**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-K**

 

**ý****                                ****ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For theFiscal Year Ended June 30, 2005**

 

**CommissionFile Number:  001-14059**

 

**IOMED, Inc.**

(Exact name of registrant asspecified in its charter)

 

| **Utah**                         | ** ** | **87-0441272**       |
|----------------------------------|------------|----------------------|
| (State or  other jurisdiction of |       | (I.R.S.  Employer    |
| incorporation  or organization)  |       | Identification  No.) |

 

**2441 South3850 West, Salt Lake City, Utah  84120**

(Address of principal executiveoffices)                               (ZipCode)

 

**(801) 975-1191**

(Registrant’s telephone number,including area code)

 

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

**CommonStock, no par value**

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act). oYes ý No

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). oYes ý No

 

The aggregate market value of the Registrant’s voting stock held bynon-affiliates based upon the closing price of the common stock as quoted onthe American Stock Exchange on December 31, 2004, was approximately$14,911,000.

 

The number of shares of Registrant’s common stock outstanding on August 31,2005, was 6,685,055.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Certain information isincorporated into Part III of this Report on Form 10-K by referenceto the Registrant’s Proxy Statement for its 2005 Annual Meeting ofShareholders.

 

 

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**TABLE OFCONTENTS**

 
| **Part I**   |   | ** ** |   | ** **                                                                                  |                         |
|-------------------|--------|------------|--------|---------------------------------------------------------------------------------------------|------------------------------|
| Item 1            |   | —     |   | Business                                                                                    |                         |
|              |   |       |   |                                                                                        |                         |
| Item 2            |   | —     |   | Properties                                                                                  |                         |
|              |   |       |   |                                                                                        |                         |
| Item 3            |   | —     |   | Legal  Proceedings                                                                          |                         |
|              |   |       |   |                                                                                        |                         |
| Item 4            |   | —     |   | Submission of Matters to a Vote of Security Holders                                         |                         |
|              |   |       |   |                                                                                        |                         |
| **Part II**  |   |       |   |                                                                                        |                         |
| Item 5            |   | —     |   | Market for Registrant’s Common Equity and Related Stockholder Matters                  |                         |
|              |   |       |   |                                                                                        |                         |
| Item 6            |   | —     |   | Selected  Consolidated Financial Data                                                       |                         |
|              |   |       |   |                                                                                        |                         |
| Item 7            |   | —     |   | Management’s Discussion and Analysis of Financial Condition and  Results of Operations |                         |
|              |   |       |   |                                                                                        |                         |
| Item 7a           |   | —     |   | Quantitative and Qualitative Information about Market Risk                                  |                         |
|              |   |       |   |                                                                                        |                         |
| Item 8            |   | —     |   | Financial Statements and Supplementary Data                                                 |                         |
|              |   |       |   | —                                                                                      | Audited Financial Statements |   |
|              |   |       |   |                                                                                        |                         |
| Item 9            |   | —     |   | Changes and Disagreements with Accountants on Accounting and  Financial Disclosure          |                         |
|              |   |       |   |                                                                                        |                         |
| Item 9A           |   | —     |   | Controls and Procedures                                                                     |                         |
|              |   |       |   |                                                                                        |                         |
| Item 9B           |   | —     |   | Other  Information                                                                          |                         |
|              |   |       |   |                                                                                        |                         |
| **Part III** |   |       |   |                                                                                        |                         |
| Item 10           |   | —     |   | Directors and Executive Officers of the  Company                                            |                         |
|              |   |       |   |                                                                                        |                         |
| Item 11           |   | —     |   | Executive Compensation                                                                      |                         |
|              |   |       |   |                                                                                        |                         |
| Item 12           |   | —     |   | Security Ownership of Certain Beneficial  Owners and Management                             |                         |
|              |   |       |   |                                                                                        |                         |
| Item 13           |   | —     |   | Certain Relationships and Related  Transactions                                             |                         |
|              |   |       |   |                                                                                        |                         |
| Item 14           |   | —     |   | Principal Accountant Fees and Services                                                      |                         |
|              |   |       |   |                                                                                        |                         |
| **Part IV**  |   |       |   |                                                                                        |                         |
| Item 15           |   | —     |   | Exhibits, Financial Statement Schedules,  and Reports on Form 8-K                      |                         |
|              |   |       |   |                                                                                        |                         |
| **Signatures**    |   |       |   |                                                                                        |                         |
|                   |        |            |        |                                                                                             |                              |  |

 

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**PART I**

 

**Item 1.****           BUSINESS**

 

**Forward-Looking Statements**

 

Certain statements contained in this report on Form 10-K (the “Report”)are “forward-looking statements” within the meaning of Section 21E of theSecurities Exchange Act of 1934, as amended. Such forward-looking statements may be identified by the use ofterminology such as “may,” “will,” “expect,” “anticipate,” “intend,” “designed,”“estimate,” “should,” or “continue” or the negatives thereof or othervariations thereon or comparable terminology. Such forward-looking statements involve known and unknown risks,uncertainties and other factors which may cause the actual results, performanceor achievements of IOMED, Inc. (the “Company”), or industry results, to bematerially different from any future results, performance or achievementsexpressed or implied by such forward-looking statements.  These risks, uncertainties and other factorsinclude, among other things, the following: the uncertainties related to the Company’s continuing profitability; theuncertainties related to the Company’s product development programs; theuncertainties related to the Company’s ability to attract collaborativedevelopment partners; the Company’s reliance on third party distribution; therisks associated with obtaining governmental approval of the Company’sproducts; the highly competitive industry in which the Company operates and therapid pace of technological change within that industry; the uncertainty ofpatented and proprietary technology protection and the Company’s reliance onsuch patented and proprietary technology (including reliance on technologylicensed from third parties); defense of the Company’s intellectual propertyrights and claims that the Company has infringed the intellectual propertyrights of third parties; changes in or failure to comply with governmentalregulation; the uncertainty of third party reimbursement for the Company’sproducts; the Company’s dependence on key employees; general economic andbusiness conditions and other factors discussed in this Report and the Company’sother Securities and Exchange Commission (“SEC”) filings.  The Company undertakes no obligation toupdate publicly any forward-looking statements for any reason, even if newinformation becomes available or other events or circumstances occur in the future.

 

**Introduction**

 

The Company was incorporated in Utah in 1974 as Motion Control, Inc.  In 1987, the Company merged with JMWAcquisition Corporation, and the name of the merged entity was changed to IOMED, Inc.  The Company is a leader in developing, manufacturingand marketing active drug delivery systems used primarily to treat acute localinflammation in the physical and occupational therapy and sports medicinemarkets.  The Company is pursuingopportunities to advance its position as a provider of quality, innovativemedical products that improve patient healthcare.  In addition, the Company is seekingcollaborative opportunities to develop its non-invasive drug deliverytechnology to satisfy unmet medical needs. The Company has proprietary iontophoresis technology in various stagesof research and product development primarily for transdermal drug delivery andfor the treatment of ophthalmic disease.

 

**Recent Development**

 

On September 15, 2005, we announced that our Board of Directorshas decided to explore various strategic alternatives for the Company tomaximize shareholder value, including possible sale transactions involving theCompany or certain of its assets.  Inconnection with this process, the Company has retained Seven Hills Partners LLCto act as its financial advisor.  We areuncertain whether any transaction will result from this process and if atransaction does result from that process what form it will take and whatimpact it may have on our stock price.

 

**Commercial Business**

 

The Company is in the business of developing, manufacturing, andmarketing proprietary products used in the site-specific, non-invasiveadministration of soluble salts or other drugs into the body for medicalpurposes.  The Company’s active drugdelivery systems employ iontophoresis (explained more fully below) as anon-invasive method of enhancing and controlling the transport of water-solubleionic drugs into and through the skin and other body tissues using a low-levelelectrical current.  The Companycurrently markets iontophoretic products used to deliver various drugcompounds.  The primary drug compoundsused with our products are potent corticosteroids for the treatment of acutelocal inflammatory conditions

 

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and Iontocaine®, the Company’s brand of lidocaine HCl 2% andepinephrine 1:100,000 topical solution, for the administration of local dermalanesthesia.  The Company’s products areused in situations when it is advisable to avoid the pain that may accompanyneedle insertion and drug injection, to minimize the infiltration of carrierfluids, and/or to avoid the damage caused by needle insertion when tissue istraumatized.

 

 

The Company’s proprietary, patented iontophoresis system (the “Phoresorâsystem” or “Phoresor”) is designed for clinical use and is comprised of areusable dose controller and single use, disposable active transdermal patchkits (“patch kits”).  The dose controllerincorporates an advanced microprocessor to precisely control drug dosage throughthe Company’s proprietary single-use, disposable patch kits, including itsIOGEL®, TransQâ, OptimATM,and Numbyâ patch kits.  The Company also markets a self-containediontophoresis system, the Companion 80TM, that provides a MobileSolutionTM allowing the patient to resume daily activity and theclinician to optimize the use of patient time in the clinic.

 

 

Using the Company’s products, medical professionals are able to deliverdexamethasone, a potent and effective corticosteroid, to treat localinflammatory conditions.  Our proprietaryproducts, combined with dexamethasone, have the potential to address asignificant unmet medical need by offering patients the benefits of theanti-inflammatory effects of dexamethasone while avoiding all of thegastrointestinal (GI) and other systemic side effects of oral drugs, such asnon-steroidal anti-inflammatory drugs (NSAIDs), including Cox-IIinhibitors.  Because of the negative sideeffects often associated with the oral or injectable administration ofdexamethasone, it is used only as a second- or third-line therapy.  However, using the Company’s technology, theadministration of this drug without the occurrence of these negative sideeffects is possible.  The Company’sproducts are used for site-specific corticosteroid therapy in clinicsnationwide to treat a variety of conditions, including those suffered by topprofessional, collegiate, and Olympic athletes.

 

 

The Company also markets a specialty pharmaceutical product, NumbyStuffâ, for thedelivery of Iontocaine with the Phoresor system.  Numby Stuff offers non-invasive, local dermalanesthesia with rapid onset, and can be used prior to needle sticks, IV starts,lumbar punctures, PICC insertions, fine needle and skin biopsies, and otherminor dermatological surgeries.

 

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**Business Strategy**

 

The majority of the Company’s revenues are generated through the saleof the Phoresor system, which consists of a reusable dose controller andsingle-use disposable patch kits.  TheCompany is continuously seeking opportunities to improve the quality of itsexisting products and to market or develop new products to support this “razor-razorblade” business model.

 

The Company intends to promote growth in its core business by:

 

•                  *Strengthen Product Lines –* Leverageexisting distributor networks and health care provider relationships and enterinto new agreements to broaden and strengthen access to our served markets.

 

•                  *Distribute New Products –* Applytechnological expertise on focused product development activities to providevalue to our customers and to improve the competitive position of our productsand our distributors.

 

•                  *Seek New Product and Market Opportunities* –Expandproduct offerings, identify new products and enter new markets bothindependently and through acquisition or collaborative relationships.

 

**Current and Future Products**

 

The following table lists the therapeutic applications of the principalproducts developed and future products pending development by the Company.  The application of the Company’s technologyas an approved pharmaceutical product for the treatment of ophthalmic diseaseis not currently under development.  Thistable is qualified in its entirety by reference to such detaileddescriptions.  There can be no assurancethat any future products will be developed successfully or approved in a timelymanner, if at all, or even if developed or approved, be successfullymanufactured or marketed.  In addition,the status of development indicated below does not necessarily indicate theorder in which the products shown may be submitted to or approved by the Foodand Drug Administration (“FDA”).

 
| **Application**           | ** ** | **Therapeutic Agent**            | ** ** | **Product Status**               |
|---------------------------|------------|----------------------------------|------------|----------------------------------|
| Acute local  inflammation |       | None specified                   |       | Currently  marketed (1)          |
| Dermal anesthesia         |       | Iontocaine                       |       | Currently  marketed              |
| Ophthalmic  diseases      |       | None specified                   |       | Pre-clinical (2)                 |
| General                   |       | Water soluble  ionic medicaments |       | Currently  marketed (1) (3) |

 

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(1)          Currently marketed under510(k) clearance for use with “ions of soluble salts or other drugs.”

(2)          All major development activity related to this programhas been suspended.  The Companycontinues to file, prosecute, maintain, and defend its intellectual propertyposition in this area and to conduct business development activities.  Any significant development efforts towardthe clinical evaluation and commercial development of this technologyapplication will likely only occur with the substantial support of acollaborative partner.

(3)          The Company is continuing to pursue additionalresearch & development opportunities for its technology that may leadto new products or therapeutic applications of its existing products.

 

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***Acute Local Inflammation***

 

 

Acute local inflammatory conditions resulting from exercise, sportsinjuries, trauma or repetitive motion disorders are among the leading types ofinjuries occurring in the workplace and among physically active adults.  The most common of these injuries includetendonitis, bursitis, carpal tunnel syndrome and epicondylitis (tennis elbow).  The Company believes the electro-transport ofcorticosteroids may provide significant advantages over other current treatmentregimens for acute local inflammation.

 

 

*Commercial Products*.  The Company pioneered the commercialintroduction of its active transdermal drug delivery systems in 1979.  These products are used principally byphysical therapists (under a doctor’s prescription) and have been clinicallyadministered in over 26 million patient treatments for the delivery ofcorticosteroids and other drugs.  Morethan 24 million of these treatments have occurred since 1990, when advancementsin patch technology made by the Company led to the introduction of its presentrange of hydrogel patches for use with its microprocessor controlled dosecontrollers.  The Company’s products arealso used by athletic trainers and physical therapists serving a number ofprofessional, collegiate, and Olympic athletes and teams, including golfers,tennis players, men’s and women’s Olympic ski teams, as well as by football,basketball, baseball and hockey teams.  TheCompany believes that its active transdermal drug delivery systems have beenaccepted in the rehabilitation marketplace due to their ease of use,non-invasiveness, recognized efficacy and lack of significant side effects.

 

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*Products Under Development*.  The Company continues to seek to develop andmarket “next generation” products for use in treating acute local inflammatoryconditions.  Enhancements to its dosecontrollers and electrode patches, as well as the developing, manufacturing,and marketing of new products are part of the Company’s efforts to providecustomers the most advanced iontophoresis technology commercially available.

 

 

IontoDexä is a miniaturized,integrated version of the Company’s active drug transport system designed forpatient in-home use to treat acute local inflammation.  This proprietary active drug transportsystem, combined with dexamethasone, has the potential to address a significantunmet medical need by offering patients the benefits of the anti-inflammatoryeffects of dexamethasone while avoiding all of the gastrointestinal (GI) andother systemic side effects of oral drugs, such as non-steroidalanti-inflammatory drugs (NSAIDs), including Cox-II inhibitors.

 

During fiscal 2001, the Company completed both a pivotal Phase III anda confirmatory Phase III clinical study for the delivery of dexamethasone totreat acute local inflammation.  Theconfirmatory study failed to meet primary clinical endpoints.  The study showed a positive response inpatients treated with the drug; however, increased benefit in the study’splacebo group prevented the statistical separation between the two patientgroups necessary to achieve the desired conclusions.  Due to these study results and to financialand other resource constraints, the Company suspended all major internaldevelopment efforts and may seek corporate development partners or otherstrategic funding sources prior to any substantial continuation of thisdevelopment program.

 

***Dermal Anesthesia***

 

Healthcare professionals recognize the importance of managing painassociated with invasive medical procedures, such as needle injections,placement of access devices (including phlebotomies, IV catheters, lumbarpunctures, epidurals, etc), dermatological procedures (biopsies, wart and moleremoval, Mohs procedures, etc), as well as gynecological and urologicalprocedures (vasectomies, etc).  In 2001,two new standards were instituted that are relevant to our productofferings.  The Occupational Safety andHealth Administration (OSHA) revised their Bloodborne Pathogen Standard,requiring employers to use safer medical devices wherever feasible in order toreduce the risk of injury from sharps. The Joint Commission on Accredited Healthcare Organizations (JCAHO) alsopassed their new Pain Management Standards requiring healthcare professionalsto inform patients of methods available to minimize pain prior to, during, andafter medical procedures.  These two newstandards favor the type of non-invasive drug delivery systems that the Companyoffers and certain product modifications under consideration could enhance theuse of the Company’s products in the dermal anesthesia market.  The Company is continuing to pursue marketingand other opportunities arising from these standards.

 

*Commercial Products*.  The Company’s Iontocaine is approved by theFDA under a New Drug Application (“NDA”) and is specifically labeled for usewith the Company’s Phoresor system and its proprietary, single use, disposableactive transdermal patch kits.

 

The Company currently sells its dermal anesthesia product into thepediatric, adult vascular access, and dermatology markets under the brand nameNumby Stuff.  Numby Stuff is used toinduce dermal anesthesia prior to invasive procedures and the Company believesit is more effective than the leading topical product.  However, to date, Numby Stuff has notgenerated significant revenues.

 

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***Ophthalmic Diseases***

 

 

The Company believes thatits unique active drug transport system presents a significant opportunity inthe ophthalmic pharmaceutical marketplace due to large patient populations withsight threatening medical needs that are unmet. Age-related macular degeneration (“AMD”) and diabetic retinopathy (“DR”)are the major causes of visual impairment in the United States and Europe. BothAMD and DR are conditions caused by angiogenesis (unwanted blood vessel growth)resulting in neovascularization that damages the retina and ultimately causesblindness.  Posterior uveitis andretinitis secondary to glaucoma also contribute considerably to loss of sightworldwide.  A common characteristic amongall of these conditions is their occurrence at the back of the eye, where drugtreatment is difficult to administer. The Company believes that its proprietary drug delivery technology mayoffer a significant improvement to the current treatments available and forunmet medical needs in this area.

