentation currency as follows:

(i)            assets and liabilities for each balance sheet presented aretranslated at the closing rate at the date of the balance sheet;

(ii)        income and expenses for each income statement are translated ataverage exchange rates; and

(iii)    all resulting exchange differences are recognized as a separatecomponent of equity.

On consolidation, exchange differencesarising from the translation of the net investment in foreign entities, aretaken to shareholders’ equity.

Goodwill andfair value adjustments arising on the acquisition of a foreign entity aretreated as assets and liabilities of the foreign entity and translated at theclosing rate. On disposal of a foreign entity, accumulated exchange differencesare recognized in the income statement in the same period in which the gain orloss on disposal is recognized.

***(e) Segment reporting***

The Group’s primary segment for IFRSsegment reporting is the business segment. A business segment is a group ofassets and operations engaged in providing products or services that aresubject to risks and returns that are different from those of other businesssegments.

Geographical regions are the secondaryreporting segments. A geographic segment is engaged in providing products orservices within a particular economic environment that are subject to risks andreturn that are different from those of components operating in other economicenvironments.

F-10

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Segmentreporting reflects the internal management reporting structure and the way thebusiness is managed.

***(f) Revenue recognition***

Revenuecomprises the fair value for the sale of goods and services, net of salestaxes, rebates and discounts and after eliminating sales within the Group.Revenue is recognized as follows:

*Contractdevelopment and licensing*

Contractdevelopment and licensing income represents amounts earned for servicesrendered under development and licensing agreements, including up-frontpayments, milestone payments, technology access fees and research anddevelopment costs recharged. Revenues are recognized where they arenon-refundable, the Group’s obligations related to the revenues have beendischarged and their collection is reasonably assured. Refundable contractrevenue is treated as deferred until such time that it is no longer refundable.In general up-front payments are deferred and amortized on a systematic basisover the period of development to filing. Milestone payments related toscientific or technical achievements are recognized as income when themilestone is accomplished.

*Royaltyincome*

Royalty incomeis recognized on an accruals basis and represents income earned as a percentageof product sales in accordance with the substance of the relevant agreement.

*Manufacturingand distribution*

Manufacturingand distribution revenues principally comprise contract manufacturing feesinvoiced to third parties and income from product sales. Revenues arerecognized upon transfer to the customer of significant risks and rewards,usually upon despatch of goods shipped where the sales price is agreed andcollectability is reasonably assured.

***(g) Intangible assets***

*Goodwill*

Goodwillrepresents the excess of the cost of an acquisition over the fair value of theGroup’s share of the net identifiable assets of the acquired subsidiary at thedate of acquisition. Goodwill is tested annually for impairment and carried atcost less accumulated impairment losses. Goodwill is allocated to cashgenerating units for the purpose of impairment testing. Each of those cashgenerating units represents the Group’s investment in each country ofoperation.

*Intellectualproperty*

Intellectualproperty comprises acquired patents, trade marks, know-how and other similarlyidentified rights. These are recorded at their fair value at acquisition dateand are amortized on a straight line basis over their estimated useful economiclives from the time they are available for use. The period over which the Groupexpects to derive economic benefits does not exceed 20 years.

*Researchand development*

Researchexpenditure is charged to the income statement in the period in which it isincurred. Development expenditure is capitalized when the criteria forrecognising as an asset are met—when it is probable that the project will be asuccess, considering its commercial and technological feasibility and costs canbe measured reliably. Regulatory and other uncertainties generally mean thatsuch criteria are 

F-11

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notmet. Where development costs are capitalized they are amortized over theiruseful economic lives from product launch. Prior to product launch the asset istested annually for impairment.

*Computersoftware*

Costs that aredirectly associated with the purchase and implementation of identifiable andunique software products by the Group are recognized as intangible assets. Expendituresthat enhance and extend the benefits of computer software programmes beyondtheir original specifications and lives are recognized as a capital improvementand added to the original cost of the software. Direct costs include thesoftware development employee costs and an appropriate portion of relevantoverheads. Software costs are amortized over their useful economic lives,generally a period of 3 to 5 years.

***(h) Property, plant and equipment***

Property, plant and equipment are stated atthe cost of purchase or construction less provision for depreciation andimpairment. The cost of property, plant and equipment includes acquisitioncosts and labour and overhead costs arising directly from the construction oracquisition of an item of property, plant and equipment.

Subsequent costs are included in the asset’scarrying amount or recognized as a separate asset, as appropriate, only when itis probable that future economic benefits associated with the item will flow tothe Group and the cost of the item can be measured reliably. All other repairsand maintenance expenditures are charged to the income statement during thefinancial period in which they are incurred.

Depreciation is not provided on freehold land or projects underconstruction. On other property, plant and equipment, depreciation is providedon the difference between the cost of an item and its estimated residual value,in equal annual instalments over the estimated useful lives of the assets asfollows:

| Freehold  buildings                |   | 2% - 5%             |   |
|------------------------------------|--------|---------------------|--------|
| Laboratory  equipment and machines |   | 10% - 33%           |   |
| Office  and other equipment        |   | 10% - 33%           |   |
| Motor  vehicles                    |   | 20%                 |   |
| Short  leasehold property          |   | period of the lease |   |

 

Assets in the course of construction aredepreciated when they have been brought into operational use.

The assets’ residual values and usefullives are reviewed, and adjusted if appropriate, at each balance sheet date. Anasset’s carrying amount is written down immediately to its recoverable amountif the asset’s carrying amount is greater than its estimated recoverableamount.

Gains andlosses on disposals are determined by comparing the disposal proceeds with thecarrying amount and are included in the income statement.

***(i) Impairment of assets***

Assets that have an indefinite useful lifeare not subject to amortization and are tested annually for impairment. Assetsthat are subject to amortization or depreciation are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountmay not be recoverable. An impairment loss is recognized for the amount bywhich the asset’s carrying amount exceeds its recoverable amount. Therecoverable amount is the higher of an asset’s fair value less costs to selland value in use. Any impairment loss is charged to the income statement in theyear concerned. For the purposes of 

F-12

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assessingimpairment, assets are grouped at the lowest levels for which there areseparately identifiable cash in flows (cash-generating units).

F-13

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The expectedcash flows generated by the assets are discounted using asset specific discountrates which reflect the risks associated with the groups of assets. These risksvary with the nature and the location of the cash generating units.

***(j) Investments***

The Groupclassifies its investments according to the purpose for which the investmentswere acquired. Management determines the classification of investments atinitial recognition and re-evaluates the designation at every reporting date.The Group has the following categories of investments:

*Available-for-salefinancial assets*

Available-for-sale financial assets arenon-derivatives that are not acquired to generate profit from short-termfluctuations in price. They are included in non-current assets unlessmanagement intends to dispose of the asset within 12 months of the balancesheet date.

Available-for-sale investments areinitially recorded at cost, being the fair value of consideration given, plustransaction costs. Subsequently, available-for-sale investments comprisingmarketable equity securities that are traded in active markets are carried attheir fair value as of each balance sheet date.

Unrealized gains and losses arising fromchanges in the fair value of non-monetary securities classified as available-for-saleinvestments are recognized in equity. When available-for-sale investments aresold or impaired, the accumulated fair value adjustments in equity are recycledinto the income statement as gains and losses from investment securities.

The Groupassesses at each balance sheet date whether there is objective evidence that afinancial asset or a group of financial assets is impaired. If any suchevidence exists for available-for-sale financial assets, the cumulative loss—measuredas the difference between the acquisition cost and the current fair value, lessany impairment loss on that financial asset previously recognized is removedfrom equity and recognized in the income statement. Impairment lossesrecognized in the income statement on equity instruments are not reversedthrough the income statement.

*Financialassets at fair value through profit or loss*

The Groupclassifies investments in this category if acquired principally for the purposeof selling in the short term or if so designated by management. Financialassets at fair value through profit or loss are initially recorded, andsubsequently carried, at fair value. Realized and unrealized gains and lossesarising from changes in the fair value of assets held in this category areincluded in the income statement in the period in which they arise. Financialassets at fair value through profit or loss are classified as current assets ifthey are either held for trading or are expected to be realized within 12months of the balance sheet date.

***(k) Inventories***

Inventories arestated at the lower of cost and net realisable value. Cost is determined usingthe first-in-first-out (FIFO) method. The cost of finished goods and work inprogress comprises raw materials, direct labour, other direct costs and anappropriate proportion of related production overheads, based on the normallevel of production capacity. Net realisable value is the estimated sellingprice in the ordinary course of business, less applicable variable sellingexpenses. Provision is made for obsolete, slow-moving or defective items whereappropriate.

F-13

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***(l) Trade receivables***

Tradereceivables are non-derivative financial assets with fixed or determinablepayments that are not quoted in an active market. They arise when the Groupprovides money, goods or services directly to a debtor with no intention oftrading the receivable. They are included in current assets, except formaturities greater than 12 months after the balance sheet date. These areclassified as non-current assets. Trade receivables are recognized initially atfair value less provision for impairment. A provision for impairment of tradereceivables is established when there is objective evidence that the Group willnot be able to collect all amounts due according to the original terms of thereceivables.

***(m) Cash and cash equivalents***

Cash and cashequivalents are highly liquid investments that are readily convertible to knownamounts of cash and which are subject to an insignificant risk of changes invalue. Cash and cash equivalents are carried in the balance sheet at cost. Forthe purposes of the cash flow statement, cash and cash equivalents comprisecash at bank and in hand, short term deposits, marketable securities andoverdrafts. Bank overdrafts are included within borrowings in currentliabilities on the balance sheet.

***(n) Borrowings***

Borrowings arerecognized initially at fair value, net of transaction costs incurred.Borrowings are subsequently stated at amortized cost, any difference betweenproceeds (net of transaction costs) and the redemption value is recognized inthe income statement over the period of the borrowings using the effectiveinterest method. Borrowings are classified as current liabilities unless theGroup has an unconditional right to defer settlement of the liability for atleast 12 months after the balance sheet date.

***(o) Convertible bonds***

On issue thedebt and equity components of a convertible bond are separated and recorded atfair value net of issue costs. The fair value of the liability portion isdetermined by applying a market interest rate for an equivalent non-convertiblebond to the forecast cash flows under the convertible bond agreement. Thisamount is recorded as a liability on an amortized cost basis until extinguishedon conversion or maturity of the bonds. The remainder of the proceeds of thebond is allocated to the conversion option which is recognized and included inshareholders’ equity, net of income tax effects. The value of the conversionoption is not changed in subsequent periods.

***(p) Paul Capital funding liabilities***

The Groupentered into two transactions with Paul Capital Royalty Acquisition Fund (‘PaulCapital’) in 2000 and 2002. Under these transactions Paul Capital provided atotal of $60m in return for the sale of a portion of the potential futureroyalty and revenue streams on a selection of the Group’s products. Theproceeds received from Paul Capital meet the definition of a financialliability under IAS 39, and are treated as such and recorded in borrowings atthe net present value of royalties expected to be paid to Paul Capital over theterm of the agreements at the effective interest rates at inception of thearrangements. Interest is charged on the liability and royalties paid to PaulCapital are treated as repayment of the liability.

***(q) Derivative financial instruments***

The Group uses derivative financialinstruments to manage its exposure to fluctuations in interest and foreignexchange rates. Specifically, the Group uses interest rate swaps, forwardcurrency contracts and currency options.

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Derivativesare initially recognized at fair value on the date a derivative contract isentered into and are subsequently re-measured at their fair value. The Groupdesignates certain derivatives as either:

·       hedges ofthe fair value of recognized assets or liabilities (fair value hedge); or

·       hedges ofhighly probable forecast transactions (cash flow hedges).

Forrelationships where hedge accounting is applied the Group documents at theinception of the transaction the relationship between hedging instruments andhedged items, as well as its risk management objective and strategy forundertaking various hedge transactions and reviews this documentation on anongoing basis.

*Fair value hedge*

Changes in the fair value of derivatives that are designated and qualifyas fair value hedges are recorded in the income statement, together with anychanges in the fair value of the hedged asset or liability that areattributable to the hedged risk.

*Cash flow hedge*

The effective portion of changes in the fair value of derivatives thatare designated and qualify as cash flow hedges are recognized in equity. Thegain or loss relating to the ineffective portion is recognized immediately inthe income statement. Amounts deferred in equity are recycled in the incomestatement in the periods when the hedged item will affect profit or loss.

*Derivatives that do not qualify for hedgeaccounting*

Changes in the fair value of any derivative instruments that do notqualify for hedge accounting are recognized immediately in the incomestatement.

***(r) Leases***

Lease agreements which transfer to theGroup substantially all the risks and rewards of ownership of an asset areclassified as finance leases. Finance leases are capitalized at the inceptionof the lease at the lower of the fair value of the leased property, plant andequipment or the present value of minimum lease payments. Each lease payment isallocated between the liability and finance charges so as to achieve a constantrate on the finance balance outstanding. The corresponding rental obligations,net of finance charges, are included in other long-term payables. Thesepayments are split between capital and interest elements using the annuitymethod. The interest element of the lease rental is included in the incomestatement. Assets held under finance leases are depreciated on a basisconsistent with similar owned assets or the lease term if shorter.

All otherleases are classified as operating leases. Payments made under operatingleases, net of lease incentives or premiums received, are charged to the incomestatement on a straight line basis over the period of the lease.

***(s) Employee benefits***

*Pensionobligations*

The Group operates various definedcontribution plans for its employees in the UK and US. The Group’scontributions to these plans are charged to the income statement in the periodto which they relate, and the assets are held in separate trustee administeredfunds. The Group has no further payment obligations once the contributions havebeen paid.

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The Group operates a funded defined benefitscheme in respect of its employees in Switzerland and an unfunded definedbenefit scheme in respect of its employees in France.

The liability recognized in the balancesheet in respect of the defined benefit pension plans is the present value ofthe defined benefit obligations at the balance sheet date less the fair valueof plan assets, together with adjustments for unrecognized past service costs.Defined benefit obligations for the schemes are calculated annually byindependent actuaries using the projected unit credit method. The present valueof the defined benefit obligations are determined by discounting the estimatedfuture cash outflows using interest rates of high quality corporate bonds thatare denominated in the currency in which the benefits will be paid, and thathave terms to maturity approximating to the terms of the related pensionliability. Service costs are included in staff costs and charged to incomestatement over the remaining average expected service lives of employees.

Actuarial gains and losses arising fromexperience adjustments and changes in actuarial assumptions are charged orcredited to equity in the Consolidated Statement of Income and Expense in theperiod in which they arise.

The Grouprecognizes actuarial gains and losses arising from experience adjustments andchanges in actuarial assumptions directly in equity, in the period they haveoccurred, in accordance to the alternative treatment allowed by the amendmentto IAS 19; Employee Benefits - Actuarial Gains and Losses, Group Plans andDisclosures.

*Share-basedcompensation*

Incentives in the form of shares areprovided to employees under share option, share purchase and long termincentive plans. The fair value of the employee services received in exchangefor the grant of the options and rewards is recognized as an expense. The totalamount to be expensed over the vesting period is determined by reference to thefair value of the options granted, which excludes the impact of any non-marketvesting conditions (for example, profitability and sales growth targets).Non-market vesting conditions are included in estimates about the number ofoptions that are expected to become exercisable.

The Group provides finance to an employeeshare ownership trust to purchase company shares on the open market to meet theGroup’s obligation to provide shares when employees exercise their options orawards. The costs of running the employee share ownership trust are charged tothe income statement as they accrue. Shares held by the employee shareownership trust are deducted from shareholders’ equity.

At each balancesheet date, the entity revises its estimates of the number of options that areexpected to become exercisable. It recognizes the impact of the revision oforiginal estimates, if any, in the income statement, and a correspondingadjustment to equity over the remaining vesting period.

***(t) Provisions***

Provisions arerecognized when the Group has a present legal or constructive obligation as aresult of past events, if it is probable that an outflow of resources will berequired to settle the obligation and the amount can be reliably estimated.Restructuring charges are provided in the period in which management hascommitted to a plan and it is probable that an obligation has been incurredthat can be reliably estimated. Provisions are not recognized for futureoperating losses.

***(u) Taxation***

Current tax isthe expected tax payable on the taxable income for the year using the tax ratesand laws that have been enacted or substantially enacted at the balance sheetdate, and any adjustment to tax payable in respect of previous years.

F-16

----

Deferred incometax is provided in full, using the liability method, on temporary differencesarising between the tax bases of assets and liabilities and their carryingamounts in the consolidated financial statements. Deferred tax assets arerecognized to the extent that it is probable that future taxable profits willbe available against which the temporary differences can be utilized. Deferredincome tax is determined using tax rates that have been enacted orsubstantially enacted by the balance sheet date. Deferred tax assets andliabilities are not discounted.

***(v) Deferred consideration***

Provisions fordeferred consideration comprise the fair value of contingent considerationarising from acquisitions. The eventual outcome is subject to the Group’sfuture performance and certain contractual terms. Provisions are reviewedannually by the Directors, and changes to the estimated fair value of thecontingent consideration are recorded as an adjustment to goodwill or theunderlying asset value.

**2**                    Financial risk management

*Financial risk factors*

The Group holds financial instruments to finance its operations and tomanage the currency risk that arises from these operations. It is the Group’spolicy that no speculative trading in financial instruments shall beundertaken. The Group finances its operations through a combination of equity,convertible bonds, bank loans and other borrowings. The main risks arising fromthe Group’s financial instruments are liquidity risk, foreign currency risk,interest rate risk, credit risk and price risk.

*Liquidityrisk*

The Group’spolicy is to maintain continuity of funding through a mixture of long-term debtand bank loans, raised to cover specific projects, and through the issue ofshares to collaborative partners, where necessary, to finance developmentcontracts. Short-term flexibility is provided through the use of overdrafts.

*Foreigncurrency risk*

All of theGroup’s operations other than its corporate offices are based overseas inEurope and North America giving rise to exposures to changes in foreignexchange rates notably the Swiss Franc, Euro and US Dollar. To minimize theimpact of any fluctuations, the Group’s policy has historically been tomaintain natural hedges by relating the structure of borrowings to the tradingcash flows that generate them. Where subsidiaries are funded centrally, this isachieved by the use of long-term loans, the exchange differences on which aretaken to reserves. Where it has not been possible to use natural hedges,currency options, accrual forward options and forward currency contracts areused. The Group has used these financial instruments during the year tominimize the currency exposure on operational transactions.

*Interestrate risk*

The Groupborrows at fixed and floating rates of interest as deemed appropriate for itscircumstances. Where necessary the Group uses interest rate swaps to achievethe desired interest rate profile.

*Creditrisk*

The Group isexposed to credit related losses in the event of non-performance by thirdparties to financial instruments. The Group does not expect any third partiesto fail to meet their obligations given the policy of selecting only partieswith high credit ratings and minimising its exposure to any one institution.

F-17

----

*Pricerisk*

The Group isexposed to equity securities price risk because of investments which have beenclassified on the consolidated balance sheet as at fair value through profit orloss.

***Fair value estimation***

The fair valueof financial instruments traded in active markets (such as trading andavailable-for-sale securities) is based on quoted market prices at the balancesheet date. The quoted market price used for financial assets held by the Groupis the current bid price. Quoted market prices or dealer quotes for similarinstruments are used for other financial instruments. The fair value of forwardforeign exchange contracts is determined using forward exchange market rates atthe balance sheet date. The nominal value less estimated credit adjustments oftrade receivables and payables are assumed to approximate their fair values.The fair value of the liabilities for the disclosure purposes is estimated bydiscounting the future cash flows at the current market interest rates that isavailable to the Group for similar financial instruments.

**3**                    Critical accounting estimates andjudgements

The preparationof the Consolidated Financial Statements requires the Group to make estimatesand judgements that affect the reported amounts of assets, liabilities,revenues and expenses, and related disclosure of contingent assets andliabilities. The Group bases its estimates and judgements on historicalexperience and on various other assumptions that it considers to be reasonable.Actual results may differ from these estimates under different assumptions orconditions.

***Revenuerecognition***

The Group’srevenue comprises revenues from contract development and licensing, royaltiesand manufacturing and distribution. The Group enters a wide variety ofcollaborative arrangements with its partners from which it may earn all, orsome of, these revenue streams. The application of the Group’s revenuerecognition policy set out earlier in this note to its complex collaborationagreements requires significant estimates and judgement. In particular, inarrangements with multiple deliverables, there may be significant judgement inseparating the different revenue generating activities.

***PaulCapital funding liabilities***

The proceedsreceived from Paul Capital are treated as a liability under IAS 39 and arerecorded within borrowings at the net present value of royalties expected to bepaid to Paul Capital at the effectiveinterest rate at inception of the agreement. Therefore in order to beable to record the funding liability significant estimation of certain of theGroup’s future cash flows is required. Royalty cash flows are periodicallyreassessed to determine the estimated funding liability. In addition such flowsare subject to foreign exchange movements.

***Impairmentof goodwill***

The Group testsannually whether goodwill has suffered any impairment, in accordance with theaccounting policy stated earlier in this note. The recoverable amounts ofcash-generating units have been determined based on value-in-use calculations.These calculations require the use of estimates. The estimates used in goodwillimpairment testing as at December 31, 2005 and 2004 are presented in Note12; Goodwill.

F-18

----

***Impairmentof other intangible assets and property, plant and equipment***

The Group testsannually whether other intangible assets and property, plant and equipment havesuffered any impairment, in accordance with the accounting policy statedearlier in this note. These calculations require the use of estimates.

***DeferredConsideration***

Provisions fordeferred consideration payable by the Group comprise the fair value ofcontingent consideration arising from acquisitions. The eventual outcome issubject to the Group’s future performance and certain contractual terms.Provisions are reviewed annually by the Directors, who make significantjudgments as to the estimated fair value of the contingent consideration. Basedon these judgments, changes to the estimated fair value of the considerationare recorded.

***ContingentLiabilities***

Provisions forcontingent liabilities are dependent upon estimates and assessments of whetherthe criteria for recognition have been met, including estimates by theDirectors as to the probable outcome and the amount of the potential cost ofresolution. Any estimate for such an accrual would be developed in consultationwith external legal advisors handling the Group’s defence in these matters andwould be based upon an analysis of potential outcomes.

***Pensions***

The Grouprecognizes actuarial gains and losses arising from experience adjustments andchanges in actuarial assumptions directly in equity, in the period they haveoccurred, in accordance to the alternative treatment allowed by the amendmentto IAS 19; Employee Benefits - Actuarial Gains and Losses, Group Plans andDisclosures. The costs are assessed in accordance with advice received fromindependent actuaries. These assumptions include inflation rate, rate ofincrease in salaries, discount rate and expected return on plan assets and aredisclosed in Note 26; Retirement benefit obligations. The selection ofdifferent assumptions could affect the future results of the Group.

***Sharebased compensation***

Incentives inthe form of shares are provided to employees under share option, share purchaseand long term incentive plans. The fair value of the employee services receivedin exchange for the grant of the options and rewards is recognized as anexpense. The expense is based upon a number of assumptions disclosed in Note27; Share capital. The selection of different assumptions could affect thefuture results of the Group.

***Amortizationlives***

Otherintangible assets are recorded at their fair value at acquisition date and areamortized on a straight line basis over their estimated useful economic livesfrom the time they are available for use. Any change in the estimated usefuleconomic lives could affect the future results of the Group.

***Taxation***

Current tax isthe expected tax payable on the taxable income for the year using the tax ratesand laws that have been enacted or substantially enacted at the balance sheetdate, and any adjustment to tax payable in respect of previous years. The Grouphas open tax issues with a number of revenue authorities and, on the basis ofexternal professional advice, continues to believe that it has made adequateprovision for any liabilities that may arise from these open assessments. Theultimate liability for such matters may vary from the amounts provided, and isdependent upon negotiations with the relevant tax authorities.

F-19

----

**4**                    Segment information

**Primaryreporting format—business segments**

Based on therisks and returns of the various segments, the Directors consider that theGroup’s primary reporting format is by business segment with geographicalreporting being the secondary format. The Group is a speciality pharmaceuticalcompany, using its multiple drug delivery technologies to create a productpipeline for out-licensing to marketing partners. The business segments consistof the Injectable business and the Oral and Inhalation business. Businesssegment data includes an allocation of corporate costs to each segment on anappropriate basis. There are no material inter-segment transfers. Thegeographic segments of UK, Europe, North America and Rest of the World reflectthe Group’s most significant regional markets. Revenue is shown by businesssegment, revenue stream and location of customer. Other geographic informationis provided by location of operation. All Group activities are continuingoperations.

**Revenue by business segment:**

| ** **                               | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                               | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                               | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Injectable                               |       |                        | 25.6       |                        |       |   | 10.5 |   |   |
| Oral  and Inhalation                     |       |                        | 49.6       |                        |       |   | 50.8 |   |   |
|                                     | ** ** | ** **                  | **75.2**   |                        | ** ** | ** ** | **61.3** |   |   |
| Revenue  earned can be analysed as:      |       |                        |       |                        |       |   |   |   |   |
| Contract  development and licensing      |       |                        |       |                        |       |   |   |   |   |
| Milestone payments                       |       |                        | 33.4       |                        |       |   | 22.1 |   |   |
| Research and development costs recharged |       |                        | 6.0        |                        |       |   | 5.5 |   |   |
|                                     |       |                        | 39.4       |                        |       |   | 27.6 |   |   |
| Royalties                                |       |                        | 25.9       |                        |       |   | 21.7 |   |   |
| Manufacturing and distribution           |       |                        | 9.9        |                        |       |   | 12.0 |   |   |
| **Total revenue**                        | ** ** | ** **                  | **75.2**   |                        | ** ** | ** ** | **61.3** |   |   |

 

**Operating loss by business segment:**

| ** **                            | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|---------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                            | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                            | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Injectable                            |       |                        | (1.4       | )                           |       |   | (18.6 | ) |   |
| Oral  and Inhalation                  |       |                        | 1.0        |                        |       |   | 2.5 |   |   |
| Operating  loss pre exceptional items | ** ** | ** **                  | **(0.4**   | **)**                       | ** ** | ** ** | **(16.1** | **)** | ** ** |
| Exceptional  items                    |       |                        | (2.7       | )                           |       |   | (21.4 | ) |   |
| Operating  loss                       | ** ** | ** **                  | **(3.1**   | **)**                       | ** ** | ** ** | **(37.5** | **)** | ** ** |
| Share  of loss in associate           |       |                        | —     |                        |       |   | (0.8 | ) |   |
| Net  interest                         |       |                        | (15.3      | )                           |       |   | (12.3 | ) |   |
| Tax                                   |       |                        | (0.2       | )                           |       |   | (0.3 | ) |   |
| Loss after  tax                       | ** ** | ** **                  | **(18.6**  | **)**                       | ** ** | ** ** | **(50.9** | **)** | ** ** |

 

F-20

----

**Total assets by business segment:**

| ** **                                              | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|---------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                              | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                                              | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Injectable                                              |       |                        | 60.4       |                        |       |   | 57.1 |   |   |
| Oral  and Inhalation                                    |       |                        | 95.6       |                        |       |   | 93.3 |   |   |
| Total  operating assets                                 | ** ** | ** **                  | **156.0**  |                        | ** ** | ** ** | **150.4** |   |   |
| Investments in associates                               |       |                        | 14.3       |                        |       |   | 0.2 |   |   |
| Available-for-sale  financial assets                    |       |                        | 5.2        |                        |       |   | 1.6 |   |   |
| Financial  assets at fair value through profit and loss |       |                        | 1.1        |                        |       |   | 0.4 |   |   |
| Cash  and cash equivalents                              |       |                        | 15.3       |                        |       |   | 34.3 |   |   |
| Total assets                                            | ** ** | ** **                  | **191.9**  |                        | ** ** | ** ** | **186.9** |   |   |

 

**Total liabilities by business segment:**

| ** **                               | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                               | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                               | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Injectable                               |       |                        | (30.5      | )                           |       |   | (40.1 | ) |   |
| Oral  and Inhalation                     |       |                        | (54.0      | )                           |       |   | (41.4 | ) |   |
| Total  operating liabilities             | ** ** | ** **                  | **(84.5**  | **)**                       | ** ** | ** ** | **(81.5** | **)** | ** ** |
| Short-term borrowings: convertible bonds |       |                        | (9.4       | )                           |       |   | — |   |   |
| Short-term  borrowings: other            |       |                        | (3.9       | )                           |       |   | (2.7 | ) |   |
| Long-term  borrowings: convertible bonds |       |                        | (50.4      | )                           |       |   | (63.6 | ) |   |
| Long-term  borrowings: other             |       |                        | (7.2       | )                           |       |   | (7.2 | ) |   |
| Total  liabilities                       | ** ** | ** **                  | **(155.4** | **)**                       | ** ** | ** ** | **(155.0** | **)** | ** ** |

 

**Property, plant and equipment andintangible assets by business segment:**

| ** **                        | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|-----------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                        | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| **Additions**                     |       |                        |       |                        |       |   |   |   |   |
| Injectable                        |       |                        | 2.3        |                        |       |   | 1.8 |   |   |
| Oral  and Inhalation              |       |                        | 4.9        |                        |       |   | 3.3 |   |   |
|                              | ** ** | ** **                  | **7.2**    | ** **                  | ** ** | ** ** | **5.1** | ** ** | ** ** |
| **Depreciation and Amortization** | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Injectable                        |       |                        | (1.9       | )                           |       |   | (1.9 | ) |   |
| Oral  and Inhalation              |       |                        | (6.3       | )                           |       |   | (6.4 | ) |   |
|                              | ** ** | ** **                  | **(8.2**   | **)**                       | ** ** | ** ** | **(8.3** | **)** | ** ** |

 

F-21

----

**Investments in associates by businesssegment:**

| ** **           | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|----------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **           | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **           | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Injectable           |       |                        | 14.3       |                        |       |   | 0.2 |   |   |
| Oral  and Inhalation |       |                        | —     |                        |       |   | — |   |   |
|                 | ** ** | ** **                  | **14.3**   |                        | ** ** | ** ** | **0.2** |   |   |

 

**Secondaryreporting format—geographic**

**Revenue by location of customer:**

| ** **     | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|----------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **     | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **     | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| UK             |       |                        | 15.2       |                        |       |   | 23.9 |   |   |
| Europe         |       |                        | 26.0       |                        |       |   | 23.8 |   |   |
| North  America |       |                        | 29.2       |                        |       |   | 8.7 |   |   |
| Rest  of World |       |                        | 4.8        |                        |       |   | 4.9 |   |   |
|           | ** ** | ** **                  | **75.2**   |                        | ** ** | ** ** | **61.3** |   |   |

 

**Total assets by location of operation:**

| ** **     | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|----------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **     | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **     | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| UK             |       |                        | 30.0       |                        |       |   | 37.7 |   |   |
| Europe         |       |                        | 89.7       |                        |       |   | 56.9 |   |   |
| North  America |       |                        | 72.2       |                        |       |   | 92.3 |   |   |
|           | ** ** | ** **                  | **191.9**  |                        | ** ** | ** ** | **186.9** |   |   |

 

**Property, plant and equipment andintangible asset additions by location of operation:**

| ** **     | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|----------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **     | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **     | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Europe         |       |                        | 4.9        |                        |       |   | 3.3 |   |   |
| North  America |       |                        | 2.3        |                        |       |   | 1.8 |   |   |
|           | ** ** | ** **                  | **7.2**    |                        | ** ** | ** ** | **5.1** |   |   |

 

F-22

----

**5**                    Exceptional items

| ** **                                           | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                           | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                                           | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Impairments                                          |       |                        | (3.5       | )                           |       |   | (19.4 | ) |   |
| Abortive  transaction costs                          |       |                        | —     |                        |       |   | (2.0 | ) |   |
| Restructuring  costs                                 |       |                        | (1.2       | )                           |       |   | — |   |   |
| Profit  on disposal of available-for-sale investment |       |                        | 2.0        |                        |       |   | — |   |   |
| Convertible  bonds exchange                          |       |                        | (6.2       | )                           |       |   | — |   |   |
|                                                 |       |                        | (8.9       | )                           |       |   | (21.4 | ) |   |

 

Following the Strategic Review and theGroup’s decision to focus on its core oral and pulmonary products and to divestits injectable business, the Group no longer views its collaborations withAstralis, Vital Living and Micap as strategic and these investments havetherefore been impaired resulting in an exceptional charge of £19.4 million.See Notes 15; Investments in associates and 16; Available for sale financialassets. During the year the Group incurred £2.0 million legal and professionalfees relating to an aborted strategic transaction.

Exceptionalitems for 2004 include a charge of £3.5 million relating to the impairment inthe investment in Vital Living and £1.2 million relating to the reorganizationof some research and development operations and other business functions. Inaddition, £2.0 million relates to the profit on disposal of the Group’sinvestment in Transition Therapeutics and a charge of £6.2 million relates tothe exchange of convertible bonds.

**6**                    Operating expenses

| ** **                                                            | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                            | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                                                            | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Cost  of sales                                                        |       |                        | 28.2       |                        |       |   | 29.2 |   |   |
| Selling,  marketing and distribution expenses                         |       |                        | 1.7        |                        |       |   | 5.9 |   |   |
| Depreciation                                                          |       |                        | 6.0        |                        |       |   | 6.2 |   |   |
| Amortization                                                          |       |                        | 2.2        |                        |       |   | 2.1 |   |   |
| Research  and development expenses                                    |       |                        | 28.0       |                        |       |   | 26.0 |   |   |
| (Gain)/loss  on financial assets at fair value through profit or loss |       |                        | (0.1       | )                           |       |   | 0.7 |   |   |
| Fair  value loss/(gain) on derivative financial instruments           |       |                        | 0.5        |                        |       |   | (0.3 | ) |   |
| Profit  on disposal of available for sale financial assets            |       |                        | —     |                        |       |   | (0.3 | ) |   |
| Other  operating expenses                                             |       |                        | 9.1        |                        |       |   | 8.1 |   |   |
| **Operating expenses before exceptional items**                       | ** ** | ** **                  | **75.6**   |                        | ** ** | ** ** | **77.6** |   |   |
| Impairments                                                           |       |                        | 3.5        |                        |       |   | 19.4 |   |   |
| Abortive  transaction costs                                           |       |                        | —     |                        |       |   | 2.0 |   |   |
| Restructuring  costs                                                  |       |                        | 1.2        |                        |       |   | — |   |   |
| Profit  on disposal of available for sale financial assets            |       |                        | (2.0       | )                           |       |   | — |   |   |
| **Total operating expenses**                                          | ** ** | ** **                  | **78.3**   |                        | ** ** | ** ** | **99.0** |   |   |

 

**Servicesprovided by the Group’s auditor and network firms**

It is the Group’s policy to employ the auditors on assignments additionalto their statutory audit duties where their expertise and experience with theGroup are important, principally tax advice and due diligence reporting onacquisitions, or where they are awarded assignments on a competitive basis.During 

F-23

----

the year the Group (including its overseassubsidiaries) obtained the following services from the Group’s auditor at costsdetailed below:

| ** **                         | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                         | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Audit  services                    |       |                        |       |                        |       |   |   |   |   |
| statutory audit                    |       |                        | 0.3        |                        |       |   | 0.4 |   |   |
| audit related regulatory reporting |       |                        | 0.2        |                        |       |   | 0.2 |   |   |
| Further  assurance services        |       |                        | 1.0        |                        |       |   | 1.2 |   |   |
| Tax services                       |       |                        |       |                        |       |   |   |   |   |
| compliance services                |       |                        | 0.1        |                        |       |   | — |   |   |
| advisory services                  |       |                        | 0.6        |                        |       |   | 0.2 |   |   |
|                               | ** ** | ** **                  | **2.2**    |                        | ** ** | ** ** | **2.0** |   |   |

 

Included in theanalysis above are audit fees paid to the Group’s auditor in the UK of £227,000(2004: £177,000) of which £15,000 (2004: £14,000) was paid in respect of theparent company. Also included above are fees paid to the Group’s auditor inrespect of non-audit services in the UK of £1,295,000 (2004: £1,141,000).

**7**                    Staff costs

| ** **                           | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|--------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                           | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                           | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Wages  and salaries                  |       |                        | 19.2       |                        |       |   | 19.7 |   |   |
| Equity  settled share based payments |       |                        | 2.9        |                        |       |   | 1.9 |   |   |
| Social  security costs               |       |                        | 2.9        |                        |       |   | 2.9 |   |   |
| Pensions                             |       |                        |       |                        |       |   |   |   |   |
| —defined benefit plans          |       |                        | 0.7        |                        |       |   | 0.2 |   |   |
| —defined contribution plans     |       |                        | 1.3        |                        |       |   | 0.7 |   |   |
| Other  benefits                      |       |                        | —     |                        |       |   | 0.8 |   |   |
|                                 | ** ** | ** **                  | **27.0**   |                        | ** ** | ** ** | **26.2** |   |   |

 

The averagenumber of people, including executive directors, employed by the Group duringthe period was 457 persons (2004: 438 persons).

**Average number of employees by businesssegment:**

| ** **           | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|----------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **           | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| Injectable           |       |                        | 113        |                        |       |   | 129 |   |   |
| Oral  and Inhalation |       |                        | 325        |                        |       |   | 328 |   |   |
|                 | ** ** | ** **                  | **438**    |                        | ** ** | ** ** | **457** |   |   |

 

The Group’s keymanagement comprises only Directors and Director’s remuneration for the year isshown in Part I, Item 6: Directors, Senior Management and Employees.