 

 

A leading obstacle in the advancement of new therapies to treat seriousophthalmic disease is the inability to both safely and effectively deliverdrugs to diseased cells in the back of the eye. Current drug delivery methods, which include intravenous, oral, topical(eye drops), intraocular injections and surgical implants, all have limitationsthat potentially affect their technical as well as their commercial viabilityin the treatment of these diseases.  Furthermore, the complex physiology of thehuman eye presents unique problems for drug delivery, which are not optimallyaddressed by current ocular drug delivery methods.

 

 

*Development Stage Products. *Using itsproprietary technology, the Company has developed an ocular drug deliverysystem that seeks to address the safe and effective administration oftherapeutics to the back of the eye. The Company’s delivery system, trademarkedOcuPhorä, allows for the site-specific administration ofa pharmacologic agent without the collateral tissue damage associated withsurgery, lasers, needle injections or implants. OcuPhor has been designed as a platform technology to deliver drugcompounds non-invasively and site-specifically to posterior segments of theeye.  Through both collaborations andinternal research efforts, the Company has made significant advancements withthe OcuPhor System.  Feasibility studiesconfirmed OcuPhor’s ability to deliver an anti-angiogenic drug to the back ofthe eye. Preliminary clinical studies in human volunteers have shown that theOcuPhor System is safe and well tolerated using both positive and negativepolarity currents and does not produce any ophthalmic changes as measured by aseries of standard tests.  Additionally,the Company has demonstrated *in-vivo*thatthe OcuPhor System is capable of delivering antiangiogenic, anti-inflammatory,antibiotic, and antiviral drugs.  TheCompany believes that OcuPhor’s transport capabilities are within thetheoretical therapeutic range of a variety of drugs, including small moleculesas well as some macromolecules and small proteins.  The Company is evaluating strategies tocapitalize on this technology, including license agreements and collaborativepartnerships to identify specific drugs which will be able to take advantage ofthe OcuPhor System and thereafter move it beyond the preclinical stage andadvance its commercial development.

 

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**General Iontophoretic Drug DeliveryTechnology and Its Advantages**

 

Iontophoretic drug delivery systems are designed to overcome many ofthe limitations associated with other drug delivery methods.  Iontophoresis is an active method of drugdelivery in which water-soluble, ionized (electrically charged) drugs aretransported through the skin or other body tissues for local or systemictherapeutic applications by applying a low-level electrical current.  The amount of drug delivered is proportionalto the total electrical charge applied (which is a function of time andcurrent).  Therefore, it is possible toprogram the system’s electrical current levels to control more precisely thedesired drug dose, delivery rate and the pattern of delivery.

 

 

Among the many drug delivery methods available today, the Companybelieves the advantages of iontophoretic drug delivery are many and include thefollowing:

 

•                  Non-invasive,needle-free

•                  Site-specificdrug delivery eliminates systemic side effects

•                  Rapidonset and cessation kinetics

•                  Controlled,programmable and titratable drug delivery capabilities

•                  Singledelivery system provides smooth, variable or bolus plasma levels, singly or incombination

•                  Enhanceddelivery of a broad range of compounds

•                  Minimalvariability in the delivery profiles among patients and body sites

•                  Potentialfor enhanced patient compliance and control

•                  MeetsOSHA pain management standards for healthcare industry

•                  Compliancewith Needle Stick Prevention Act of 2001.

 

Although the fundamentals of iontophoresis have been understood fordecades, the method only became commercially practicable as a means ofdelivering drugs as a result of advances in electronics, materials science andelectrochemistry.  These advances led tothe development of more efficient and adaptable drug patches and more reliable,compact and programmable dose controllers. The Company has an expansive portfolio of intellectual property withwhich it has developed iontophoretic systems that have unique and enhancedperformance characteristics, which the Company believes are adaptable to anumber of clinical settings and therapeutic applications.

 

**Patents and Proprietary Rights**

 

The Company’s proprietary technology includes patents, trademarks,trade secrets and other proprietary know-how. These technologies are used in various combinations in the testing,evaluation and formulation of optimal ionic drug solutions and in the research,development, design and manufacture of microprocessor controlled power suppliesand active transdermal patches which are specifically designed and constructedfor particular therapeutic applications.

 

The Company has implemented a policy of actively patenting andmaintaining as trade secrets and proprietary information all inventions andtechnologies that it believes are important to its business operations.  The Company generally seeks patent protectionfor its key proprietary technologies in the United States and other majormarkets.  The Company also relies ontrade secrets, know-how, continuous

 

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technological innovations and licensing opportunities to develop andmaintain its competitive position.  TheCompany seeks protection of its trade secrets and proprietary know-how, inpart, through confidentiality agreements. Employees, consultants, advisors, collaborators, and other individualsand entities are required to execute confidentiality agreements upon the startof employment or other contractual relationships.

 

In 1997, theCompany acquired exclusive worldwide rights to Elan Corporation, plc’s (“Elan”)broad base of United States and foreign patents, in vitro drug transport dataand in vivo animal and human clinical data, in addition to other proprietaryknow-how in iontophoretic drug delivery and electro-transport fields.

 

As of June 30, 2005, the Company held or had rights to utilizeapproximately 75 United States patents and 78 foreign patents and has (or hasthe rights to utilize) 4 pending patent applications in the United States and29 pending patent applications in foreign countries.  The Company also owns or has licensed rightsto issued and pending United States patents governing the design andmanufacture of certain myoelectric prosthetic devices which it has sublicensedto a third party in connection with the sale of the Company’s Motion Controldivision in December 1996.

 

**Collaborative Relationships and Licenses**

 

The Company may enter into new collaborative relationships.  The potential collaborative partners mayprovide proprietary drugs, technology, financial resources, research andpharmaceutical manufacturing capabilities or marketing infrastructure to aid inthe development and commercialization of the Company’s current and futureproducts.  Depending on the availabilityof financial, marketing and scientific resources and other factors, the Companymay also license or cross-license its technology or products to others andretain profit sharing, royalty, manufacturing, co-marketing, co-promotion orsimilar rights.  Any such arrangementscould limit the Company’s flexibility in pursuing alternatives for thedevelopment or commercialization of its products.

 

The Company’s license arrangements and prior collaborativerelationships include the following:

 

*Elan*.  In March 1997, the Company acquiredexclusive world-wide licenses to certain iontophoretic drug deliverytechnologies, including rights to Elan’s broad base of United States andforeign patents, in vitro drug transport data and in vivo animal and humanclinical data, in addition to other proprietary know-how in iontophoretic drugdelivery and electro-transport fields. Under the terms of the license, the Company is obligated to pay Elan aroyalty on net revenues, as defined in the agreement.

 

*Alza*.  In 1993, the Company entered into across-license agreement with Alza Corporation (“Alza”).  Under the agreement, non-exclusive, royaltyfree rights to certain patented technologies were exchanged.

 

*University of Utah*.  In 1974, the Company entered into a licensingagreement with the University of Utah Research Foundation (“University”).  Under the agreement, as amended, the Companyobtained an exclusive license to certain iontophoretic drug deliverytechnologies developed at the University. Under the terms of the amended license, the Company is obligated to paythe University a royalty on certain sales of its iontophoretic drug deliveryproducts through the year 2007.

 

**Manufacturing**

 

All of the Company’s products are inspected, labeled and prepared forshipment at its manufacturing facility in Salt Lake City, Utah.  At this facility, the Company alsomanufactures the patch kits and other electrode products using several proprietarymaterials, components, processes and production technologies developed by theCompany in conjunction with its equipment and materials suppliers.  The Company has manufactured all of the drugelectrode patches it has sold, and believes its electrode manufacturingcapacity can be expanded to meet its needs for the foreseeable future.

 

The Company outsources the manufacture and assembly of its Phoresordose controllers, which employ a variety of sub-assemblies and components thatare designed or specified by the Company. These components and subassemblies are manufactured by third parties,and are then shipped to a contract manufacturer for final assembly.  The Company’s manufacturing activities forthe Phoresor are limited to design, labeling, inspection and packaging.  The Company does not manufacture or repackageany drugs or compounds used in its delivery systems.

 

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The Company and certain of its suppliers are required to comply withFDA regulations governing manufacturing practices, including the Quality SystemRegulations, which mandate controls for product design, control andquality.  The Company believes it is incompliance with current Quality System Regulations.  The Company is also certified to Europeanquality systems regulation ISO13485, which is similar to ISO 9001 and includesadditional elements specifically for medical device manufacturers.  Additionally, the Company has earned theright, through continued compliance to European regulations, to place the CEmark on its products, allowing it to market them in the Europeancommunity.  The Company has GoodManufacturing Practices (“GMP”) audits conducted on a regular basis.

 

**Sales and Distribution**

 

The Company’s marketing strategy is to position its products in themarketplace as the preferred means of administering a wide range of drugs.  The Company currently employs the use ofmultiple sales and distribution channels, including (i) a network ofmedical supply dealers; (ii) independent sales representatives; and (iii) nationaldistribution partners.  The Company usesthese distribution channels to maximize its sales and marketing resources.

 

The Company currently sells the majority of its products into thephysical and occupational therapy, sports medicine and other healthcaremarkets.  The Company employs anationwide network of distributors and independent sales representatives tosell and distribute its products in those markets.  This distribution network is supported byregional business managers and internal customer service representatives whoare employees of the Company.  Inaddition to the Company’s domestic sales and distribution efforts for its localinflammation products in the United States, it maintains marketing and salesactivities in international markets. These sales are made through independent distributors operating in thosecountries.

 

During the fourth quarter of fiscal 2004, the Company restructured itsindependent distribution network to achieve long-term growth objectives.  This restructuring resulted in termination ofsome dealer relationships and reallocation of territories.  Although the restructuring negativelyimpacted fiscal 2005 product sales and average selling prices, the Companybelieves that the breadth of its product line, distributor pricing incentives,and the reduced interference among distributors that resulted from therestructuring will support the development of stronger business relationshipswith its long-term strategic distribution partners.

 

Two distributorscombined to account for approximately 40%, 32% and 25% of the Company’s totalproduct sales for the fiscal years ended June 30, 2005, 2004 and2003.  Although valued distributionchannels, in the event of a loss of either distributor, the Company believesthat it could continue to reach a substantial portion of its end user customersthrough alternative distribution channels. Less than 10% of product sales are to foreign customers.

 

**Government Regulation**

 

Both drugs and medical devices, including the Company’s iontophoreticdrug delivery systems, are subject to extensive regulation by the FDA in theUnited States and by comparable authorities in other foreign countries.

 

The Company’s iontophoretic drug delivery products involve a medicaldevice component, thereby subjecting such products to compliance with the FDA’sregulations governing medical devices. Where such medical devices are labeled for use with a specificpharmaceutical product for a specific therapeutic indication, they are subjectto the FDA’s regulations governing both medical devices and pharmaceuticalproducts.  The Company’s futureiontophoretic drug delivery systems may involve a pharmaceutical component orspecific labeling for use with a pharmaceutical product.

 

Products regulated as medical devices may not be commerciallydistributed in the United States unless they have been cleared or approved bythe FDA.  Currently, there are twomethods for obtaining FDA clearance or approval of medical devices.  Devices deemed to pose less risk are placedin class I (general controls) or class II (general and special controls) andqualify for 510(k) notification, a procedure under section 510(k) of theFederal Food, Drug, and Cosmetic Act.  Amedical device that does not qualify for the 510(k) clearance is placed inclass III, which is reserved for devices deemed by the FDA to pose the greatestrisk. A preamendment class III device is one that was on the market before May 28,1976.  This status means that

 

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the device at present can be marketed through a 510(k) clearance, butit remains subject to a call for a Pre-Market Approval (“PMA”) applicationunder section 515 of the Drug Act. A PMA application generally requires a more complex submission than a510(k) notification.  Typically, itrequires showing that the device is safe and effective based on extensive andcostly preclinical and clinical tests, as well as information about the deviceand its components regarding, among other things, manufacturing, labeling andpromotion.

 

The regulatory status of iontophoretic devices is complex.  The FDA has classified them as class IIdevices eligible for marketing through 510(k) premarket clearance when intendedfor use with a drug whose labeling bears adequate directions for the device’suse with that drug.  However, if aniontophoretic device is intended for use with a drug that is not labeled foruse with the device, the FDA considers the iontophoresis device to be apreamendment class III device.

 

The Company’s Phoresor received 510(k) clearance as a preamendmentclass III device labeled for use with ions of soluble salts or otherdrugs.  In 1995, the FDA approved an NDAfor Iontocaine to be used as a local anesthetic and delivered iontophoreticallyby the Phoresor, which effectively moved the Phoresor into class II for thisintended use.  Unlike Iontocaine,dexamethasone does not have an NDA approval allowing it to be labeled foriontophoretic delivery.  Thus, at thepresent time, the Company’s Phoresor is a preamendment class III device whenused with dexamethasone (or any drug other than Iontocaine).  The Company is not currently seeking, andgives no assurance that it will ever obtain, an approved NDA for theiontophoretic delivery of any drug other than Iontocaine.

 

In August 2000, the FDA published a proposed rule to amendthe physical medical device regulations to remove the class III iontophoresisdevice identification.  Because theCompany’s products are all approved as class II devices, the Company does notbelieve that the proposed regulation would have any effect on the Company’sability to continue the manufacturing and selling of its current products.

 

A lengthy and complex regulatory framework also applies to the labelingand marketing of specific drugs. Generally these pharmaceutical products require the submission of anNDA.  The NDA approval process generallyentails: (i) conducting preclinical laboratory and animal testing toenable FDA authorization of an Investigational New Drug (“IND”) application, (ii) initialIND clinical studies to define safety and dose parameters, (iii) wellcontrolled IND clinical trials to demonstrate product safety and efficacy, and (iv) submissionto the FDA of an NDA.  Preclinicalstudies involve laboratory evaluation of product characteristics and animalstudies to assess the efficacy and safety of the drug.  Human clinical trials are typically conductedin three sequential phases.  Phase Itrials normally consist of testing the product in a small number of healthyvolunteers for safety and pharmacokinetic parameters using single and multipledosing regimens.  In Phase II trials, themanufacturer evaluates safety, initial efficacy, and dose ranging of theproduct for specific indications in a somewhat larger patient population.  Phase III trials typically involve expandedtesting for safety and clinical efficacy in a broad patient population atmultiple clinical testing centers.  TheFDA, under Good Laboratory Practice regulations, regulates the preclinical andclinical studies.  Results of the studiesmust be submitted to the FDA for review. The FDA may grant marketing approval, require additional testing and/orinformation, or deny the application. The process of obtaining FDA approval for a new product through thisprocess may take several years and typically involves substantial risks and theexpenditure of substantial resources.

 

The FDA regulates the Company’s quality control and manufacturingprocedures by requiring it and certain of its contract suppliers to comply withcertain standards, including compliance with the Quality System Regulations(for devices) and current GMP regulations (for drugs).

 

The Company may be subject to certain fees that the FDA is authorizedto collect, including user fees authorized under the Public Health Security andBioterrorism Preparedness and Response Act of 2002, which includes thereauthorization of user fees under the Prescription Drug User Fee Amendments of2002 (PDUFA III).

 

Agencies similar to the FDA regulate medical devices and pharmaceuticalproducts in most foreign countries. The International Standards Organization(ISO) has established regulations for medical devices in the European Union.Currently, the Company is in compliance with these regulations and its productsare CE Marked. The Company will be required to meet the regulations of anyforeign country where it markets its products. In addition, various aspects ofthe Company’s business and operations are also regulated by a

 

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number of other governmental agencies including the Drug EnforcementAgency, U.S. Department of Agriculture, the Environmental Protection Agency,the Occupational Safety and Health Administration as well as by other federal,state and local authorities.

 

Noncompliance with these various government regulatory requirementscould result in enforcement actions that could include fines, plant closure, arecall of the Company’s products or other civil or criminal sanctions.Noncompliance as well as unanticipated changes in existing regulatoryrequirements or adoption of new requirements could have a material adverseeffect on the Company.

 

**Competition**

 

The drug delivery, pharmaceutical and biotechnology industries arehighly competitive and rapidly evolving, with significant developments expectedto continue at a rapid pace.  The Company’ssuccess depends upon maintaining a competitive position and developing productsand technologies for efficient and cost effective drug delivery.  The Company’s products compete with otherdrugs and drug delivery systems, including other iontophoretic deliverysystems.  The Company believes itsproducts compete on the basis of quality, efficacy, cost, convenience, safety andpatient compliance.

 

The Company is aware of many other competitors in the general field ofdrug delivery, including, among others, competitors developing injectable orimplantable drug delivery systems, oral drug delivery technologies, passivetransdermal systems, oral transmucosal systems and intranasal and inhalationsystems.  The Company is also aware ofother companies that have developed or are currently developing iontophoreticand other active transdermal drug delivery systems.

 

Alza, Transport Pharmaceuticals, Inc. (“Transport”) , Vyteris, Inc.,and Empi, Inc. are the principal competitors engaged in the developmentand/or marketing of iontophoretic devices. Alza, a licensee of the Company, and Transport, are undertaking thedevelopment of iontophoretic drug delivery systems, but do not currently marketan iontophoretic product.  Vyteris isengaged in the development of iontophoretic drug delivery systems and currentlysells an iontophoretic product for the inducement of dermal anesthesia.  Empi is the Company’s primary competitor inthe sale of iontophoretic drug delivery systems for the treatment of acutelocal inflammation in the physical therapy market and, the Company estimates,controls a majority of that market.

 

The Company’s iontophoretic system for delivering Iontocaine for theinducement of dermal anesthesia primarily competes with traditional methods ofdelivering dermal anesthetics by needle injection or is used in circumstanceswhere either no anesthesia is used, due to the pain associated with needleinjection (including needle injections themselves), or where topical anestheticcreams are used.  The most effective andwidely used topical anesthetic cream, EMLA, is manufactured and sold byAstraZeneca International, a large international pharmaceutical company.  There can be no assurance that the Companycan effectively compete with these products or any other drug delivery system.

 

**Employees**

 

As of June 30, 2005, the Company has 50 full-time employees, 8 ofwhom hold either an advanced business or technical degree.  Of the Company’s full-time employees on thatdate,, 6 were engaged in engineering and product development, 26 inmanufacturing and quality control, and 18 in sales, marketing and generaladministration.  None of the Company’semployees is represented by a labor union. The Company has not experienced any employee related work stoppages andconsiders its relations with employees to be good.

 

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**Item 2.****           PROPERTIES**

 

The Company’s administrative, manufacturing operations, and researchoffice space is housed in a single facility, consisting of approximately 34,000square feet, located at 2441 South 3850 West in Salt Lake City, Utah.  The facility is leased to the Company until December 31,2012.  The Company believes itsfacilities will be adequate and suitable for its present needs and thatadditional space will be available as needed.

 

**Item 3.****           LEGALPROCEEDINGS**

 

The following discussion provides a summary of certain outstanding andsettled legal matters.  In addition tothe specific legal matters discussed below, the Company is subject to variousclaims and legal proceedings covering matters that arise in the ordinary courseof business.

 

**(a) Outstanding Legal Matters**

 

***Birch Point Medical, Inc.v IOMED, Inc.***, U.S. District Court for thedistrict of Minnesota.  This claim wasfiled on May 11, 2004.  Thecomplaint involves a patent infringement claim asserted against the Company byBirch Point Medical, Inc., a Minnesota corporation, related to the Company’srecently released Companion 80 product, which is an iontophoretic drug deliverysystem.  The patent-in-suit is U.S.Patent No. 6,653,014, which Birch Point Medical acquired byassignment.  Birch Point Medical has notasserted that any of the Company’s other products infringe thepatent-in-suit.  The Company has deniedinfringement, and has asserted a counterclaim for a declaratory judgment ofnoninfringement and/or that the patent is invalid.  The parties have filed cross motions forsummary judgment on the issue of infringement, which have not been ruledupon.  At this stage it is too early topredict the outcome.  The Company intendsto vigorously defend this lawsuit and prosecute its counterclaims.

 

***EEMSO, Inc. v. Compex Technologies, Inc.f/k/a Rehabilicare, Inc. (“Compex”) and Iomed, Inc.*,**U.S. District Court for the Northern District of Texas*.*  This action was initially filed on April 6,2005 by a competitor of Iomed in the District Court of Dallas County, Texas,192nd Judicial District and was removed by Iomed and co-defendantCompex Technologies to the U.S. District for the Northern District of Texas,Dallas Division.  The complaint allegesthat Compex, a distributor of Iomed’s iontophoretic drug delivery products,wrongfully and in violation of a non-disclosure agreement with EEMSO, providedconfidential proprietary information to Iomed pertaining to an integratedelectrode iontophoretic device that had been developed by EEMSO.  The complaint further alleges that Iomed misappropriatedthis information and incorporated features of the EEMSO product in its ownintegrated electrode product (the Companion80), and that Iomed is liable forinterference with contract, unfair competition, conversion and civilconspiracy.  EEMSO seeks injunctiverelief and monetary damages.  The case isin the discovery phase and it is too early to predict the outcome.   Based on its own initial analysis of thecomplaint Iomed believes that there is no basis for EEMSO’s claims against theCompany and intends to vigorously defend against these claims.

 

Management does not believe that the outcomes of the legal mattersdiscussed in this section above will have a material adverse impact on theCompany.  However, the legal fees andexpenses in these actions will likely be material and, in the event of anunfavorable resolution, the outcome could have a material adverse impact on theCompany’s business, financial position, or results of operations.

 

**(b) Settled Legal Matters**

 

Effective on August 31, 2005 the parties to the followingproceedings, **IOMED, Inc. v. JamalYanaki, et. al, Yanaki  v. IOMED, Inc. et al, Moss v. IOMED, Inc.,et al** and **Yanaki v IOMED, Inc.,et al,** entered into a settlement pursuant to which the Company’sinvolvement in each of these matters was resolved.  In connection with thatagreement, the Company made a net payment of $137,500 and received a royaltyfree non-exclusive license to use certain intellectual property owned by adefendant.  The Company also entered into mutual releases of claims witheach of the parties to the litigation.

 

***IOMED, Inc. v.Jamal Yanaki, et al.,***Third District Court ofUtah, Salt Lake County.  IOMED filed theComplaint in this action on April 2, 2002. As amended on December 2, 2002 (the “Amended Complaint”), IOMEDnamed as defendants Jamal Yanaki, ActivaTek, LLC, Ceramatec, Inc., AshokJoshi, James Weersing, Shunt Power Technology, LLC, and Empi, Inc.  On February 27, 2003, IOMED filed anadditional complaint against JRW Technology, Inc. in the Third DistrictCourt of Utah, Salt Lake County

 

14

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asserting claims arising out of the same factual allegations.  Mr. Yanaki is a former IOMED executiveofficer.  ActivaTek, LLC is a companyformed by Mr. Yanaki and Ceramatec following his resignation from IOMED.  Ceramatec is an engineering consultingfirm.  Mr. Joshi is the principalowner of Ceramatec.  Mr. Weersing isthe former chief executive officer and chairman of IOMED.  Shunt Power Technology and JRW Technology arecompanies formed by Mr. Weersing. Empi is IOMED’s principal competitor in the iontophoreticmarketplace.  In addition, Mr. Weersingwas a managing director of MBW Venture Partners, LP, which beneficially ownedmore than five percent of IOMED’s common stock at the time the litigationcommenced.

 

The claims arose out of IOMED’s allegations that the defendants engagedin conduct to misappropriate IOMED’s confidential information related to a newproduct that was being developed by IOMED under the supervision of Messrs. Weersingand Yanaki.  In the Amended Complaint,IOMED alleged that all defendants misappropriated trade secrets, tortiouslyinterfered with IOMED’s economic relationships and engaged in a civilconspiracy. IOMED further alleges that Messrs. Weersing and Yanaki engagedin fraud and tortiously interfered with IOMED’s contractual relationships,breached fiduciary duties and duties of loyalty and, that Mr. Yanakibreached his contract with IOMED and an implied covenant of good faith and fairdealing.  IOMED sought injunctive reliefagainst all defendants.

 

In response, a Counterclaim was filed with respect to the AmendedComplaint on January 10, 2003 against IOMED and certain IOMED employees,including Mr. Robert J. Lollini, President and Chief ExecutiveOfficer.  The counterclaim alleged, amongother things, defamation and sought, among other things, $5 million in monetarydamages.

 

***Yanaki v. IOMED, Inc.,et al*** and ***Moss v. IOMED, Inc., et al****,* U.S. District Court for the District ofUtah.  On April 14, 2003, Mr. Yanakiand Ms. Susan I. Moss filed separate Complaints against IOMED and certainIOMED employees and agents, alleging violation of civil rights, invasion ofprivacy, intentional infliction of emotional distress, trespassing, andconspiracy. These actions, which were subsequently consolidated into a singleaction, are related to the state court action involving Jamal Yanaki, et al.discussed above in that they arose out of the seizure of Mr. Yanaki’scomputer hard drives, other electronic media, and certain business files,pursuant to an order by the Third Judicial District Court for the State ofUtah.  The court-ordered seizure wasconducted by the Salt Lake County Sheriff’s Office.  Mr. Yanaki and Ms. Moss wereseeking, among other things, combined monetary damages of $60 million.  On January 27, 2004, the court granted,with prejudice, the Company’s motion to dismiss these claims.  The Tenth Circuit Court of Appeals affirmedthe District Court’s dismissal.

 

***Yanaki v IOMED, Inc.,et al***, Third District Court of Utah, Salt LakeCounty.  Mr. Yanaki filed theComplaint against IOMED and certain IOMED employees on June 24, 2003.  The complaint alleged, among other things,unlawful employment practices, discrimination and breach of contract by theCompany and certain of its employees. This Complaint is related to the state court action involving JamalYanaki, et al. discussed above in that the claims asserted arose from the sameseries of transactions and occurrences.  Mr. Yanakiwas seeking compensatory and punitive damages, declaratory relief, andattorneys’ fees.  On February 10,2004, the Court granted the Company’s motion to dismiss this claim.  The plaintiff indicated an intent to askleave of the Court to file claims as a Counterclaim in the trade secretlitigation described above.  In addition,the Utah State Court of Appeals upheld the Utah State District Court rulingwhich granted the Company’s motion to dismiss this claim.

 

**Item 4.****           SUBMISSION OF MATTERSTO A VOTE OF SECURITY HOLDERS**

 

No matters were submitted to a vote of security holders during thefourth quarter of the fiscal year covered by this Report.

 

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**PART II**

 

**Item 5.****           MARKETFOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

 

### **Market Information**

 

The Company’s common stock is traded on the American Stock Exchange(the “AMEX”), under the symbol “IOX”. The following table sets forth, for the periods indicated, the high andlow sales prices as reported by the AMEX. These prices represent quotations between dealers and do not includeretail mark-up, markdown or commission, and do not necessarily represent actualtransactions.

 
| ** **     | ** ** | **Fiscal 2005** | ** ** | **Fiscal 2004** | ** ** |
|----------------|------------|-----------------|------------|-----------------|------------|
| ** **     | ** ** | **High**        | ** ** | **Low**         | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $               | 2.95       |            | $          | 1.36 |   | $ | 2.94 |   | $ | 1.00 |   |
| Second Quarter |       | $               | 2.72       |            | $          | 1.60 |   | $ | 2.58 |   | $ | 1.86 |   |
| Third Quarter  |       | $               | 2.78       |            | $          | 1.70 |   | $ | 3.50 |   | $ | 1.90 |   |
| Fourth Quarter |       | $               | 2.38       |            | $          | 1.85 |   | $ | 3.74 |   | $ | 2.40 |   |

 

### **Security Holders**

 

As of June 30, 2005, there were 121 shareholders of record of theCompany’s common stock.

 

### **Dividends**

 

The Company has not paid dividends to date and does not anticipate orcontemplate paying cash dividends in the foreseeable future.  It is the present intention of management toutilize all available funds for the development and growth of the Company’sbusiness.

 

**Equity CompensationPlan Information**

 

The following table shows information about the securities authorizedfor issuance under the Company’s equity compensation plans as of June 30,2005:

 
| **Plan Category**                                           | ** ** | **(a)  Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights** | ** ** | **(b)  Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **(c)  Number of securities  remaining available for future  issuance under equity  compensation plans  (excluding securities reflected  in column (a))** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders     |       | 1,323,391                                                                                               |       | $                                                                                       | 2.50       |                                                                                                                                                      | 1,498,123  |   |
|                                                        |       |                                                                                                    |       |                                                                                    |       |                                                                                                                                                      |       |
| Equity  compensation plans not approved by security holders |       | —                                                                                                  |       | —                                                                                  |       | —                                                                                                                                                    |       |
|                                                        |       |                                                                                                    |       |                                                                                    |       |                                                                                                                                                      |       |
| Total                                                       |       | 1,323,391                                                                                               |       | $                                                                                       | 2.50       |                                                                                                                                                      | 1,498,123  |   |

 

### **Recent Sales of UnregisteredSecurities**

 

None.

 

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**Item 6.****           SELECTED FINANCIAL DATA**

 

The following selected income statement data for the years ended June 30,2005, 2004 and 2003, and the balance sheet data as of June 30, 2005 and 2004are derived from the audited financial statements included in this report andshould be read in conjunction with those financial statements and the notesthereto.  The selected income statementdata for the years ended June 30, 2002 and 2001, and the balance sheetdata as of June 30, 2003, 2002 and 2001 are derived from the auditedconsolidated financial statements of the Company, which are not included hereinand are qualified by reference to such financial statements and the notesthereto.  Certain reclassifications havebeen made to prior year balances to conform to the financial statementpresentation included herein.

 
| ** **                                              | ** ** | **Fiscal Year ended June 30,** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| **Income Statement Data:**                              |       |                                |       |   |   |   |   |   |   |   |   |
|                                                    |       |                                |       |   |   |   |   |   |   |   |   |
| Product sales, net                                      |       | $                                   | 11,426,000 |   | $ | 12,189,000 |   | $ | 11,935,000 |   | $ | 11,169,000 |   | $ | 11,142,000 |   |
| Cost of products sold                                   |       | 4,401,000                           |       | 4,607,000 |   | 4,376,000 |   | 4,165,000 |   | 3,807,000 |   |
| Gross profit                                            |       | 7,025,000                           |       | 7,582,000 |   | 7,559,000 |   | 7,004,000 |   | 7,335,000 |   |
|                                                    |       |                                |       |   |   |   |   |   |   |   |   |
| Operating costs and expenses:                           |       |                                |       |   |   |   |   |   |   |   |   |
| Selling,  general and administrative                    |       | 5,703,000                           |       | 5,593,000 |   | 5,711,000 |   | 5,585,000 |   | 8,042,000 |   |
| Research and  development                               |       | 993,000                             |       | 1,050,000 |   | 1,232,000 |   | 2,600,000 |   | 7,707,000 |   |
| Non-recurring  (income) expense                         |       | —                              |       | — |   | (76,000 | )(1) | 1,695,000 | (2)  | 353,000 | (3) |
| Total costs  and expenses                               |       | 6,696,000                           |       | 6,643,000 |   | 6,867,000 |   | 9,880,000 |   | 16,102,000 |   |
|                                                    |       |                                |       |   |   |   |   |   |   |   |   |
| Income (loss) from operations                           |       | 329,000                             |       | 939,000 |   | 692,000 |   | (2,876,000 | ) | (8,767,000 | ) |
|                                                    |       |                                |       |   |   |   |   |   |   |   |   |
| Interest expense                                        |       | (121,000                            | )          | (169,000 | ) | (213,000 | ) | (263,000 | ) | (78,000 | ) |
| Interest income & other, net (4)               |       | 217,000                             |       | 184,000 |   | 306,000 |   | 777,000 |   | 969,000 |   |
|                                                    |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (loss)                                       |       | $                                   | 425,000    |   | $ | 954,000 |   | $ | 785,000 |   | $ | (2,362,000 | ) | $ | (7,876,000 | ) |
|                                                    |       |                                |       |   |   |   |   |   |   |   |   |
| **Diluted Per Common Share Amounts:**                   |       |                                |       |   |   |   |   |   |   |   |   |
| Net income (loss)                                       |       | $                                   | 0.06       |   | $ | 0.12 |   | $ | 0.10 |   | $ | (0.36 | ) | $ | (1.20 | ) |
|                                                    |       |                                |       |   |   |   |   |   |   |   |   |
| Shares used  in computing diluted per share amounts (5) |       | 7,665,000                           |       | 7,708,000 |   | 7,497,000 |   | 6,545,000 |   | 6,541,000 |   |
|                                                    |       |                                |       |   |   |   |   |   |   |   |   |
| **Balance Sheet Data:**                                 |       |                                |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                               |       | $                                   | 8,293,000  |   | $ | 7,338,000 |   | $ | 5,921,000 |   | $ | 4,422,000 |   | $ | 6,436,000 |   |
| Restricted cash                                         |       | 585,000                             |       | 1,062,000 |   | 1,689,000 |   | 2,279,000 |   | 2,655,000 |   |
| Total assets                                            |       | 12,538,000                          |       | 12,511,000 |   | 12,491,000 |   | 12,079,000 |   | 16,896,000 |   |
| Long-term  obligations, including current portion       |       | 1,368,000                           |       | 1,971,000 |   | 2,569,000 |   | 3,125,000 |   | 3,700,000 |   |
| Accumulated deficit                                     |       | (31,732,000                         | )          | (32,157,000 | ) | (33,111,000 | ) | (33,896,000 | ) | (31,534,000 | ) |
| Shareholders’ equity                               |       | 9,868,000                           |       | 9,443,000 |   | 8,416,000 |   | 7,631,000 |   | 9,983,000 |   |

 

_________________________

(1)          Reflects the reversal of the remainingaccrual amount relating to the fiscal 2000 lease abandonment charge forfacilities relocation.

(2)          Reflects a $1,190,000 non-recurring,non-cash charge for the impairment of long-lived assets and a $505,000non-recurring restructuring charge.

(3)          Reflects a non-recurringrestructuring charge.

(4)          Includes income from contract research, royalties, andlicense fees.

(5)          See Notes to Consolidated Financial Statements forinformation concerning the computation of per share amounts.

 

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**Item 7.****           MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*The following discussion of the financialcondition and results of operations of the Company should be read inconjunction with the Consolidated Financial Statements and the related Notesthereto included elsewhere in this Report. The following Management’s Discussion and Analysis of FinancialCondition and Results of Operations contains forward-looking statements, withinthe meaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934, that involve risks anduncertainties.  The Company’s actualresults of operations could differ significantly from those anticipated in suchforward-looking statements as a result of numerous factors discussed under Item1 “Business” and elsewhere in this Report.*

 

**Overview**

 

The Company is a leader in the development, manufacture and sale ofactive drug delivery systems primarily used to treat local inflammation in thephysical and occupational therapy and sports medicine markets.  The Company’s current product line is basedon proprietary iontophoretic drug delivery technology.  The majority of the Company’s revenues havebeen generated through the sale of the Phoresor system, including the reusabledose controller and single use, disposable patch kits.  The Company is pursuing opportunities toadvance its position as a provider of quality, innovative medical products thatimprove patient healthcare.  In addition,the Company is seeking collaborative opportunities to develop its non-invasivedrug delivery technology to satisfy unmet medical needs.  The Company has proprietary iontophoresistechnology in various stages of research and product development primarily fortransdermal drug delivery and for the treatment of ophthalmic disease.  From its inception through fiscal 2002, theCompany had generally incurred operating losses as a result of costs associatedwith internally funded research and development activities.  During fiscal 2003, 2004 and 2005, theCompany reported net income.  As of June 30,2005, the Company’s accumulated deficit was approximately $31.7 million.  The Company’s ability to sustainprofitability will depend on its ability to achieve market acceptance andsuccessfully expand sales of its existing products and successfully completethe development of, receive regulatory approvals for, and successfullymanufacture and market its current and future products, and resolve pendinglitigation matters, as to which there can be no assurance.