F-24

----

**8**                    Other income and expenses

| ** **                                                            | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                            | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                                                            | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Gain/(loss)  on financial assets at fair value through profit or loss |       |                        | 0.1        |                        |       |   | (0.7 | ) |   |
| Profit  on disposal of available-for-sale investment                  |       |                        | 2.0        |                        |       |   | 0.3 |   |   |
|                                                                  | ** ** | ** **                  | **2.1**    |                        |       |   | (0.4 | ) |   |

 

**9**                    Finance costs and income

| ** **                                        | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|---------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                        | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                                        | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| **Interest and similar  expense:**                | ** ** |                        | ** ** | ** **                  |       |   | ** ** | ** ** |   |
| Interest:                                         |       |                        |       |                        |       |   |   |   |   |
| —bank borrowings                             |       |                        | (0.7       | )                           |       |   | (0.5 | ) |   |
| —Paul Capital arrangements                   |       |                        | (11.3      | )                           |       |   | (12.7 | ) |   |
| —interest on convertible bonds               |       |                        | (5.7       | )                           |       |   | (5.8 | ) |   |
|                                              | ** ** |                        | **(17.7**  | **)**                       |       |   | **(19.0** | **)** |   |
| Foreign  exchange on Paul Capital arrangements    |       |                        | —     |                        |       |   | (3.3 | ) |   |
| Fair value  losses on financial instruments:      |       |                        |       |                        |       |   |   |   |   |
| —loss on exchange of convertible bonds       |       |                        | (6.2       | )                           |       |   | — |   |   |
| **Total interest and similar expense**            | ** ** |                        | **(23.9**  | **)**                       |       |   | **(22.3** | **)** |   |
| **Interest and similar income:**                  |       |                        |       |                        |       |   |   |   |   |
| Paul  Capital change in estimated future payments |       |                        | 6.0        |                        |       |   | 9.0 |   |   |
| Other  interest income                            |       |                        | 0.8        |                        |       |   | 1.0 |   |   |
| Foreign  exchange on Paul Capital arrangements    |       |                        | 1.8        |                        |       |   | — |   |   |
| **Total interest and  similar income**            | ** ** |                        | **8.6**    | ** **                  |       |   | **10.0** | ** ** |   |

 

**10**             Income tax

| ** **                       | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|----------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                       | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| **Current income tax  expense:** |       |                        |       |                        |       |   |   |   |   |
| Foreign tax                      |       |                        | 0.2        |                        |       |   | 0.3 |   |   |

 

There was no deferred tax component in thetax charge.

Foreign tax relates principally towithholding tax paid on remittance of royalties to Switzerland which is notrecoverable.

F-25

----

The tax on the Group’s losses before tax differs from the theoreticalamount that would arise using the standard rate of corporation tax in the UK. Thedifferences are explained below:

| ** **                                                              | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                              | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                                                              | ** ** | **%**                       | ** ** | **%**                       | ** ** |
| Loss  before tax multiplied by rate of corporation tax in the UK of 30% | ** ** |                        | **30.0**   | ** **                  |       |   | **30.0** | ** ** |   |
| Effects  of:                                                            |       |                        |       |                        |       |   |   |   |   |
| Adjustments  in respect of foreign tax rates                            |       |                        | 17.2       |                        |       |   | (4.4 | ) |   |
| Adjustment  to tax in respect of prior periods                          |       |                        | (0.1       | )                           |       |   | — |   |   |
| Expenses  not deductible for tax purposes                               |       |                        | (8.2       | )                           |       |   | (7.1 | ) |   |
| Tax  losses for which no deferred tax asset was recognized              |       |                        | (40.0      | )                           |       |   | (19.6 | ) |   |
| Tax  losses utilized                                                    |       |                        | 1.9        |                        |       |   | 1.0 |   |   |
| Capital  allowances utilized                                            |       |                        | 0.2        |                        |       |   | — |   |   |
| Withholding  taxes                                                      |       |                        | (0.7       | )                           |       |   | (0.6 | ) |   |
| Other                                                                   |       |                        | (1.3       | )                           |       |   | 0.1 |   |   |
| **Effective tax rate**                                                  | ** ** |                        | **(1.0**   | **)**                       |       |   | **(0.6** | **)** |   |

 

The Group has estimated total tax lossesavailable to be set off against future taxable profits of £280.0 million (December 31,2004: £271.1 million). These losses arise primarily in Switzerland and the US.Of the £280.0 million of losses carried forward, £22.0 million expire in 2006,£65.1 million expire between 2007 and 2009, £191.6 million expire from 2010onwards and £1.3 million of losses may be carried forward indefinitely. TheGroup also has other tax allowances available of £59.8 million (December 31,2004: £56.6 million)

No deferred tax asset has been recognized, given theuncertainty of the recoverability of the Group’s tax losses carried forward.

**11**             Earnings per share

| ** **                                  | ** ** | **Year to**            | ** ** | **Year to**            | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                  | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                                  | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Attributable  loss before exceptional items |       |                        | (9.7       | )                           |       |   | (29.5 | ) |   |
| Exceptional  items                          |       |                        | (8.9       | )                           |       |   | (21.4 | ) |   |
| Basic  and diluted attributable loss        |       |                        | (18.6      | )                           |       |   | (50.9 | ) |   |

 

| ** **                                                    | ** ** | **Number** | ** ** | **Number** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                    | ** ** | **m**      | ** ** | **m**      | ** ** |
| Basic  and diluted weighted average number of shares in issue |       |       | 615.2      |       |       |   | 624.9 |   |   |
| Loss per Ordinary Share before exceptional items              |       |       | (1.6       | p)         |       |   | (4.7 | p) |   |
| Exceptional  items                                            |       |       | (1.4       | p)         |       |   | (3.4 | p) |   |
| Basic and  diluted loss per Ordinary Share                    |       |       | (3.0       | p)         |       |   | (8.1 | p) |   |

 

There is no difference between basic anddiluted loss per share since in a loss making year all potential shares fromconvertible bonds, stock options, warrants and contingent issuance of sharesare anti dilutive.

Shares held bythe SkyePharma PLC General Employee Benefit Trust have been excluded from theweighted average number of shares.

F-26

----

**12**             Goodwill

| ** **                                  | ** ** | **As at**              | ** ** | **As at**              | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                  | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                                  | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| **Cost**                                    | ** ** |                        | ** ** | ** **                  |       |   | ** ** | ** ** |   |
| Beginning  of the year                      |       |                        | 82.7       | ** **                  |       |   | 82.7 | ** ** |   |
| Additions  during the year                  |       |                        | —     | ** **                  |       |   | — | ** ** |   |
| Exchange  differences                       |       |                        | —     | ** **                  |       |   | — | ** ** |   |
| **End of the year**                         | ** ** |                        | **82.7**   | ** **                  |       |   | **82.7** | ** ** |   |
| **Accumulated impairment and depreciation** |       |                        |       | ** **                  |       |   |   | ** ** |   |
| Beginning  of the year                      |       |                        | 14.0       | ** **                  |       |   | 14.0 | ** ** |   |
| Amortization  charge                        |       |                        | —     | ** **                  |       |   | — | ** ** |   |
| Exchange  differences                       |       |                        | —     | ** **                  |       |   | — | ** ** |   |
| **End of the year**                         | ** ** |                        | **14.0**   | ** **                  |       |   | **14.0** | ** ** |   |
| **Net book value**                          |       |                        |       | ** **                  |       |   |   | ** ** |   |
| **Beginning of the year**                   | ** ** |                        | **68.7**   | ** **                  |       |   | **68.7** | ** ** |   |
| **End of the year**                         | ** ** |                        | **68.7**   | ** **                  |       |   | **68.7** | ** ** |   |

 

Goodwill arose on the acquisition of SkyePharma Inc (£35.6 million),SkyePharma Canada Inc (£29.2 million) and SkyePharma AB (£3.9 million) and hasbeen allocated to the following business segments/ cash-generating units:

| ** **           | ** ** | **As at**              | ** ** | **As at**              | ** ** |
|----------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **           | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **           | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Injectables          |       |                        | 38.6       |                        |       |   | 38.6 |   |   |
| Oral  and inhalation |       |                        | 30.1       |                        |       |   | 30.1 |   |   |
| ** **           | ** ** | ** **                  | **68.7**   |                        | ** ** | ** ** | **68.7** |   |   |

 

Goodwill is not amortized but is testedannually for impairment or more frequently if there are indications thatgoodwill might be impaired. Value in use calculations are generally utilized tocalculate recoverable amount.

Value in use is calculated as the netpresent value of the projected risk-adjusted cash flows of the cash-generatingunit to which goodwill is allocated. The cash flow projections are based on themost recent business plans approved by management which cover a period of 10years, and are adjusted where necessary to take account of longer patent lives.The discount rate applied may vary depending on the risk profile of the assetbeing valued but is typically 15%, which is the Group’s average pre-taxdiscount rate derived from a capital asset pricing model.

The key assumptions for the value in usecalculations are those regarding the launch dates of products, their growthrates, the discount rates used and the period over which the cash flows areprojected. The assumptions made reflect past experience, market research andexpectations of future market trends.

Goodwill wastested for impairment both at December 31, 2005 and December 31,2004. No impairment was identified.

F-27

----

**13**             Other intangible assets

| ** **                                  | ** ** | **Intellectual  property** | ** ** | **Software  costs** | ** ** | **Development  costs** | ** ** | **Total**   | ** ** |
|---------------------------------------------|------------|----------------------------|------------|---------------------|------------|------------------------|------------|-------------|------------|
| ** **                                  | ** ** | **£m**                | ** ** | **£m**         | ** ** | **£m**            | ** ** | **£m** | ** ** |
| **Cost**                                    | ** ** |                       | ** ** | ** **          |       |                   | ** ** | ** **  |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| At  January 1, 2004                    |       |                       | 36.1       |                |       |                   | 0.8        | ** **  |       |   | 0.7 |   |   |   | 37.6 |   |   |
| Exchange  differences                       |       |                       | —     |                |       |                   | —     | ** **  |       |   | (0.1 | ) |   |   | (0.1 | ) |   |
| Additions  during the year                  |       |                       | 2.9        |                |       |                   | 0.1        | ** **  |       |   | — |   |   |   | 3.0 |   |   |
| At  December 31, 2004                  |       |                       | 39.0       |                |       |                   | 0.9        | ** **  |       |   | 0.6 |   |   |   | 40.5 |   |   |
| Exchange  differences                       |       |                       | 0.2        |                |       |                   | —     | ** **  |       |   | 0.4 |   |   |   | 0.6 |   |   |
| Additions  during the year                  |       |                       | 1.8        |                |       |                   | 0.1        | ** **  |       |   | — |   |   |   | 1.9 |   |   |
| **At December 31, 2005**               | ** ** |                       | **41.0**   | ** **          |       |                   | **1.0**    | ** **  |       |   | **1.0** | ** ** |   |   | **43.0** | ** ** |   |
| **Accumulated impairment and depreciation** |       |                       |       |                |       |                   |       | ** **  |       |   |   |   |   |   |   |   |   |
| At  January 1, 2004                    |       |                       | 10.4       |                |       |                   | 0.6        | ** **  |       |   | 0.5 |   |   |   | 11.5 |   |   |
| Exchange  differences                       |       |                       | 0.1        |                |       |                   | —     | ** **  |       |   | — |   |   |   | 0.1 |   |   |
| Amortization  charge                        |       |                       | 2.0        |                |       |                   | 0.1        | ** **  |       |   | 0.1 |   |   |   | 2.2 |   |   |
| At  December 31, 2004                  |       |                       | 12.5       |                |       |                   | 0.7        | ** **  |       |   | 0.6 |   |   |   | 13.8 |   |   |
| Exchange  differences                       |       |                       | (0.1       | )                   |       |                   | —     | ** **  |       |   | 0.4 |   |   |   | 0.3 |   |   |
| Amortization  charge                        |       |                       | 2.0        |                |       |                   | 0.1        | ** **  |       |   | — |   |   |   | 2.1 |   |   |
| **At December 31, 2005**               | ** ** |                       | **14.4**   | ** **          |       |                   | **0.8**    | ** **  |       |   | **1.0** | ** ** |   |   | **16.2** | ** ** |   |
| **Net book value**                          |       |                       |       |                |       |                   |       | ** **  |       |   |   |   |   |   |   |   |   |
| **At December 31, 2005**               | ** ** |                       | **26.6**   | ** **          |       |                   | **0.2**    | ** **  |       |   | **—** | ** ** |   |   | **26.8** | ** ** |   |
| **At December 31, 2004**               | ** ** |                       | **26.5**   | ** **          |       |                   | **0.2**    | ** **  |       |   | **—** | ** ** |   |   | **26.7** | ** ** |   |
| **At December 31,  2003**              | ** ** |                       | **25.7**   | ** **          |       |                   | **0.2**    | ** **  |       |   | **0.2** | ** ** |   |   | **26.1** | ** ** |   |

 

There are no intangible assets withindefinite useful lives. All amortization charges in the year have been chargedthrough administrative expenses.

Intellectual property acquired during 2005mainly relates to the purchase of licenses to intellectual property in the areaof pulmonary delivery.

Included withinintellectual property is £2.0 million of assets which are not yet in use. Theseassets have not been amortized but have been tested for impairment consistentwith the method set out for goodwill in Note 12. No impairment was identified.

F-28

----

**14**             Property, plant and equipment

| ** **                     | ** ** | **Land and  buildings** | ** ** | **Laboratory  equipment and  machines** | ** ** | **Assets under  construction** | ** ** | **Office and other  equipment** | ** ** | **Motor  vehicles** | ** ** | **Total**   | ** ** |
|--------------------------------|------------|------------------------------|------------|----------------------------------------------|------------|-------------------------------------|------------|-------------------------------------------|------------|---------------------|------------|-------------|------------|
| ** **                     | ** ** | **£m**                  | ** ** | **£m**                                  | ** ** | **£m**                         | ** ** | **£m**                               | ** ** | **£m**         | ** ** | **£m** | ** ** |
| **Cost**                       | ** ** |                         | ** ** | ** **                                   |       |                                | ** ** | ** **                                |       |                | ** ** | ** **  |       |   | ** ** |   |   |   |   |   |   |   |   |   |   |
| At  January 1, 2004       |       |                         | 31.9       |                                         |       |                                | 35.6       |                                      |       |                | 3.0        |        |       |   | 3.0 |   |   |   | 0.3 |   |   |   | 73.8 |   |   |
| Exchange                       |       |                         | —     |                                         |       |                                | 0.2        |                                      |       |                | (0.2       | )           |       |   | (0.1 | ) |   |   | — |   |   |   | (0.1 | ) |   |
| Additions                      |       |                         | 0.5        |                                         |       |                                | 2.9        |                                      |       |                | 0.6        |        |       |   | 0.1 |   |   |   | 0.1 |   |   |   | 4.2 |   |   |
| Transfers                      |       |                         | 0.6        |                                         |       |                                | 1.8        |                                      |       |                | (2.5       | )           |       |   | 0.1 |   |   |   | — |   |   |   | — |   |   |
| Disposals                      |       |                         | (0.1       | )                                            |       |                                | (0.2       | )                                         |       |                | —     |        |       |   | (0.1 | ) |   |   | (0.1 | ) |   |   | (0.5 | ) |   |
| At  December 31, 2004     |       |                         | 32.9       |                                         |       |                                | 40.3       |                                      |       |                | 0.9        |        |       |   | 3.0 |   |   |   | 0.3 |   |   |   | 77.4 |   |   |
| Exchange                       |       |                         | (0.7       | )                                            |       |                                | (0.6       | )                                         |       |                | 0.1        |        |       |   | — |   |   |   | — |   |   |   | (1.2 | ) |   |
| Additions                      |       |                         | 0.2        |                                         |       |                                | 1.4        |                                      |       |                | 1.4        |        |       |   | 0.2 |   |   |   | — |   |   |   | 3.2 |   |   |
| Transfers                      |       |                         | —     |                                         |       |                                | 0.1        |                                      |       |                | (0.1       | )           |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Disposals                      |       |                         | (0.1       | )                                            |       |                                | (0.1       | )                                         |       |                | (0.1       | )           |       |   | (0.2 | ) |   |   | (0.1 | ) |   |   | (0.6 | ) |   |
| **At December 31, 2005**  | ** ** |                         | **32.3**   | ** **                                   |       |                                | **41.1**   | ** **                                |       |                | **2.2**    | ** **  |       |   | **3.0** |   | ** ** | ** ** | **0.2** |   | ** ** | ** ** | **78.8** |   |   |
| **Depreciation**               |       |                         |       |                                         |       |                                |       |                                      |       |                |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| At  January 1, 2004       |       |                         | 9.9        |                                         |       |                                | 18.6       |                                      |       |                | —     |        |       |   | 2.2 |   |   |   | 0.1 |   |   |   | 30.8 |   |   |
| Provided  in the year          |       |                         | 2.0        |                                         |       |                                | 3.6        |                                      |       |                | —     |        |       |   | 0.4 |   |   |   | — |   |   |   | 6.0 |   |   |
| Disposals                      |       |                         | (0.1       | )                                            |       |                                | (0.1       | )                                         |       |                | —     |        |       |   | (0.1 | ) |   |   | — |   |   |   | (0.3 | ) |   |
| At  December 31, 2004     |       |                         | 11.8       |                                         |       |                                | 22.1       |                                      |       |                | —     |        |       |   | 2.5 |   |   |   | 0.1 |   |   |   | 36.5 |   |   |
| Exchange                       |       |                         | (0.4       | )                                            |       |                                | (0.2       | )                                         |       |                | —     |        |       |   | — |   |   |   | — |   |   |   | (0.6 | ) |   |
| Provided  in the year          |       |                         | 2.1        |                                         |       |                                | 3.8        |                                      |       |                | —     |        |       |   | 0.3 |   |   |   | — |   |   |   | 6.2 |   |   |
| Disposals                      |       |                         | (0.1       | )                                            |       |                                | —     |                                      |       |                | —     |        |       |   | (0.3 | ) |   |   | — |   |   |   | (0.4 | ) |   |
| **At December 31, 2005**  | ** ** |                         | **13.4**   | ** **                                   |       |                                | **25.7**   | ** **                                |       |                | **—** | ** **  |       |   | **2.5** |   | ** ** | ** ** | **0.1** |   | ** ** | ** ** | **41.7** |   |   |
| **Net book value**             | ** ** |                         | ** ** | ** **                                   |       |                                | ** ** | ** **                                |       |                | ** ** | ** **  |       |   | ** ** |   | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** |   |   |
| **At December 31, 2005**  | ** ** |                         | **18.9**   | ** **                                   |       |                                | **15.4**   | ** **                                |       |                | **2.2**    | ** **  |       |   | **0.5** |   | ** ** | ** ** | **0.1** |   | ** ** | ** ** | **37.1** |   |   |
| **At December 31, 2004**  | ** ** |                         | **21.1**   | ** **                                   |       |                                | **18.2**   | ** **                                |       |                | **0.9**    | ** **  |       |   | **0.5** |   | ** ** | ** ** | **0.2** |   | ** ** | ** ** | **40.9** |   |   |
| **At December 31,  2003** | ** ** |                         | **22.0**   | ** **                                   |       |                                | **17.0**   | ** **                                |       |                | **3.0**    | ** **  |       |   | **0.8** |   | ** ** | ** ** | **0.2** |   | ** ** | ** ** | **43.0** |   |   |

 

All depreciation charges in the year havebeen charged through administrative expenses.