 

**Recent Development**

 

On September 15, 2005, we announced that our Board of Directorshas decided to explore various strategic alternatives for the Company tomaximize shareholder value, including possible sale transactions involving theCompany or certain of its assets.  Inconnection with this process, the Company has retained Seven Hills Partners LLCto act as its financial advisor.  We areuncertain whether any transaction will result from this process and if atransaction does result from that process what form it will take and whatimpact it may have on our stock price.

 

**Fiscal Years Ended June 30, 2005 and2004**

 

*Product sales. *Product salesdecreased 6% to $11.4 million in fiscal 2005 from $12.2 million in fiscal2004.  Product sales in the currentperiod were impacted by a reduction in the Company’s average selling pricesdue, in part, to factors relating to the restructuring of the Company’sdistribution network.  In addition, theeffect of cost constraints in physical therapy clinics, including legislativechanges in certain workers’ compensation markets, is, among other factors,resulting in decreased reimbursement for physical therapy services, which mayhave an indirect impact on the utilization of the Company’s products.  Other market trends have resulted in anincreasing portion of the Company’s sales to large national suppliers who offera broader line of products and lower overall pricing.  These suppliers have greater access to theCompany’s volume discounts, which results in lower average selling pricesrealized by the Company.  Sales in thecurrent period were further impacted by a reduction in inventory levels carriedby certain of the Company’s dealers.  TheCompany believes the inventory reductions were due, in part, to therestructuring of its dealer network. Existing orders from dealers that reduced their inventory levels haveimproved, but have not returned to historical levels.  Sales in fiscal 2005 were favorably impactedby increased unit volumes of new products, which, to date, have exceeded theCompany’s estimates.

 

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*Costs of Products Sold. *Costs of productssold were $4.4 million in fiscal 2005 compared to $4.6 million in the prioryear.  Gross margins on product saleswere 61.5% in fiscal 2005 compared to 62.2% in the prior year.  The beneficial effects of the renegotiatedfacility lease, including decreased monthly rent and allocated depreciationexpense, mitigated the effects of lower total product sales and average sellingprices on gross margin.

 

*Selling, General and AdministrativeExpenses. *Selling,general and administrative expenses increased 2% to $5.7 million in fiscal 2005compared to $5.6 million in the prior year. The increase relates primarily to litigation expenses which off-set thereductions in on-going selling, general and administrative expenses achievedfrom operating efficiencies initiated over the last four years.  Although the recent resolution of certain ofthis litigation (See “Item 3. Legal Proceedings.”) will have a beneficial effect,litigation related expenses will continue to effect future general andadministrative expenses.  Expensesrelated to litigation, including the establishment of reserves with respectthereto, were $1.0 million and $0.4 million in fiscal 2005 and 2004, respectively.   The Company continues to look foropportunities to reduce expenses.  Thebeneficial effects of a re-negotiated facility lease also resulted inadditional expense reductions and cash flow contributions during fiscal 2005.

 

*Research and Product DevelopmentExpense. *Researchand product development expenditures decreased 5% to $1.0 million in fiscal2005 compared to $1.1 million for the prior year.  The decrease is primarily a result of thebeneficial effects of the renegotiated facility lease, including decreasedallocations of monthly rent and depreciation expense.  During fiscal 2006, the Company intends tofocus research and product development efforts on its core business and newmarket opportunities for its iontophoresis technology.

 

*Other Income and Expenses. * Interest expense decreased to $121,000 infiscal 2005 from $169,000 in the prior year due to a decreasing balance onlong-term obligations.  Interest incomeand other miscellaneous income was $217,000 in fiscal 2005 compared to $184,000in the prior year.  Amounts in bothperiods reflect interest earnings on invested cash balances and income from aroyalty and license agreement.  Theincrease was due to increased interest income from improved rates and a largerinvested cash balance offset, in part, by reduced royalty income from theroyalty and license agreement.  Under theterms of this agreement, the royalty rate decreased beginning during fiscal2004.

 

*Income Taxes. *During fiscal years 2005 and 2004, the Companyrecognized no income tax expense due to certain future tax benefits and thereversal of valuation allowance that had been previously recorded to offsetdeferred tax assets associated with the Company’s net operating losscarryforwards.  The Company hassubstantial net operating loss carryforwards, which, under the current “changeof ownership” rules of the Internal Revenue Code of 1986, as amended, maybecome subject to substantial annual limitation in the future.  Such “changes of ownership” can result frompurchases and sales of our shares by large shareholders.  If we experience a 50% change in theownership of our stock, then we may be limited in the amount of net operatingloss carryforwards that we can use in any given year.  Due to the uncertainty of the realizabilityof the Company’s net deferred tax assets, primarily associated with netoperating loss carryforwards, the Company has recorded a full valuationallowance to offset these deferred tax assets. The Company will continue to monitor the realizability of these assetsand could adjust the valuation allowance in the future.

 

*Net Income. *The Company recognized net income of $425,000,or $0.06 per diluted share, during fiscal 2005 compared with net income of$954,000, or $0.12 per diluted share, during the prior year. The fluctuationsare a result of the changes discussed above.

 

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**Fiscal Years Ended June 30, 2004 and2003**

 

*Revenues*.  The Company achieved record annual productsales of $12.2 million in fiscal 2004, a 2% increase from $11.9 million infiscal 2003.  Revenues from increasedunit volume were offset, in part, by dealer price incentives introduced duringthe fourth quarter of fiscal 2004 that were recorded as a reduction ofrevenues.  Sales from three productsintroduced by the Company in the last half of fiscal 2004 contributed to anincrease in unit volume demand.

 

*Costs of Products Sold*.  Costs of products sold increased 5% to $4.6million in fiscal 2004 from $4.4 million in fiscal 2003.  Gross margins on product sales were 62% and63% in fiscal 2004 and 2003, respectively. The decreased gross margin was due, in part, to price incentivesintroduced during the fourth quarter of fiscal 2004.

 

*Selling, General and Administrative Expenses*.  Selling, general and administrative expensesdecreased 2% to $5.6 million in fiscal 2004 compared to $5.7 million in2003.  This decrease relates primarily todecreased sales and marketing expenses, offset, in part, by an increase ingeneral and administrative expenses.

 

*Research and Product Development Expense*.  Research and product development expendituresdecreased 15% to $1,050,000 in fiscal 2004 from $1,232,000 in fiscal 2003,reflecting reduced consulting and other expenses associated with adetermination to focus development efforts on improvements to existing productsand completing development of new products for its core business.

 

*Non-recurring (income) expense.*  During fiscal 2003, the Company fulfilled itsobligations related to the non-recurring expense taken in fiscal 2000 forcertain non-cancelable abandoned lease and other obligations related to theCompany’s relocation to its new facilities. As a result, in fiscal 2003 the Company reversed the remaining amountthat was expensed as a non-recurring item in fiscal 2000 and realized aone-time benefit of $76,000.

 

*Other Income and Expenses*.  Interest expense decreased to $169,000 infiscal 2004 from $213,000 in fiscal 2003 due to a decreasing balance onlong-term obligations.  Interest incomeand other miscellaneous income was $184,000 in fiscal 2004 compared to $306,000in fiscal 2003.  Amounts in both periodsreflect interest earnings on invested cash balances and income from a royaltyand license agreement.  The decrease isprimarily due to reduced royalty income from the royalty and license agreement,which under the terms of the agreement, the royalty rate decreased duringfiscal 2004 and future periods.

 

*Income Taxes*.  No income tax expense was recognized for fiscal 2004 or 2003.

 

*Net Income*.  Net income of $954,000 in fiscal 2004 was a22% increase over the $785,000 net income reported in fiscal 2003.  The improvement in fiscal 2004 wasprincipally a result of reduced operating expenses.

 

**Liquidity and Capital Resources**

 

During fiscal 2005, 2004, and 2003, the Company’s operations, includingcosts associated with its research and development programs, were fundedlargely by cash flow from its commercial operating business.

 

As of June 30, 2005, the Company had cash and cash equivalentstotaling approximately $8.3 million. Additionally, the Company had approximately $0.6 million of long-termrestricted cash, invested in mutual funds and used to secure long-termfinancing.  Cash in excess of immediaterequirements is invested in a manner which is intended to maximize liquidityand return while minimizing investment risk, and, whenever possible, theCompany seeks to minimize the potential effects of concentration of creditrisk.

 

The Company generated $1.1 million, $1.4 million and $1.7 million incash from operating activities in fiscal 2005, 2004 and 2003,respectively.  The decrease in positiveoperating cash flow in fiscal 2005 was a result of decreased net income,primarily from lower product sales and increased litigation related expenses,and lower depreciation and amortization expenses offset, in part, by a netincrease in trade accounts payable and accrued expenses related to the timingof payments for litigation and other expenses.  In fiscal 2004, cash generated from operationswas offset, in part, from the payment of certain accrued and other liabilities.

 

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As of June 30, 2005, the Company had approximately $1.4 million,including the current portion, outstanding under financing agreements.  The Company does not anticipate a significantinvestment in capital equipment during the next 12 months.  The Company’s equipment and furnitureexpenditures were $61,000, $95,000, and $200,000 in fiscal 2005, 2004, and2003, respectively.

 

Other sources and uses of cash during the periods included thefollowing:  During fiscal 2005, theCompany used $603,000 for payments on long-term obligations and its restrictedcash requirements decreased $477,000. The reduction in cash restrictions resulted from payments made onlong-term obligations and more favorable terms negotiated with the lender.  During fiscal 2004, the Company used $598,000for payments on long-term obligations; received $73,000 in proceeds fromexercise of stock options; and its restricted cash requirements decreased$627,000.  During fiscal 2003, theCompany used $556,000 for payments on long-term obligations and its restrictedcash requirements decreased $590,000.

 

During fiscal 2006, costs associated with its commercial business,including research and development activities, will be funded internally fromthe Company’s established commercial business; term loan and capital leasefinancing agreements; and from existing cash balances.  The Company anticipates that at its currentoperating levels, existing cash balances and cash generated from operationswill be sufficient to fund its operating needs through fiscal 2007 andbeyond.  However, the Company may berequired to or elect to raise additional capital before that time.  The Company’s actual capital requirementswill depend on numerous factors, many of which are outside the Company’scontrol.

 

### **Disclosure About Contractual Obligations**

 

The following table represents the Company’s contractual obligations asof June 30, 2005:

 
| ** **                    | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------|------------|----------------------------|------------|
| **Contractual Obligation**    | ** ** | **Total**                  | ** ** | **Less Than  1 year** | ** ** | **1 – 3 years** | ** ** | **3 – 5 years** | ** ** | **Greater  than 5  years** | ** ** |
| Term loan obligations         |       | $                          | 1,377,000  |   | $ | 486,000 |   | $ | 891,000 |   | $ | — |   | $ | — |   |
| Capital Lease obligations     |       | 123,000                    |       | 123,000 |   | — |   | — |   | — |   |
| Operating Leases              |       | 2,127,000                  |       | 271,000 |   | 552,000 |   | 559,000 |   | 745,000 |   |
| Total Contractual Obligations |       | $                          | 3,627,000  |   | $ | 880,000 |   | $ | 1,443,000 |   | $ | 559,000 |   | $ | 745,000 |   |
|                               |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Operating lease obligations in the above schedule primarily reflect the lease agreement for the Company’s administrative, manufacturing operations, and research office facility.

 

**Critical Accounting Policies**

 

The Securities Exchange Commission’sFinancial Reporting Release No. 60 requires all companies to include adiscussion of critical accounting policies or methods used in the preparationof financial statements.  The followinglist is not intended to be a comprehensive list of all of our accountingpolicies.  Our significant accounting policiesare more fully described in Note 1 of our consolidated financial statements.  In many cases, the accounting treatment of aparticular transaction is dictated by U.S. generally accepted accountingprinciples, with no need for management’s judgment or estimation in itsapplication.  There are also areas inwhich management’s judgment in selecting an available alternative would notproduce a materially different result. The following is a brief discussion of the more significant accountingpolicies and methods we employ:

 

*General* - The preparation of financial statements inconformity with U.S. generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities at the date of the financial statements and thereported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

*RevenueRecognition* –Revenues on product sales are recognized when there is persuasive evidence thatan arms length transfer has occurred, generally upon shipment, when title haspassed, and the price is fixed or determinable. The Company provides its customers certain purchase incentives,including performance

 

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rebates and volume pricing discounts, basedon the achievement of specified purchase levels.  The Company accrues for performance rebatesbased upon estimated customer purchase levels and records volume pricingdiscounts when products are purchased. Revenue, which is stated as net product sales, is reduced by theseincentives.

 

*Long LivedAssets* – Thecarrying amounts of long-lived assets, and the related amortization periods,are reviewed for impairment whenever events occur or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable within theestimated useful life.  When the Companydetermines the existence of impairment indicators, the impairment loss ismeasured based on the excess of carrying value over the estimated fair value ofthe impaired assets.  The carrying valueof the underlying assets is reduced, with the reduction charged to expense, sothat the carrying value is equal to fair value.

 

*Inventories* – Inventories are stated at the lower ofcost or market.  Cost is determined usingthe first-in, first-out method.  TheCompany evaluates the carrying value of its inventories at least quarterly,taking into account such factors as historical and anticipated future salescompared with quantities on hand, the price the Company expects to obtain forits products in their respective markets compared with historical cost, and theremaining shelf life of goods on hand.

 

**Additional Risk Factors**

 

Future results could differ materially from those currently anticipatedby the Company due to a number of factors, including those identified in this section andelsewhere in this Form 10-K, any of which could have a material adverseimpact on the Company’s business, financial condition or results of operations.

 

*Uncertainty of Future Profitability*.  With limited exception, prior to fiscal 2003,the Company has sustained losses in each fiscal year.  The Company had an accumulated deficit of$31.7 million as of June 30, 2005. The Company’s ability to sustain profitability will depend on itsability to maintain and successfully expand market acceptance and sales of itsexisting products, its ability to successfully complete the development of,receive regulatory approvals for and successfully manufacture and market itsnew products, and its ability to efficiently manage and resolve its currentlitigation matters.  The success of theCompany’s current and future products may also depend on the timing of newproduct introductions by the Company relative to its competitors and otherfactors.

 

*Reliance on Third Party Distribution.* The Company presently markets its productsthrough a nationwide network of independent distributors and salesrepresentatives.  In order to broadendistribution and market penetration of its current and future products, the Companymay expand its marketing presence through direct sales and marketing or throughco-marketing of its products with collaborative marketing partners ordistributors that have national or market-specific marketing capabilities.There can be no assurance that the Company will be able to maintain existing,or establish new, marketing arrangements on terms favorable to the Company, ifat all.  Two distributors combined toaccount for approximately 40%, 32% and 25% of the Company’s total product salesfor the fiscal years ended June 30, 2005, 2004 and 2003.  Although the Company has alternativedistribution channels, product sales may decrease in the event of a loss ofeither distributor.

 

*Intense Competition and Rapid TechnologicalChange.*  Thedrug delivery, pharmaceutical and biotechnology industries are highlycompetitive and rapidly evolving, with significant developments expected tocontinue at a rapid pace.  Manycompetitors, including public and private corporations, academic institutions,governmental agencies and other public and private research organizations, areinvolved in the development of drug delivery systems, including competingelectrotransport-related drug delivery technologies.  Many of these competitors have substantiallygreater financial and other resources, are more experienced, and are larger,more established organizations than the Company.  In addition, these competitors may offerbroader product lines, have greater name recognition, and offer discounts as acompetitive tactic.  Accordingly,competitors may succeed in developing competing technologies, and obtaining FDAapproval or gaining market share for products, more rapidly than theCompany.  Many of these competitorscurrently have drug delivery products that are approved or in development.  There can be no assurance the Company’scompetitors will not succeed in more rapidly developing or marketing productsthat are more effective or commercially attractive than the Company’s currentor future products, or that would render the Company’s products obsolete ornoncompetitive.  There can also be noassurance the

 

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Company will have the financial resources, technical or managementexpertise, or manufacturing or support capability to compete in the future.

 

The first pharmaceutical product to reach the market in a therapeuticarea or using a certain drug delivery technology generally obtains andmaintains a significant market share relative to later entrants to themarket.  The Company’s success willdepend on its ability to maintain a competitive position and develop newproducts and technologies for efficient and cost effective drug delivery.  There can be no assurance any of the Company’sproducts will have advantages that will be significant enough to cause medicalprofessionals to prefer or even use them. New drugs or further development of alternative drug delivery methodsmay provide greater therapeutic benefits for a specific drug or indication, ormay offer comparable performance at lower cost, than that offered by theCompany’s products.

 

*Dependence on Patents and ProprietaryTechnology.* TheCompany’s ability to commercialize and continue to commercialize its productsand products under development will depend, in part, on its or its licensors’ability, both in the United States and in other countries, to obtain patents,enforce those patents, preserve trade secrets and operate without infringing onthe proprietary rights of third parties.