Included in freehold property is an amountof £4.9 million (2004: £5.1 million) in respect of land which is notdepreciated.

At December 31, 2005, the carryingamount of the Group’s laboratory equipment and machines includes an amount of£Nil (2004: £1.2 million) and motor vehicles an amount of £0.1 million (2004:£0.1 million)  in respect of assets heldunder finance leases and hire purchase arrangements.

At December 31,2005, the net book value of the tangible assets pledged as collateral in theframework of various borrowing agreements (disclosed in Note 22; Borrowings)was £1.9 million (2004: £2.1 million). The Group did not identify any tangibleassets temporarily idle as at the balance sheet date.

F-29

----

**15**             Investments in associates

| ** **                                   | ** ** | **As at**              | ** ** | **As at**              | ** ** |
|----------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                   | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                                   | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Beginning  of the year                       |       |                        | —     |                        |       |   | 14.3 |   |   |
| Reclassification  of investment as associate |       |                        | 14.2       |                        |       |   | — |   |   |
| Additions                                    |       |                        | 0.1        |                        |       |   | 3.0 |   |   |
| Share  of loss                               |       |                        | —     |                        |       |   | (0.8 | ) |   |
| Impairment                                   |       |                        | —     |                        |       |   | (16.3 | ) |   |
| **End of the year**                          | ** ** | ** **                  | **14.3**   |                        | ** ** | ** ** | **0.2** |   |   |

 

The investmentin Astralis Limited was recorded at £0.2 million at December 31, 2005(2004: £14.3 million) and had a market value of £0.4 million (2004: £9.6million). Following the Strategic Review and the Group’s decision to focus onits core oral and pulmonary products and to divest its injectable business, theGroup no longer views its collaboration with Astralis as strategic. Thiscombined with the current uncertainties concerning Astralis’ financial positionresulted in the Group impairing its investment to its estimated fair value.

**16**             Available for sale financial assets

| ** **                              | ** ** | **As at**              | ** ** | **As at**              | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                              | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                              | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Beginning  of the year                  |       |                        | 22.0       |                        |       |   | 5.2 |   |   |
| Exchange                                |       |                        | —     |                        |       |   | 0.1 |   |   |
| Reclassification  as associate          |       |                        | (14.2      | )                           |       |   | — |   |   |
| Additions                               |       |                        | 2.0        |                        |       |   | 0.1 |   |   |
| Disposal                                |       |                        | (0.6       | )                           |       |   | (1.8 | ) |   |
| Impairments                             |       |                        | (3.5       | )                           |       |   | (2.6 | ) |   |
| Revaluation  (deficit)/surplus transfer |       |                        | (0.5       | )                           |       |   | 0.6 |   |   |
| End of the  year                        |       |                        | 5.2        |                        |       |   | 1.6 |   |   |

 

Available forsale financial assets comprise the following unlisted securities:

**VecturaGroup plc**

Vectura is a UKemerging pharmaceutical company traded on the Alternative Investment Market.Vectura is developing a range of inhaled drugs for the treatment of lungdiseases and conditions where delivery via the lungs can provide significantbenefits, such as rapid onset of action, improved efficacy and improvedtolerability compared with current therapies. During 2005 the Group sold 2million ordinary shares in Vectura for £1.6 million. As at December 31,2005 the remaining holding was 1.2 million ordinary shares. The investment wasrecorded at £1.0 million at December 31, 2005 (2004: £2.0 million). In January 2006the Group sold the remaining 1.2 million ordinary shares.

**VitalLiving Inc**

Vital Livingprimarily develops and markets evidence-based nutriceuticals. These aredeveloped for incorporation by physicians into a standard physician/ patientprogram, supported by a specially designed compliance regimen. Vital Living isbased in the US. During 2005 the Group received 2,101,422 Vital Living commonshares with a value of £68,000 ($120,000) in lieu of interest due on the 12%senior secured 

F-30

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convertiblenotes. As at December 31, 2005 the total SkyePharma holding was 16,993,599common shares, 1 million series D convertible preferred shares, $1 million 12%senior secured convertible notes due 2008 and 4 million warrants expiring 2008,representing approximately 17.2% of the common shares. The investment in VitalLiving was recorded at £0.4 million at December 31, 2005 (2004: £1.7million). Following the Strategic Review and the Group’s decision to focus onits core oral and pulmonary products and to divest its injectable business, theGroup no longer views its collaboration with Vital Living as strategic and thisinvestment has therefore been impaired.

**Micapplc**

Micap plc is aUK science-based technology company traded on the Alternative InvestmentMarket. As at December 31, 2005 the total SkyePharma holding was 5,238,334ordinary shares and 1,830,000 convertible shares, representing approximately9.4% of the ordinary share capital. The investment in Micap recorded at £0.2million at December 31, 2005 (2004: £1.5 million). Following the StrategicReview and the Group’s decision to focus on its core oral and pulmonaryproducts and to divest its injectable business, the Group no longer views itscollaboration with Micap as strategic and this investment has therefore beenimpaired.

**CadeStruktur Corp**

Cade Strukturwas formerly a drug delivery company engaged in research and development andworldwide commercialisation of pharmaceutical formulations. The currentbusiness is the development, financing and completion of industrial andinfrastructure projects in Europe. As at December 31, 2005, the totalSkyePharma holding of Cade Struktur, a Canadian company, was 869,086 shares,representing approximately 10.1% of the ordinary share capital. The shares wereoriginally acquired consequent upon the acquisition of the assets of Hyal PharmaceuticalCorp. SkyePharma has not attributed a fair value to these shares and they havebeen recorded at £Nil (2004: £ Nil).

**17**             Inventories

| ** **                     | ** ** | **As at**              | ** ** | **As at**              | ** ** |
|--------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                     | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                     | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Raw  materials and consumables |       |                        | 1.2        |                        |       |   | 2.1 |   |   |
| Work  in progress              |       |                        | 0.2        |                        |       |   | 1.0 |   |   |
| Finished  goods                |       |                        | 0.1        |                        |       |   | 1.0 |   |   |
|                           |       |                        | 1.5        |                        |       |   | 4.1 |   |   |
| Inventory  provisions          |       |                        | —     |                        |       |   | (0.5 | ) |   |
|                           |       |                        | 1.5        |                        |       |   | 3.6 |   |   |

 

The cost ofinventories recognized as an expense and included in cost of sales is disclosedin Note 6; Operating expenses.

F-31

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**18**             Trade and other receivables

| ** **                      | ** ** | **As at**              | ** ** | **As at**              | ** ** |
|---------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                      | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Trade  receivables              |       |                        | 3.5        |                        |       |   | 2.4 |   |   |
| Less  provision for impairment  |       |                        | —     |                        |       |   | (0.1 | ) |   |
| Net  trade receivables          |       |                        | 3.5        |                        |       |   | 2.3 |   |   |
| Other  receivables              |       |                        | 1.9        |                        |       |   | 2.2 |   |   |
| Interest  receivable            |       |                        | 0.4        |                        |       |   | 0.6 |   |   |
| Prepayments  and accrued income |       |                        | 12.4       |                        |       |   | 9.1 |   |   |
|                            |       |                        | 18.2       |                        |       |   | 14.2 |   |   |

 

**19**             Financial assets at fair value through profit and loss

| ** **                 | ** ** | **As at**              | ** ** | **As at**              | ** ** |
|----------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                 | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                 | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Beginning  of the year     |       |                        | 1.0        |                        |       |   | 1.1 |   |   |
| Revaluation  to fair value |       |                        | 0.1        |                        |       |   | (0.7 | ) |   |
| End of the  year           |       |                        | 1.1        |                        |       |   | 0.4 |   |   |

 

Financialassets at fair value through profit or loss comprise 5% convertible loan notesdue at par in June 2007. The notes were received from GeneMedix plc in2002 as an initial payment under an agreement to jointly develop an extendedrelease formulation of Interferon alpha-2b using SkyePharma’s DepoFoamTMtechnology. The notes are convertible at any time, at SkyePharma’s option, intobetween approximately 8.3 million and 11.2 million GeneMedix ordinary shares.There are no restrictions or a lock-up period on conversion of the notes.GeneMedix can elect to redeem in cash some or all of the notes on conversion.The notes were designated as at fair value through profit or loss on initialrecognition.

**20**             Cash and cash equivalents

| ** **                | ** ** | **As at**              | ** ** | **As at**              | ** ** |
|---------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Cash  at bank and in hand |       |                        | 15.3       |                        |       |   | 26.8 |   |   |
| Short  term deposits      |       |                        | —     |                        |       |   | 7.5 |   |   |
|                      |       |                        | 15.3       |                        |       |   | 34.3 |   |   |

 

The short termdeposit is a dual currency deposit of sterling versus US dollars, which earnsan effective interest rate of 10.5%. If the sterling/US dollar spot rate is ator above 1.75 at expiry, the £7.5 million deposit will be returned in USdollars at 1.75 ($13.1 million), otherwise it will be returned in sterling.

F-32

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**21**             Trade and other payables

| ** **                                | ** ** | **As at**              | ** ** | **As at**              | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                                | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| Trade  payables                           |       |                        | 6.7        |                        |       |   | 6.8 |   |   |
| Other  taxation and social security costs |       |                        | 1.2        |                        |       |   | 2.0 |   |   |
| Accruals                                  |       |                        | 12.7       |                        |       |   | 12.2 |   |   |
|                                      |       |                        | 20.6       |                        |       |   | 21.0 |   |   |

 

**22**             Borrowings

| ** **                            | ** ** | **As at**              | ** ** | **As at**              | ** ** |
|---------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                            | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
| ** **                            | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| **Current**                           |       |                        |       |                        |       |   |   |   |   |
| Convertible  bonds due June 2005 |       |                        | 9.4        |                        |       |   | — |   |   |
| Bank borrowings                       |       |                        | 3.5        |                        |       |   | 2.3 |   |   |
| Property  mortgage                    |       |                        | 0.3        |                        |       |   | 0.3 |   |   |
| Paul  Capital funding liabilities     |       |                        | —     |                        |       |   | 0.7 |   |   |
| Finance  lease liabilities            |       |                        | 0.1        |                        |       |   | 0.1 |   |   |
| Other  current borrowings             | ** ** | ** **                  | **3.9**    |                        | ** ** | ** ** | **3.4** |   |   |
| **Total current borrowings**          | ** ** | ** **                  | **13.3**   |                        | ** ** | ** ** | **3.4** |   |   |
| **Non-current**                       |       |                        |       |                        |       |   |   |   |   |
| Convertible  bonds due May 2024  |       |                        | 50.4       |                        |       |   | 50.8 |   |   |
| Convertible  bonds due June 2025 |       |                        | —     |                        |       |   | 12.8 |   |   |
|                                  | ** ** | ** **                  | **50.4**   |                        | ** ** | ** ** | **63.6** |   |   |
| Bank borrowings                       |       |                        | —     |                        |       |   | 0.6 |   |   |
| Property  mortgage                    |       |                        | 7.1        |                        |       |   | 6.6 |   |   |
| Paul  Capital funding liabilities     |       |                        | 44.7       |                        |       |   | 43.9 |   |   |
| Finance  lease liabilities            |       |                        | 0.1        |                        |       |   | — |   |   |
| Other  non-current borrowings         | ** ** | ** **                  | **51.9**   |                        | ** ** | ** ** | **51.1** |   |   |
| **Total non-current borrowings**      | ** ** | ** **                  | **102.3**  |                        | ** ** | ** ** | **114.7** |   |   |
| **Total borrowings**                  | ** ** | ** **                  | **115.6**  |                        | ** ** | ** ** | **118.1** |   |   |

 

**Bankborrowings**

At December 31, 2005 bank borrowingsinclude two amounts due to the Basellandschaftliche Kantonalbank of £0.9million (CHF 2 million) and £0.7 million (CHF 1.5 million) (2004: £0.9 million(CHF 2 million) and £0.7 million (CHF 1.5 million)). Both loans can beterminated with six weeks notice by either party and bear interest at 6.5% and6.0% respectively. Both loans are secured on the assets of Jago and the £0.7million (CHF 1.5 million) loan is guaranteed by SkyePharma PLC.

The Group had aloan as at December 31, 2005 with GE Capital Corp of £1.4 million ($2.4million) (2004: £1.9 million ($3.7 million)). The loan is secured by certainassets of SkyePharma Inc, SkyePharma US Inc and SkyePharma PLC. The loan bearsinterest at 8.0% and is repayable by instalments until September 2007.

F-33

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**Convertiblebonds**

Convertiblebonds are disclosed in Note 23; Convertible bonds.

**Propertymortgage**

At December 31,2005, the Group had a property mortgage facility with the BasellandschaftlicheKantonalbank of £6.9 million (CHF 15.5 million) (2004: £7.4 million (CHF 16.1million)). The mortgage is in two tranches, both secured by the assets of Jago.The first tranche of £2.7 million (CHF 6.2 million) bears interest at 2.75% andis repayable by instalments over 20 years semi-annually. The second tranche of£4.1 million (CHF 9.3 million) bears interest at 2.75% and is repayable byinstalments over 50 years semi-annually.

**PaulCapital funding liabilities**

The Group entered into two transactionswith Paul Capital Royalty Acquisition Fund (‘Paul Capital’) in 2000 and 2002. Underthese transactions Paul Capital provided a total of $60 million in return forthe sale of a portion of the potential future royalty and revenue streams on aselection of the Group’s products.

Whilst thecontractual arrangement with Paul Capital is a royalty agreement under whichroyalties are payable on revenues earned and payments received, the proceedsreceived from Paul Capital meet the definition of a financial liability underIAS 39, and are treated as a financial liability. Royalties paid to PaulCapital are treated as repayment of the liability and interest is charged onthe liability using the effective interest rate at inception of each agreement.The estimated future payments to PaulCapital are discounted using each contract’s original effective interest andany adjustment is recognized as income or expense in the income statement

**Financelease liabilities**

Obligationsunder hire purchase and finance leases are secured upon the assets to whichthey relate and as at December 31, 2005 £Nil (2004: £0.1 million (SKR 0.9million)) is guaranteed by SkyePharma PLC.

**Maturity analysis of non-current borrowings**

| ** **                        | ** ** | **As at December 31, 2005** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **1 to 2 Years**                 | ** ** | **2 to 5 Years** | ** ** | **Over 5 Years** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | **£m**                                     | ** ** | **£m** | ** ** | **£m** | ** ** | **£m** | ** ** |
| Convertible  bonds                |       |                                            | —     |   |   |   | — |   |   |   | 63.6 | ** ** |   | **63.6** | ** ** |
| Bank  borrowings                  |       |                                            | 0.6        |   |   |   | — |   |   |   | — | ** ** |   | **0.6** | ** ** |
| Property  mortgage                |       |                                            | 0.3        |   |   |   | 0.8 |   |   |   | 5.5 | ** ** |   | **6.6** | ** ** |
| Paul  Capital funding liabilities |       |                                            | 4.9        |   |   |   | 22.1 |   |   |   | 16.9 | ** ** |   | **43.9** | ** ** |
| **Non-current borrowings**        | ** ** | ** **                                      | **5.8**    |   | ** ** | ** ** | **22.9** |   | ** ** | ** ** | **86.0** | ** ** |   | **114.7** | ** ** |

 

| ** **                        | ** ** | **As at December 31, 2004** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **1 to 2 Years**                 | ** ** | **2 to 5 Years** | ** ** | **Over 5 Years** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | **£m**                                     | ** ** | **£m** | ** ** | **£m** | ** ** | **£m** | ** ** |
| Convertible  bonds                |       |                                            | —     |   |   |   | — |   |   |   | 50.4 | ** ** |   | **50.4** | ** ** |
| Property  mortgage                |       |                                            | 0.3        |   |   |   | 0.8 |   |   |   | 6.0 | ** ** |   | **7.1** | ** ** |
| Paul  Capital funding liabilities |       |                                            | 10.6       |   |   |   | 21.5 |   |   |   | 12.6 | ** ** |   | **44.7** | ** ** |
| Finance  lease liabilities        |       |                                            | 0.1        |   |   |   | — |   |   |   | — | ** ** |   | **0.1** | ** ** |
| **Non-current borrowings**        | ** ** | ** **                                      | **11.0**   |   | ** ** | ** ** | **22.3** |   | ** ** | ** ** | **69.0** | ** ** |   | **102.3** | ** ** |

 

F-34

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**Currency analysis of borrowings**

| ** **                        | ** ** | **As at December 31, 2005** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **Sterling**                                    | ** ** | **$US** | ** ** | **Swiss francs** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | **£m**                                     | ** ** | **£m** | ** ** | **£m** | ** ** | **£m** | ** ** |
| Convertible  bonds                |       |                                            | 63.6       |   |   | — |   |   | — | ** ** |   | **63.6** | ** ** |
| Bank  borrowings                  |       |                                            | —     |   |   | 0.6 |   |   | — | ** ** |   | **0.6** | ** ** |
| Property  mortgage                |       |                                            | —     |   |   | — |   |   | 6.6 | ** ** |   | **6.6** | ** ** |
| Paul  Capital funding liabilities |       |                                            | —     |   |   | 43.9 |   |   | — | ** ** |   | **43.9** | ** ** |
| **Total borrowings**              | ** ** | ** **                                      | **63.6**   |   | ** ** | **44.5** | ** ** | ** ** | **6.6** | ** ** |   | **114.7** | ** ** |

 

| ** **                        | ** ** | **As at December 31, 2004** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **Sterling**                                    | ** ** | **$US** | ** ** | **Swiss francs** | ** ** | **Total** | ** ** |
| ** **                        | ** ** | **£m**                                     | ** ** | **£m** | ** ** | **£m** | ** ** | **£m** | ** ** |
| Convertible  bonds                |       |                                            | 50.4       |   |   | — |   |   | — | ** ** |   | **50.4** | ** ** |
| Property  mortgage                |       |                                            | —     |   |   | — |   |   | 7.1 | ** ** |   | **7.1** | ** ** |
| Paul  Capital funding liabilities |       |                                            | —     |   |   | 44.7 |   |   | — | ** ** |   | **44.7** | ** ** |
| Finance  lease liabilities        |       |                                            | —     |   |   | — |   |   | 0.1 | ** ** |   | **0.1** | ** ** |
| **Total borrowings**              | ** ** | ** **                                      | **50.4**   |   | ** ** | **44.7** | ** ** | ** ** | **7.2** | ** ** |   | **102.3** | ** ** |