 

The patent positions of drug delivery, pharmaceutical and biotechnologycompanies are highly uncertain and involve complex legal and factualquestions.  There can be no assurance thepatents currently owned and licensed by the Company, or any future patents,will prevent other companies from developing similar or therapeutically equivalentproducts, or that other companies will not be issued patents that may preventthe sale of Company products or require licensing and the payment ofsignificant fees or royalties by the Company. Furthermore, there can be no assurance any of the Company’s products ormethods will be patentable, will not infringe upon the patents of thirdparties, or that the Company’s patents or future patents will give the Companyan exclusive position in the subject matter claimed by those patents.  The Company may be unable to avoidinfringement of third party patents and may have to obtain licenses, defendinfringement actions or challenge the validity of those patents in court.  See “Item 3. Legal Proceedings.”  There can be no assurance a license will beavailable to the Company, if at all, on terms and conditions acceptable to theCompany, or that the Company will prevail in any patent litigation.  There can be no assurance the Company’spending patent applications will result in issued patents, patent protectionwill be secured for any particular technology, any patents that have been ormay be issued to the Company or its licensors will be valid or enforceable orthat the Company’s patents will provide meaningful protection to the Company.

 

The Company also relies on trade secrets and other unpatentedproprietary information in its product development activities.  The Company seeks to protect trade secretsand proprietary knowledge, in part, through confidentiality agreements with itsemployees, consultants, advisors and collaborators.  To the extent the Company relies onconfidential information to maintain its competitive position, there can be noassurance other parties may not independently develop the same or similar information.  These agreements may not effectively preventdisclosure of the Company’s confidential information and may not provide theCompany with an adequate remedy in the event of unauthorized disclosure of suchinformation.  The Company’s failure toobtain or maintain patent and trade secret protection, for any reason, couldhave a material adverse effect on the Company’s business, financial positionand results of operations.  Also, theeffect of potential legislative changes on the Company’s intellectual propertyis uncertain.

 

*Defense of Our Intellectual Property Rights*.  If we fail to protect our proprietary rightsadequately, our competitors might gain access to our technology and, even if weprotect it properly, unauthorized parties might attempt to copy aspects of theCompany’s products or to obtain and use information that the Company regards asproprietary.  Other persons mightindependently develop similar or competing technologies or methods or designaround the Company’s patents.  Inaddition, the laws of many foreign countries in which the Company or itscustomers do business do not protect intellectual property rights to the sameextent as the laws of the United States. As a result, competitors might offer similar products with which theCompany might not be able to compete successfully.

 

Furthermore, the Company might be required to expend significantresources to monitor and protect its intellectual property rights.  It may initiate claims or litigation againstthird parties for infringement of its proprietary rights or to establish thevalidity of its proprietary rights.  Anylitigation involving the Company’s intellectual property, whether or not it isresolved in the Company’s favor, could result in

 

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significant expense and divert the efforts of the Company’s technicaland management personnel.  See “Item 3.Legal Proceedings.”

 

*Exploration of Strategic Alternatives*.  On September 15, 2005, we announced thatour Board of Directors has decided to explore various strategic alternativesfor the Company to maximize shareholder value, including possible saletransactions involving the Company or certain of its assets.  In connection with this process, the Companyhas retained Seven Hills Partners LLC to act as its financial advisor to theCompany.

 

We are uncertain whether any transaction will result from this processand if a transaction does result from that process what form it will take andwhat impact it may have on our stock price. Uncertainties related to this process include:

 

•                  Theexploration of strategic alternatives may disrupt our operations and divertmanagement’s attention, which could have a material adverse effect on ourbusiness, financial condition or results of operations;

 

•                  Theperceived uncertainties as to our future direction may result in the loss of,or failure to attract, customers, employees or business partners;

 

•                  Difficultiesretaining or replacing key employees who leave because we are exploringstrategic alternatives;

 

•                  Theprocess of exploring strategic alternatives may be more time consuming andexpensive than we currently anticipate; and

 

•                  Wemay not be able to identify attractive strategic alternatives, and even if suchalternatives are identified, we may not ultimately consummate a transaction or,if consummated, such transaction may not enhance shareholder value.

 

*Retention and Attraction of Key Employees.* The Company is dependent on its ability tocontinue to attract and retain qualified scientific, managerial, manufacturing,engineering and sales and marketing personnel. There is intense competition for qualified personnel in the Company’sarea of activity, and there can be no assurance the Company will be able tocontinue to attract and retain the qualified personnel necessary for thedevelopment of its business.  The Companydoes not carry key-man insurance with respect to any of its executives oremployees.

 

*Uncertainties Related to Product Development.* The Company maybe required or elect to undertake time-consuming and costly product developmentactivities, including clinical trials, and seek regulatory approval for newapplications and products.  Productrevenues may not be realized from the sale of any such products for severalyears, if at all.  The Company can giveno assurance that its product development efforts, either alone or incollaboration with other parties, will ever be successfully completed, that itcan obtain required regulatory approvals of its products, that future productscan be manufactured at acceptable cost or with appropriate quality, or that itsproducts can meet market needs or achieve market acceptance.

 

Before seeking regulatory approval for the commercial sale of itsproducts, the Company must demonstrate through preclinical studies and clinicaltrials that those products are safe and effective for use in the targetindications.  There can be no assurancesthe Company will be able to complete its clinical trials in a timely manner, ifat all.  The results from preclinicalstudies and early clinical trials may not be indicative of results the Companywill obtain in large-scale testing. There can be no assurance the Company’s clinical trials will demonstratesufficient safety and efficacy to obtain requisite regulatory approvals or thatthose clinical trials will result in additional marketable products.  The use of any product the Company developsmay produce undesirable side effects that could result in the interruption,delay or suspension of clinical trials, or the failure to obtain FDA or otherregulatory approval for targeted indications. If the Company’s future products are not shown to be safe and effectivein clinical trials, the resulting delays in developing other compounds andconducting related preclinical testing and clinical trials, as well as the needfor additional financing to complete such testing and trials, could have amaterial adverse effect on the Company’s business, financial condition, andresults of operations.

 

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*Uncertainties Related to CollaborativePartners. *TheCompany has previously entered into arrangements with corporate partners,licensors, licensees and other parties for the development, clinical testing,manufacture, marketing or commercialization of certain of its products or productsin development.  The process ofestablishing collaborative partners is difficult, time-consuming, and involvessignificant uncertainty.  Discussionswith potential collaborators may not lead to the establishment of newcollaborative relationships on favorable terms, if at all.  If successful in establishing a collaborativeagreement, such agreement may never result in the successful development ofproducts or the generation of significant revenue.  Until the Company elects to and enters intoadditional collaborative agreements, it will be required to internally fund allof its research and development expenditures. Any such agreements could limit the Company’s flexibility in pursuingalternatives for the development or commercialization of its products. To theextent the Company chooses not, or is not able, to establish suchcollaborations, it could experience significantly increased business risk andcapital requirements in the development, clinical testing, manufacturing,marketing and commercialization of new products.  The Company could also encounter significantdelays in introducing products into markets or find that the development,manufacture or sale of proposed products in such markets is adversely affectedby the absence of those collaborative arrangements.

 

*Need to Manage Expanding Operations.* If the Company is successful in achievingincreased market acceptance of its current and future products, it will berequired to expand its operations, particularly in the areas of research anddevelopment, sales and marketing, and manufacturing. As the Company expands itsoperations in these areas, those expansions will likely result in new andincreased responsibilities for management personnel and place significantstrain on the Company’s management, operating and financial systems and otherresources. To accommodate any such growth and compete effectively, the Companywill be required to implement improved information systems, procedures andcontrols, and to expand, train, motivate and manage its work force. The Company’sfuture success will depend to a significant extent on the ability of itscurrent and future management personnel to operate effectively bothindependently and as a group.  There canbe no assurance the Company’s personnel, systems, procedures and controls willbe adequate to support the Company’s future operations.

 

*Risks Related to Possible BusinessCombinations or Acquisitions*.  From time to time, we have evaluated and inthe future may evaluate potential acquisitions of businesses, services,products or technologies.  Theseacquisitions may result in a potentially dilutive issuance of equitysecurities, the incurrence of debt and contingent liabilities, and amortizationof expenses related to intangible assets. In addition, acquisitions involve numerous risks, including difficultiesin the assimilation of the operations, technologies, services and products ofthe acquired companies, the diversion of management’s attention from otherbusiness concerns, risks of entering markets in which we have no or limiteddirect prior experience and the potential loss of key employees of the acquiredcompany.

 

*Future Capital Needs; Uncertainty ofAdditional Funding.* Our capital requirements will depend onnumerous factors, including but not limited to, requirements to improve orincrease manufacturing capacity, business acquisition opportunities, the costsand timing of research and development activities, the number and type ofclinical tests required in seeking approval of products from governmentalagencies, the success of the development efforts, the costs and timing of salesand marketing expansion, the extent to which existing and new products gainmarket acceptance, the ability to enter into new collaborative relationships,competing technological and market developments, the progress of distributors’sales efforts, the costs involved in preparing, filing, prosecuting,maintaining, enforcing and defending intellectual property rights,  and other factors.

 

Although the Company believes that at its current operating levels,existing cash balances and cash generated from operations will be sufficient tofund its operating needs through fiscal 2007 and beyond, it may be required orelect to raise additional capital before that time.  To satisfy its capital requirements, theCompany may seek to raise funds through public or private financings,collaborative relationships or other arrangements. Any additional equityfinancing may be dilutive to shareholders and debt financing may involvesignificant restrictive covenants. Collaborative arrangements to raise additional funds may require theCompany to relinquish its rights to certain of its technologies, products ormarketing territories. There can be no assurance that any such financing, ifrequired, will be available on terms satisfactory to the Company, if atall.  Failure to raise capital whenneeded could have a material adverse effect on the Company’s business,financial condition and results of operations.

 

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*Uncertainty of Government Regulation.* The research, development, manufacture andmarketing of the Company’s products are extensively regulated by the FDA, whichrequires its approval of drugs and medical devices before they can be marketedin the United States.  Similar approvalsare also required from other regulatory bodies in foreign countries.  The regulatory processes established by thesegovernment agencies are lengthy, expensive and uncertain.  In addition, once approval is obtained, thatapproval may be withdrawn.

 

The Company has received approval from the FDA on its NDA forIontocaine, and the FDA has allowed the Company to market its iontophoreticdose controllers and electrode products for use with ions of soluble salts orother drugs under the FDA’s 510(k) regulations governing medical devices.  However, in 1994, the FDA publicly statedthat it intends to require manufacturers of iontophoretic devices to obtainPMAs for marketed devices currently used with drugs not specifically labeledfor iontophoretic delivery, which would include the Company’s dose controllerfor use with ions of soluble salts or other drugs, such as dexamethasone.  The agency to date has not published such aregulation.

 

If the FDA calls for PMAs for preamendment class III iontophoreticdevices, the Company would be required to have a PMA accepted for filing by theFDA within 90 days after the date of the final regulation calling forPMAs.  There can be no assurance that theCompany would be able to complete and file a PMA within the prescribed timeperiod, or that the FDA would approve it. The Company’s failure to submit a PMA within the required timeframecould result in the Company being required to cease commercial distribution ofthe Phoresor system for use with any drug other than Iontocaine.  Any interference with the Company’s abilityto distribute its Phoresor system for use with dexamethasone would have amaterial adverse effect on the Company’s financial condition and results ofoperations.

 

Even if the Company obtains regulatory approval, a marketed product,its manufacturer and its manufacturing facilities and pertinent operations aresubject to extensive regulation and periodic inspections.  Discovery of previously unknown problems witha product, manufacturer or facility could result in FDA sanctions, restrictionson a product or manufacturer, or an order to withdraw and/or recall a specificproduct from the market.  There can alsobe no assurance that changes in the legal or regulatory framework or othersubsequent developments will not result in the limitation, suspension orrevocation of regulatory approvals granted to the Company.  Such events, were they to occur, could have amaterial adverse effect on the Company’s business, financial condition andresults of operations.

 

The Company and certain of its suppliers are also required to complywith US and foreign regulations governing manufacturing practices, whichmandate procedures for extensive control and documentation of product design,control and validation of the manufacturing process and overall productquality.  If the Company or its suppliersfail to comply with applicable regulations regarding these manufacturingpractices, the Company could be subject to sanctions.

 

Under the FDA’s regulations, when a manufacturer changes or modifies adevice for which it has received a 510(k) clearance, it is required to obtainan additional 510(k) clearance for the modified device if the modificationsignificantly affects the safety or efficacy of the device, or if themodification results in a major change in intended use.  In such cases, the manufacturer is expectedto make the initial determination as to whether the modification is of a kindthat would require a new 510(k) clearance. The FDA’s regulations provide only limited guidance in making thisdetermination.  The FDA has cleared theCompany’s iontophoretic dose controller and electrode kits for marketing undera 510(k) clearance.  Since obtaining its510(k) clearances, the Company has made modifications to its products.  Based on the checklist developed by the FDAto assist manufacturers in determining whether they are required to obtain a510(k) clearance for a modified device, the Company has determined that a new510(k) submission was not required in connection with the commercialintroduction of such products.  However,there can be no assurance that the FDA will not require the Company to obtainadditional 510(k) clearances with respect to those products.  If the FDA requires the Company to submit anew 510(k) notice for any device modification, the Company may be prohibitedfrom marketing the modified device until the 510(k) notice is cleared by theFDA.

 

The Company may be required to comply with other proposed and new USand foreign regulations governing its current and future products.  There can be no assurance that proposed andnew regulations will not have a materially adverse effect on the Company.

 

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*Dependence on Limited Sources of Supply.* Key materials used in many of the Company’selectrode products have limited sources of supply.  In addition, the Company’s contract to obtainIontocaine from Abbott Laboratories terminated and an alternative supply sourcehas not been identified.  The Companybelieves that, if necessary, alternative sources may be developed or alternatematerials may be substituted for each of these limited-source materials.  Although the Company has not experienceddifficulty acquiring these materials on commercially reasonable terms and insufficient quantities to maintain required production levels, no assurance canbe given that price increases or interruptions in the supply of these materialswill not occur in the future or that the Company will not have to seek alternatesuppliers or obtain substitute materials, which may require additional productvalidations and regulatory submissions. Any significant price increase, interruption of supply, inability tosecure an alternate source or qualify a substitute material could have amaterial adverse effect on the Company’s ability to manufacture its products orto obtain or maintain regulatory approval of its products.

 

The Company’s current dose controllers are manufactured under acontract with a third party electronics manufacturer.  There can be no assurance that its presentsupplier can manufacture sufficient quantities of dose controllers that meetquality and performance standards on a timely basis.  If the supplier cannot meet the Company’srequirements, or in the event of an interruption of its supply, the Companywould be required to identify, qualify and validate an alternate supply sourcewithin a reasonable period of time.

 

*Limited Manufacturing Experience.* The Company manufactures its iontophoreticdrug delivery electrode patches in quantities sufficient to satisfy its currentlevel of product sales.  Significantcapital expenditures on manufacturing equipment or contract manufacturing maybe required to increase its manufacturing capacity for existing products or anymodifications to existing products or new products.    There can be no assurance the Company cansuccessfully increase its capacity on a profitable basis, or contract withanother party on terms acceptable to the Company, if at all.  Significant increases in production volumewill likely require changes in the Company’s product and manufacturing processin order to facilitate increased automation of the Company’s production.  There can be no assurance such changes inproducts or processes or efforts to automate the Company’s manufacturingprocess will be successful.

 

The Company believes its facilities operate in accordance with theQuality System Regulations currently prescribed by the FDA and other qualitysystems regulations, including ISO13485, which is similar to ISO 9001 andincludes additional elements specifically for medical device manufacturers, andCE Mark standards.  In addition, theCompany has GMP audits conducted by a qualified, independent organization on aregular basis.  There can be no assurancethe Company will be able to maintain such compliance, particularly if the scaleof the Company’s manufacturing operations changes.

 

*Uncertainty of Health Care Reimbursement.* The Company’s ability to maintain and increasecurrent sales levels of its products successfully will depend, in part, on theextent to which reimbursement for the costs of those products and relatedtreatments will be available from government health administration authorities,private health insurers and other organizations in the United States and inforeign markets where the Company’s products will be sold and used. Third partypayors can affect the pricing or relative attractiveness of the Company’sproducts by regulating the reimbursement they provide on the Company’s orcompeting products or therapies.  Therecan be no assurance such reimbursement will continue at present levels, if atall.  Some insurance carriers do notreimburse health care providers for use of the Company’s products in certainapplications.  Furthermore, significantuncertainty exists as to the reimbursement status of new health care products.

 

The Company is unable to predict what adverse impact on the Company, ifany, additional government regulations, legislation or initiatives or changesby third party payors affecting reimbursement or other matters that mayinfluence decisions to obtain medical devices may have.

 

*Risk of Product Liability, Product Recallsand Warranty Claims; Availability of Insurance.* The testing, marketing and sale of drug deliveryand related pharmaceutical products for use in humans involves unavoidablerisks.  The use of the Company’s productsin clinical trials and the sale of its products upon approval may expose theCompany to potential product liability resulting from the use of suchproducts.  In addition, the existence ofa product liability claim, a product recall or excessive warranty claims (inany such case, whether arising from defects in design or manufacture orotherwise) could have an adverse effect on the Company’s product sales orrequire a change in the indications for which it may be used.