 

**Interest rate analysis**

| ** **                        | ** ** | **As at December 31, 2005** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **Sterling**                                    | ** ** | **$US** | ** ** | **Swiss francs** | ** ** |
| ** **                        | ** ** | **%**                                           | ** ** | **%** | ** ** | **%** | ** ** |
| Convertible  bonds                |       | 8.9/ 9.5/  13.3                                 |       | — |   |   | — |   |   |
| Bank borrowings                   |       | —                                          |       | 8.0 |   |   | — |   |   |
| Property  mortgage                |       | —                                          |       | — |   |   | 2.8 |   |   |
| Paul Capital  funding liabilities |       | —                                          |       | 24.0/ 30.0 |   |   | — |   |   |

 

| ** **                        | ** ** | **As at December 31, 2004** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|
| ** **                        | ** ** | **Sterling**                                    | ** ** | **$US** | ** ** | **Swiss francs** | ** ** |
| ** **                        | ** ** | **%**                                           | ** ** | **%** | ** ** | **%** | ** ** |
| Convertible  bonds                |       | 8.9/ 9.5                                        |       | — |   |   | — |   |   |
| Property  mortgage                |       | —                                          |       | — |   |   | 2.8 |   |   |
| Paul  Capital funding liabilities |       | —                                          |       | 24.0/ 30.0 |   |   | — |   |   |
| Finance lease  liabilities        |       | —                                          |       | — |   |   | 6.5 |   |   |

 

**Fairvalues**

At December 31, 2005, the carrying amount of non-currentliabilities, compared with the fair value was as follows:

| ** **                        | ** ** | **Carrying  Amount** | ** ** | **Fair Value** | ** ** |
|-----------------------------------|------------|----------------------|------------|---------------------|------------|
| ** **                        | ** ** | **£m**          | ** ** | **£m**         | ** ** |
| Convertible  bonds                |       |                 | 63.6       |                |       |   | 83.5 |   |   |
| Bank  borrowings                  |       |                 | 0.6        |                |       |   | 0.6 |   |   |
| Property  mortgage                |       |                 | 6.6        |                |       |   | 6.6 |   |   |
| Paul  Capital funding liabilities |       |                 | 43.9       |                |       |   | 43.9 |   |   |
|                              | ** ** | ** **           | **114.7**  |                | ** ** | ** ** | **134.6** |   |   |

 

F-35

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At December 31, 2004, the carrying amount of non-currentliabilities, compared with the fair value was as follows:

| ** **                        | ** ** | **Carrying  Amount** | ** ** | **Fair Value** | ** ** |
|-----------------------------------|------------|----------------------|------------|---------------------|------------|
| ** **                        | ** ** | **£m**          | ** ** | **£m**         | ** ** |
| Convertible bonds            |       |                 | 50.4       |                |       |   | 75.9 |   |   |
| Property  mortgage                |       |                 | 7.1        |                |       |   | 7.1 |   |   |
| Paul  Capital funding liabilities |       |                 | 44.7       |                |       |   | 44.7 |   |   |
| Finance  lease liabilities        |       |                 | 0.1        |                |       |   | 0.1 |   |   |
|                              | ** ** | ** **           | **102.3**  |                | ** ** | ** ** | **127.8** |   |   |

 

**Undrawnfacility**

AtDecember 31, 2005 the Group had an overdraft facility of £1.3 million (CHF3 million) (2004: £1.4 million, CHF 3 million) with the BasellandschaftlicheKantonalbank secured on the assets of Jago.

**23**             Convertible bonds

In June 2005 the Group issued £20million 8% convertible bonds, with a first put after five years by the holderof the bonds, and a final maturity of June 2025. The bonds are convertibleat the option of the holder into SkyePharma Ordinary Shares at an initialconversion price of 77 pence at any time prior to maturity. The bond contains aprice reset feature such that if on June 3, 2006 the Company’s averageshare price for the preceding 10 days (reset price) is less than the conversionprice, then the conversion price shall be adjusted to the reset price subjectto a maximum reduction of 25% in the conversion price. The conversion price wasreset to 58 pence on June 3, 2006. Unless previously redeemed orconverted, the bonds will be redeemed by the Group at their principal amount inJune 2025. The convertible bonds existing at December 31, 2005, duein May 2024, were not affected by this transaction.

On June 19, 2005 £9.8 million of convertiblebonds due June 2005 were redeemed in full by the Company at theirprincipal amount.

As a result ofthese transactions the Group has £69.6 million convertible bonds dueMay 2024 at a conversion price of 95 pence, and £20 million convertiblebonds due June 2025 at a conversion price of 58 pence.

**24**             Derivativefinancial instruments

| ** **                                             | ** ** | **As at  December 31,  2004** | ** ** | **As at  December 31,  2005** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **                                             | ** ** | **£m**                             | ** ** | **£m**                             | ** ** |
| Interest  rate swap                                    |       |                                    | (0.2       | )                                       |       |   | — |   |   |
| **Total derivative  financial instrument liabilities** | ** ** | ** **                              | **(0.2**   | **)**                                   | ** ** | ** ** | **—** |   |   |

 

The Group’spolicy is to hedge interest rate exposures through the use of interest rateswaps and currency exposures through the use of currency options, accrualforward options and forward currency contracts. None of these derivativefinancial instruments qualify to be treated as hedges and accordingly gains andlosses are recorded in the income statement.

F-36

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**25**             Provisions

| **Group**                      | ** ** | ** **  | ** ** | **Pension** | ** ** | **Restructuring** | ** ** | **Total** | ** ** |
|--------------------------------|------------|-------------|------------|-------------|------------|-------------------|------------|-----------|------------|
| ** **                     | ** ** | **£m** | ** ** | **£m** | ** ** | **£m**       | ** ** |
| At  January 1, 2005       |       |        | 1.7        |        |       |              | 0.3        |      |       |   | 2.0 |   |   |
| Actuarial  losses              |       |        | 0.3        |        |       |              | —     |      |       |   | 0.3 |   |   |
| Charge  for the year           |       |        | (0.1       | )           |       |              | —     |      |       |   | (0.1 | ) |   |
| Utilized                       |       |        | —     |        |       |              | (0.3       | )         |       |   | (0.3 | ) |   |
| **At December 31,  2005** |       |        | 1.9        |        | ** ** | ** **        | **—** |      |       |   | 1.9 |   |   |

 

| ** **               | ** ** | **As at  December 31,  2004** | ** ** | **As at  December 31,  2005** | ** ** |
|--------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **               | ** ** | **£m**                             | ** ** | **£m**                             | ** ** |
| Current  (restructuring) |       |                                    | 0.3        |                                    |       |   | — |   |   |
| Non  current (pension)   |       |                                    | 1.7        |                                    |       |   | 1.9 |   |   |
| ** **               | ** ** | ** **                              | **2.0**    |                                    | ** ** | ** ** | **1.9** |   |   |

 

**Pensionprovision**

The pensionprovision relates to the retirement commitments under its defined benefitschemes in respect of its employees in Switzerland and France.

**Restructuringprovision**

Therestructuring provision relates to the reorganization of research anddevelopment operations and other business functions involving reductions instaff at most sites.

**26**             Retirementbenefit obligations

**Definedcontribution plans**

The Groupoperates various defined contribution plans for its employees in the UK and US.The Group’s contributions to these plans are charged to the income statement inthe period to which they relate, and the assets are held in separate trusteeadministered funds. The income statement charge related to defined contributionplans is disclosed in Note 7; Staff costs.

**Definedbenefit plan**

The Group operates unfunded defined benefitschemes in respect of its employees in Switzerland and France.

The liabilities of the defined benefit schemes operated by the Groupare presented below:

| ** **                            | ** ** | **As at  December 31,  2004** | ** ** | **As at  December 31,  2005** | ** ** |
|---------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **                            | ** ** | **£m**                             | ** ** | **£m**                             | ** ** |
| Balance sheet  obligations for:       | ** ** |                                    | ** ** | ** **                              |       |   | ** ** | ** ** |   |
| **Defined benefit pension  benefits** | ** ** |                                    | **1.7**    | ** **                              |       |   | **1.9** | ** ** |   |

 

F-37

----

The amounts recognized in the balance sheet are determined as follows:

| ** **                             | ** ** | **As at  December 31,  2004** | ** ** | **As at  December 31,  2005** | ** ** |
|----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **                             | ** ** | **£m**                             | ** ** | **£m**                             | ** ** |
| Present  value of funded obligations   |       |                                    | 6.3        |                                    |       |   | 6.4 |   |   |
| Fair  value of plan assets             |       |                                    | (5.3       | )                                       |       |   | (5.3 | ) |   |
|                                   |       |                                    | 1.0        |                                    |       |   | 1.1 |   |   |
| Present  value of unfunded obligations |       |                                    | 0.7        |                                    |       |   | 0.8 |   |   |
| **Liability in the balance  sheet**    | ** ** | ** **                              | **1.7**    |                                    | ** ** | ** ** | **1.9** |   |   |

 

The amounts recognized in the income statement are as follows:

| ** **                        | ** ** | **Year ended  December 31,  2004** | ** ** | **Year ended  December 31,  2005** | ** ** |
|-----------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                        | ** ** | **£m**                                  | ** ** | **£m**                                  | ** ** |
| Current  service cost             |       |                                         | 0.2        |                                         |       |   | 0.3 |   |   |
| Interest  cost                    |       |                                         | 0.3        |                                         |       |   | 0.3 |   |   |
| Expected  losses on assets        |       |                                         | (0.2       | )                                            |       |   | (0.2 | ) |   |
| **Total included in staff  cost** | ** ** | ** **                                   | **0.3**    |                                         | ** ** | ** ** | **0.4** |   |   |

 

The actuarial return on plans assets was£0.2 million (2004: £0.2 million).

The movement in the defined benefit obligation over the year is asfollows:

| ** **                              | ** ** | **Year ended  December 31,  2004** | ** ** | **Year ended  December 31,  2005** | ** ** |
|-----------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                              | ** ** | **£m**                                  | ** ** | **£m**                                  | ** ** |
| Beginning  of the year                  |       |                                         | 6.7        |                                         |       |   | 7.0 |   |   |
| Exchange  adjustment                    |       |                                         | (0.1       | )                                            |       |   | (0.1 | ) |   |
| Current  service cost                   |       |                                         | 0.2        |                                         |       |   | 0.3 |   |   |
| Contributions                           |       |                                         | (0.3       | )                                            |       |   | (0.3 | ) |   |
| Interest  on pension scheme liabilities |       |                                         | 0.3        |                                         |       |   | 0.3 |   |   |
| Expected  losses on assets              |       |                                         | (0.2       | )                                            |       |   | (0.2 | ) |   |
| Actuarial  losses recognized in equity  |       |                                         | 0.4        |                                         |       |   | 0.2 |   |   |
| **End of the year**                     | ** ** | ** **                                   | **7.0**    |                                         | ** ** | ** ** | **7.2** |   |   |

 

The movement in the fair value of the plan assets over the year is asfollows:

| ** **                              | ** ** | **Year ended  December 31,  2004** | ** ** | **Year ended  December 31,   2005** | ** ** |
|-----------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                              | ** ** | **£m**                                  | ** ** | **£m**                                        | ** ** |
| Beginning  of the year                  |       |                                         | 4.7        |                                               |       |   | 5.3 |   |   |
| Exchange  adjustment                    |       |                                         | 0.3        |                                               |       |   | (0.1 | ) |   |
| Current  service cost                   |       |                                         | 0.2        |                                               |       |   | 0.3 |   |   |
| Interest  on pension scheme liabilities |       |                                         | 0.3        |                                               |       |   | 0.3 |   |   |
| Benefits  paid                          |       |                                         | (0.5       | )                                                  |       |   | (0.7 | ) |   |
| Actuarial  gains recognized in equity   |       |                                         | 0.3        |                                               |       |   | 0.2 |   |   |
| **End of the year**                     | ** ** | ** **                                   | **5.3**    |                                               | ** ** | ** ** | **5.3** |   |   |

 

F-38

----

At December 31, 2005 and 2004 actuarial valuations were performedby professionally qualified actuaries on the present value of the accruedliabilities calculated under the projected unit method. The principalassumptions made by the actuaries were:

| ** **                      | ** ** | **2004**                  | ** ** | **2005**                  | ** ** |
|---------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                      | ** ** | **% per annum** | ** ** | **% per annum** | ** ** |
| Inflation  rate                 |       |                      | 2.0        |                      |       |   | 1.9 |   |   |
| Rate  of increase in salaries   |       |                      | 2.5        |                      |       |   | 2.3 |   |   |
| Discount  rate                  |       |                      | 4.0        |                      |       |   | 3.7 |   |   |
| Expected  return on plan assets |       |                      | 2.4        |                      |       |   | 2.0 |   |   |

 

Assumptions regarding future mortality experience are set based onadvice in accordance with published statistics and experience in Switzerlandand France.

| ** ** | ** ** | **2004**  | ** ** | **2005**  | ** ** |
|------------|------------|-----------|------------|-----------|------------|
| ** ** | ** ** | **years** | ** ** | **years** | ** ** |
| Male       |       |      | 17.3       |      |       |   | 17.3 |   |   |
| Female     |       |      | 20.8       |      |       |   | 20.8 |   |   |

 

| ** **                                       | ** ** | **2004**    | ** ** | **2005**    | ** ** |
|--------------------------------------------------|------------|-------------|------------|-------------|------------|
| ** **                                       | ** ** | **£m** | ** ** | **£m** | ** ** |
| Actuarial  gains recognized in equity            |       | (0.1        | )          | (0.1        | )          |
| Cumulative  actuarial gains recognized in equity |       | (0.1        | )          | (0.1        | )          |

 

Plan assets are comprised as follows:

| ** ** | ** ** | **2004**    | ** ** | **2005**    | ** ** |
|------------|------------|-------------|------------|-------------|------------|
| ** ** | ** ** | **£m** | ** ** | **£m** | ** ** |
| Equity     |       |        | 4.3        |        |       |   | 4.7 |   |   |
| Other      |       |        | 1.0        |        |       |   | 0.6 |   |   |
| ** ** | ** ** | ** **  | **5.3**    |        | ** ** | ** ** | **5.3** |   |   |

 

Expectedcontributions to post employment benefit plans for the year ending December 31,2006 are £0.6 million.

**27**             Sharecapital

| ** **                   | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
|------------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                   | ** ** | **Number  of shares**  | ** ** | **Number  of shares**  | ** ** | **£m**                 | ** ** | **£m**                 | ** ** |
| **Authorized**               |       |                        |       |                        |       |                        |       |                        |       |   |   |   |   |
| Ordinary  Shares of 10p each |       | 1,102,000,000               |       | 1,102,000,000               |       |                        | 110.2      |                        |       |   | 110.2 |   |   |

 

F-39

----

 

| ** **                                          | ** ** | **Ordinary  Shares of  10p each** | ** ** | **Nominal  value** | ** ** | **Deferred  ‘B’ Shares of  10p each** | ** ** | **Nominal  value** | ** ** | **Total  nominal  value** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------|------------|--------------------|------------|----------------------------------------------------------------|------------|--------------------|------------|---------------------------|------------|
| ** **                                          | ** ** | **Number**                                  | ** ** | **£m**        | ** ** | **Number**                                                     | ** ** | **£m**        | ** ** | **£m**               | ** ** |
| **At January 1, 2004**                         |       | 618,669,940                                 |       |               | 61.9       |                                                           |       |               | 12,000,000 |                      |       |   | 1.2 |   |   |   | 63.1 |   |   |
| Exercise  of share options                          |       | 478,803                                     |       |               | —     |                                                           |       |               | —     |                      |       |   | — |   |   |   | — |   |   |
| Issue  of shares to Research Development Foundation |       | 3,250,000                                   |       |               | 0.3        |                                                           |       |               | —     |                      |       |   | — |   |   |   | 0.3 |   |   |
| **At January 1, 2005**                         |       | 622,398,743                                 |       |               | 62.2       |                                                           |       |               | 12,000,000 |                      |       |   | 1.2 |   |   |   | 63.4 |   |   |
| Rights  issue                                       |       | 125,627,357                                 |       |               | 12.6       |                                                           |       |               | —     |                      |       |   | —   |   |   |   | 12.6 |   |   |
| Acquisition  of shares in Astralis                  |       | 5,482,238                                   |       |               | 0.6        |                                                           |       |               | —     |                      |       |   | — |   |   |   | 0.6 |   |   |
| Exercise  of share options                          |       | 255,808                                     |       |               | —     |                                                           |       |               | —     |                      |       |   | — |   |   |   | — |   |   |
| **At December 31,  2005**                      |       | 753,764,146                                 |       |               | 75.4       |                                                           |       |               | 12,000,000 |                      |       |   | 1.2 |   |   |   | 76.6 |   |   |

 

The Group raised £34.8 million net of expensesby means of a rights issue of 125,627,357 new Ordinary Shares.

The Group alsoissued 5,482,238 Ordinary Shares to two former Astralis Directors to acquire11,160,000 common shares in Astralis.

**Deferred‘B’ shares**

In July 2000, 12 million deferred ‘A’and 12 million deferred ‘B’ shares were issued to Dr Gonella, the vendor ofJago, under a settlement agreement that established the full and finalsettlement of the deferred consideration payable on the acquisition of Jago.The holders of deferred ‘A’ and ‘B’ shares have no rights to participate in theprofits of the Company, no voting rights and on a winding up or other return ofcapital only receive the nominal value of their shares if the holders ofOrdinary Shares in the capital of the Company have received the sum of £1million per Ordinary Share. Under the terms of the settlement agreement,following the US launch and first commercial sale of Paxil CRTM byGlaxoSmithKline in 2002, the 12 million deferred ‘A’ shares were automaticallyconverted into 12 million Ordinary Shares.

The 12 milliondeferred ‘B’ shares automatically convert to 12 million Ordinary Shares on theCompany’s receipt of a royalty statement under the current license agreementstating that reported sales of Paxil CRTM have exceeded $1,000 million duringany calendar period prior to January 1, 2006 or exceeded $337 millionbetween January 1, 2006 and May 3, 2006. The conditions have not beenmet and the deferred ‘B’ shares have been transferred to the Company Secretaryfor no consideration for him to hold as custodian.

**Warrants**

The Company has the following warrants outstanding:

**(a)**          ‘D’ and‘E’ warrants

The ‘D’ and ‘E’ warrants were issued in March 2002 as part of theconsideration for the agreement with Paul Capital to fund new productdevelopment. The ‘D’ and ‘E’ warrants entitle the holders to subscribe for atotal of 5 million Ordinary Shares at any time during the period to December 31,2008 at an exercise price of 73.75 pence per Ordinary Share. A value of £0.3million, deemed to be the fair value of the ‘D’ and ‘E’ warrants, has beenrecorded in Other Reserves.

**(b)**          ‘F’warrants

The ‘F’ warrants were issued in December 2003 as part of the £2.7million ($5 million) loan with GE Capital Corp. The ‘F’ warrants entitle theholders to subscribe for a total of 300,000 Ordinary Shares at any 

F-40

----

time until the repayment date of the loanat an exercise price of £1.20 per Ordinary Share. A value of £39,000, deemed tobe the fair value of the ‘F’ warrants, has been recorded in Other Reserves.

**(c)**           Otherwarrants

Warrants wereissued in December 1999 as part of the acquisition of DepoTech and entitlethe holders to subscribe for 371,353 Ordinary Shares at any time during theperiod beginning December 31, 1999 and ending on February 25, 2005 atan exercise price of $1.142 (59.5 pence) per Ordinary Share. All of thesewarrants lapsed unexercised on February 25, 2005.

**PotentialIssues of Ordinary Shares**

**(a)**          Employeeshare schemes

The Group encourages employee participation in its shares throughownership and continues to operate various incentive schemes whereby Directorsand employees are to able to acquire shares, and potential shares, in the Company.Further details are provided in Note 28; Share based payments.

**(b)**          Deferredconsideration on acquisition of Krypton

The deferred consideration on the acquisition of Krypton provides thata maximum of 37.5 million Ordinary Shares would be issued contingent on achange in control of the Company at a share price of not less than 80 pencecompounded at an annual rate of 10% (£2.08 as at December 31, 2005), orsatisfaction of various conditions and hurdles which lapsed on December 31,2003. No provision for deferred consideration has been recognized as at December 31,2005.

**(c)**           PaulCapital Royalty Acquisition Fund

In March 2002the Group announced a second transaction with Paul Capital Royalty AcquisitionFund under which SkyePharma would issue Ordinary Shares up to a value of $7.5million if royalties and milestones received by SkyePharma in respect of thoseproducts included in the transaction were not in excess of minimum annualpayments required to be made to Paul Capital. During 2005 the royalties receivedby SkyePharma were substantially in excess of the minimum payments required tobe made to Paul Capital, consequently the Company has not recognized aprovision.

**28**             Sharebased payments

The Group operates various share basedcompensation plans as follows:

**Optionschemes**

Options granted to UK and Europeanemployees are only exercisable between the third and tenth anniversary of thedate of grant, and are subject to the Company’s Code of Business Conduct andEthics for dealing in Shares, and the Model Code. Options granted to USemployees prior to 2001 vest at 25% per annum from the date of grant and therewere no performance criteria. UK and European options granted prior to 2001 mayonly be exercised if the growth in the Company’s share price over a consecutivethree-year period exceeds the growth over the same period in the FTSE All ShareIndex. This criteria was satisfied for the first time in March 2000.Employees with options that are within their exercise period are now able toexercise those options within any one-year period from the date the performancecondition is satisfied. Super Options are exercisable after five years and aresubject to higher performance conditions in accordance with those recommendedby the Association of British Insurers.

F-41

----

Following changes to the option plansapproved at the Annual General Meeting in June 2001, options granted toDirectors and senior employees since that date are subject to performanceconditions linked to the total shareholder return of a comparator group ofcompanies, and are not subject to retesting. Options granted to other USemployees continue to vest at 25% per annum with no performance criteria, andother European employees who are not Directors or senior employees can exercisetheir options after three years and are not subject to performance conditions.The Group’s option plans are detailed further in Part I, Item 6:Directors, Senior Management and Employees. It is the intention of the Groupthat no further options grants will be made under any of the option plans.

The following table summarizes the activity in share options for theyear to December 31, 2005:

| ** **                           | ** ** | **Share options** | ** **     | **Option price** | ** ** |
|--------------------------------------|------------|------------------------|----------------|-----------------------|------------|
| **At January 1, 2004**          | ** ** |                   | **52,345,218** | ** **            |       | **44.8p–93.0p** | ** ** |
| Exercised                            |       |                   | (478,803       | )                     |       | 44.8p–66.5p |   |
| Cancelled  or expired                |       |                   | (3,883,170     | )                     |       | 46.5p–91.3p |   |
| **At December 31, 2004**        | ** ** |                   | **47,983,245** | ** **            |       | **44.8p–93.0p** | ** ** |
| Exercised                            |       |                   | (255,808       | )                     |       | 46.5p–55.6p |   |
| Forfeited                            |       |                   | (9,654,453     | )                     |       | 46.5p–92.0p |   |
| Cancelled  or expired                |       |                   | (2,171,974     | )                     |       | 46.5p–92.0p |   |
| Rights  issue adjustment (see below) |       |                   | 1,596,534      |                  |       | 1.8p–3.7p |   |
| **At December 31, 2005**        | ** ** |                   | **37,497,544** | ** **            |       | **43.0p–89.3p** | ** ** |
| **Exercisable**                      |       |                   | 22,180,175     |                  |       | 43.0p–89.3p |   |

 

The weighted average exercise price as at December 31,2005 was 58.6 pence.

The market value of Ordinary Shares as at December 31,2005 was 49.75 pence. The market value of Ordinary Shares during 2005 rangedfrom the lowest closing mid-price of 34.25 pence to the highest closingmid-price of 66.75 pence per share. No options were granted during the currentyear.

F-42

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At December 31, 2005 the following Ordinary Shares were underoption to employees or former employees of the Group:

| **Normal expiry date** | ** ** | ** ** | ** ** | **Option price  for each  Ordinary Share  of 10p** | ** ** | **Number of  options over  Ordinary Shares  of 10p** | ** ** |
|----------------------------------|------------|------------|------------|------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| April,  26 2006                  |       |       | 72.0p      |                                                                   |       |                                                                     | 930,937    |   |   |
| April 7,  2007              |       |       | 63.8p      |                                                                   |       |                                                                     | 529,100    |   |   |
| January 28,  2008           |       |       | 49.0p      |                                                                   |       |                                                                     | 129,254    |   |   |
| March 31,  2008             |       |       | 89.3p      |                                                                   |       |                                                                     | 829,615    |   |   |
| October 5,  2008            |       |       | 43.0p      |                                                                   |       |                                                                     | 570,128    |   |   |
| April 19,  2009             |       |       | 66.7p      |                                                                   |       |                                                                     | 2,272,318  |   |   |
| May 25,  2009               |       |       | 54.4p      |                                                                   |       |                                                                     | 5,076,891  |   |   |
| September 7,  2009          |       |       | 54.6p      |                                                                   |       |                                                                     | 199,044    |   |   |
| June 6,  2010               |       |       | 87.6p      |                                                                   |       |                                                                     | 442,185    |   |   |
| November 3,  2010           |       |       | 78.4p      |                                                                   |       |                                                                     | 1,411,387  |   |   |
| June 12,  2011              |       |       | 77.4p      |                                                                   |       |                                                                     | 4,066,007  |   |   |
| October 31,  2011           |       |       | 53.4p      |                                                                   |       |                                                                     | 913,309    |   |   |
| April 12,  2012             |       |       | 69.4p      |                                                                   |       |                                                                     | 4,847,662  |   |   |
| May 24,  2012               |       |       | 75.4p      |                                                                   |       |                                                                     | 447,637    |   |   |
| September 25,  2012         |       |       | 49.6p      |                                                                   |       |                                                                     | 1,114,377  |   |   |
| April 7,  2013              |       |       | 44.6p      |                                                                   |       |                                                                     | 13,570,809 |   |   |
| September 26,  2013         |       |       | 59.5p      |                                                                   |       |                                                                     | 146,884    |   |   |
|                             |       |       |       |                                                                   |       |                                                                     | 37,497,544 |   |   |

 

Following completion of the Company’sRights Issue announced on September 28, 2005 the number and exercise priceapplicable to options were adjusted to take account of the dilution in thevalue of options caused by the Rights Issue. The number of options wasincreased by 4% and the exercise price was reduced by 4%.

As stated above, no options were granted toemployees in 2004 or 2005. For those options granted in prior years whichimpact the income statement, fair values were determined using an optionpricing model based on Black-Scholes but adjusted to model the particularfeatures of the options. The fair value of these options is consistent with thevalues previously disclosed for SEC filing purposes.

The Rights Issue had no effect on the fairvalue of options.

The totalexpense relating to share based payments, which are all equity settledtransactions, is disclosed in Note 7; Staff costs.

F-43

----

**DeferredShare Bonus Plan (“DSB”)**

Under the rules of this plan, Directors and senior employeesreceive conditional rights to acquire Ordinary Shares in the Company, at theprevailing market rates at the time of grant. Eligible employees are awarded rightsto acquire a maximum number of shares at the beginning of a three year period,a proportion of which they will be entitled to receive at the end of thatperiod depending on the extent to which the performance conditions set by theRemuneration Committee at the time the allocation is made are satisfied. If theperformance conditions are not satisfied the share award will lapse. Awards areeither linked to the deferral of annual bonus (DSB Matching Share Awards) orstand alone share awards (LTIP Awards). Further information on awards andperformance conditions are detailed in Part I, Item 6: Directors, SeniorManagement and Employees.

| ** **                              | ** ** | **LTIP Awards** | ** **    | **DSB Matching  Share Awards** | ** ** |
|-----------------------------------------|------------|----------------------|---------------|------------------------------------------|------------|
| **Outstanding At January 1, 2005** | ** ** |                 | **3,679,499** | ** **                               |       |   | **2,046,093** | ** ** |   |
| Granted                                 |       |                 | 3,979,684     | ** **                               |       |   | 640,103 | ** ** |   |
| Rights  Issue Adjustment                |       |                 | 301,830       | ** **                               |       |   | 90,299 | ** ** |   |
| Forfeited                               |       |                 | —        | ** **                               |       |   | — | ** ** |   |
| Cancelled  or expired                   |       |                 | 518,084       | ** **                               |       |   | 88,801 | ** ** |   |
| Released                                |       |                 | —        | ** **                               |       |   | 434,395 | ** ** |   |
| **At December 31,  2005**          | ** ** |                 | **7,442,929** | ** **                               |       |   | **2,253,299** | ** ** |   |

 

Following completion of the Company’sRights Issue announced on September 28, 2005 the number of sharescomprising the LTIP Awards and DSB Matching Share Awards was adjusted to takeaccount of the dilution in the value of conditional shares caused by the RightsIssue. The number of shares under award was increased by 4%.

For the purposes of IFRS 2 the fair values of LTIP Awards and DSBMatching Shares Awards have been determined using a Monte Carlo Simulationmodel. The Monte Carlo Simulation model takes into account the comparativetotal shareholder return performance element attaching to these share awards. Thefollowing table sets out the assumptions used in determining the fair value ofthese share awards:

|                           |   | LTIP Awards                                                                                                                                           |   |   | DSB Matching Share Awards |
|--------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|---------------------------|
| Model                          |   | Monte Carlo Simulation                                                                                                                                |
| Rationale                      |   | This model takes into account the market  based performance conditions (comparative TSR) attaching to the LTIP Awards  and DSB Matching Share Awards. |
| Date of Grant                  |   | June 3, 2005                                                                                                                                     |   |   | June 9, 2005         |   |   | February 2, 2005 |
| Share Price  on Grant (£) |   | 0.54                                                                                                                                                  |   |   | 0.53                      |   |   | 0.64 |
| Exercise  Price                |   | nil                                                                                                                                                   |   |   | nil                       |   |   | nil |
| Expected  Dividend Yield       |   | n/a                                                                                                                                                   |   |   | n/a                       |   |   | n/a |
| Expected  Volatility           |   | 47.23%                                                                                                                                                |   |   | 47.18%                    |   |   | 48.96% |
| Risk Free  Interest Rate       |   | 4.22%                                                                                                                                                 |   |   | 4.73%                     |   |   | 4.57% |
| Expected Life                  |   | 3 years                                                                                                                                               |   |   | 3 years                   |   |   | 3 years |
| Fair Value (£)            |   | 0.40                                                                                                                                                  |   |   | 0.40                      |   |   | 0.57 |

 

The excepted volatility is calculated asthe historic volatility of the Company share return over the three years priorto each grant date.

F-44

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In determining the charge to the incomestatement, the Company has assumed that the number of share awards that will ultimatelyvest is reduced by 5% per annum.

The Rights Issue had no effect on the fairvalue of LTIP Awards and DSB Matching Share Awards.

The totalexpense relating to share based payments, which are all equity settledtransactions, is disclosed in Note 7; Staff costs.

**InternationalShare Purchase Plan (“ISPP”)**

All employees are eligible to participate in the ISPP whereby employeesbuy shares in the Company. These shares are called Partnership Shares and areheld in trust on behalf of the employee. For every Partnership Share bought bythe employee the Company will give the employee one share free of charge(Matching Shares). The employees have to take their shares out of the plan onleaving the Company and will not be entitled to the Matching Shares if theyleave within three years of buying the Partnership Shares. In addition, theCompany can also award employees rights to acquire up to a maximum of £3,000 ofshares (Free Shares). There are no vesting conditions attaching to the FreeShares other than being continuously employed by a Group company on the thirdanniversary of the date of grant.

| ** **                              | ** ** | **Matching Shares** | ** **  | **Free Shares** | ** ** |
|-----------------------------------------|------------|--------------------------|-------------|----------------------|------------|
| **Outstanding At January 1, 2005** | ** ** |                     | **348,831** | ** **           |       |   | **30,411** | ** ** |   |
| Granted                                 |       |                     | 211,460     | ** **           |       |   | — | ** ** |   |
| Rights  Issue Adjustment                |       |                     | n/a         | ** **           |       |   | 2,723 | ** ** |   |
| Forfeited                               |       |                     | —      | ** **           |       |   | — | ** ** |   |
| Cancelled  or expired                   |       |                     | 41,109      | ** **           |       |   | 7,855 | ** ** |   |
| Released                                |       |                     | 88,347      | ** **           |       |   | — | ** ** |   |
| **At December 31,  2005**          | ** ** |                     | **430,835** | ** **           |       |   | **25,279** | ** ** |   |

 

Following the completion of the Company’sRights Issue announced on September 28, 2005 the number of sharesapplicable to Free Shares was adjusted to take account of the dilution in thevalue of conditional shares caused by the Rights Issue. The number of sharesunder award was increased by 4%.

For the purposes of IFRS 2 the fair valueof these Matching Shares and Free Shares is determined as the market value ofthe shares at the date of grant. In determining the charge to the incomestatement, the Company has assumed that the number of share awards that willultimately vest is reduced by 10% per annum.

The Rights Issue had no effect on the fairvalue of the Free Shares.

The totalexpense relating to share based payments, which are all equity settledtransactions, is disclosed in Note 7; Staff costs.

F-45

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**29**             Reserves

| ** **                                             | ** ** | **Share  premium** | ** ** | **Translation  reserve** | ** ** | **Fair value  reserve** | ** ** | **Retained  losses** | ** ** |
|--------------------------------------------------------|------------|--------------------|------------|--------------------------|------------|------------------------------|------------|----------------------|------------|
| ** **                                             | ** ** | **£m**        | ** ** | **£m**              | ** ** | **£m**                  | ** ** | **£m**          | ** ** |
| **At January 1, 2004**                            | ** ** |               | **319.3**  | ** **               |       |                         | **1.6**    | ** **           |       |   | **—** | ** ** |   |   | **(364.3** | **)** |   |
| On  issue of shares to Research Development Foundation |       |               | 1.5        |                     |       |                         | —     |                 |       |   | — |   |   |   | — |   |   |
| Exercise  of share options                             |       |               | 0.2        |                     |       |                         | —     |                 |       |   | — |   |   |   | — |   |   |
| Exchange  adjustments                                  |       |               | —     |                     |       |                         | (2.5       | )                    |       |   | — |   |   |   | — |   |   |
| Revaluation  deficit transfer                          |       |               | —     |                     |       |                         | —     |                 |       |   | (0.5 | ) |   |   | — |   |   |
| Loss  for the year                                     |       |               | —     |                     |       |                         | —     |                 |       |   | — |   |   |   | (18.6 | ) |   |
| Share  based payments charge                           |       |               | —     |                     |       |                         | —     |                 |       |   | — |   |   |   | 4.1 |   |   |
| Pension  actuarial losses                              |       |               | —     |                     |       |                         | —     |                 |       |   | — |   |   |   | (0.1 | ) |   |
| **At December 31, 2004**                          | ** ** |               | **321.0**  | ** **               |       |                         | **(0.9**   | **)**                |       |   | **(0.5** | **)** |   |   | **(378.9** | **)** |   |
| Rights  issue                                          |       |               | 25.1       |                     |       |                         | —     |                 |       |   | — |   |   |   | — |   |   |
| Expenses  of rights issue                              |       |               | (2.9       | )                        |       |                         | —     |                 |       |   | — |   |   |   | — |   |   |
| Acquisition  of shares in Astralis                     |       |               | 2.3        |                     |       |                         | —     |                 |       |   | — |   |   |   | — |   |   |
| Exercise  of share options                             |       |               | 0.1        |                     |       |                         | —     |                 |       |   | — |   |   |   | — |   |   |
| Exchange  adjustments                                  |       |               | —     |                     |       |                         | (0.3       | )                    |       |   | — |   |   |   | — |   |   |
| Impairments                                            |       |               | —     |                     |       |                         | —     |                 |       |   | 0.5 |   |   |   | — |   |   |
| Revaluation  surplus transfer                          |       |               | —     |                     |       |                         | —     |                 |       |   | 0.2 |   |   |   | — |   |   |
| Loss  for the year                                     |       |               | —     |                     |       |                         | —     |                 |       |   | — |   |   |   | (50.9 | ) |   |
| Share  based payments charge                           |       |               | —     |                     |       |                         | —     |                 |       |   | — |   |   |   | 2.4 |   |   |
| Purchase  of own shares                                |       |               | —     |                     |       |                         | —     |                 |       |   | — |   |   |   | (0.4 | ) |   |
| Repayment  of convertible bonds due June 2005     |       |               | —     |                     |       |                         | —     |                 |       |   | — |   |   |   | 0.7 |   |   |
| **At December 31,  2005**                         | ** ** |               | **345.6**  | ** **               |       |                         | **(1.2**   | **)**                |       |   | **0.2** | ** ** |   |   | **(427.1** | **)** |   |

 

**30**             Otherreserves

| ** **                                                 | ** ** | **Merger  reserve** | ** ** | **Warrants  reserve** | ** ** | **Equity of  convertible  bonds** | ** ** | **Total other  reserves** | ** ** |
|------------------------------------------------------------|------------|---------------------|------------|-----------------------|------------|----------------------------------------|------------|--------------------------------|------------|
| ** **                                                 | ** ** | **£m**         | ** ** | **£m**           | ** ** | **£m**                            | ** ** | **£m**                    | ** ** |
| **At January 1, 2004**                                | ** ** |                | **9.0**    | ** **            |       |                                   | **0.4**    | ** **                     |       |   | **0.7** | ** ** |   |   | **10.1** | ** ** |   |
| Exchange  and issue of convertible bonds due May 2024 |       |                | —     | ** **            |       |                                   | —     | ** **                     |       |   | 22.3 |   |   |   | 22.3 |   |   |
| **At December 31, 2004**                              | ** ** |                | **9.0**    | ** **            |       |                                   | **0.4**    | ** **                     |       |   | **23.0** | ** ** |   |   | **32.4** | ** ** |   |
| Issue  of convertible bonds due June 2025             |       |                | —     | ** **            |       |                                   | —     | ** **                     |       |   | 6.1 |   |   |   | 6.1 |   |   |
| Repayment  of convertible bonds due June 2005         |       |                | —     | ** **            |       |                                   | —     | ** **                     |       |   | (0.7 | ) |   |   | (0.7 | ) |   |
| **At December 31,  2005**                             | ** ** |                | **9.0**    | ** **            |       |                                   | **0.4**    | ** **                     |       |   | **28.4** | ** ** |   |   | **37.8** | ** ** |   |

 

The mergerreserve relates to the acquisition of Krypton Limited during 1996. The warrantreserve relates to the ‘D’, ‘E’ and ‘F’ warrants described in Note 27; Sharecapital. The equity element of the convertible bonds reserve relates to theconvertible bonds due May 2024 and June 2025.