 

27

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Product liability insurance in the Company’s industry is expensive anddifficult to obtain.  Although theCompany currently has product liability insurance, there can be no assurancethe existing coverage is adequate.  TheCompany will seek to maintain and appropriately increase its insurance coverageas its product sales increase and the clinical development of its new productapplications progress.  There can be noassurance that the Company will be able to maintain its current levels ofinsurance on acceptable terms, will be able to secure increased coverage as thecommercialization of its products proceeds or that any particular level ofinsurance will provide adequate protection against potential liabilities.

 

*Uncertanties Relatedto Income Taxes*. Our ability to utilize our net operating losses may be significantlylimited if we or our shareholders engage in transactions that result in an “ownershipchange” as defined in Section 382 of the Internal Revenue Code.  In the event our usage of net operatinglosses were to become subject to limitation and we are profitable, our earningsand cash flows could be adversely impacted due to our increased taxliability.   In addition, the financialbenefits of certain strategic alternatives, which may be available to us, suchas a disposition of a portion of our assets, would be reduced if the use of ournet operating losses is subject to limitation.

 

*Potential Volatility of Share Price*.  The market price of the Company’s commonshares, like that of the common shares of many other drug delivery,pharmaceutical, biotechnology, medical device and other high technologycompanies, is likely to be highly volatile. Factors such as fluctuations or volatility in the Company’s operatingresults, announcements of technological innovations, results of clinical trialsor new commercial products by the Company or competitors, regulatory developmentsin the United Sates or foreign countries, changes in the current structure ofhealth care financing and payment systems, developments in or disputesregarding patent or other proprietary rights, general market conditions,economic and other external factors may have a significant effect on the marketprice of the common shares.  In addition,sales of substantial amounts of common shares (including shares issuable uponexercise of outstanding options and warrants) in the public market couldadversely affect the market price of the common shares.  Such sales could also make it more difficultfor the Company to sell equity securities or equity-related securities in thefuture at a time and price that the Company deems appropriate.

 

*Anti-Takeover Provisions of Certain of theCompany’s Agreements.* Certain provisions of a cross-licenseagreement between the Company and Alza may have the effect of deferring,delaying or preventing a change in control of the Company, a merger involvingthe Company or the assignment or transfer of certain technologies of theCompany.  Under the agreement, theCompany and Alza, among other things, exchanged non-exclusive, royalty freerights to certain patented technologies which each party believed to be ofsignificant strategic importance to the potential technological success of manyiontophoretic drug delivery applications. Both parties are prohibited from assigning their rights under theagreement to certain named companies or any other entity that derives more than50 percent of its income from the development, licensing and/or sale of drugdelivery systems to other pharmaceutical companies without first receiving theconsent of the other party.  Restrictionsimposed on the Company’s ability to assign its rights under this agreement mayhave the effect of prohibiting a sale of the Company to such named companies orentities, or may otherwise limit the Company’s ability to capitalize on thecommercial and other economic potential of these technologies through atechnology license, asset sale, merger, combination or similar transaction.

 

*Environmental Matters.* The Company’s research and developmentactivities involve the controlled use of hazardous materials, chemicals andvarious radioactive compounds.  Thesematerials, and their use, disposal and handling, are extensively regulated byfederal, state and local government authorities.  Although the Company believes its safetyprocedures for handling and disposing of such materials comply in all materialrespects with the standards prescribed by state and federal regulations, therisk of accidental environmental contamination or personal injury from thesematerials cannot be completely eliminated. In the event of such an accident,the Company could be held liable for any damages and any such liability couldexceed the resources of the Company. There can be no assurance the Company will not be required to incursignificant costs to comply with environmental and health and safety laws andregulations in the future.

 

28

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**Item 7a.****                             QUANTITATIVEAND QUALITATIVE INFORMATION ABOUT MARKET RISK**

 

Not applicable.

 

**Item 8.****                                   FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 

The Company’s consolidated financial statements are included elsewherein this Report.

 

**Item 9.****                                   CHANGESAND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**Item 9A.****                          CONTROLSAND PROCEDURES**

 

Our Chief Executive Officer and Chief Accounting Officer, afterconducting an evaluation, together with other members of the Company’smanagement, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures as of the end of the period covered by thisreport, have concluded that the Company’s disclosure controls and procedureswere effective to ensure that information required to be disclosed by theCompany in its reports filed or submitted under the Securities Exchange Act of1934 (the “Exchange Act”) is recorded, processed, summarized, and reportedwithin the time periods specified in the rules and forms of the SEC. Therewere no significant changes in the Company’s internal controls or in otherfactors that could significantly affect these controls subsequent to thatevaluation, and there were no significant deficiencies or material weaknessesin such controls requiring corrective actions.

 

**Item 9B.****                          OTHERINFORMATION**

 

None.

 

29

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**Consolidated Financial Statements**

 

 

**IOMED, Inc.**

 

 

**June 30, 2005**

 

30

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**INDEX TO FINANCIAL STATEMENTS**

 

**IOMED, Inc.**

 
| **Audited  Financial Statements:**                                                        | ** ** |
|-------------------------------------------------------------------------------------------|------------|
| ** **                                                                                | ** ** |
| Report of Independent Registered Public  Accounting Firm                                  | ** ** |
|                                                                                      | ** ** |
| Balance Sheets at June 30, 2005 and 2004                                                  | ** ** |
|                                                                                      | ** ** |
| Income Statements for the Years Ended June  30, 2005, 2004 and 2003                       | ** ** |
|                                                                                      | ** ** |
| Statements of Shareholders’ Equity for the  Years Ended June 30, 2005, 2004 and 2003 | ** ** |
|                                                                                      | ** ** |
| Statements of Cash Flows for the Years Ended  June 30, 2005, 2004 and 2003                | ** ** |
|                                                                                      | ** ** |
| Notes to Financial Statements                                                             | ** ** |

 

31

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**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

 

The Board of Directors and Shareholders

IOMED, Inc.

 

We have audited the accompanying balance sheets of IOMED, Inc. as ofJune 30, 2005 and 2004, and the related statements of income, shareholders’equity, and cash flows for each of the three years in the period ended June 30,2005. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. We were not engagedto perform an audit of the Company’s internal control over financial reporting.Our audits included consideration of internal control over financial reportingas a basis for designing audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on theeffectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion. Anaudit also includes examining, on a test basis, evidence supporting the amountsand disclosures in the financial statements, assessing the accountingprinciples used and significant estimates made by management, and evaluatingthe overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above presentfairly, in all material respects, the financial position of IOMED, Inc. at June30, 2005 and 2004, and the results of its operations and its cash flows foreach of the three years in the period ended June 30, 2005, in conformity withU.S. generally accepted accounting principles.

 
|   | /S/:    ERNST & YOUNG LLP |   |
|--------|----------------------------------------------|--------|

 

Salt Lake City, Utah

August 5, 2005, except for paragraph 5

of Note 11, as to which the date is

August 31, 2005

 

32

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**IOMED, Inc.**

 

**BALANCE SHEETS**

 
| ** **                                                                                                                         | ** ** | **June 30,** | ** **       |
|------------------------------------------------------------------------------------------------------------------------------------|------------|--------------|------------------|
| ** **                                                                                                                         | ** ** | **2005**     | ** **       | **2004** | ** ** |
| ASSETS                                                                                                                             | ** ** | ** **   | ** **       | ** ** | ** ** |
| Current  assets:                                                                                                                   | ** ** | ** **   | ** **       | ** ** | ** ** |
| Cash and cash equivalents                                                                                                          |       | $            |  8,293,000  |   | $ |  7,338,000 |   |
| Accounts receivable, less allowance for  doubtful accounts of $62,000 in 2005 and 2004                                             |       | 1,319,000    |             | 1,347,000 |   |
| Inventories                                                                                                                        |       | 1,153,000    |             | 1,095,000 |   |
| Prepaid expenses                                                                                                                   |       | 101,000      |             | 93,000 |   |
| Total current assets                                                                                                               |       | 10,866,000   |             | 9,873,000 |   |
|                                                                                                                               |       |         |             |   |   |
| Equipment  and furniture, net                                                                                                      |       | 1,025,000    |             | 1,505,000 |   |
| Restricted  cash                                                                                                                   |       | 585,000      |             | 1,062,000 |   |
| Other assets                                                                                                                       |       | 62,000       |             | 71,000 |   |
| Total assets                                                                                                                       |       | $            |  12,538,000 |   | $ |  12,511,000 |   |
|                                                                                                                               |       |         |             |   |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                          | ** ** | ** **   | ** **       | ** ** | ** ** |
| Current  liabilities:                                                                                                              | ** ** | ** **   | ** **       | ** ** | ** ** |
| Trade accounts payable                                                                                                             |       | $            |  211,000    |   | $ |  448,000 |   |
| Accrued liabilities                                                                                                                |       | 1,091,000    |             | 649,000 |   |
| Current portion of long-term obligations                                                                                           |       | 532,000      |             | 603,000 |   |
| Total current liabilities                                                                                                          |       | 1,834,000    |             | 1,700,000 |   |
|                                                                                                                               |       |         |             |   |   |
| Long-term  obligations                                                                                                             |       | 836,000      |             | 1,368,000 |   |
|                                                                                                                               |       |         |             |   |   |
| Commitments  and contingencies                                                                                                     |       |         |             |   |   |
|                                                                                                                               |       |         |             |   |   |
| Shareholders’  equity:                                                                                                        |       |         |             |   |   |
| Common shares, no par value; 100,000,000  shares authorized; 6,585,213 shares issued and outstanding in 2005 and 2004              |       | 34,719,000   |             | 34,719,000 |   |
| Convertible preferred shares, no par value;  10,000,000 shares authorized; 893,801 shares issued and outstanding in 2005  and 2004 |       | 6,881,000    |             | 6,881,000 |   |
| Accumulated deficit                                                                                                                |       | (31,732,000  | )                | (32,157,000 | ) |
| Total shareholders’ equity                                                                                                    |       | 9,868,000    |             | 9,443,000 |   |
| Total liabilities and shareholders’ equity                                                                                    |       | $            |  12,538,000 |   | $ |  12,511,000 |   |

 

See accompanying notes.

 

33

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**IOMED, Inc.**

 

**INCOME STATEMENTS**

 
| ** **                           | ** ** | **Year ended June 30,** | ** ** |
|--------------------------------------|------------|-------------------------|------------|
| ** **                           | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                 |       |                    |       |   |   |   |   |
| Product  sales, net                  |       | $                       | 11,426,000 |   | $ | 12,189,000 |   | $ | 11,935,000 |   |
| Cost of  products sold               |       | 4,401,000               |       | 4,607,000 |   | 4,376,000 |   |
| Gross profit                         |       | 7,025,000               |       | 7,582,000 |   | 7,559,000 |   |
| Operating  costs and expenses:       |       |                    |       |   |   |   |   |
| Selling, general and administrative  |       | 5,703,000               |       | 5,593,000 |   | 5,711,000 |   |
| Research and product development     |       | 993,000                 |       | 1,050,000 |   | 1,232,000 |   |
| Non-recurring income                 |       | —                  |       | — |   | (76,000 | ) |
| Total costs and expenses             |       | 6,696,000               |       | 6,643,000 |   | 6,867,000 |   |
| Income from  operations              |       | 329,000                 |       | 939,000 |   | 692,000 |   |
|                                 |       |                    |       |   |   |   |   |
| Interest  expense                    |       | (121,000                | )          | (169,000 | ) | (213,000 | ) |
| Interest  income and other, net      |       | 217,000                 |       | 184,000 |   | 306,000 |   |
| Income  before income tax expense    |       | 425,000                 |       | 954,000 |   | 785,000 |   |
| Income tax  expense, net             |       | —                  |       | — |   | — |   |
| Net income                           |       | $                       | 425,000    |   | $ | 954,000 |   | $ | 785,000 |   |
|                                 |       |                    |       |   |   |   |   |
| Basic net  income per common share   |       | $                       | 0.06       |   | $ | 0.15 |   | $ | 0.12 |   |
|                                 |       |                    |       |   |   |   |   |
| Diluted net  income per common share |       | $                       | 0.06       |   | $ | 0.12 |   | $ | 0.10 |   |

 

See accompanying notes.

 

34

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**IOMED, Inc.**

 

**STATEMENTS OF SHAREHOLDERS’ EQUITY**

 
| ** **                    | ** ** | ** ** | ** ** | **Convertible  Preferred  Shares** | ** ** | **Accumulated  Deficit** | ** ** | **Total**   | ** ** |
|-------------------------------|------------|------------|------------|------------------------------------|------------|--------------------------|------------|-------------|------------|
| **Common Shares**             |
| **Shares**                    | ** ** | **Amount** |
| **Balance  at June 30, 2002** |       | 6,544,670  |       | $                                  | 34,646,000 |                     | $          | 6,881,000   |       | $ | (33,896,000 | ) | $ | 7,631,000 |   |
| Net income                    |       | —     |       | —                             |       | —                   |       | 785,000     |       | 785,000 |   |
| **Balance  at June 30, 2003** |       | 6,544,670  |       | 34,646,000                         |       | 6,881,000                |       | (33,111,000 | )          | 8,416,000 |   |
| Stock options exercised       |       | 40,543     |       | 73,000                             |       | —                   |       | —      |       | 73,000 |   |
| Net income                    |       | —     |       | —                             |       | —                   |       | 954,000     |       | 954,000 |   |
| **Balance  at June 30, 2004** |       | 6,585,213  |       | 34,719,000                         |       | 6,881,000                |       | (32,157,000 | )          | 9,443,000 |   |
| Net income                    |       | —     |       | —                             |       | —                   |       | 425,000     |       | 425,000 |   |
| **Balance at  June 30, 2005** |       | 6,585,213  |       | $                                  | 34,719,000 |                     | $          | 6,881,000   |       | $ | (31,732,000 | ) | $ | 9,868,000 |   |

 

See accompanying notes.

 

35

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**IOMED, Inc.**

 

**STATEMENTS OF CASH FLOWS**

 
| ** **                                                                         | ** ** | **Year ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                         | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Cash  flows from operating activities**                                          | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                       | 425,000    |   | $ | 954,000 |   | $ | 785,000 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                    |       |   |   |   |   |
| Depreciation and amortization                                                      |       | 550,000                 |       | 954,000 |   | 955,000 |   |
| Other non-cash charges                                                             |       | —                  |       | — |   | (76,000 | ) |
| Changes in operating assets and  liabilities:                                      |       |                    |       |   |   |   |   |
| Accounts receivable                                                                |       | 28,000                  |       | (47,000 | ) | (107,000 | ) |
| Inventories                                                                        |       | (58,000                 | )          | (68,000 | ) | (146,000 | ) |
| Prepaid expenses                                                                   |       | (8,000                  | )          | 26,000 |   | (5,000 | ) |
| Trade accounts payable                                                             |       | (237,000                | )          | (56,000 | ) | 195,000 |   |
| Accrued expenses and other liabilities                                             |       | 442,000                 |       | (353,000 | ) | 64,000 |   |
| Net cash  provided by operating activities                                         |       | 1,142,000               |       | 1,410,000 |   | 1,665,000 |   |
|                                                                               |       |                    |       |   |   |   |   |
| **Cash  flows from investing activities**                                          |       |                    |       |   |   |   |   |
| Purchases of  equipment and furniture                                              |       | (61,000                 | )          | (95,000 | ) | (200,000 | ) |
|                                                                               |       |                    |       |   |   |   |   |
| **Cash  flows from financing activities**                                          |       |                    |       |   |   |   |   |
| Proceeds  from issuance of common shares                                           |       | —                  |       | 73,000 |   | — |   |
| Change in  restricted cash                                                         |       | 477,000                 |       | 627,000 |   | 590,000 |   |
| Payments on  long-term obligations                                                 |       | (603,000                | )          | (598,000 | ) | (556,000 | ) |
| Net cash  provided by (used in) financing activities                               |       | (126,000                | )          | 102,000 |   | 34,000 |   |
|                                                                               |       |                    |       |   |   |   |   |
| Net increase  in cash and cash equivalents                                         |       | 955,000                 |       | 1,417,000 |   | 1,499,000 |   |
| Cash and  cash equivalents at beginning of year                                    |       | 7,338,000               |       | 5,921,000 |   | 4,422,000 |   |
| Cash and  cash equivalents at end of year                                          |       | $                       | 8,293,000  |   | $ | 7,338,000 |   | $ | 5,921,000 |   |
|                                                                               |       |                    |       |   |   |   |   |
| **Supplemental  disclosures of cash flow information**                             |       |                    |       |   |   |   |   |
| Cash paid  for interest                                                            |       | $                       | 124,000    |   | $ | 169,000 |   | $ | 213,000 |   |
| Cash paid  for income taxes                                                        |       | $                       | —     |   | $ | — |   | $ | — |   |

 

See accompanying notes.

 

36

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**IOMED, Inc.**

 

**NOTES TO FINANCIAL STATEMENTS**

 

**1.             Description ofBusiness and Summary of Significant Accounting Policies**

 

*Description of Business*

 

IOMED, Inc., a Utah corporation (the “Company”), is a leader in thedevelopment, manufacture and sale of active drug delivery systems usedprimarily to treat acute local inflammation in the physical and occupationaltherapy and sports medicine markets.  TheCompany is pursuing opportunities to advance its position as a provider ofquality, innovative medical products that improve patient healthcare.  In addition, the Company is seekingcollaborative opportunities to develop its non-invasive drug deliverytechnology to satisfy unmet medical needs. The Company has proprietary technology in various stages of research andproduct development primarily for transdermal drug delivery and for the treatmentof ophthalmic disease.

 

*Estimates*

 

Preparation of financial statements in conformity with U.S. generallyaccepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities at thedate of the financial statements and the reported amounts of revenue andexpenses during the reporting period. Actual results could differ from those estimates.