F-46

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**31**             Commitments

| ** **                               | ** ** | **As at  December 31,  2004** | ** ** | **As at  December 31,  2005** | ** ** |
|------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **                               | ** ** | **£m**                             | ** ** | **£m**                             | ** ** |
| **Commitments under operating  leases**  | ** ** |                                    | ** ** |                                    |       |   |   |   |   |
| Operating  leases on land and buildings: |       |                                    |       |                                    |       |   |   |   |   |
| In one  year or less                     |       |                                    | 2.5        |                                    |       |   | 2.3 |   |   |
| In two  to five years                    |       |                                    | 10.7       |                                    |       |   | 10.4 |   |   |
| In  five years or more                   |       |                                    | 15.6       |                                    |       |   | 14.6 |   |   |
|                                     | ** ** |                                    | **28.8**   |                                    | ** ** | ** ** | **27.3** |   |   |
| Other  operating leases:                 | ** ** |                                    | ** ** |                                    |       |   |   |   |   |
| In one  year or less                     |       |                                    | —     |                                    |       |   | 0.1 |   |   |
|                                     | ** ** |                                    | **—** |                                    | ** ** | ** ** | **0.1** |   |   |

 

In addition the Group has committed toundertake certain clinical trials on behalf of its partners under developmentand licensing agreements.

The Group iscommitted to make certain payments to third parties contingent upon futureevents such as the approval and launch of products.

**32**             Contingencies

At December 31, 2005 the Company hadprovided guarantees on various bank borrowings of its subsidiaries as set outin Note 22; Borrowings.

In common withmost business enterprises, Group companies are subject to a number of claimsfrom third parties, the outcome of which cannot at present be determined butwhich are not considered to be material in the context of these financialstatements. Provisions have been made in these financial statements for anyliabilities which are expected to materialize from such claims.

**33**             RelatedParties

At the end of December 1998,Ian Gowrie-Smith (through a family-owned trust) acquired a 51% interest in 10East 63rd Street Inc., the company which owns 10 East 63rd Street, a propertyin New York. In December 2002 Mr. Gowrie-Smith acquired a further 49%interest. SkyePharma PLC has been in occupation of approximately half of thatproperty since January 1997, subject to tenancy agreements based uponindependent valuation. In August 2003 the Company took occupation of theentire building under an eight-year tenancy agreement, at which time the annualrent was increased from $420,000 per annum to $720,000 per annum until August 2008,and $942,500 per annum from August 2008 to August 2011. A portion ofthese premises is currently sub-let by the Group.

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**34**             Principalsubsidiaries

**Subsidiary undertakings**

| **Company**                   | ** ** | ** **  | ** ** | **Country of incorporation** | ** ** | **% held of nominal value and voting rights** | ** ** | **Principal activities** |
|-------------------------------|------------|-------------|------------|------------------------------|------------|-----------------------------------------------|------------|--------------------------|
| SkyePharma  Canada Inc.*      |       | Canada      |       | 100%                         |       | Research and  development                     |
| SkyePharma  Production SAS*   |       | France      |       | 100%                         |       | Manufacturing  of pharmaceuticals             |
| SkyePharma  (Jersey) Limited* |       | Jersey      |       | 100%                         |       | Issue of  bonds                               |
| Krypton  Limited              |       | Gibraltar   |       | 100%                         |       | Exploitation  of intellectual property        |
| SkyePharma  AB*               |       | Sweden      |       | 100%                         |       | Research and  development                     |
| Jago Holding  AG              |       | Switzerland |       | 100%                         |       | Holding  company                              |
| Jagotec AG                    |       | Switzerland |       | 100%                         |       | Exploitation  of intellectual property        |
| SkyePharma AG                 |       | Switzerland |       | 100%                         |       | Research and  development                     |
| SkyePharma  Holding AG*       |       | Switzerland |       | 100%                         |       | Holding  company                              |
| SkyePharma  Holding Inc.*     |       | US          |       | 100%                         |       | Holding  company                              |
| SkyePharma  Inc.              |       | US          |       | 100%                         |       | Development  of pharmaceuticals               |
| SkyePharma US  Inc.           |       | US          |       | 100%                         |       | Development  of pharmaceuticals and licensing |

----

*                    Directly held by the Company.

**Associates**

| **Company**       | ** ** | ** ** | ** ** | **Country of incorporation** | ** ** | **% held of nominal value and voting rights** | ** ** | **Principal activities** |
|-------------------|------------|------------|------------|------------------------------|------------|----------------------------------------------------|------------|--------------------------|
| Astralis  Limited |       | US         |       | 40%                          |       | Research and development                           |

 

**35**             Subsequentevent

In May 2006SkyePharma announced that it had entered into an agreement with KosPharmaceuticals Inc to jointly develop FlutiformTM. Kos will have exclusiverights to market FlutiformTMin the US and a right of first negotiation in Canada. SkyePharmacould receive up to $165 million in milestone payments on achievement of allregulatory and revenue targets (of which $25 million has been paid up front)together with royalties starting in the mid teens on sales by Kos.

**36**             Transitionfrom accounting practices generally accepted in the UK to InternationalFinancial Reporting Standards

The Group reported under UK GAAP in itsfinancial statements for the year ended December 31, 2004. The Group isrequired under the Listing Rules to report under IFRS for the year endingDecember 31, 2005 and present comparatives for the year endedDecember 31, 2004. Consequently, the Group’s date of transition to IFRS isJanuary 1, 2004.

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Set out beloware reconciliations of total equity and reserves and income from UK GAAP toIFRS.

**Totalequity and reserves**

| ** **                                              | ** ** | **Notes**  | ** ** | **January 1,  2004** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------------------|------------|------------|------------|---------------------------|------------|-----------------------------|------------|
| ** **                                              | ** ** | ** ** | ** ** | **£m**               | ** ** | **£m**                 | ** ** |
| **Total equity and reserves as reported under UK GAAP** |       |       |       | ** **                |       |                        | **84.9**   | ** ** |   |   | **63.6** | ** ** |   |
| **Adjustments to conform  to IFRS**                     |       |       |       | ** **                |       |                        |       |   |   |   |   |   |   |
| Revenue  recognition                                    |       |       | (a)        | ** **                |       |                        | (19.6      | ) |   |   | (6.7 | ) |   |
| Sale  of royalty interests to Paul Capital              |       |       | (b)        | ** **                |       |                        | (36.1      | ) |   |   | (39.0 | ) |   |
| Goodwill  amortization                                  |       |       | (d)        | ** **                |       |                        | —     |   |   |   | 4.1 |   |   |
| Convertible  bonds                                      |       |       | (e)        | ** **                |       |                        | 1.5        |   |   |   | 16.4 |   |   |
| Fixed  assets investments                               |       |       | (f)        | ** **                |       |                        | —     |   |   |   | (0.5 | ) |   |
| Other  financial instruments                            |       |       | (g)        | ** **                |       |                        | 0.4        |   |   |   | (0.2 | ) |   |
| Pensions                                                |       |       | (h)        | ** **                |       |                        | (1.3       | ) |   |   | (1.2 | ) |   |
| **Total equity and  reserves under IFRS**               |       |       |       | ** **                |       |                        | **29.8**   | ** ** |   |   | **36.5** | ** ** |   |

 

**Loss for the year**

| ** **                                      | ** ** | **Notes**  | ** ** | **Year ended**December 31,  2004 | ** ** |
|-------------------------------------------------|------------|------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | ** ** | ** ** | **£m**                                | ** ** |
| **Loss for the year as reported under UK GAAP** |       |       |       | ** **                                 |       |   | **(24.3** | **)** |   |
| **Adjustments to conform  to IFRS**             |       |       |       | ** **                                 |       |   |   |   |   |
| Revenue  recognition                            |       |       | (a)        | ** **                                 |       |   | 13.1 |   |   |
| Sale  of royalty interests to Paul Capital      |       |       | (b)        | ** **                                 |       |   | (1.7 | ) |   |
| Share  based payments                           |       |       | (c)        | ** **                                 |       |   | (2.8 | ) |   |
| Goodwill  amortization                          |       |       | (d)        | ** **                                 |       |   | 4.1 |   |   |
| Convertible  bonds                              |       |       | (e)        | ** **                                 |       |   | (6.5 | ) |   |
| Other  financial instruments                    |       |       | (g)        | ** **                                 |       |   | (0.5 | ) |   |
| **Loss for the year under  IFRS**               |       |       |       | ** **                                 |       |   | **(18.6** | **)** |   |

 

**Cashflow statement**

The transition from UK GAAP to IFRS doesnot change any of the cash flows of the Group. The IFRS cash flow statement issimilar to UK GAAP, but presents various cash flows in different categories andin a different order from the UK GAAP cash flow statement. All of the IFRSaccounting adjustments net out within cash generated from operations, exceptfor the inclusion of the repayment of the Paul Capital funding liabilities.

The IFRS adjustments set out in the reconciliations are explainedbelow:

**(a) Revenuerecognition**

Under UK GAAP SkyePharma has generallyrecognized up front payments immediately in full where there are no materialfuture obligations and the payments are non-refundable, on the basis that theup front payment relates to past services. Under IFRS up front payments willgenerally be deferred and amortized on a systematic basis over the period ofproduct development to filing. However, the accounting for each agreement willcontinue to be determined on an individual basis.

The IFRSrestatement increases revenue in the year to December 31, 2004 by £13.1million so reducing operating and retained loss by £13.1 million. This relatesto up front payments that have been 

F-49

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previouslyrecognized in the UK GAAP financial statements in earlier years but which underIFRS would not have been recognized in full, but deferred across the period ofdevelopment to filing. The restatement increases deferred income at December 31,2004 by £6.7 million (2003: £19.6 million).

**(b) Saleof royalty interests to Paul Capital**

The Group entered into two transactionswith Paul Capital Royalty Acquisition Fund (‘Paul Capital’) in 2000 and 2002.Under these transactions Paul Capital provided a total of $60 million in returnfor the sale of a portion of the potential future royalty and revenue streamson a selection of the Group’s products. Under UK GAAP the proceeds receivedfrom Paul Capital are treated as a sale and recorded as operating income andthe royalties are expensed when incurred.

Under IFRS the proceeds received from PaulCapital meet the definition of a financial liability under IAS 39, and aretreated as such. No operating income is recognized, royalties paid to PaulCapital are treated as repayment of the liability and in addition interest isimputed on the liability using the effective rate as at inception of theagreement. The contractual arrangement with Paul Capital is unaffected by thischange in accounting and the arrangement remains a royalty agreement underwhich royalties are payable on revenues earned and payments received. Theliability has no face amount but represents the net present value of royaltieswe expect to pay Paul Capital over the term of the agreement, discounted at theeffective rate at inception of the agreement.

The IFRSrestatement increases the loss in the year to December 31, 2004 by £1.7million and decreases net assets at December 31, 2004 by £39.0 million(2003: £36.1 million).

**(c) Sharebased payments**

IFRS 2 requires that for share optionawards to employees, the fair value of the employee services received should bemeasured by reference to the fair value of the share option at the grant date.This differs significantly from the treatment under UK GAAP where the charge tothe profit and loss account was based on the difference between the fair valueof the shares at the date of grant and the exercise price. Since SkyePharma hashistorically granted employee options where the share price at the date ofgrant equals the exercise price, there has been no charge recorded under UKGAAP.

SkyePharma hasadopted full retrospective application of IFRS 2. The IFRS restatement resultsin an additional charge to the income statement in the year to December 31,2004 of £2.8 million, increasing both operating and retained loss. Therestatement has no impact on net assets.

**(d) Goodwillamortization**

Under UK GAAPgoodwill has been amortized over its estimated expected useful life which theDirectors determined as 20 years. Under IFRS, goodwill is considered to have anindefinite life and so is not amortized, but is subject to annual impairmenttesting. Therefore the annual goodwill charge made under UK GAAP will not berecorded under IFRS from January 1, 2004, the IFRS transition date. TheIFRS restatement results in a reduction in the amortization charge in the yearto December 31, 2004 of £4.1 million thereby reducing both operating andretained loss.

**(e) Convertiblebonds**

Under UK GAAP the total net proceeds of theconvertible bond issues in 2000 (due in 2005) and 2004 (due in 2024) wererecorded as debt. Under IFRS the conversion feature of each of the bonds mustbe split from the debt and classified as equity. The net impact of the changesto IFRS and in particular the split of the equity component of each bond hasled, at December 31, 2004, to a reduction in the carrying value ofconvertible debt of £16.4 million (2003: £1.5 million) and a correspondingincrease in equity. While the 

F-50

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carrying valueof the convertible debt in the balance sheet is reduced, the amount of debtrepayable at maturity is unchanged and consequently under IFRS the Grouprecords higher interest charges in each year to maturity or conversion.

In the year to December 31, 2004, theimpact of these factors led to an additional interest charge of £0.3million.The terms of the debt are unaffected and the physical cash payments due remainthe same; as such the cost of the debt in cash terms is unaffected.

During the year to December 31, 2004the Group exchanged £49.6 million of the convertible bonds due 2005 for bondsdue 2024 in the same amount, leaving £9.8 million 2005 bonds outstanding. UnderUK GAAP no gain or loss arose on the exchange. However un-amortized issue costsof £0.3 million were written off under UK GAAP as exceptional interest charge.Under IFRS the refinancing of the £49.6 million convertible is treated as anextinguishment of the original debt and the issue of new debt recorded at fairvalue since the discounted present value of the cash flows of the twoinstruments differ by more than 10% (2005 Bond replaced by a 2024 Bond). Theextinguishment and debt issue costs lead to the additional charge of £6.2million recorded in the IFRS income statement in 2004.

In total theIFRS adjustments on the convertible bonds result in an additional interestcharge in the 2004 income statement of £6.5 million and an increase in netassets at December 31, 2004 by £16.4 million. Of the £6.5m additionalinterest charge, £0.3m relates to the IFRS accounting for convertible bonds ingeneral and £6.2 million is an additional charge caused by the 2004 refinancingof SkyePharma’s convertible bond due 2005.

**(f) Fixedassets investments**

Under UK GAAPfixed asset investments are stated at the lower of cost and net realisablevalue. Under IFRS most of SkyePharma’s investments are classified as ‘Available-for-salefinancial assets’ and as such stated at fair value with any unrealized gains orlosses recorded in equity. The IFRS restatement reduces net assets at December 31,2004 by £0.5 million (2003: £Nil) and does not effect the income statement.

**(g) Otherfinancial instruments**

Under UK GAAP, periodic gains and losses oninterest and foreign currency derivatives designated as hedges are notrecognized until the operational transactions to which they are linked occur.No derivatives have qualified as hedges under IFRS and therefore in accordancewith IAS 39 such instruments have been recognized at fair value at the balancesheet date with gains and losses being recorded in the income statement.

SkyePharma isadopting full retrospective application of IAS 32 and IAS 39 and has thereforerestated its opening balance and 2004 result accordingly. This restatement hasled to an additional charge in the year to December 31, 2004 of £0.5million, increasing both operating and retained loss. As at December 31,2004 the IFRS restatement reduces net assets by £0.2 million (2003: £0.4 millionincrease).

**(h) Pensions**

The IFRSadjustment on pensions relates to the Company’s pension schemes in Switzerlandand France. In accordance with IFRS 1, the Group has fully recognized allactuarial gains and losses on its pension schemes in Switzerland and France at January 1,2004, its transition date. Ongoing actuarial gains and losses will berecognized in the Statement of Recognized Income and Expenditure.

F-51

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**(i) Other**

Under IFRS theGroup is required to capitalize research and development costs when thecriteria laid out in IAS 38 are met. The Group has reviewed its historicalresearch and development projects and determined that no expenditure incurredto date meets the criteria for capitalization in IAS 38. However the Group willcontinue to review its development expenditure against the relevant criteriaand will capitalize such expenditure when it is appropriate.