 

*Cash Equivalents*

 

TheCompany considers all highly liquid investments with maturities of three monthsor less, when purchased, to be cash equivalents, including $290,000 restrictedto secure the current portion of certain long-term obligations (see note 4).

 

*Concentrations of Credit Risk*

 

The Company’s financial instruments that are exposed to concentrationsof credit risk consist primarily of cash, cash equivalents and trade accountsreceivable.  Cash and cash equivalentsare held in federally insured financial institutions or invested in high-gradeshort-term commercial paper issued by major United States corporations.  The Company sells its products primarily to,and has trade accounts receivable with, independent durable medical equipmentdealers in the United States and abroad. Less than 10% of product sales are to foreign customers.  As a general policy, collateral is not requiredfor accounts receivable.  The Companymaintains an allowance for losses based upon expected collections of accountsreceivable.  Additionally, customers’financial condition and credit worthiness are regularly evaluated andhistorical losses have not been material. Combined sales to the Company’s two largest customers accounted forapproximately 40%, 32% and 25% of the Company’s total product sales for theyears ended June 30, 2005, 2004 and 2003. At June 30, 2005, 2004 and 2003, amounts due from such customersaccounted for approximately 55%, 47% and 29% of trade receivables, all of whichwas current.  The Company considerscredit risk from concentrations of trade accounts receivable to below.

 

*Revenue Recognition*

 

Revenues onproduct sales are recognized when there is persuasive evidence that an armslength transfer has occurred, generally upon shipment, when title has passed,the price is fixed or determinable, and collectibility is reasonablyassured.  The Company provides itscustomers certain purchase incentives, including performance rebates and volumepricing discounts, based on the achievement of specified purchase levels.  The Company accrues for performance rebatesbased upon estimated customer purchase levels and records volume pricing discountswhen products are purchased.  Revenue, which is stated as net productsales, is reduced by these incentives.

 

37

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*Research and Product Development and Patent Costs*

 

The Company expenses costs associated with its research and developmentefforts, including collaborative relationship efforts, as incurred.  Research and development expenses includesalaries and benefits, facility costs, overhead allocations, clinical trials,consulting, contract services, and costs related to development of commercialscale manufacturing capabilities.  TheCompany also incurs certain costs in the preparation, application, filing,maintenance and defense of patents and trademarks.  Where such costs primarily relate to patentsand trademarks covering technologies or products which are under development orin the early stages of commercialization, the Company expenses such costs asincurred.

 

*Inventories*

 

Inventories are stated at the lower of costor market.  Cost is determined using thefirst-in, first-out method.  The Companyevaluates the carrying value of its inventories at least quarterly, taking intoaccount such factors as historical and anticipated future sales compared withquantities on hand, the price the Company expects to obtain for its products intheir respective markets compared with historical cost, and the remaining shelflife of goods on hand. Inventories consist of the following:

 
| ** **       | ** ** | **June 30,** | ** ** |
|------------------|------------|--------------|------------|
| ** **       | ** ** | **2005**     | ** ** | **2004** | ** ** |
| Raw  materials   |       | $            | 643,000    |   | $ | 660,000 |   |
| Work-in-progress |       | 56,000       |       | 54,000 |   |
| Finished  goods  |       | 454,000      |       | 381,000 |   |
|             |       | $            | 1,153,000  |   | $ | 1,095,000 |   |

 

*Equipment and Furniture*

 

Equipment and furniture are stated at cost.  Depreciation and amortization is computedusing the straight-line method over estimated useful lives of three to fiveyears.  Leasehold improvements areamortized over the term of the lease or the useful life of the improvements,whichever is shorter.  Equipment and furnitureconsist of the following:

 
| ** **                                      | ** ** | **June 30,** | ** ** |
|-------------------------------------------------|------------|--------------|------------|
| ** **                                      | ** ** | **2005**     | ** ** | **2004** | ** ** |
| Manufacturing  equipment                        |       | $            | 1,790,000  |   | $ | 1,777,000 |   |
| Office and  research and development equipment  |       | 2,137,000    |       | 2,145,000 |   |
| Leasehold  improvements                         |       | 2,749,000    |       | 2,736,000 |   |
|                                            |       | 6,676,000    |       | 6,658,000 |   |
| Less  accumulated depreciation and amortization |       | (5,651,000   | )          | (5,153,000 | ) |
|                                            |       | $            | 1,025,000  |   | $ | 1,505,000 |   |
|                                                 |            |              |            |  |  |  |  |  |

 

## *LongLived Assets*

 

Thecarrying amounts of long-lived assets, and the related amortization periods,are reviewed for impairment whenever events occur or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable within theestimated useful life.  When the Companydetermines the existence of impairment indicators, the impairment loss ismeasured based on the excess of carrying value over the estimated fair value ofthe impaired assets.  The carrying valueof the underlying asset is reduced, with the reduction charged to operatingexpense, so that the carrying amount is equal to the estimated fair value.

 

38

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*Stock-based Compensation*

 

The Company haselected to follow Accounting Principles Board Opinion No. 25-*Accounting for**Stock Issued to Employees*(APB 25) and related Interpretations in accounting for its employee stockoptions rather than adopting the alternative fair value accounting provided forunder Financial Accounting Standards Board (“FASB”) Statement of FinancialAccounting Standards (“SFAS”) No. 123, *Accountingfor Stock-Based Compensation*, as amended by SFAS No. 148, *Accounting for Stock Based Compensation — Transitionand Disclosure*. Because the exercise price of the Company’s employeestock options equals the market price of the underlying shares on the date ofgrant, under APB 25, the Company does not recognize any compensationexpense.  The following table illustratesthe effect on net income and net income per common share had compensation costfor the Company’s employee stock options been determined consistent with themethodology prescribed under SFAS 123:

 
| ** **                                                                 | ** ** | **June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------|------------|
| ** **                                                                 | ** ** | **2005**     | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income -  as reported                                                  |       | $            | 425,000    |   | $ | 954,000 |   | $ | 785,000 |   |
| Less: Total stock compensation expense  determined under fair value method |       | (248,000     | )          | (273,000 | ) | (128,000 | ) |
| Net income -  pro forma                                                    |       | $            | 177,000    |   | $ | 681,000 |   | $ | 657,000 |   |
|                                                                       |       |         |       |   |   |   |   |
| Net income  per common share:                                              |       |         |       |   |   |   |   |
| Basic - as reported                                                        |       | $            | 0.06       |   | $ | 0.15 |   | $ | 0.12 |   |
| Diluted - as reported                                                      |       | $            | 0.06       |   | $ | 0.12 |   | $ | 0.10 |   |
|                                                                       |       |         |       |   |   |   |   |
| Basic - pro forma                                                          |       | $            | 0.03       |   | $ | 0.10 |   | $ | 0.10 |   |
| Diluted - pro forma                                                        |       | $            | 0.02       |   | $ | 0.09 |   | $ | 0.09 |   |

 

Proforma information regarding net income and net income per common share isrequired by SFAS 123, and has been determined as if the Company had accountedfor its employee stock options under the fair value method of that Statement.The fair value of these options was estimated at the date of grant using aBlack-Scholes option pricing model with the following weighted averageassumptions for 2005, 2004 and 2003, respectively: risk-free interest rates of3.6%, 3.3% and 3.8%; dividend yield of 0%; volatility factors of the expectedmarket price of the Company’s common stock of 0.64, 0.80 and 0.74; and aweighted-average expected life of the option of 6 years.

 

In December 2004,the FASB issued SFAS 123R, Share-Based Payment, which establishes standards forthe accounting for transactions in which an entity exchanges its equityinstruments for goods or services.  A keyprovision of this statement is the requirement of a public entity to measurethe cost of employee services received in exchange for an award of equity instruments(including stock options) based on the grant date fair value of the award andrecognized over the vesting period.   Asmodified, SFAS 123R will be effective for the Company’s fiscal year beginningJuly 1, 2005, and requires the use of either the Modified Prospective or theModified Retrospective application method. The Company will adopt the Modified Prospective method, which requiresthe application of SFAS 123R to new awards and to awards modified, repurchased,or cancelled after the effective date. Additionally, compensation cost for the portion of outstanding awardsfor which service has not been rendered (such as unvested options) that areoutstanding as of the date of adoption shall be recognized as the remainingservices are rendered.

 

The Companyexpects that the adoption of SFAS 123R will result in significant stock-basedcompensation expense.  Had we adoptedStatement 123R in prior periods, the Company believes the impact of thatstandard would have approximated the impact of Statement 123 as described inthe disclosure of pro forma net income and net income per common share in theabove table.

 

39

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Stock compensationexpense for options granted to non-employees has been determined in accordancewith SFAS 123 and the Emerging Issues Task Force consensus in Issue No. 96-18, *Accounting for Equity Instruments that are Issued toOther than Employees for Acquiring, or in Conjunction with Selling Goods orServices* (EITF 96-18).  Thefair value of options granted to non-employees and the associated expense isperiodically re-measured as the underlying options vest.

 

## *Net Income Per Common Share*

 

The Company’s net income per common share has been calculated inaccordance with SFAS No. 128-*Earnings Per Share*and, accordingly, includes a computation of both basic and diluted net incomeper common share.  Net income aspresented in the income statements represents the numerator used in computingnet income per common share and the following table sets forth the computationof the weighted average shares used in determining basic and diluted net incomeper common share:

 
| ** **                                                                                                           | ** ** | **2005**           | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|----------|------------|----------|------------|
| ** **                                                                                                           | ** ** | **(in thousands)** | ** ** |
| Denominator for basic net income per common  share — weighted average shares                                    |       | 6,585              |       | 6,559    |       | 6,545    |       |
| Dilutive securities: preferred stock, warrants  and stock options                                                    |       | 1,080              |       | 1,150    |       | 952      |       |
| Denominator for diluted net income per  common share — adjusted weighted average shares and assumed conversions |       | 7,665              |       | 7,709    |       | 7,497    |       |

 

In all periods presented, certain securities were not included in thecomputation of diluted income per share due to their antidilutive effect.  At June 30, 2005, options to purchaseapproximately 669,000 common shares at a weighted average exercise price of$3.44 were not included.  At June 30,2004, options to purchase approximately 422,000 common shares were notincluded.  At June 30, 2003, options topurchase approximately 1,291,000 common shares and warrants to purchaseapproximately 45,000 common shares were not included.

 

*Income Taxes*

 

The Company accounts for income taxes using the asset and liabilitymethod.  Under the asset and liabilitymethod, deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases, and operating loss and tax credit carryforwards.  Deferred tax assets and liabilities aremeasured using enacted tax rates expected to apply to taxable income in theyears in which those temporary differences are expected to be recovered orsettled.  The effect on deferred taxassets and liabilities of a change in tax rates is recognized in income in theperiod that includes the enactment date.

 

**2.             RestrictedCash**

 

The Company maintains an interest bearing money market account with alending bank, $585,000 of which is being held as a compensating balance under along-term obligation (see notes 1 and 4) and is restricted as towithdrawal.  The restricted cash balancerequirement decreases over the life of the obligation as payments are made.

 

40

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**3.             Accrued Liabilities**

 

Accrued liabilities consist of the following:

 
| ** **                    | ** ** | **June 30,** | ** ** |
|-------------------------------|------------|--------------|------------|
| ** **                    | ** ** | **2005**     | ** ** | **2004** | ** ** |
| Payroll and  related benefits |       | $            | 217,000    |   | $ | 269,000 |   |
| Professional  fees            |       | 598,000      |       | 167,000 |   |
| Royalties                     |       | 70,000       |       | 74,000 |   |
| Other                         |       | 206,000      |       | 139,000 |   |
|                          |       | $            | 1,091,000  |   | $ | 649,000 |   |

 

**4.             Commitments**

 

*Operating Leases*

 

The Company leasesspace and certain equipment under non-cancelable operating lease agreementsthat expire at various dates through 2012. Rental expense for such leases was $286,000, $347,000 and $382,000 forthe years ended June 30, 2005, 2004 and 2003, respectively.  It is generally expected that, in the normalcourse of business, operating leases that expire will be renewed or replaced byother leases with similar terms.  Futureminimum lease payments under non-cancelable operating leases at June 30, 2005,were $2,127,000.  These obligations mature as follows:  fiscal 2006 — $271,000; fiscal 2007 —$278,000; fiscal 2008 — $274,000; fiscal 2009 — $276,000; and fiscal 2010 andthereafter — $1,028,000.

## * *

*Long-Term Obligations*

 

The Company has acquired certain equipment and furniture under capitallease agreements.  The capitalized costof such equipment was $1,339,000 at June 30, 2005 and 2004 and accumulatedamortization was $1,210,000 and $1,009,000, respectively.  Under these capital lease agreements, theCompany is required to meet certain financial covenants, all of which have beenmet at June 30, 2005.

 

During fiscal 2001, the Company refinanced $2,700,000 of capital leaseobligations into a term loan, collateralized by the underlying assets andrestricted cash, with a fixed rate of 6.82%, payable in 84 monthly installmentsof $40,519 maturing April 2008.  At June30, 2005, the outstanding balance was $1,250,000.  Payments of approximately $486,000 are duewithin one year, of which $414,000 is principal reduction.

 

The carryingvalues of the long-term obligations approximate fair values as the interestrates on these long-term obligations approximate market rates of interest.  Future minimum payments under long-termobligations consisted of the following at June 30, 2005:

 
| Year ending June 30:                           |   |      |    |
|------------------------------------------------|--------|-----------|---------|
| 2006                                           |   | 610,000   |    |
| 2007                                           |   | 486,000   |    |
| 2008                                           |   | 405,000   |    |
| Thereafter                                     |   | —    |    |
| Total  minimum payments                        |   | 1,501,000 |    |
| Amounts  representing interest                 |   | (133,000  | )       |
| Present  value of net minimum payments         |   | 1,368,000 |    |
|                                           |   |      |    |
| Less current  portion of long-term obligations |   | (532,000  | )       |
| Long-term  obligations                         |   | $         | 836,000 |   |
|                                                |        |           |         |  |

 

41

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## *Royalty Agreements*

 

The Company is the licensee under royalty agreements, which provide forthe payment of royalties to the licensor based upon net sales of the productsunder royalty.  Royalty expense in eachof the three years in the period ended June 30, 2005 was not material.

## * *

**5.             Shareholders’Equity**

 

*Series D Convertible Preferred Shares*

 

The Series D preferred shares are convertible at the option of theholder into common shares, on a share-for-share basis, subject to adjustmentfor certain corporate transactions. Further, the Series D preferred shares are non-redeemable, non-votingand have no dividend, liquidation or similar preferences over common shares butare entitled to a pro rata share of any such distribution as if the Series Dpreferred shares had been converted into common shares.

 

*Stock Options*

 

The Company has adopted and approved two incentive stock compensationplans.  The Company’s 1988 Stock OptionPlan was approved by the shareholders in November 1988 and the Company’s 1997Share Incentive Plan was approved by the shareholders in November 1997.  The 1988 Stock Option Plan expired in August1998 and no further grants were made under the Plan following the adoption ofthe 1997 Share Incentive Plan.  In general,options granted vest over zero to five years. A summary of the activity under the Plans during each of the three yearsended June 30, 2005, is as follows:

 
| ** **                | ** ** | **Shares**               | ** ** | **Outstanding Stock Options** | ** ** | **Weighted-**        | ** ** |
|---------------------------|------------|--------------------------|------------|-------------------------------|------------|----------------------|------------|
| ** **                | ** ** | **Available  for Grant** | ** ** | **Number of  Shares**         | ** ** | **Price  Per Share** | ** ** | **Average  Exercise Price** | ** ** |
| Balance at  June 30, 2002 |       | 1,516,593                |       | 1,477,383                     |       | $1.49-$9.00          |       | $ | 3.11 |   |
| Options granted           |       | (301,000                 | )          | 301,000                       |       | $0.70-$1.17          |       | $ | 0.94 |   |
| Options exercised         |       | —                   |       | —                        |       | —               |       | $ | — |   |
| Options canceled          |       | 156,686                  |       | (246,251                      | )          | $1.89-$8.88          |       | $ | 3.31 |   |
| Balance at  June 30, 2003 |       | 1,372,279                |       | 1,532,132                     |       | $0.70-$9.00          |       | $ | 2.65 |   |
| Options granted           |       | (75,000                  | )          | 75,000                        |       | $2.20-$3.00          |       | $ | 2.36 |   |
| Options exercised         |       | —                   |       | (40,543                       | )          | $0.90-$2.44          |       | $ | 1.80 |   |
| Options canceled          |       | 158,553                  |       | (192,372                      | )          | $ .90-$9.00     |       | $ | 3.09 |   |
| Balance at  June 30, 2004 |       | 1,455,832                |       | 1,374,217                     |       | $0.70-$9.00          |       | $ | 2.60 |   |
| Options granted           |       | (74,000                  | )          | 74,000                        |       | $2.20-$2.43          |       | $ | 2.39 |   |
| Options exercised         |       | —                   |       | —                        |       | —               |       | $ | — |   |
| Options canceled          |       | 116,291                  |       | (124,826                      | )          | $0.90-$8.88          |       | $ | 3.47 |   |
|                      |       |                     |       |                          |       |                 |       |   |   |
| Balance at  June 30, 2005 |       | 1,498,123                |       | 1,323,391                     |       | $0.70-$9.00          |       | $ | 2.50 |   |

 

42

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The weighted average fair value of options granted in the years endedJune 30, 2005, 2004 and 2003, was $2.39, $1.45 and $0.63, respectively.  Additional information regarding the optionsoutstanding at June 30, 2005 follows:

 
| **Options Outstanding**        | ** ** | **Options Exercisable** | ** ** |
|--------------------------------|------------|-------------------------|------------|
| **Range of  Exercise  Prices** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $0.70—$1.89               |       | 654,342                 |       | 6.65 |   | $ | 1.53 |   | 452,473 |   | $ | 1.59 |   |
| $2.20—$3.24               |       | 463,685                 |       | 5.60 |   | $ | 2.44 |   | 413,351 |   | $ | 2.39 |   |
| $3.75—$4.80               |       | 81,798                  |       | 3.88 |   | $ | 4.22 |   | 75,790 |   | $ | 4.19 |   |
| $6.50—$9.00               |       | 123,566                 |       | 4.12 |   | $ | 6.70 |   | 131,153 |   | $ | 6.69 |   |
|                           |       |                    |       |   |   |   |   |   |   |   |   |
| $0.70—$9.00               |       | 1,323,391               |       | 5.88 |   | $ | 2.50 |   | 1,072,767 |   | $ | 2.70 |   |

 

In accordance with EITF 96-18, the Company accounts for stock optionsissued to non-employees at fair value. The value of such stock options is amortized to expense over the vestingperiod.  No compensation expense relatedto such stock options was recognized in fiscal years ended June 30, 2005, 2004and 2003.

 

**6.             Non-recurringIncome**

 

In fiscal 2003, the Company fulfilled its obligations related to anon-recurring expense taken in fiscal 2000 for certain non-cancelable abandonedlease and other obligations associated with its facility relocation.  As a result, in fiscal 2003 the Companyreversed the remaining $76,000 expensed as a non-recurring item in fiscal 2000.

 

**7.             Employee BenefitPlan**

 

The Company has established a 401(k) savings plan for its full-timeemployees and makes a matching contribution based on a percentage of thecontributions of participating employees.  The Company contributed approximately$100,000, $79,000 and $64,000 for the years ended June 30, 2005, 2004 and 2003,respectively.

 

**8.             Income Taxes**

 

Deferred taxes result from differences in the carrying value of variousassets and liabilities between income tax reporting and financial reportingpurposes.  These differences arise fromdiffering depreciation methods, and other reserves that are deductible indifferent periods for tax and financial reporting purposes.

 

The approximate tax effect of temporary differences, net operating losscarryforwards and tax credit carryforwards as of June 30, 2005 and 2004, is asfollows:

 
| ** **                         | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|------------------------------------|------------|-------------|------------|-------------|------------|
| Deferred tax  assets:              |       |        |       |        |       |
| Net operating loss carryforwards   |       | $           | 7,238,000  |        | $          | 7,110,000 |   |
| Book in excess of tax depreciation |       | 744,000     |       | 649,000     |       |
| Book in excess of tax amortization |       | 2,518,000   |       | 2,891,000   |       |
| Tax credit carryforwards           |       | 801,000     |       | 874,000     |       |
| Allowances and accruals            |       | 274,000     |       | 290,000     |       |
| Total  deferred tax assets         |       | 11,575,000  |       | 11,814,000  |       |
| Valuation  allowance               |       | (11,575,000 | )          | (11,814,000 | )          |
| Net deferred  tax assets           |       | $           | —     |        | $          | — |   |

 

43

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There were nosignificant deferred tax liabilities in 2005 or 2004.  The valuation allowance decreased by $239,000during the fiscal year.

 

There were no netdeferred income tax provisions in any of the years presented.  The Company recorded no current federal orstate income tax provision for fiscal 2005, 2004 and 2003.

 

The reconciliation of income taxes at the statutory United Statesfederal income tax rate and the Company’s effective income tax expense is asfollows:

 
| ** **                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Tax at U.S.  statutory rates                  |       | 34.0     | %          | 34.0     | %          | 34.0     | %          |
| State tax,  net of federal tax benefit        |       | 3.3      |       | 3.3      |       | 3.3      |       |
| Tax credits                                   |       | 17.4     |       | (1.9     | )          | 3.9      |       |
| Non-deductible  interest and other expenses   |       | 3.1      |       | 1.4      |       | 1.7      |       |
| Effect of  deferred tax valuation adjustments |       | (57.8    | )          | (36.8    | )          | (42.9    | )          |
| Effective  income tax rate (percentage)       |       | —   | %          | —   | %          | —   | %          |

 

As of June 30, 2005, the Company had approximately $19,823,000 and $15,092,000in federal and state net operating loss carryforwards, respectively, and$801,000 in federal tax credit carryforwards, that expire through 2024.  Utilization of the Company’s net operatingloss and tax credit carryforwards is limited to the future taxable income ofthe Company.  Under the “change ofownership” provisions of the Internal Revenue Code, utilization of these netoperating loss and credit carryforwards may become subject to substantialannual limitation in the future.  Such “changesof ownership” can result from purchases and sales of our shares by largeshareholders.  If such a change inownership of our shares was to occur, we may be limited in the amount of netoperating loss carryforwards that we can use in any given year.

 

**9.             Contingencies**

 

The Company issubject to various claims and legal proceedings (see Note 11) covering mattersthat arise in the ordinary course of its business activities.  Except as otherwise disclosed, managementbelieves any liability that may ultimately result from the resolution of thesematters will not have a material adverse effect on the Company’s consolidatedfinancial position, operating results, or cash flows.

 

**10.          Quarterly FinancialInformation (Unaudited)**

 
| ** **                   | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **Total** | ** ** |
|------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|-----------|------------|
| Fiscal 2005                  |       |               |       |                |       |               |       |                |       |      |       |
| Product sales                |       | $                  | 3,017,000  |                | $          | 2,589,000          |       | $                   | 2,879,000  |      | $          | 2,941,000 |   | $ | 11,426,000 |   |
| Gross profit                 |       | 1,873,000          |       | 1,613,000           |       | 1,727,000          |       | 1,812,000           |       | 7,025,000 |       |
| Net income                   |       | 326,000            |       | 37,000              |       | 32,000             |       | 30,000              |       | 425,000   |       |
|                         |       |               |       |                |       |               |       |                |       |      |       |
| Basic net income per share   |       | $                  | 0.05       |                | $          | 0.01               |       | $                   | —     |      | $          | — |   | $ | 0.06 |   |
| Diluted net income per share |       | $                  | 0.04       |                | $          | —             |       | $                   | —     |      | $          | — |   | $ | 0.06 |   |
|                         |       |               |       |                |       |               |       |                |       |      |       |
| Fiscal 2004                  |       |               |       |                |       |               |       |                |       |      |       |
| Product sales                |       | $                  | 2,922,000  |                | $          | 3,010,000          |       | $                   | 3,094,000  |      | $          | 3,163,000 |   | $ | 12,189,000 |   |
| Gross profit                 |       | 1,818,000          |       | 1,894,000           |       | 1,923,000          |       | 1,947,000           |       | 7,582,000 |       |
| Net income                   |       | 117,000            |       | 213,000             |       | 280,000            |       | 344,000             |       | 954,000   |       |
|                         |       |               |       |                |       |               |       |                |       |      |       |
| Basic net income per share   |       | $                  | 0.02       |                | $          | 0.03               |       | $                   | 0.04       |      | $          | 0.05 |   | $ | 0.15 |   |
| Diluted net income per share |       | $                  | 0.02       |                | $          | 0.03               |       | $                   | 0.04       |      | $          | 0.04 |   | $ | 0.12 |   |

 

44

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**11.          Litigation**

 

A description of certain outstanding and settled legal mattersinvolving the Company is provided below. In addition to the legal matters discussed below, the Company is subjectto various claims and legal proceedings covering matters that arise in theordinary course of business.

 

(a) Outstanding Legal Matters

 

A patent infringement claim has been asserted against the Companyregarding its Companion 80 product.  TheCompany has denied infringement, and has asserted a counterclaim for adeclaratory judgment of non-infringement and/or that the patent isinvalid.  The parties have filed crossmotions for summary judgment on the issue of infringement, which have not beenruled upon.  At this stage it is tooearly to predict the outcome.

 

Additionally, the Company is a co-defendant with a distributor of theCompany’s products, in a claim asserting misappropriation of confidentialinformation.  The Company has denied allallegations of the complaint.  This caseis in the discovery phase and it is too early to predict the outcome.

 

Management does not believe that the outcomes of these legal matterswill have a material adverse impact on the Company.  However, legal fees and expenses will likelybe material and, in the event of an unfavorable resolution, the outcome couldhave a material adverse impact on the Company’s business, financial position,or results of operations.

 

(b) Settled Legal Matters

 

Effective August 31, 2005, the Company entered into a settlement thatresolved the Company’s involvement in all of the legal matters mentionedbelow.  The accompanying financialstatements include accruals for estimated settlement amounts and finalsettlement amounts did not differ materially from amounts accrued.

 

In April 2002, the Company filed two civil complaints in state courtagainst two former executives, among others, alleging misappropriation of theCompany’s trade secrets, interference with economic relationships and civilconspiracy.  The claims arose out of theCompany’s allegations that the defendants engaged in conduct to misappropriateconfidential information related to a new product that was being developed bythe Company under the supervision of the two former executives.  The Company sought injunctive relief againstall defendants.  In response, acounterclaim was filed against the Company and certain Company employeesseeking, among other things, $5 million in monetary damages.

 

In addition, two separate federal court complaints were filed againstthe Company and certain Company employees and agents, alleging violation of theplaintiffs’ federal civil rights, invasion of privacy, intentional inflictionof emotional distress, trespassing, and conspiracy.  These complaints were related to one of thestate court actions filed by the Company in that they arose out of thecourt-ordered seizure of computer hard drives, other electronic media, andcertain business files of certain of the defendants in one of the state courtactions.  Such seizure was conducted bythe Salt Lake County Sheriff’s Office. The two federal court complaints sought, among other things, combinedmonetary damages of $60 million.  TheUnited States District Court granted, with prejudice, the Company’s motion todismiss the two federal civil rights complaints filed against the Company.  The Tenth Circuit Court of Appeals affirmedthe District Court’s dismissal.

 

A plaintiff in one of the federal civil rights complaints also filed aUtah state court complaint against the Company and certain Company employeesalleging discrimination, among other things. This complaint was related to one of the state court actions filed by theCompany in that the claims asserted arose from the same series of transactionsand occurrences.  The Utah State DistrictCourt granted the Company’s motion to dismiss the plaintiff’s discriminationclaim.  In addition, the Utah State Courtof Appeals upheld the Utah State District Court ruling, which granted theCompany’s motion to dismiss this claim.

 

45

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**PART III**

 

**Item 10. DIRECTORS AND EXECUTIVEOFFICERS OF THE COMPANY**

 

Information required by this item is included under “Election ofDirectors,” “The Board of Directors and Committees,” “Code of Business Conductand Ethics,” and “Executive Officers” in the Company’s Proxy Statement to befiled in connection with its Annual Meeting of Shareholders, to be held onNovember 11, 2005, and is incorporated herein by reference.

 

**Item 11. EXECUTIVE COMPENSATION**

 

The information required by this item is included under “Compensationof Directors and Executive Officers” in the Company’s Proxy Statement to befiled in connection with its Annual Meeting of Shareholders, to be held onNovember 11, 2005, and is incorporated herein by reference.

 

**Item 12. SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT**

 

The information required by this item is included under “SecurityOwnership of Certain Beneficial Owners and Management” in the Company’s ProxyStatement to be filed in connection with its Annual Meeting of Shareholders, tobe held on November 11, 2005, and is incorporated herein by reference.

 

**Item 13. CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS**

 

The information required by this item is included under “CertainRelationships and Related Transactions” in the Company’s Proxy Statement to befiled in connection with its Annual Meeting of Shareholders, to be held onNovember 11, 2005, and is incorporated herein by reference.

 

**Item 14. PRINCIPAL ACCOUNTANT FEESAND SERVICES**

 

The information required by this item is included under “Fees paid toIndependent Accountants” in the Company’s Proxy Statement to be filed in connectionwith its Annual Meeting of Shareholders, to be held on November 11, 2005, andis incorporated herein by reference.

 

46

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**PARTIV**

 

**Item 15. EXHIBITS, FINANCIALSTATEMENT SCHEDULES**

 

**Financial Statements**

 

The consolidated financial statements of the Company are includedelsewhere in this Report.

 

**Schedules**

 

No schedules are required in connection with the filing of this Reportas amounts are either immaterial or are otherwise disclosed in the financial statements.

 

**Exhibits**

 
| **Number** | ** ** | **Description**                                                                                                                                            |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1**      |       | Amended and Restated Articles of Incorporation of the Company                                                                                              |
| 3.2*       |       | Amended and Restated Bylaws of the Company                                                                                                                 |
| 4.1*       |       | Reference is made to Exhibit 3.1                                                                                                                           |
| 4.2*       |       | Specimen of Common Share Certificate                                                                                                                       |
| 4.3***     |       | 1988 Stock Option Plan of the Company                                                                                                                      |
| 4.4***     |       | 1997 Share Incentive Plan of the Company                                                                                                                   |
| 10.1*      |       | License Agreement between the Company and Elan International  Services, dated April 14, 1997                                                               |
| 10.2*      |       | License Agreement between the Company and Drug Delivery Systems,  Inc., dated April 14, 1997                                                               |
| 10.3*      |       | Asset Acquisition Agreement between the Company and Fillauer, Inc.,  dated December 27, 1996                                                               |
| 10.4*      |       | License Agreement between the Company and Fillauer, Inc., dated  December 26, 1996                                                                         |
| 10.5*      |       | Manufacturing Agreement between the Company and KWM Electronics  Corporation, dated November 1, 1996                                                       |
| 10.6*      |       | Research and Development Agreement among the Company, Dermion, Inc.  and Ciba-Geigy Corporation, dated March 29, 1996                                      |
| 10.7*      |       | Agreement between the Company and Laboratoires Fournier S.C.A., dated  February 20, 1996                                                                   |
| 10.8*      |       | Agreement between the Company and ALZA Corporation, dated July 28,  1993                                                                                   |
| 10.9*      |       | License Agreement between the Company and the University of Utah  Research Foundation, dated October 1, 1992                                               |
| 10.10*     |       | Exchange Agreement among the Company, Novartis Pharmaceuticals  Corporation and Dermion, Inc., dated November 1, 1997                                      |
| 10.11*     |       | First Amendment of Research & Development Agreement among the  Company, Novartis Pharmaceuticals Corporation and Dermion, Inc. dated  November 1, 1997 |
| 10.12****  |       | Lease between the Company and NP#2, dated May 22, 2000                                                                                                     |
| 10.13#     |       | Amendment to Lease Agreement between the Company and NP#2, dated  September 17, 2004                                                                       |
| 11.1*****  |       | Statement re computation of earnings per share                                                                                                             |
| 21.1*      |       | Schedule of Subsidiaries                                                                                                                                   |
| 23.1##     |       | Consent of Ernst & Young LLP, Independent Registered Public  Accounting Firm                                                                           |
| 31.1##     |       | Certification of Chief Executive Officer                                                                                                                   |
| 31.2##     |       | Certification of Chief Accounting Officer                                                                                                                  |
| 32.1##     |       | Certification of Chief Executive Officer                                                                                                                   |
| 32.2##     |       | Certification of Chief Accounting Officer                                                                                                                  |

 

----

| *     |   | Filed by the Company as an exhibit to the Form S-1 Registration  Statement on April 23, 1998.  |
|-------|--------|------------------------------------------------------------------------------------------------|
| **    |   | Filed by the Company as an exhibit to the Annual Report on Form 10-K  on September 28, 1998.   |
| ***   |   | Filed by the Company as an exhibit to the Form S-8 Registration  Statement on February 9, 2000 |
| ****  |   | Filed by the Company as an exhibit to the Annual Report on Form 10-K  on September 28, 2000.   |
| ***** |   | Information included in consolidated financial statements.                                     |
| #     |   | Filed by the Company as an exhibit to the Annual Report on Form 10-K  on September 28, 2004.   |
| ##    |   | Filed herewith.                                                                                |

 

47

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|   |               | IOMED, INC. |
|--------|--------------------|-------------|
|   |               |        |   |
| Date:  | September 27, 2005 | By:         | /s/ ROBERT J. LOLLINI |   |
|   |               |        | Robert J. Lollini |
|   |               |        | President and Chief Executive Officer |
|   |               |        |   |
|   |               |        |   |
| Date:  | September 27, 2005 | By:         | /s/ BRIAN L. MOWER |   |
|   |               |        | Brian L. Mower |
|   |               |        | Chief Accounting Officer |

 

**SIGNATURES**

 

In accordance with the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Company and in thecapacities and on the dates indicated.

 
| **Signature**           | ** ** | ** ** | **Capacity** | ** ** | **Date**           |
|-------------------------|------------|------------|--------------|------------|--------------------|
|                    |       |       |         |       |               |
| /s/ PETER J. WARDLE     |       |       | Chairman     |       | September 27, 2005 |
| Peter J. Wardle         |       |       |         |       |               |
|                    |       |       |         |       |               |
| /s/ JOHN W. FARA, PH.D. |       |       | Director     |       | September 27, 2005 |
| John W. Fara, Ph.D.     |       |       |         |       |               |
|                    |       |       |         |       |               |
| /s/ MICHAEL T. SEMBER   |       |       | Director     |       | September 27, 2005 |
| Michael T. Sember       |       |       |         |       |               |
|                    |       |       |         |       |               |
| /s/ WARREN WOOD         |       |       | Director     |       | September 27, 2005 |
| Warren Wood             |       |       |         |       |               |
|                    |       |       |         |       |               |
| /s/ ROBERT J. LOLLINI   |       |       | Director     |       | September 27, 2005 |
| Robert J. Lollini       |       |       |         |       |               |

 

48

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