**37**             Summaryof Material Differences between IFRS and U.S. GAAP

SkyePharma adopted International Financial Reporting Standards asadopted in the European Union (“IFRS”) as of January 1, 2004. SkyePharma’sconsolidated financial statements, presented elsewhere in this document, havebeen prepared in accordance with IFRS, which differ in certain materialrespects from U.S. generally accepted accounting principles (“U.S. GAAP”).Application of U.S. GAAP would have affected the results of operations andbalance sheets for the years ended and as of December 31, 2004 and 2005. Thematerial differences between IFRS and U.S. GAAP as they relate to SkyePharmaare discussed in further detail below.

| ** **                                               | ** ** | **Notes**  | ** ** | **Year to  December 31,  2004** | ** ** | **Year to  December 31,  2005** | ** ** |
|----------------------------------------------------------|------------|------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                               | ** ** | ** ** | ** ** | **£m**                               | ** ** | **£m**                               | ** ** |
| **Loss under IFRS**                                      |       |       |       |                                      |       |                                      | (18.6      | ) |   |   | (50.9 | ) |   |
| U.S.  GAAP adjustments:                                  |       |       |       |                                      |       |                                      |       |   |   |   |   |   |   |
| Business  combinations                                   |       |       |       |                                      |       |                                      |       |   |   |   |   |   |   |
| Amortization of other intangible assets                  |       |       | (1b)       |                                      |       |                                      | (0.4       | ) |   |   | (0.4 | ) |   |
| Depreciation of property, plant and equipment            |       |       | (1c)       |                                      |       |                                      | 1.0        |   |   |   | 0.6 |   |   |
| Deferred taxes                                           |       |       | (1d)       |                                      |       |                                      | (0.1       | ) |   |   | 0.2 |   |   |
| Investments  in associates                               |       |       | (4)        |                                      |       |                                      | (3.8       | ) |   |   | 11.1 |   |   |
| Convertible  bonds                                       |       |       | (5)        |                                      |       |                                      | 4.6        |   |   |   | 0.3 |   |   |
| Paul  Capital funding liabilities                        |       |       | (6)        |                                      |       |                                      | (5.2       | ) |   |   | (3.1 | ) |   |
| Share  based compensation                                |       |       | (7)        |                                      |       |                                      | 1.8        |   |   |   | — |   |   |
| Revenue  recognition                                     |       |       | (8)        |                                      |       |                                      | —     |   |   |   | (5.0 | ) |   |
| Other                                                    |       |       | (9)        |                                      |       |                                      | (0.1       | ) |   |   | (2.0 | ) |   |
| **Net loss under U.S. GAAP**                             |       |       |       |                                      |       |                                      | (20.8      | ) |   |   | (49.2 | ) |   |
| **Net loss per Ordinary  Share under U.S. GAAP (pence)** |       |       |       |                                      |       |                                      | (3.4p      | ) |   |   | (7.9p | ) |   |

 

F-52

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| ** **                                                         | ** ** | **Notes**  | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                         | ** ** | ** ** | ** ** | **£m  (restated)**     | ** ** | **£m**                 | ** ** |
| **Shareholders’ funds under IFRS**                            |       |       |       |                        |       |                        | 36.5       |   |   |   | 31.9 |   |   |
| U.S. GAAP  adjustments:                                            |       |       |       |                        |       |                        |       |   |   |   |   |   |   |
| Business  combinations                                             |       |       |       |                        |       |                        |       |   |   |   |   |   |   |
| Goodwill                                                           |       |       | (1a)       |                        |       |                        | 59.4       |   |   |   | 62.5 |   |   |
| Other intangible assets                                            |       |       | (1b)       |                        |       |                        | 4.0        |   |   |   | 4.1 |   |   |
| Property, plant and equipment                                      |       |       | (1c)       |                        |       |                        | (7.0       | ) |   |   | (6.2 | ) |   |
| Deferred taxes                                                     |       |       | (1d)       |                        |       |                        | (1.6       | ) |   |   | (1.5 | ) |   |
| Contingent consideration recorded within shareholders’  funds |       |       | (1e)       |                        |       |                        | 22.6       |   |   |   | 22.6 |   |   |
| Shares  issued relating to contingent consideration                |       |       | (2)        |                        |       |                        | (11.3      | ) |   |   | (11.3 | ) |   |
| Deferred  shares to be issued                                      |       |       | (3)        |                        |       |                        | (11.3      | ) |   |   | (11.3 | ) |   |
| Investments  in associates                                         |       |       | (4)        |                        |       |                        | (11.1      | ) |   |   | — |   |   |
| Convertible  bonds                                                 |       |       | (5)        |                        |       |                        | (18.3      | ) |   |   | (24.1 | ) |   |
| Paul  Capital funding liabilities                                  |       |       | (6)        |                        |       |                        | (4.3       | ) |   |   | (10.3 | ) |   |
| Revenue  recognition                                               |       |       | (8)        |                        |       |                        | —     |   |   |   | (5.0 | ) |   |
| Other                                                              |       |       | (9)        |                        |       |                        | 1.3        |   |   |   | (1.4 | ) |   |
| **Shareholders’ funds  under U.S. GAAP**                      |       |       |       |                        |       |                        | 58.9       |   |   |   | 50.0 |   |   |

 

**Description of U.S. GAAP Adjustments**

**(1) Business combinations**

SkyePharma hadentered into business combinations prior to the January 1, 2004 date ofadoption of IFRS. Under IFRS, these business combinations have not beenrestated to conform with the requirements of IFRS 3; Business Combinations, aspermitted by the exemption provided by IFRS 1, which SkyePharma elected toapply. As a result, such transactions under IFRS differ from U.S. GAAP.

Differencesbetween IFRS and amounts recorded for U.S. GAAP as a result of the exemptionprovided by IFRS 1 are as follows:

(a)          Goodwill

On IFRStransition goodwill has been fixed at its historic carrying value in accordancewith IFRS 1 and certain balances remain recorded in shareholders’ funds.Prior to the adoption of IFRS, SkyePharma amortized the goodwill recordedwithin non-current assets over a suitable period, not normally exceeding 20years. However, the goodwill recorded in shareholders’ funds was not amortized.

Under U.S. GAAPgoodwill is not amortized, but tested annually for impairment. No goodwillimpairments have been recognized under IFRS or U.S. GAAP for the years ended December 31,2004 and 2005.

Amountspreviously reported for our consolidated shareholders’ funds in accordance withU.S. GAAP differ from those amounts shown for the fiscal years ended December 31,2004 as presented in this Annual Report. Prior to the introduction of IFRS,under UK GAAP, in a purchase business combination amounts recorded in excess ofassets acquired and liabilities assumed were recorded as goodwill in theaccounts of the acquiring entity. Upon consolidation of the newly acquiredsubsidiary there was no need to translate the goodwill from the subsidiarycurrency to the reporting entity currency. Under U.S. GAAP this goodwill isrecorded as an asset acquired in the purchased entity and the goodwill isrecorded in the newly acquired entity. Upon consolidation of the acquiredentity all assets and liabilities of the subsidiary, including the goodwillamounts, are required to be translated at the balance sheet date. In prioryears we had made no adjustment for this difference in accounting 

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treatmentbetween UK and U.S. GAAP in our U.S. GAAP reconciliation. Consequently, we haverestated our net assets and shareholders’ funds under U.S. GAAP at December 31,2004 to reflect the impact of the adjustments made to our goodwill. As aresult, our restated U.S. GAAP shareholders’ funds reflect a decrease in netassets of £25.8 million in 2004 (from £84.7 million to £58.9 million).

(b)         Otherintangible assets

Prior to theadoption of IFRS, no intangible assets had been separately identified andrecognized as a result of purchase accounting. This is because the intangibleassets were considered to be an integral part of the business acquired and wereincluded within goodwill and eliminated against shareholders’ funds.

Under U.S. GAAPthe purchase consideration was allocated to identifiable intangible assets,including any resulting from research and development. Identifiable intangibleassets are reflected as assets and amortized over their estimated revenueearning life.

(c)          Property,plant and equipment

Prior to theadoption of IFRS, where the aggregate of the fair values of the net assetsacquired exceeded the cost of the acquired net assets resulting in goodwill,such excess was credited directly to reserves. Negative goodwill arising on theacquisition of Jago Production SAS has been accounted for according to thispolicy.

Under U.S. GAAPsuch excess is eliminated by proportionately reducing the value of thenon-current assets acquired.

(d)         Deferredtaxes

Prior to theadoption of IFRS, no deferred taxation was recorded on business combinations.

Under U.S. GAAPdeferred taxation associated with certain purchase accounting differences wasrecorded.

(e)          Contingentconsideration recorded within shareholders’ funds

Prior to theadoption of IFRS, the contingent consideration issued in connection with Jagowas estimated and recognized within shareholders’ funds as deferred shares. Theshares were recorded using the market price at the date of issuance of thedeferred shares. The contingent consideration is described in Note 27; Sharecapital.

Under U.S. GAAPcontingent consideration is only recognized when determinable beyond reasonabledoubt. As a result the contingent consideration was not recognized on the dateof acquisition.

**(2) Shares issued relating to contingentconsideration**

Prior to theadoption of IFRS, the deferred ‘A’ shares were automatically converted intoOrdinary Shares as described in Note 27; Share capital.

Under U.S. GAAPthese shares were recorded within shareholders’ funds at the market price atthe date of conversion.

**(3) Deferred shares to be issued**

Prior to theadoption of IFRS, the deferred ‘B’ shares were recognized within shareholders’funds using the market price at their date of issuance as described in Note 27;Share capital.

Under U.S. GAAPcontingent consideration is recognized only when determinable beyond reasonabledoubt. As a result, the contingent consideration has not been recognized andthe deferred shares have 

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beenreversed out of shareholders’ funds. The conditions have not been met and thedeferred ‘B’ shares have been transferred to the Company Secretary for noconsideration for him to hold as custodian.

**(4) Investments in associates**

Under IFRS theCompany has accounted for its investment in Astralis as an associated undertakingfrom December 2004, when it gained significant influence.

Under U.S. GAAPthe ability to exercise significant influence resulted in a change inclassification from an available for sale investment to an equity methodinvestment under APB 18; Equity method of accounting for investments in commonstock. On initial application of the equity method the Group retroactivelyrestated the investment, results of operations and retained earnings in amanner consistent with the accounting for a ‘step’ acquisition of a subsidiarywhich is different to the treatment under IFRS. This constituted a change inaccounting principle. In consideration of this change in status, the investmentin Astralis has been adjusted for increases in ownership interest according tothe accounting for a ‘step’ acquisition and reduced to recognize the Group’sshare of the losses of Astralis after the date of initial acquisition.

**(5) Convertible bonds**

Under IFRS theconversion feature of each convertible bond is split from the debt and classifiedas equity.

Under U.S. GAAPthe convertible bonds do not contain a beneficial conversion feature asspecified in EITF 98-5, Accounting for Convertible Securities withBeneficial Conversion Features or Contingently Adjustable Conversion Ratios andtherefore each convertible bond has not been split between debt and equity.Consequently the carrying value of the convertible bonds is higher and theinterest charges are lower than under IFRS.

**(6) Paul Capital funding liabilities**

Under IFRS theestimated payments to Paul Capital are discounted using each contract’soriginal effective interest rate. Any change in the estimated future paymentsto Paul Capital is recognized immediately as an income or expense in the incomestatement.

Under U.S. GAAPthe proceeds received from Paul Capital are treated as a floating ratefinancial liability. Any change in the estimated future payments to PaulCapital is effectively spread forward and reflected in a reduced implicitinterest cost in future years. Consequently the carrying value of the PaulCapital funding liabilities and finance costs are higher than under IFRS.

**(7) Share based compensation**

The Group’saccounting for share based payments under IFRS is disclosed in Note 1;Accounting policies.

Under U.S. GAAPSkyePharma adopted the Modified Prospective Application transition method ofSFAS 123R; Share Based Payment (revised 2004) (“SFAS 123R”), as of January 1,2005, having previously applied APB 25; Accounting for Stock Issued toEmployees. There were no material differences between IFRS and U.S. GAAP forthe year ended and as of December 31, 2005.

**(8) Revenue recognition**

Under IFRS theCompany accounts for revenues in accordance with IAS 18 and allocates revenueto the separate elements of each contract after consideration of the fairvalues and commercial substance of the contracts. The basis of such allocationdiffers from the allocation made under U.S. GAAP which, following the moreprescriptive guidance in EITF 01-9; Accounting for Consideration Given bya Vendor 

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toa Customer, EITF 00-21; Accounting for Revenue Arrangements with MultipleDeliverables and SAB 104; Revenue recognition, for determining thedeliverable elements, the fair values of these deliverables and the allocationof consideration received.

Under U.S.GAAP, the Company has accounted for contingent marketing contributions as areduction of up-front consideration received in determining the revenue to berecognized. If the contingent marketing contributions do not reach thecontractually agreed reimbursements, the difference would be recognized asrevenue at the time further marketing contributions are no longer required.Under IFRS, marketing contributions are expensed as incurred, in line with thetiming of the resulting expected product sales. Furthermore, under EITF 00-21,pre-launch samples are considered a separate unit of accounting to whichrevenue is allocated, with such allocated revenue recognized as samples aredelivered. Under IFRS, the samples are accounted for as a marketingcontribution and expensed upon delivery.

**(9) Other**

Otherdifferences relate to the treatment of purchases of intellectual property andretirement benefit obligations.

**(10) U.S. GAAP developments**

Recentdevelopments in U.S. financial reporting standards are outlined below:

SFAS 154;Accounting changes and Error Corrections, a replacement of APB Opinion No. 20and FAS 3.

In June 2005,the Financial Accounting Standards Board issued SFAS 154; Accounting Changesand Error Corrections, a replacement of APB Opinion No. 20 and FAS 3 (SFAS154). This statement replaces Opinion 20 and FAS 3, and changes therequirements for the accounting for, and reporting of, a change in accountingprinciple. APB Opinion No. 20 previously required that most voluntarychanges in accounting principle be recognized by including in net income of theperiod of the change the cumulative effect of changing to the new accountingprinciple. SFAS 154 requires retrospective application to prior periods’financial statements of changes in accounting principle. SFAS 154 is effectivefor SkyePharma for the period beginning January 1, 2006. SkyePharma iscurrently reviewing this issue to measure the potential impact on theconsolidated results of operations, financial position, and cash flows.

FSP No. FAS115-1 and FSP FAS 124-1; The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments.

In November 2005,the Financial Accounting Standards Board issued this FASB Staff Position (FSP)which addresses the determination as to when an investment is consideredimpaired, whether that impairment is other than temporary, and the measurementof an impairment loss. This FSP also includes accounting considerationssubsequent to the recognition of an other-than-temporary impairment and requirescertain disclosures about unrealized losses that have not been recognized asother-than-temporary impairments. The guidance in this FSP amends FASBStatements No. 115, Accounting for Certain Investments in Debt and EquitySecurities, and No. 124, Accounting for Certain Investments Held byNot-for-Profit Organizations, and APB Opinion No. 18, The Equity Method ofAccounting for Investments in Common Stock. FSP FAS 115-1 is effectivefor SkyePharma for the period beginning January 1, 2006. SkyePharma is currentlyreviewing this issue to measure the potential impact on the consolidatedresults of operations, financial position, and cash flows.

Other recentaccounting pronouncements issued by the FASB (including the Emerging IssuesTask Force), the AICPA, and the SEC are not believed by management to have amaterial impact on SkyePharma’s present or future consolidated financialstatements.

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**INDEX OF EXHIBITS FILED WITH THE 2004 20-F**

**Item 19: Exhibits**
| **1.1** | ** ** | **Memorandum and Articles of Association of  SkyePharma PLC**                                                                                                                |
|---------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |       | 1.1.1                                                                                                                                                                        |   | Memorandum of Association of SkyePharma PLC** |
|         |       | 1.1.2                                                                                                                                                                        |   | Articles of Association of SkyePharma PLC, as amended on May 30, 2002*** |
| **4.1** | ** ** | **Solaraze® Agreements with Bioglan**                                                                                                                                   |
|         |       | 4.1.1                                                                                                                                                                        |   | Licensing and manufacturing agreement for Europe dated March 13, 2000 between  JagoTech AG and Bioglan Pharma PLC**+ |
|         |       | 4.1.2                                                                                                                                                                        |   | Addendum agreement for the U.S. dated December 28, 2000 between JagoTech AG  and Bioglan Pharma PLC**+ |
| 4.2     | ** ** | **Directors and Officers Service Contracts**                                                                                                                                 |
|         |       | 4.2.1                                                                                                                                                                        |   | Contract of employment between the Company and Donald Nicholson dated  February 28, 1996** |
|         |       | 4.2.2                                                                                                                                                                        |   | Contract of employment between the Company and Frank Condella dated February  27, 2006 |
|         |       | 4.2.3                                                                                                                                                                        |   | Contract of employment between the Company and Dr. Kenneth Cunningham dated  March 1, 2006 |
|    |       | 4.2.4                                                                                                                                                                        |   | Letter of appointment between the Company and Dr. Argeris (Jerry) Karabelas  dated February 2, 2006 |
|         |       | 4.2.5                                                                                                                                                                        |   | Proforma letter of appointment in respect of the appointment of Non-Executive  Directors****** |
| **4.3** | ** ** | **Share Purchase Plans**                                                                                                                                                     |
|         |       | 4.3.1                                                                                                                                                                        |   | The SkyePharma PLC Deferred Share Bonus Plan*** |
| **4.4** | ** ** | **Amendments to the 1996 Acquisition Agreement, dated April 7, 2000 and May 11,  2000, between Dr Jacques Gonella and SkyePharma PLC***                                      |
| **4.5** | ** ** | **Development and Marketing Strategic Alliance Agreement among Endo  Pharmaceuticals Inc., SkyePharma Inc. and SkyePharma Canada Inc. dated as of  December 31, 2002 ****+** |

 

 

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| **4.6**  | ** ** | **License Agreement, dated March 20, 1998, between SmithKline Beecham plc (now  part of GlaxoSmithKline plc), Jagotec AG and Jago Pharma AG*****+**             |
|----------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **8.1**  | ** ** | **List of SkyePharma PLC’s subsidiaries (See “Item 4: Information on the  Company — Business Operations — Organizational Structure”)** |
| **12.1** | ** ** | **Certification of Michael Ashton filed pursuant to 17 CFR 240.13(a) — 14(a)**                                                                             |
| **12.2** | ** ** | **Certification of Donald Nicholson filed pursuant to 17 CFR 240.13(a) — 14(a)**                                                                           |
| **13.1** | ** ** | **Certification of Michael Ashton filed pursuant to 17 CFR 240.13(a) — 14(b)  and 18 U.S. C/1350(a) and (b)**                                              |
| **13.2** | ** ** | **Certification of Donald Nicholson filed pursuant to 17 CFR 240.13(a) — 14(b)  and 18 U.S. C/1350(a) and (b)**                                            |
| **15.1** | ** ** | **Consent of Independent Registered Public Accounting Firm**                                                                                                    |

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| *      |   | Incorporated  by reference to the Company’s Annual Report on Form 20-F for the financial  year ended December 31, 1999 (Commission File No. 0-29860)                                                                                                                                           |   |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| **     |   | Incorporated by reference to the Company’s Annual Report on Form 20-F for the  financial year ended December 31, 2000 (Commission File No. 0-29860)                                                                                                                                            |   |
| ***    |   | Incorporated by reference to the Company’s Annual Report on Form 20-F for the  financial year ended December 31, 2001 (Commision File No. 0-29860)                                                                                                                                             |   |
| ****   |   | Incorporated by reference to the Company’s Annual Report on Form 20-F for the  financial year ended December 31, 2002 (Commision File No. 0-29860)                                                                                                                                             |   |
| *****  |   | Incorporated by reference to the Company’s Annual Report on Form 20-F for the  financial year ended December 31, 2003 (Commision File No. 0-29860)                                                                                                                                             |   |
| ****** |   | Incorporated by reference to the Company’s Annual Report on Form 20-F for the  financial year ended December 31, 2004 (Commision File No. 0-29860)                                                                                                                                             |   |
| +      |   | Confidential treatment has been granted for portions of this document. The  information omitted pursuant to such confidential treatment order has been  filed separately with the SEC in accordance with Rule 24b-2 under the  Securities Exchange Act of 1934, as amended (“Rule 24b-2”) |   |

 

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